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Series 66

Handling Client Funds - Suitability

If at any time you knowingly recommend an unsuitable investment to a client, with the intention to defraud, you are liable for both civil and criminal penalties. Suitability is defined in many ways, a few of which will be discussed here.

Look Out!
The SEC specifically defines suitability as follows:
When your broker recommends that you buy or sell a particular security, your broker must have a reasonable basis for believing that the recommendation is suitable for you. In making this assessment, your broker must consider your risk tolerance, other security holdings, financial situation (income and net worth), financial needs, and investment objectives.

The USA requires IAs to determine the suitability of investment recommendations given each client's circumstances. Failure to do so is considered an unethical business practice and is subject to penalties.

The following practices are examples of violations of the suitability rules:
  • Recommending securities without having a reasonable basis for the recommendation
  • Recommending securities without taking the client's financial situation, needs and objectives into account
  • Recommending the same security to all clients
  • Failing to describe important facts and risks about the security to each client
  • Making trades of excessive size in a client's account
  • Churning in a client account (making trades too frequently)
  • Providing services that are not appropriate to the client's situation and needs
  • Failing to inquire into client's tax situation, risk tolerance and other assets
The Investment Advisers Act of 1940 also defines failure to meet suitability standards as an unethical practice. An IA who does not make reasonable inquiry, or suitable recommendations given the information from such an inquiry, is guilty of violating the suitability requirements.

Next: Prudent Investor Standards »


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