NASAA Series 66 Uniform Combined State Law ExaminationLaws, Regulations, and Guidelines, including Prohibition on Unethical Business PracticesMedium
An agent of a broker-dealer is preparing to sell shares of a newly issued municipal bond to a client. The agent is aware that the client's financial profile indicates a preference for conservative investments and a need for liquidity. The municipal bond, while tax-exempt, is long-term, unrated, and carries significant interest rate risk. The agent recommends the bond without fully explaining these specific risks or verifying the client's understanding. This action is a violation of the agent's:
- ADuty of suitability.
- BDuty of disclosure, but not suitability.
- CDuty of confidentiality.
- DSupervisory obligations.
Show answer & explanationAnswer & explanation
Correct answer: A. Duty of suitability.
The duty of suitability requires an agent to have a reasonable basis to believe that a recommendation is suitable for a specific client, considering their financial situation, investment objectives, and risk tolerance. Recommending a long-term, unrated, speculative bond to a client preferring conservative, liquid investments, without adequately explaining the risks, is a clear breach of this duty.
Why the other options are wrong
- B. While there's a failure of disclosure, the core issue is that the underlying recommendation itself is unsuitable for the client's profile.
- C. Duty of confidentiality relates to protecting client information, not investment recommendations.
- D. Supervisory obligations apply to the firm or supervisor, not directly to the agent making the recommendation.
Agent Duty of Suitability
An agent must have a reasonable basis to believe that a recommendation is suitable for a client, considering their investment profile, objectives, and risk tolerance.
- Requires 'reasonable diligence' to understand the client's profile.
- Recommendations must align with objectives, risk tolerance, and financial situation.
- Adequate disclosure of risks is part of ensuring suitability.
Memory trick: Fit the investment to the investor, like a tailored suit.