Investor Suitability Claims on the Rise


The subprime and credit crises affecting the economy have revealed an array of suitability abuses by Wall Street investment firms. While a rising stock market hides many abuses by brokerage firms, suitability abuses are more easily identifiable when times are tough. For example, many risk-averse investors with conservative objectives have recently discovered that they have sustained huge losses on unsuitable investments recommended to them as being very safe. Auction rate securities, short-term bond funds, AAA rated debt securities, and mortgage heavy mutual funds provide recent examples of suitability abuses.

Unbeknownst to many public investors, brokerage firms have an affirmative duty to only recommend securities to investors if the securities are suitable (reasonable) for the investor in light of the investor’s personal circumstances and, most importantly, the investor’s investment objectives. Stated another way, brokerage firms (and their registered representatives) have legal duties to gather information about what is suitable for a customer and not to recommend an investment unless they have reasonably determined that the investment is suitable for the investor based on a variety of factors, the most important of which is the investor’s investment objective. For example, if that investment objective is income and preservation of capital, a brokerage firm violates its duty by recommending a high-risk investment. This is not brain surgery. Brokerage firms only need to do some pretty basic things to comply with their duties. Notwithstanding these fundamental duties, the majority of cases we have seen recently have involved variations on the claim of unsuitability.

In recent months, we have filed a number of securities arbitration claims on behalf of investors involving Morgan Keegan Bond Funds, the Schwab YieldPlus Fund, and Auction Rate Securities (“ARS”). Most of these claims have involved unsuitable investment recommendations among other violations.

The Morgan Keegan Bond Funds were and are unsuitable for any investor whose investment objectives were not high-risk speculation. These funds contained more than 50% in mortgage related securities. Yet, Morgan Keegan routinely recommended and sold these funds as safe and diversified investments to people who were risk averse and thought they were investing in a low risk bond fund. And Morgan Keegan did so long after it expected a collapse in the housing market!

Similarly, major brokerage firms unsuitably sold ARS as liquid, cash equivalent investments to investors whose investment objectives were income and preservation of capital. Those firms include UBS Financial Services, Bear, Stearns & Co., Inc., Citigroup Global Markets, Inc., J.P. Morgan Securities, Inc., Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. Incorporated/ Morgan Stanley DW Inc., RBC Dain Rauscher Inc., A.G. Edwards & Sons, Inc., Piper Jaffray & Co., SunTrust Capital Markets Inc., Wachovia Capital Markets, LLC, and Bank of America Securities LLC. The firms knew, or certainly should have known, that ARS were neither “short-term” nor “cash equivalents.” They also knew that they auctions would inevitably fail if the major brokerage firms withdrew their support from the market.

Even Charles Schwab (Talk to Chuck) violated its suitability duties when it sold its YieldPlus Fund to money market investors and others whose objective was a safe, short-term investment. Schwab told investors that the share price “may fluctuate minimally” and that it was a suitable, slightly higher-yielding alternative to money market funds. In reality, as of November 30, 2007, 46.2% of the Schwab YieldPlus Fund was invested in mortgage-backed securities, and only 6.6% was invested in short-term investments!

Suitability claims are uniquely individual claims. By their very nature, such claims depend on individual facts and circumstances. Suitability claims are not appropriate for class actions because they are based on facts which are not common to the class as a whole but which vary from individual to individual.

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and individual investors in suitability cases and other investment disputes. For further information, please contact us.