Every recommendation stands on the client file behind it, and that file has to exist before the trade.
You can't judge whether an investment fits a person you don't know. The North American Securities Administrators Association (NASAA) therefore makes asking a conduct rule. NASAA Model Rule 102(a)(4)-1(a) covers recommendations that an advisory client buy, sell or exchange a security. Making one without reasonable grounds to believe it suits the client is an unethical business practice. Those grounds must be based on reasonable inquiry into the client's investment objectives, financial situation and needs. NASAA model rules bind a state only as that state adopts them.
KEY: Recommending without inquiry is itself the violation, even if the investment later does well. The inquiry must also come first. A profile completed after the trade supports nothing.
After a reasonable inquiry, you may generally rely on what the client tells you. Facts that contradict those answers still call for follow-up questions.
Identity comes first. Confirm the client is who they claim to be, usually with a government-issued photo ID.
Common mistakes
- Counting home equity as a cushion. Dana's $348,000 net worth looks roomy. Her $72,000 of liquid net worth and $24,000 reserve gap rule out a seven-year lockup.
- Grossing up by the effective rate. Gross up by the marginal rate, as the TEY example shows.
- Using old Social Security math. For anyone born in 1960 or later, claiming at 62 cuts 30%, not the 25% that applied when FRA was 66. Waiting until 72 still pays 124%, not 140%.
Bottom line
- Recommend only after reasonable inquiry into objectives, financial situation and needs (NASAA Model Rule 102(a)(4)-1(a)).
- Keep the written client information behind each recommendation, and update it when circumstances change (Model Rule 203(a)-2(a)(18)).
- Give each goal an amount, a date and a priority, and fund needs before wishes.
- Surplus is income minus fixed and discretionary expenses, and three to six months of expenses sit in reserve before anything long-term or illiquid.
Exam shortcut
Work profile questions in decision order. Eliminate any answer that recommends a product before facts are gathered or updated. Next, check for the reserve before anything illiquid, and needs before wishes. On a TEY question, find the marginal bracket. An effective rate in the stem is bait. For claiming questions, multiply the FRA benefit by 0.70 for age 62 or by 1.24 for age 70. Stop the credits at 70.
The full lesson (about 4,184 words, 28 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- C20
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