(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile. A customer's investment profile includes, but is not limited to, the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.
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Stockbroker Sanctioned For Trades For Client She Thought Was Autistic
November 4, 2015
If you have been a stockbroker long enough, inevitably you are presented with the prospect of opening a brokerage account for a customer who presents issues that give you pause. A recent FINRA regulatory settlement raises questions about a customer who appeared intellectually challenged and whose account sustained losses of nearly one-third its value. Did the stockbroker take advantage? Is this simply a case of unfortunate losses sustained via a well-meaning recommendation? You be the judge.
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Karen Tautges-Parisian submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Karen Tautges-Parisian, Respondent (AWC 2014040305901, October 27, 2015).
Tautges-Parisian first became registered in 2001 with FINRA member firm Ameriprise Financial Services, Inc., where she remained until her voluntary resignation on December 12, 2013.
Intellectual Development Disorder
In 2008, another stockbroker referred a 50-year-0ld janitor with no prior investment experience to Tautges-Parisian. The customer is characterized in the AWC as having:
a low IQ and was diagnosed with intellectual development disorder
As asserted in the AWC:
Tautges-Parisian believed that the customer was autistic.
In opening the new account, the AWC asserts that the customer:
transferred to that account the vast majority of his assets (approximately $65,000).
A Question of Suitability
In May 2009, Tautges-Parisian recommended that the customer invest $14,904 in 8,000 shares of Oceanfreight, Inc. ("OCNF") stock, which was then trading at $1.83 per share. Although Tautges-Parisian allegedly had learned about OCNF from other brokers, the AWC asserts that she failed to personally conduct adequate due diligence.
When the OCNF had dropped to $.99 per share by November 2009, Tautges-Parisian then recommended the purchase of additional shares. "hoping that if the price of the stock rose, the customer would be able to get out of the stock sooner." There is no indication as to the stockbroker's strategy if the stock either remained unchanged or dropped further. In any event, the customer purportedly bought another $7,000 of OCNF, which then brought his accumulated holdings to 20% of his account's valuation.
The AWC alleges that in June 2010:
the customer sold his OCNF shares for a total loss of $16,032.52. Ameriprise later reimbursed the customer for his losses.
Risk Assessment
In finding that Tautges-Parisian had violated FINRA Rule 2010 and former "Suitability Rule" NASD Rule 2310, which has since been replaced by FINRA Rule 2111, FINRA asserted that the stockbroker lacked reasonable grounds for believing that the May and November 2009 OCNF purchases were a suitable investment for the customer because given:
his financial condition and circumstances, the customer could not afford the risk associated with investing in penny stocks and should not have been concentrated in such a risky investment.
In accordance with the terms of the AWC, FINRA imposed upon Tautges-Parisian a $5,000 fine and a 9-month suspension from associating with any member firm in any and all capacities.
Bill Singer's Comment
In some suitability cases, I find myself questioning whether the actions by the brokerage firm and regulator are more "Monday Morning Quarterbacking" than a fair expression of outrage. When first reading this AWC, my initial inclination was to view Ameriprise's and FINRA's actions against Tautges-Parisian as based upon the cynical, clearer vision of 20/20 hindsight. I reached that position based upon a sense that Tautges-Parisian probably didn't know or have reason to know that the customer may have lacked the competency to evaluate her stock recommendations -- after all, many new client intakes occur solely over the telephone or via email and sometimes that masks any indications of and "intellectual development disorders." On re-reading the AWC, however, I noted the assertion that Tautges-Parisian believed that the customer was autistic and that fact altered my view from some skepticism to an acceptance of the rectitude of the firm's and FINRA's actions.
There were many steps that Tautges-Parisian could have taken to better protect herself when dealing with any disabled or challenged customer should the condition raise issues about investment decisions. In the specific case of the customer at issue, Tautges-Parisian could have contacted her manager and compliance department, memorialized her concerns about her client's ability to participate in investment decisions, obtain guidance as to how best to handle such an account, and, thereafter, execute the plan presented to her by her firm. If nothing else, she would have established a "good faith" record of having sought guidance rather than merely following her own opinion.
Many registered persons maintain the misplaced belief that if a client is not "legally" deemed incompetent to handle his or her financial affairs that there is no further issue in executing trades in the account. Although the legal checklist for finding someone "incompetent" is often daunting, such is not the same checklist when it comes to considerations of suitability. As this AWC demonstrates, the Suitability Rule does not speak in terms of the "mental competency" of the customer but shifts the onus to the registered person, who is charged with having a "reasonable basis to believe" that a recommendation is "suitable" for the customer -- and that belief must be based upon that registered person's due diligence of the customer's background. That a given customer may still be competent to handle his or her investment decisions does not give license to a stockbroker to recommend overly speculative stocks or to place the account into an overly concentrated position. Finally, it could be argued that notwithstanding the customer's developmental challenges in this AWC, investing a 50-year-old janitor with $65,000 in assets into $22,000 worth of one stock raises suitability issues in its own right.
