The majority of securities claims revolve around the issue of suitability. Before making an investment recommendation, a financial advisor must make a reasonable inquiry into the customer's particular financial situation, including their financial status, tax status and investment objectives. An investment is unsuitable when it is contrary to the customer's financial needs and objectives.
Financial services firms must keep a record of the customer's important financial information such as income, liquid net worth and tax status. This information is usually recorded in the customer's account application. The account application will also attempt to categorize customer investment objectives into several main categories:
- Conservative - Income
- Moderate - Income & Growth
- Moderate - Growth
- Aggressive - Growth
- Aggressive - Speculation
Oftentimes, the financial advisor will pre-select a customer's investment objectives when opening an account. Brokerage firms must accurately record this information and periodically update the data whenever a customer's financial situation changes. When a financial advisor intentionally or negligently selects the wrong investment objective or fails to update the information when necessary, suitability problems usually arise.
Each time a recommendation is made, the financial advisor must make a suitability determination. This determination is not limited to whether the individual security being recommended was suitable, but whether the security is suitable given the customer's entire portfolio. A suitable investment standing on its own can be unsuitable when viewed in the context of the client's need for diversification and asset allocation. For instance, a recommendation to buy a utility stock may be unsuitable for a customer that already has a heavy concentration in utility stocks.