What is My Stock Broker's Duty to Me?
By Sean Sweeney on January 12, 2012
What is your Stock Broker's duty to you? How do you know if he or she has breached that duty?
When you go to a used car lot, the used car salesmen has almost no duty to you. Other than the duty not to commit fraud (put sawdust in the oil to make the car run smoother, or roll back the odometer to show less miles) it is an arms length transaction where the salesmen is free to sell you a Ferrari or a Ford station-wagon... caveat emptor, let the buyer beware.
However, your broker is not a used car salesmen. He or she does have certain duties to you. First and foremost the Broker has a duty pursuant to the National Association of Securities Dealer (NASD) rule 2310, a duty only to make suitable recommendations. The rule states,
(a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs. (b) Prior to the execution of a transaction recommended to a non-institutional customer…a member shall make reasonable efforts to obtain information concerning: (1) the customer’s financial status, (2) the customer’s tax status; (3) the customer’s investment objectives; and (4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.This rule has been interpreted to impose three main suitability obligations on a broker prior to recommending or soliciting a customer to purchase, sell, or exchange any security.
- Reasonable basis suitability - The firm itself must have a reasonable basis to believe, based on adequate due diligence, that a recommendation is suitable at least for some investors.
- Customer specific suitability - The firm/broker must have reasonable grounds to believe a recommendation is suitable for the specific investor, meaning that looking at the individuals risk tolerance, investment goals, and liquidity needs that the investment is appropriate for that investor at that time.
- Quantitative and Asset-allocation suitability - The firm/broker must have a reasonable basis to believe the number of recommended transactions within a certain period is not excessive and that the quantity of any one particular asset class is not excessive as well.
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