Given that this AWC largely revolves around FINRA's Suitability Rule, let's read it:
FINRA Rule 2111. Suitability
(b) A member or associated person fulfills the customer-specific suitability obligation for an institutional account, as defined in Rule 4512(c), if (1) the member or associated person has a reasonable basis to believe that the institutional customer is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies involving a security or securities and (2) the institutional customer affirmatively indicates that it is exercising independent judgment in evaluating the member's or associated person's recommendations. Where an institutional customer has delegated decisionmaking authority to an agent, such as an investment adviser or a bank trust department, these factors shall be applied to the agent.*** Supplementary Material ***
.01 General Principles. Implicit in all member and associated person relationships with customers and others is the fundamental responsibility for fair dealing. Sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of FINRA rules, with particular emphasis on the requirement to deal fairly with the public. The suitability rule is fundamental to fair dealing and is intended to promote ethical sales practices and high standards of professional conduct.
.02 Disclaimers. A member or associated person cannot disclaim any responsibilities under the suitability rule.
.03 Recommended Strategies. The phrase "investment strategy involving a security or securities" used in this Rule is to be interpreted broadly and would include, among other things, an explicit recommendation to hold a security or securities. However, the following communications are excluded from the coverage of Rule 2111 as long as they do not include (standing alone or in combination with other communications) a recommendation of a particular security or securities:
(a) General financial and investment information, including (i) basic investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment, (ii) historic differences in the return of asset classes (e.g., equities, bonds, or cash) based on standard market indices, (iii) effects of inflation, (iv) estimates of future retirement income needs, and (v) assessment of a customer's investment profile;(b) Descriptive information about an employer-sponsored retirement or benefit plan, participation in the plan, the benefits of plan participation, and the investment options available under the plan;(c) Asset allocation models that are (i) based on generally accepted investment theory, (ii) accompanied by disclosures of all material facts and assumptions that may affect a reasonable investor's assessment of the asset allocation model or any report generated by such model, and (iii) in compliance with Rule 2214 (Requirements for the Use of Investment Analysis Tools) if the asset allocation model is an "investment analysis tool" covered by Rule 2214; and(d) Interactive investment materials that incorporate the above..04 Customer's Investment Profile. A member or associated person shall make a recommendation covered by this Rule only if, among other things, the member or associated person has sufficient information about the customer to have a reasonable basis to believe that the recommendation is suitable for that customer. The factors delineated in Rule 2111(a) regarding a customer's investment profile generally are relevant to a determination regarding whether a recommendation is suitable for a particular customer, although the level of importance of each factor may vary depending on the facts and circumstances of the particular case. A member or associated person shall use reasonable diligence to obtain and analyze all of the factors delineated in Rule 2111(a) unless the member or associated person has a reasonable basis to believe, documented with specificity, that one or more of the factors are not relevant components of a customer's investment profile in light of the facts and circumstances of the particular case.
.05 Components of Suitability Obligations. Rule 2111 is composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability.
(a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the member's or associated person's familiarity with the security or investment strategy. A member's or associated person's reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.(b) The customer-specific obligation requires that a member or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer's investment profile, as delineated in Rule 2111(a).(c) Quantitative suitability requires a member or associated person who has actual or de facto control over a customer account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation..06 Customer's Financial Ability. Rule 2111 prohibits a member or associated person from recommending a transaction or investment strategy involving a security or securities or the continuing purchase of a security or securities or use of an investment strategy involving a security or securities unless the member or associated person has a reasonable basis to believe that the customer has the financial ability to meet such a commitment.
.07 Institutional Investor Exemption. Rule 2111(b) provides an exemption to customer-specific suitability regarding institutional investors if the conditions delineated in that paragraph are satisfied. With respect to having to indicate affirmatively that it is exercising independent judgment in evaluating the member's or associated person's recommendations, an institutional customer may indicate that it is exercising independent judgment on a trade-by-trade basis, on an asset-class-by-asset-class basis, or in terms of all potential transactions for its account.
November 3, 2015: Bill Singer talks with Shah Gilani, a market analyst with Capital Wave Forecast and Short Side Fortunes, on his trading career and popular investment newsletters; the downside of the rise of electronic stock exchanges; the connection between regulatory issues and volatility; how the SEC has been complicit in the rise of High Frequency Trading; and the implications of scandals like LIBOR and foreign currency manipulation. "Volatility is the new face of the market," Gilani says. "It's here to stay, it's going to increase and it will drive the markets."WATCH
