Just as a low tide near the seashore can reveal shipwrecks, a falling stock market often reveals misconduct by investment advisers. This is particularly true with respect to an investment adviser’s duty to recommend only investments to a customer that are suitable in light of the customer’s investment objectives, status in life and risk tolerance. Unfortunately many investors only learn that their advisers have violated this duty when adverse market conditions develop.
When you open an investment account with a brokerage firm, your broker accepts a duty to recommend suitable investments. If your broker fails to perform that duty, you may be able to bring a suitability claim ? in essence, a claim for investment malpractice ? against the firm for not doing its job. Such claims are typically brought through arbitration, which is less formal, less expensive, and often more efficient than suing someone in court. But what constitutes a suitable investment, and what exactly is a suitability claim?
There are two types of suitability, general and specific. Before a broker can recommend an investment, the investment must be suitable in both ways. General suitability means that the brokerage firm has studied the investment and understands it, and that it has determined that the investment is sound enough to warrant the firm’s recommendation. A flawed financial product that does not perform as represented is not suitable for anyone, and thus would violate the duty of general unsuitability. Specific suitability, on the other hand, means that the firm has evaluated the investment objectives and risk tolerance of each of its clients and has determined that the investment is suitable for goals and needs of the specific investor for whom the investment is being recommended. For example, an investment that makes perfect sense for a young investor with a high income and a high tolerance for risk might not be suitable for a retiree trying to preserve his nest egg and generate a safe and consistent return.
If a brokerage firm does its due diligence and only recommends suitable investments, it will generally not have any legal liability if the market goes down and the investor loses money. But if the broker cuts corners and does not do its due diligence, the firm is exposed to potential liability. “Not only that,” says attorney Craig T. Jones, “but the firm is not doing what it is being paid to do, which is bad business.” Jones is a partner in the Atlanta law firm of Page Perry, which assists investors throughout the country with arbitration claims against brokers and investment advisers. “The financial industry has a professional as well as legal obligation to do right by its customers,” says Jones, “and that includes paying compensation when its people ignore professional standards.”
From a legal standpoint, suitability claims generally fall into two categories: negligence or breach of fiduciary duty. Since the duty to recommend suitable investments is essentially a duty to act reasonably, the breach of that duty gives rise to a claim for negligence. At a bare minimum, all brokers owe that duty. There is a higher duty, however, owed by financial investment advisers and other financial professionals who hold themselves out as giving investment advice?including brokers who have such a relationship of trust and confidence with their clients that they are relied upon as investment advisers and not as mere order-takers. That duty is a fiduciary one, meaning that there is such a relationship of confidence and trust bestowed upon the adviser that he or she has a duty to put the client’s interest first, which is a higher duty than simply the duty to recommend suitable investments. For example, an investment may be generally suitable for the marketplace and may even be suitable for the particular client’s investment objectives, but if the firm has a selfish motive for recommending that investment over others ? perhaps because the firm has a proprietary interest in the investment, because that investment pays higher fees to the firm, or because the firm is trying to unload its own holdings of that investment ? it may be a violation of fiduciary duty, especially if the firm’s self-interest is not fully disclosed.
In short, there are two different standards of care for suitability claims?negligence and fiduciary?and determining which standard applies depends upon the nature of the relationship in question. The success of the claim, and the defenses against it, has a lot to do with which standard applies and whether the facts of the case support a violation of that standard. A firm that is sued for negligently recommending an unsuitable investment can defend itself by showing that it had a reasonable basis for making the recommendation at the time it was made, but a firm being sued for a fiduciary violation has to show that it was not only acting reasonably, but in the client’s best interest ? a much harder showing to make. Accordingly, much of the lawyering that goes into representing investors in investment malpractice claims involves developing the facts of the case to determine whether the relationship between the firm and the client can be characterized as a fiduciary one. Even if the account agreement specifies that there is no fiduciary duty owed, the circumstances can give rise to a fiduciary duty. “Every case is different,” says Jones, “and each case turns on its own factual merits. If you think you have a suitability claim ? or any other kind of claim against a broker or financial adviser ? we would be happy to talk to you about your options.”
Jones cautions those who may have claims to be mindful of the legal deadlines, or statutes of limitations, that may apply. “Every state has different deadlines for bringing different types of claims, typically ranging from two to six years, so anyone seeking legal advice on whether to bring a claim needs to act quickly.” In addition to suitability claims based on negligence or breach of fiduciary duty, an investor may have a claim for fraud based on deliberate misrepresentations, or the failure to disclose what should have been disclosed. Even negligent misrepresentations that fall short of fraud, but which the broker should not have made knowing that the client was relying on them, may be the basis for a claim, as well as breach of contract. A suitability claim that is characterized as a negligence claim might have a four-year statute of limitations in a given state, but if the same claim is characterized as a breach of contract then it might be subject to a six-year statute of limitations in the same state. “Usually the firm’s account agreement has language that requires it to perform its duties in a particular way,” says Jones, “and anything that would be unsuitable is going to be a breach of the written contract.” Most states allow a longer period of time to sue for breach of contract than for negligence or fraud.
“Even if you think it has been too long to make any kind of claim,” says Jones, “it is still a good idea to talk to a lawyer who is experienced at handling securities arbitrations.” Since arbitrators are more typically more concerned about fairness than legal technicalities, there have been many cases in which arbitrators have been willing to overlook statutes of limitations in favor of reaching a fair result. Furthermore, if there has been fraud involved, the statute of limitations may not even start to run until the time that the fraud is discovered, or should have been discovered. “Bottom line,” says Jones, “is that you should consult a lawyer as soon as you believe that you may have a claim, but even if it has been a long time we may still be able to find a way to help you.”