Time since appeal filed – 11 months 2 days
Time since last brief – 8 months 11 days
Pages – 19
Footnotes – 36
Summary
This one is a blockbuster because it adopts a per se suitability rule prohibiting reps from recommending risky strategies including non-diversified investments or margin for unsophisticated investors of modest means – even those who want to speculate. It is one of the most important Commission cases in many years on the issue of suitability.
Cespedes was a registered rep at A.G. Edwards. NYSE censured and barred him for 10 years based on unsuitable recommendations to 14 customers. He recommended margin debt and high concentration in technology based unit investment trusts that was not suitable for his elderly and unsophisticated customers.
Unit investment trusts are not actively managed and are non-diversified. They are heavily weighted in only a few stocks. They are much more volatile than more diversified investments such as mutual funds. Not only did Cespedes recommend his clients invest in unit investment trusts, but he also recommended they use margin debt to make the investments. All the clients were unsophisticated, trusted Cespedes, and were seeking low risk investments with little or no risk to their principal. Most were retired or nearing retirement age, and had modest annual incomes and net worth.
The case is of note because it emphasizes that a rep has a duty "to make 'a customer-specific determination of suitability and to tailor his recommendations to a customer's financial profile and investment objectives.'" (footnote omitted)
It is also very important because it prohibits a rep from recommending risky investments or strategies even to an unsophisticated investor of modest means who wants to speculate.
Discussion
This case is interesting because the Commission appears to be adopting a per se rule concerning suitability – risky investments may never be recommended for unsophisticated investors of modest wealth. Indeed, the Commission noted that regardless of whether a customer wants to engage in speculation a registered rep must abstain from making recommendations inconsistent with the customer's financial situation. In other words, speculative investment recommendations are per se unsuitable for certain investors, regardless of the investor's objectives. Further, highly concentrated investments or highly speculative strategies such as margin are per se not suitable for investors who seek safe non-speculative investments and who can not stand the loss of their entire principal.
The opinion includes significant discussion of the inherent risks due to non-diversification and trading on margin. It finds that these strategies are wholly unsuitable for investors who seek to preserve capital, are unsophisticated or are seeking non-volatile investments.
Also of note is that the Commission relied on customer new account documents for determining customer objectives. It rejected Cespedes claim that customer objectives might have changed, noting that this claim was inconsistent with actual investor testimony
Comment
The Commission emphasized that risky investments, including margin, may never be recommended for unsophisticated investors of modest wealth. Reps under such circumstances may perhaps take orders, but must refrain from recommending.
Unit investment trusts are not actively managed and are non-diversified. They are heavily weighted in only a few stocks. They are much more volatile than more diversified investments such as mutual funds. Not only did Cespedes recommend his clients invest in unit investment trusts, but he also recommended they use margin debt to make the investments. All the clients were unsophisticated, trusted Cespedes, and were seeking low risk investments with little or no risk to their principal. Most were retired or nearing retirement age, and had modest annual incomes and net worth.
The case is of note because it emphasizes that a rep has a duty "to make 'a customer-specific determination of suitability and to tailor his recommendations to a customer's financial profile and investment objectives.'" (footnote omitted)
It is also very important because it prohibits a rep from recommending risky investments or strategies even to an unsophisticated investor of modest means who wants to speculate.
Discussion
This case is interesting because the Commission appears to be adopting a per se rule concerning suitability – risky investments may never be recommended for unsophisticated investors of modest wealth. Indeed, the Commission noted that regardless of whether a customer wants to engage in speculation a registered rep must abstain from making recommendations inconsistent with the customer's financial situation. In other words, speculative investment recommendations are per se unsuitable for certain investors, regardless of the investor's objectives. Further, highly concentrated investments or highly speculative strategies such as margin are per se not suitable for investors who seek safe non-speculative investments and who can not stand the loss of their entire principal.
The opinion includes significant discussion of the inherent risks due to non-diversification and trading on margin. It finds that these strategies are wholly unsuitable for investors who seek to preserve capital, are unsophisticated or are seeking non-volatile investments.
Also of note is that the Commission relied on customer new account documents for determining customer objectives. It rejected Cespedes claim that customer objectives might have changed, noting that this claim was inconsistent with actual investor testimony
Comment
The Commission emphasized that risky investments, including margin, may never be recommended for unsophisticated investors of modest wealth. Reps under such circumstances may perhaps take orders, but must refrain from recommending.
