Customer Suitability Claims Against Financial Advisors and Broker-Dealers in FINRA Arbitations: Key Considerations, Risks, and Advantages
The Financial Industry Regulatory Authority (FINRA) arbitration process is the primary forum for resolving disputes between investors and financial professionals, including financial advisors and broker-dealers. Among the most common claims in FINRA arbitration are customer suitability claims, in which investors allege that their financial advisor recommended investments that were inappropriate for their investment profile.
For example, an elderly retiree with limited investment experience who is seeking stable income should typically not be placed in high-risk leveraged ETFs or speculative private placements. If their financial advisor recommended such investments, and the retiree suffered significant losses, a suitability claim may be warranted.
If you are considering filing a FINRA arbitration claim against a financial advisor or broker-dealer for unsuitable investment recommendations, it is essential to understand the legal framework, key considerations, risks, and potential rewards of pursuing such a claim.
Understanding the Legal Basis of Customer Suitability Claim
FINRA Rule 2111: The Suitability Standard
FINRA Rule 2111 requires that financial professionals have a “reasonable basis” to believe that an investment recommendation is suitable for a customer based on their:
- Investment objectives (e.g., growth, income, capital preservation)
- Risk tolerance (low, moderate, high)
- Age and financial situation
- Investment experience and knowledge
- Liquidity needs
- Time horizon for investing
Your financial advisor is required to go through each of these factors with an initial meeting and properly assess these factors or recommended investments that were inconsistent with their profile. Your financial advisor is required to know and fully understand each of these factors for your specific situation. Your advisor is also required to meet with you on an annual basis to make sure that the investment strategies and investments continue to meet these factors.
Common Types of Suitability Violations
A suitability claim arises when an investor alleges that their advisor failed to properly assess these factors or recommended investments that were inconsistent with their profile. Some common suitability violations include:
1. Overconcentration in Risky Assets
Example: A 60-year-old investor seeking moderate returns was advised to place 50% of their portfolio in a single energy stock. When oil prices crashed, they lost half their investment. The advisor failed to properly diversify the portfolio, exposing the investor to unnecessary risk.
2. Recommending High-Risk or Speculative Investments
Example: A financial advisor placed a conservative investor into a leveraged options trading strategy, promising high returns. When the market turned volatile, the investor suffered substantial losses. This investment was unsuitable given the client’s risk tolerance and lack of options trading experience.
3. Churning (Excessive Trading for Commissions)
Example: A broker executed dozens of trades per week in a client’s account, generating huge commissions but little overall gain. Churning can be a form of an unsuitable strategy because it prioritizes the advisor’s profits over the investor’s best interests.
4. Failure to Explain Risks
Example: A retired school teacher was encouraged to invest in a private placement real estate fund without being told that the investment was illiquid and she wouldn’t be able to access her money for several years. When she needed to withdraw funds for medical expenses, she found out too late that she was locked in.
5. Failure to Consider Tax Implications
Example: A broker advised an investor to sell long-term holdings in a highly appreciated stock without discussing the capital gains tax consequences, resulting in an unexpected and significant tax bill.
Deciding Whether to Bring a FINRA Arbitration Claim
Before initiating a FINRA arbitration claim, investors should carefully evaluate several key factors:
1. Strength of the Evidence
To succeed in a FINRA arbitration, the investor must prove that:
- The advisor knew or should have known that the investment was unsuitable.
- The investor relied on the advisor’s recommendation when making the investment.
- The investor suffered financial harm as a result.
Key evidence in these cases includes:
- Account statements showing transactions.
- New account forms and risk tolerance questionnaires completed at the start of the relationship.
- Email and written correspondence demonstrating what the advisor told the investor.
- Expert testimony on industry standards and best practices.
2. Costs vs. Potential Recovery
FINRA arbitration involves costs, including:
- Filing fees, which can range from a few hundred dollars to several thousand, depending on the size of the claim.
- Attorney’s fees, which are often on a contingency basis but sometimes hourly.
- Expert witness fees, which may be necessary to establish industry standards and damages.
Example: If an investor lost $20,000 due to an unsuitable investment, but the legal fees and arbitration costs could total $15,000, it may not make financial sense to pursue arbitration. However, if the losses were $500,000, arbitration is a much more viable option.
3. Statute of Limitations and Eligibility Rules
- FINRA Rule 12206(a) typically imposes a six-year eligibility rule, meaning that a claim must be filed within six years of the event giving rise to the dispute. However, if your case is dismissed under this rule and your state has a longer statute of limitation period, you may not be precluded from bringing the action in the courts in your state.
- Some states impose additional statutes of limitations, typically between two and six years for fraud or breach of fiduciary duty claims.
4. Likelihood of Recovery
Winning an arbitration claim is only valuable if the financial advisor or firm can pay the award.
- Large broker-dealers typically have the resources to satisfy awards.
- Small advisory firms or independent brokers may lack sufficient assets to pay a judgment.
Potential Risks of Filing a FINRA Arbitration
While arbitration may seem like an attractive option, investors should consider the potential downsides:
1. Limited Discovery
Unlike traditional litigation, FINRA arbitration does not allow for depositions or extensive discovery. Investors may have limited access to internal brokerage documents, making it harder to prove a claim.
2. Final and Binding Decision
FINRA arbitration awards are final and binding, with very limited grounds for appeal.
3. Arbitrator Bias
FINRA arbitration panels are composed of industry and public arbitrators. Some investors perceive that industry arbitrators may favor financial professionals, making it harder to win claims.
Potential Advantages of Filing a FINRA Arbitration
Despite the risks, FINRA arbitration offers several advantages for investors:
1. Faster Resolution
Compared to traditional court litigation, arbitration is typically much faster—often concluding within 12-18 months rather than taking years.
2. Lower Costs
While arbitration has costs, it is generally cheaper than full-scale litigation, with lower attorney’s fees and procedural costs.
3. Recovery of Losses
If successful, an investor may be able to recover:
- Actual investment losses
- Interest on losses
- Attorney’s fees and costs (in some cases)
- Punitive damages (if the broker’s conduct was egregious)
Example: A client who lost $300,000 due to an unsuitable private placement investment could potentially recover the full amount plus interest and potentially consequential damages through arbitration.
Conclusion: Is FINRA Arbitration the Right Move?
Investors who suspect that their financial advisor recommended unsuitable investments should carefully assess their situation before initiating FINRA arbitration. Weighing the strength of the evidence, potential recovery, costs, and alternative dispute resolution options is critical to making an informed decision.
If you believe you have a valid suitability claim, consulting with an experienced FINRA arbitration attorney can help you navigate the process, maximize your chances of success, and protect your financial future. At Parker Daniels Kibort, our team has extensive experience representing clients in disputes involving financial advisors, insurers, lenders, and insurance agents. Contact us for tailored, strategic counsel to help mitigate risks and safeguard your interests.
Mr. Kibort practices in business litigation and financial-services litigation, including representing customers who have suffered damages related to unsuitable investments, misrepresentation, failure to disclose, and premium financed life insurance schemes.
This blog entry is not legal advice and does not create an attorney-client relationship; it is merely an example to provide some legal education. It is simply intended to provide general information. Each case is fact specific and requires its own unique solution. It is strongly recommended that you seek the advice of a qualified attorney to help you with any questions you have.
Parker Daniels Kibort is a full-service litigation law firm located in Minneapolis, Minnesota. We have a proven record of success at the highest levels for our clients. We can handle your matters in Minnesota, Wisconsin, North Dakota, California, and Washington D.C.. For questions or more information, give us a call at 612.355.4100
