A suitability claim is one of the most common customer claims made to a panel of securities arbitrators.
Did you ever wonder why investment professionals ask questions about your investment experience, risk tolerance and more? FINRA’s suitability rule, FINRA Rule 2111, is based on a fundamental FINRA requirement that brokerage firms and their associated persons (sometimes referred to as brokers, financial advisers or financial consultants) deal fairly with their customers. FINRA has prepared this document to educate investors about our suitability rule—and to explain the reasons why firms and their associated persons may ask their customers questions about their financial situation.
FINRA’s suitability rule states that firms and their associated persons “must have a reasonable basis to believe” that a transaction or investment strategy involving securities that they recommend is suitable for the customer. This reasonable belief must be based on the information obtained through the reasonable diligence of the firm or associated person to ascertain the customer’s investment profile. The rule requires firms and associated persons to seek to obtain information about the customer’s:
- other investments;
- financial situation and needs, which might include questions about annual income and liquid net worth;
- tax status, such as marginal tax rate;
- investment objectives, which might include generating income, funding retirement, buying a home, preserving wealth or market speculation;
- investment experience;
- investment time horizon, such as the expected time available to achieve a particular financial goal;
- liquidity needs, which is the customer’s need to convert investments to cash without incurring significant loss in value; and
- risk tolerance, which is a customer’s willingness to risk losing some or all of the original investment in exchange for greater potential returns.
To help ensure that customers receive suitable investment advice, firms and their associated persons are required to learn as much about a customer’s investment profile as possible before recommending a securities transaction or investment strategy. The rule thus places an obligation on a firm and associated person to seek information from customers. Customers are not required to provide this information; therefore, the suitability rule provides some flexibility when information is unavailable despite the fact that the firm or associated person asked for it. This process is governed by FINRA Rule 2090 titled “Know Your Customer.”
The suitability of the overall mix of investments in a portfolio is determined by asset allocation. Asset allocation is the split of investment products between cash, fixed income, equities or other non-traditional asset classes.