* The purchase of low priced ("penny") stocks for anyone but the most speculative investor. There have been a number of arbitration cases brought by investors against "boiler room" operations that push low priced stocks in which the broker-dealers make a market. The sales tactics of these companies generally prey on the greed of the potential customer. Often, these brokers will promise huge returns in short periods of time and pressure investors to make immediate purchases. These tactics should, of course, raise a red flag to anyone.

* The purchase of certain corporate bonds ("junk bonds"), may provide high returns but involve a high risk. Since interest rates have been lower in recent years, investors who previously relied upon investments in Certificates of Deposit to provide interest income have, in many cases, sought higher returns than the CD's could provide. Respondents will assert in their Answer that the customer demanded higher rates of return and surely should have realized that higher rates meant higher risks.

* The purchase of illiquid partnership interests for an individual who requires liquidity. If a customer has limited liquid assets, the purchase of partnership interests for which there may or may not be a secondary market, may be deemed unsuitable. Often, the sale of partnership interests, particularly when they are proprietary to a broker-dealer, results in higher commissions to the selling broker, creating significant motivation to induce his or her customers to invest.

Under the rules of the National Association of Securities Dealers (NASD), a broker recommending the purchase or sale of a security to a client is required to have "reasonable grounds for believing that the recommendation is suitable for such client upon the basis of the facts, if any, disclosed by such client as to his or her other security holdings and as to his or her financial situation and needs." [NASD Manual - Rules of Fair Practice, Art. III Sec. 2].

The New York Stock Exchange's (NYSE) "Know Your Client" rule requires members to use due diligence to learn the essential facts relative to every client. [NYSE Rule 405].

It is incumbent upon a broker to elicit information concerning the client's investment objectives and financial needs. Under the Rules of Fair Practice, a broker must recommend only those securities he believes, after investigation of the issuer, to be consistent with the client's objectives and needs.

Misrepresentations and Omissions

This is one of the most common issues in securities arbitration. Misrepresentation may be intentional or unintentional. A broker may be held liable for misrepresenting the risks of an investment or for failing to disclose the risks when the broker knew or should have known that the customer would rely on what he said or failed to say regarding the risks of the investment. The misrepresentation or omission must have been made "in connection with" the customer's decision to buy or sell the security.

For example: A broker works for a broker-dealer that serves a market maker for XYZ Corporation. The broker calls a client and tells the client only that XYZ Corporation is a great buy because the Company just entered into a contract which calls for the sale of millions of widgets to ABC Corporation. The broker knew, but failed to tell the client that the sales from XYZ to ABC account for 50% of XYZ's total business over the next three years. The contract does in fact exist and XYZ's financial projections demonstrate that the Company will profit significantly from the contract. The day before the broker made the call to the client, the broker learned that ABC Corporation had filed for bankruptcy and the broker fails to mention this to the client.

The client buys the stock of XYZ Corporation and, not surprisingly, the stock drops by 75% within the month. The argument is that the client bought the XYZ stock based upon or "in connection with" the broker's representation regarding the contract between XYZ and ABC (which was a material factor in the client's decision to invest in XYZ) and, "but for" the broker's failure to mention that 50% of XYZ's business came from ABC and that ABC had filed for bankruptcy protection, (which was significant, rather than incidental) the client would not have purchased the stock. The balance of the argument is that the fall in the value of XYZ's stock was directly attributable to the insolvency of ABC corporation. These factors are necessary to establish causation. "But for" the misrepresentation and omissions on the part of the broker, the client would not have acted in the manner he did and "but for" the wrongful conduct on the part of the broker, the client would not have suffered losses.To establish causation, you must be able to show both loss causation -- that the representations or omissions caused the economic harm and transaction causation -- that the violations in question caused you to engage in the transaction in question.

Positive statements by a broker about a particular security may be "puffery", but alone are not sufficient to state a cause of action. However, a broker's guarantee that a security will yield a specific percentage return may be actionable. To determine whether or not such a representation constitutes a cause of action, you must examine the issue of justifiable reliance on the misrepresentation. This can be particularly important where the oral representations of the broker are disputed by a prospectus or other written material provided to you.

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