A New York City Investment Fraud Lawyer Explains Unsuitability
Rule 405 of the New York Stock Exchange (NYSE) Rules imposes a requirement on member organizations to “use due diligence to learn the essential facts relative to every customer, every order, every cash or margin account accepted or carried by such organization and every person holding power of attorney over any account accepted or carried by such organization.”
Rule 405 serves many purposes. It imposes a requirement on broker-dealers to know their clients so they do not make unsuitable investment recommendations to customers. It is also aimed at preventing broker-dealers from consummating the fraudulent securities transactions of their customers.
Investors may make a stockbroker misconduct claim and allege unsuitability if an investment professional fails to follow Rule 405. A violation of Rule 405, dubbed the “Know Your Customer” rule, can result in civil liability in certain circumstances. An investment professional who makes unsuitable investments could also, in some cases, be charged with criminal acts including violations of securities laws. This could occur, for example, if it is demonstrated that an investment manager engaged in a pump-and-dump scheme or in account churning.
What is Unsuitability?
Whether an investment is suitable or not is going to depend upon the risk tolerance of the investor, the sophistication of the investor, and the investor’s stated preferences and goals, among other factors.
A broker-dealer or an investment manager who makes a bad recommendation or a purchase a client does not like is not automatically going to be held responsible for unsuitability. The key factor in determining if an investment was unsuitable in an actionable way is whether the investment is plainly against a client’s investment criteria or desired investment behavior.
If an investment manager invest a substantial chunk of a risk-adverse elderly client’s retirement funds in a speculative microcap stock, for example, this would be a clear example of unsuitability. Most legal actions arising from claims of unsuitability are not this clear-cut and investment professionals can raise myriad defenses to try to avoid being held accountable for breaching a duty to a client by making an unsuitable investment.
What are the Legal Consequences of Unsuitability?
Financial professionals expected to follow Rule 405 have a duty to understand the investment goals and plans made by their clients. A failure to follow these regulations can result in a claim of misconduct. Legal actions may be taken against brokers and brokerages. Investors who wish to pursue legal action against financial advisors or money managers for unsuitability can argue breach of fiduciary duty. A mandatory securities arbitration may also come before the Financial Industry Regulatory Authority.
Investment managers may make unsuitable investments for the purposes of “churning” a client’s account. Churning occurs when an investment professional is motivated not by providing the best investment advice or opportunities for clients but instead by a desire to increase commissions. Churning may be considered a violation of Rule 10B-5 of the Securities and Exchange Act of 1934.
Stock brokers who participate in pump and dump schemes could also recommend unsuitable investments to clients for purposes of artificially raising the value of microcap or penny stocks. Pump and dump schemes may be a criminal violation under 18 U.S. Code Section 1348.
The legal consequences of unsuitability vary depending upon the type of investments made, as well as allegations made about the reasons for the unsuitable investments. Whenever you are facing civil actions, regulatory actions or criminal proceedings, you need to get legal help.
How a New York Investment Fraud Lawyer Can Help With Unsuitability
A New York investment fraud lawyer can provide legal advice if you are accused of making unsuitable investments.
Call today to learn how Bukh Law Firm, PLLC can represent financial professionals and brokerage firms in unsuitability claims.
