NASAA Series 66 Uniform Combined State Law ExaminationLaws, Regulations, and Guidelines, including Prohibition on Unethical Business PracticesMedium
An agent of a broker-dealer is found to have recommended a security to a client based solely on a rumor heard from a friend, without conducting any independent research or due diligence. The security subsequently performed poorly, causing the client significant losses. This action by the agent constitutes:
- AA failure of reasonable basis suitability.
- BChurning.
- CUnauthorized trading.
- DA violation of the duty of best execution.
Show answer & explanationAnswer & explanation
Correct answer: A. A failure of reasonable basis suitability.
Reasonable basis suitability requires an agent to conduct proper due diligence on a security to ensure it is suitable for at least some investors. Recommending a security based solely on a rumor, without independent research, demonstrates a lack of reasonable basis for the recommendation, regardless of the client's individual suitability.
Why the other options are wrong
- B. Churning involves excessive trading to generate commissions, which is not described here.
- C. Unauthorized trading occurs when trades are executed without the client's permission, which is not the issue in this scenario.
- D. Best execution relates to obtaining the most favorable terms for a client's trade, not the recommendation itself.
Reasonable Basis Suitability
Reasonable basis suitability requires an agent to have a reasonable basis to believe that a recommendation is suitable for at least some investors, based on adequate due diligence.
- This is the first component of a two-part suitability obligation.
- It focuses on the investment product itself, not the individual client.
- Requires independent research and analysis, not just relying on rumors.
Memory trick: First, 'Know Your Product'; then, 'Know Your Client'.