In England, a bartender in a tavern is responsible for the person who becomes intoxicated at his bar. At some point a bar tender has a duty to cut off the drinker’s supply of liquor. This was known in England as the dram shop law. At that time, taverns, bars, saloons, pubs and so forth were called dram shops. Over time, there was a movement to bring the legal concept of the dram shops cases into other areas of law. In the securities industry the equivalent of the dram shop law is called “financial suicide”.
Stock brokers and other investment professionals have a duty to refuse unsolicited transaction when the transactions are inappropriate for a customer based on his or her financial condition. Department of Enforcement v. Robert Joseph Kernweis, 2000 WL 33299605 (N.A.S.D.R.); Stephen Thorlief Rangen, Release No. 38486, 64 S.E.C. Docket 628, 1997 WL 163991 (S.E.C. Release No); John M. Reynolds, S.E.C. Exchange Act Release No. 34-30036, 50 S.E.C. 805, 1991 WL 288500 (S.E.C. Release No). In other words, when a customer seeks to engage in highly speculative or aggressive trading, a broker still has an obligation to ensure that his recommendations are suitable for the client given the client’s financial situation, needs, and other security holdings. Id. Under these circumstances, the broker has an affirmative duty to cut a customer off, and stop what is known “financial suicide.”
In John M. Reynolds, S.E.C. Exchange Act Release No. 34-30036, 50 S.E.C. 805, 1991 WL 288500 (S.E.C. Release No), the Commission determined that even if the customer had authorized aggressive trading, the broker was not entitled to ignore the financial situation and character of the account. Further, the Commission stated that whether the customer considers the broker’s transactions appropriate is not the test for determining the propriety of his conduct.
“Even if a customer wishes to engage in trading that is not consistent with his or her financial needs and investment goals, the registered representative is required to counsel the customer in a manner consistent with his or her financial situation.” District Bus. Conduct Comm. v. Euripides, Complaint No. C9B950014, 1997 WL 1121335 (N.A.S.D.R.) (NBCC July 28, 1997).
A representative not only has a duty to refrain from making unsuitable recommendations, he has a duty to warn against unsuitable investments. In Stephen Thorlief Rangen, Release No. 38486, 64 S.E.C. Docket 628, 1997 WL 163991 (S.E.C. Release No), the Commission rejected the broker’s argument that “it would have been wrong for him to refuse their orders merely because he felt that the investments were not suitable”. Id. The Commission held that the test is not whether the customers considered the transaction in their account suitable, but whether the broker fulfilled his obligations under the rules. Id. As a broker monitors the customer’s account for continuing suitability, it may discover that the customer’s financial condition no longer makes her suitable for selected investments or investment strategies. Once aware of this, the broker is required to provide its customer with adequate disclosure concerning the risks of continuing such a perilous trading strategy.
Even in a non-discretionary account, a broker has a duty to advise the customer when her investment strategies are no longer suitable in light of her financial situation. Peterzell v. Dean Witter Reynolds, Inc., American Arbitration Association Case No. 32-136-0416-10. (Nov. 9, 1990); Trans National Group Services, Inc. v. Paine Webber, Inc., NASD Arbitration No. 91-00770, 1992 WL 472902 (June 30, 1992).
Regardless of whether the account is discretionary or non-discretionary, a broker has a duty to refrain from executing certain trades requested by the investor when such trades are unsuitable to the investor’s financial condition. Cass v. Shearson Lehman Hutton, NASD Arbitration No. 91-01484, 1994 WL 1248585 (Jan. 31, 1994); In Cass, the Panel said:
“[I]t was especially improper for Shearson to allow Mr. Cass to continue his disastrous trading strategy [once the $1,000,000 loss occurred] since Shearson holds out its registered representatives to be not merely brokers but financial consultants. A competent financial consultant never would have permitted Mr. Cass to continue his disastrous trading strategy.”
In Peterzell v. Charles Schwab & Company, Inc., Warren Way, Walton Lee Schieman, Docket No. 88-02868, 1991 WL 202358 (N.A.S.D. June 17, 1991), the investor, sought damages in arbitration alleging that his discount broker had induced him to purchase unsuitable investments. The Panel awarded the customer a portion of his claim and wrote:
“Claimant, Joel Peterzell, contributed to his losses by providing false information, devising a questionable strategy and continuing to trade as losses mounted. Suitability, however, is an ongoing obligation and, although Charles Schwab initially met its suitability obligations, it failed to maintain any ongoing supervision of the Claimant’s suitability….
At some point in time, Claimant became unsuitable, even with his false representations. Charles Schwab’s Compliance Department should have, at that time, realized his losses were disproportionate to his claimed net worth and annual income.”