Martindale-Hubbell
State Bar of Georgia
PIAMBA
Atlanta Bar Association

Common Claims in FINRA Arbitration

Unsuitability

The most common claim in FINRA arbitration is unsuitability. Approximately one-third of all claims assert unsuitability. Brokerage firms and their associated persons are obligated to act diligently to learn the essential facts about the customer and any investments under consideration, and to make only suitable investment recommendations. These obligations are the bedrocks of broker duties. It has been said that the suitability rule is based on a "homely truth about investing - that investment decisions can be made only in light of the goals and needs of the person for whom they are made." An unsuitable recommendation constitutes a dishonest, unethical and fraudulent practice. Brokers and their firms can be made to pay for an investor's losses suffered as a result of an unsuitable recommendation.

FINRA revised its suitability rule in July 2012. New FINRA Rule 2111 reiterates that many obligations under the new rule existed before the new rule. This can be very helpful to investor claimants asserting unsuitability claims. In addition, there are some very significant changes that are helpful to investor claimants. Under new Rule 2111, the broker must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable based on an inquiry about the essential facts about the customer's investment objectives and needs. New Rule 2111 also expands what is meant by a "recommendation" beyond a recommendation to buy or sell, to include an explicit recommendation to hold or not to sell a security, or to not make any changes to an account. This captures many situations that used to be arguably beyond the suitability rule.

New Rule 2111 also expanded and clarified the meaning of an essential facts inquiry to include an inquiry into the customers' age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs (particularly relevant to alternative investments such as non-traded REITs so prevalent today), risk tolerance, and any other information provided by the customer in connection with such recommendation. New Rule 2111 further provides that the broker must obtain and analyze all these factors unless the broker has a reasonable basis to believe (which must be documented with specificity) that one or more factors are not relevant.

There are three components of the suitability rule. The first component is reasonable basis suitability, which means that the investment must be suitable for at least some investors. In other words, the broker or firm must exercise "due diligence" to learn the material risks and economic issues relating to a proposed investment and the promoters behind the investment. Such due diligence may generate red flags signaling potential problems that must be disclosed to potential investors, and may render the investment unsuitable for any investor. The second component is customer-specific suitability, which means that the recommendation must be suitable for the particular customer at hand based on the customer's investment profile, including the above-mentioned factors. Brokers are required to update their understanding of these factors since they may change over time. In addition, a customer may have multiple, differing investment objectives that require the firm to clarify the customer's intent and, if necessary, reconcile or determine how it will handle differing objectives. The third component is quantitative suitability, which applies to brokers with de facto control over a customer's account. The quantitative suitability rule implicitly acknowledges that a series of transactions, even if suitable if viewed in isolation, may, when taken together, be excessive and unsuitable for the customer in light of the customer's investment profile. A failure regarding any of these suitability components is actionable in FINRA arbitration, and brokers and their firms can be made to pay damages flowing from a broker's violation of the suitability rule.

A broker's lack of understanding of a product or strategy could also violate the suitability rule. Brokers are required to present all material risks and potential rewards of an investment or investment strategy in a fair and balanced manner. If a broker does not fully understand the material risks, he or she cannot properly disclose them to the customer as required. Boilerplate risk disclosures in a prospectus are no defense to this requirement.

A customer's financial wherewithal also has a bearing on suitability. Brokers are prohibited from recommending a transaction or investment strategy if there is a reasonable basis to believe that the customer lacks the financial ability to meet such a commitment.

FINRA Regulatory Notice 12-25, which was published to provide additional guidance on New Suitability Rule 2111, implicitly acknowledges the fiduciary duty of brokerage firms and their associated persons by holding that the suitability requirement prohibits a broker from placing his or her interests ahead of the customer's interest, and that any recommendation must be consistent with the customer's best interest.

Sam Brannan is a FINRA arbitration lawyer serving Atlanta. If you believe that your investment adviser or stockbroker made unsuitable investment recommendations or placed you in unsuitable investments, you should consult with an attorney with experience in representing investors in FINRA arbitrations. Brannan Law, LLC has extensive experience in representing investors with unsuitability claims in FINRA arbitrations in Georgia and nationwide. We would be happy to evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.

Misrepresentation and Omission Claims

Misrepresentation and omission of material facts is a different claim than unsuitability although it often goes hand in hand with it. Misrepresentation and omission of material facts is not a requirement for an unsuitability claim. FINRA rules, state and federal securities statutes, and the common law prohibit misrepresentation and/or omission of material facts in connection with the purchase or sale of a security. All material facts (i.e., risks) must be fully and fairly disclosed. Misleading half-truths are prohibited. What is material is what a reasonable person would consider to be important in deciding whether or not to invest in the security or investment strategy recommended.

Claims for fraudulent misrepresentation and omissions can be made pursuant to state and federal anti-fraud statutes as well as common law fraud claims. State and federal anti-fraud statutes provide that is unlawful for a person, in connection with the offer, sale, or purchase of a security, directly or indirectly:

  • (1) To employ a device, scheme, or artifice to defraud;
  • (2) To make an untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it is made, not misleading; or
  • (3) To engage in an act, practice, or course of business that operates or would operate as a fraud or deceit upon another person.

In Georgia, common law fraud may be actual or constructive. The five elements of actual fraud under Georgia law are: (1) false representation by the respondent; (2) scienter (i.e., fraudulent intent); (3) intent to induce the claimant to act or refrain from acting; (4) justifiable reliance by the claimant; and (5) damage to the claimant. Constructive fraud exists where respondent acted or failed to act contrary to a legal or equitable duty, trust or confidence justly reposed, which is contrary to good conscience and operates to the injury of the claimant. Put another way, constructive fraud is actual fraud without scienter. In addition, actionable misrepresentations and/or omissions may be entirely unintentional and grounded in negligence.

If your investment adviser or stockbroker misrepresented or failed to disclose important risks regarding an investment, you should consult with an attorney with experience in representing investors in FINRA arbitrations. Sam Brannan is a FINRA arbitration attorney. Brannan Law, LLC has extensive experience in representing wronged investors in FINRA arbitrations in Georgia and nationwide. We would be happy to evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.