Recognizing Unsuitable Recommendations
Understanding what makes a recommendation unsuitable is just as important as knowing what makes it suitable. Recognizing red flags helps protect customers and avoid regulatory violations.
Categories of Unsuitable Recommendations
1. Product Mismatch
When the product doesn't match customer needs:
| Red Flag | Example |
|---|---|
| Risk mismatch | Aggressive funds for conservative investor |
| Time horizon mismatch | Illiquid products for short-term needs |
| Objective mismatch | Growth funds when income is needed |
| Tax mismatch | Muni bonds in IRA (no tax benefit) |
2. Excessive Trading (Churning)
Churning is excessive trading to generate commissions:
| Indicator | Description |
|---|---|
| High turnover rate | Portfolio traded multiple times per year |
| High cost-equity ratio | Trading costs high relative to account value |
| In-and-out trading | Buying and selling same securities quickly |
| Unnecessary switches | Moving between similar products |
Key Point: Churning violates the quantitative suitability component of Rule 2111.
3. Switching Violations
Switching involves moving a customer from one product to another:
| Suitable Switch | Unsuitable Switch |
|---|---|
| Lower fees, better performance | Higher fees, no benefit |
| Better matches objectives | Resets surrender period |
| Customer requested | Generates new commission |
| Documented benefit | No documented rationale |
Recent FINRA Enforcement (2025)
FINRA ordered Securities America to pay $2 million in restitution for:
- Over 1,000 unsuitable Class A mutual fund switches
- Over 2,000 unsuitable short-term sales
- Customers paid $2,019,040 in unnecessary fees
Variable Annuity Red Flags
Unsuitable VA Recommendations
| Red Flag | Why It's a Problem |
|---|---|
| VA inside IRA/401(k) | Tax deferral already exists, adds fees |
| Short time horizon | Surrender charges, no time to benefit |
| Elderly customer | May not benefit from long-term tax deferral |
| Frequent VA exchanges | New surrender period, lost benefits |
| Ignoring fees | Higher costs than alternatives |
VA Exchange Concerns
When recommending a VA exchange, consider:
- Is the customer giving up valuable benefits (stepped-up death benefit)?
- Will a new surrender period begin?
- Are fees comparable or lower?
- Is there a documented customer benefit?
Senior Investor Concerns
FINRA has heightened focus on recommendations to seniors:
Red Flags for Senior Sales
| Red Flag | Concern |
|---|---|
| Long surrender periods | May exceed life expectancy |
| Complex products | May not understand |
| High-risk investments | May not have time to recover |
| Liquidity constraints | May need access to funds |
| Large percentage of assets | Over-concentration |
FINRA Rule 2165 Protections
Firms can:
- Place temporary holds on suspicious disbursements (up to 25 business days)
- Contact trusted contact person
- Report suspected exploitation
Breakpoint Violations
Breakpoint Selling
Breakpoint selling occurs when sales are structured to avoid breakpoints:
| Violation | Example |
|---|---|
| Just below breakpoint | $49,500 purchase when $50,000 gets discount |
| Splitting purchases | Multiple smaller purchases to avoid breakpoint |
| Not disclosing LOI | Failing to mention Letter of Intent option |
| Not aggregating | Not combining family accounts for ROA |
Key Point: Representatives must inform customers of breakpoint opportunities. Failure to do so is a violation.
Concentration Risk
Over-Concentration Concerns
| Red Flag | Issue |
|---|---|
| Single sector | All assets in one industry |
| Single security | Too much in one stock/fund |
| Single asset class | No diversification |
| All with one company | VA + funds from same insurer |
Suitable recommendations typically include appropriate diversification.
Documentation Failures
What Must Be Documented
| Element | Importance |
|---|---|
| Customer profile | Basis for suitability |
| Recommendation rationale | Why this product |
| Alternatives considered | Due diligence evidence |
| Risks disclosed | Customer understanding |
| Customer acknowledgment | Agreement to proceed |
Red Flag: Missing Documentation
If you can't document why a recommendation was suitable, it may not have been suitable.
Consequences of Unsuitable Recommendations
For Representatives
| Consequence | Description |
|---|---|
| Fines | Monetary penalties |
| Suspension | Temporary bar from industry |
| Expulsion | Permanent bar from industry |
| Disgorgement | Return of commissions |
| Restitution | Compensate customer losses |
For Firms
| Consequence | Description |
|---|---|
| Fines | Can be millions of dollars |
| Restitution orders | Repay affected customers |
| Enhanced supervision | Additional regulatory oversight |
| Reputational damage | Loss of customer trust |
Preventing Unsuitable Recommendations
Best Practices
- Know your customer - Thorough KYC before recommending
- Know your product - Understand what you're recommending
- Document everything - Rationale, disclosures, acknowledgments
- Consider alternatives - Is there a better option?
- Ongoing review - Monitor recommendations over time
- Ask questions - When in doubt, seek guidance
Key Exam Points
- Churning - Excessive trading for commissions, violates quantitative suitability
- VA in IRA - Classic example of unsuitable (redundant tax deferral)
- Breakpoint selling - Structuring to avoid discounts is a violation
- Switching - Must document customer benefit, not just commission
- Senior investors - Heightened scrutiny, may place temporary holds
- Concentration - Over-concentration in single sector/security is unsuitable
- Document - If you can't show why it was suitable, it may not have been
A representative recommends numerous trades in a customer's account, generating significant commissions but providing little benefit to the customer. This practice is called:
A customer wants to invest $49,500 in Class A mutual fund shares. The breakpoint for a reduced sales charge is $50,000. What should the representative do?
Which of the following is a red flag for an unsuitable variable annuity recommendation?
6.1 Mutual Fund Transactions
Chapter 6: Processing Transactions