NASAA Series 63Ethical Practices and ObligationsMedium
A client, aged 72, informs their agent that they wish to reallocate 80% of their conservative fixed-income portfolio into highly speculative penny stocks, stating they want to 'make up for lost time' before they pass away. The client has no prior experience with such volatile investments, and their stated risk tolerance on file is 'low.' The agent executes the trades as requested by the client, documenting the client's specific instructions. Under the Uniform Securities Act, the agent has most likely committed:
- AUnauthorized trading
- BA suitability violation
- CSelling away
- DChurning
Show answer & explanationAnswer & explanation
Correct answer: B. A suitability violation
Even with client instructions, an agent has an obligation to ensure that recommended or executed transactions are suitable for the client's financial situation, investment objectives, and risk tolerance. Executing trades for highly speculative penny stocks for a 72-year-old client with a conservative portfolio and low risk tolerance, despite their request, is a clear suitability violation.
Why the other options are wrong
- A. Unauthorized trading occurs when an agent executes trades without specific client permission. Here, the client specifically requested the trades.
- C. Selling away involves selling securities not offered by the agent's employing broker-dealer, which is not described in this scenario.
- D. Churning involves excessive trading to generate commissions, which is not explicitly stated or implied by this single reallocation.
Suitability Obligation
Agents must have a reasonable basis to believe that a recommendation or transaction is suitable for the client based on their investment profile.
- Client profile includes age, financial situation, investment experience, objectives, and risk tolerance.
- Even if a client requests an unsuitable trade, the agent may still be liable if they execute it without proper diligence.
- Documentation of client instructions does not absolve the agent of suitability responsibilities if the trade is clearly inappropriate.
Memory trick: Suitability ensures the investment fits the client like a glove.