A securities broker cannot recommend an investment without conducting sufficient due diligence into the investment.

All securities brokers are overseen by the Financial Industry Regulatory Authority (FINRA). FINRA rules require that every investment recommendation have a reasonable basis to believe that an investment or investment strategy is suitable for the investor.

To ensure suitability, brokers have a duty to conduct due diligence and to understand the risk profile of the investments that the broker’s brokerage approved for sale.  Providing a prospectus to an investor is not a substitute for understanding the investment and only making recommendations consistent with that information. 

At the very least, a broker must read and understand the prospectus. A brokerage is extremely reckless when that brokerage fails to read a prospectus and gives contradictory representations. Additionally, an adviser has the duty of full disclosure, which includes disclosure of material items in a prospectus.

Additionally, beyond just reading the prospectus, there are several things a broker must know to meet the minimum requirements for diligence. Without these, a recommendation is not suitable for any investor. At the very minimum, a broker should understand the following:

• The liquidity of the investment
• The existence of a secondary market and the pricing transparency in any secondary market transactions
• The creditworthiness of the investment issuer
• If the investment relies on collateral, the credit worthiness of the collateral
• Risk factors such as principal, return, and/or interest rate risk
• Tax consequences
• The investment’s costs and fees

Further, the investigation extends not just to understanding the investment but also to the investor. The broker must exercise diligence to ascertain the essential facts of the broker’s investor. Many things can influence a determination into the investor’s investment sophistication, risk tolerance and objectives. A suitable investment cannot be recommended without knowing these things.

Over the past 20-plus years, Jeffrey Pederson has successfully handled numerous cases concerning the failure of a broker to conduct appropriate investigation into an investment.