Chapter 5: Ethical Practices and Obligations - B. Suitability

Question 1

Suitability

Answer 1

Recommendations of securities to customers must be based on the suitability of the investment to the customer’s investment needs. In order to determine an investment’s suitability for a customer, agents and broker/dealers must make a reasonable effort to obtain relevant information from the customer and evaluate the following factors: financial condition, investment objective, tolerance for risk, and investment experience.

In the early 1980s, NASAA Model Rules released a statement of policy concerning Dishonest and Unethical Business Practices of Broker/Dealers and Agents. Actions that would violate the Dishonest and Unethical Business Practices of Broker/Dealers and Agents include the following:

• Engaging in transactions solely to generate commissions, excessive trading in time and/or frequency (known as churning). With regard to mutual funds, a similar practice is referred to as switching, or moving a client from one fund family to another in order to generate commissions;
• Failing to disclose important facts concerning the risks of an investment;
• Recommending a security without having a reasonable basis for the recommendation, or without properly assessing the customer’s financial condition, needs, or objectives; and
• Performing trades that are excessive in size in relation to the customer’s resources.

If a client directs the agent to effect a trade which the agent feels is unsuitable for that client, the agent may effect the transaction but should obtain a signed “non-solicitation” letter prior to making the trade.