Liquidity Need

A firm assigns each product on its approved list a general risk rating, such as low, medium, or high. A principal approves a recommendation as suitable primarily because the product carries the firm's "low risk" rating, without separately considering whether other factors specific to this particular customer, such as her liquidity needs or tax situation, might make the product inappropriate for her despite its general risk category. Is relying on the product's general risk rating this way adequate?

1. A.Yes — a product's assigned risk rating is specifically designed to reflect its overall suitability for any customer whose account documentation doesn't indicate a specific objection to that risk level.Wrong. A general product risk rating is not designed to capture individualized customer factors like liquidity needs or tax situation.
2. B.No — a product's general risk rating reflects a broad category assessment and doesn't account for factors specific to an individual customer, such as liquidity needs or tax situation, that can make even a generally low-risk product unsuitable for a particular person; suitability requires looking at the specific customer, not just the product's general category.Correct. Individualized customer factors need their own consideration beyond a product's general risk category.
3. C.No, but only because the firm's risk rating categories should include more gradations than just low, medium, and high.Wrong. Adding more rating categories does not address that a product-level rating can't capture individualized customer factors.
4. D.Yes, provided the customer's account documentation does not specifically list liquidity needs or tax considerations as a stated concern.Wrong. The absence of a stated concern on the form does not mean those factors don't need to be considered as part of an individualized analysis.

Why: No. A product's general risk rating reflects a broad category assessment and doesn't account for factors specific to an individual customer, such as liquidity needs or tax situation, that can make even a generally low-risk product unsuitable for a particular person; suitability requires looking at the specific customer, not just the product's general category.

A client with high liquidity needs over the next few months should hold:

1. A.A 30-year bondA 30-year bond can be sold at any time, which makes it look marketable, but its price swings with rates and the client could be forced to sell at a loss precisely when cash is needed. Liquidity for a short horizon means principal stability, not just the ability to find a buyer.
2. B.An illiquid partnershipAn illiquid partnership interest generally has no ready secondary market and may impose transfer restrictions or lockups. That is the opposite of what a client needing cash within months requires.
3. C.A small-cap growth fundFund shares redeem daily, so this choice satisfies marketability, but small-cap growth is among the most volatile equity categories. A short horizon leaves no time to recover from a drawdown, so the redemption feature alone does not make it suitable.
4. D.A money market fundCorrect - liquid and stable.

Why: A money market fund or short-term instruments provide the liquidity and stability needed.

A customer clears the minimum income and net worth standards printed in a program's prospectus. The representative proposes placing a large share of the customer's liquid assets into that program. What has the customer's clearing of those standards accomplished?

1. A.It establishes that the recommendation is in his best interest, since the sponsor set those standards.Wrong. A sponsor's threshold is a condition on who may buy, not a judgment about any individual.
2. B.It moves responsibility for the recommendation to the sponsor, which drafted and published the standards.Wrong. Responsibility for a recommendation stays with the party who made it.
3. C.It clears a minimum condition for buying at all and leaves the firm's own care and concentration analysis intact.Correct. Eligibility is settled; everything the firm owes the customer is still open.
4. D.It makes concentration irrelevant, because a qualifying investor can by definition bear the loss.Wrong. Capacity to absorb a sized loss is not capacity to absorb a loss of any size.

Why: A program's stated investor standards are an entry gate the sponsor writes for a whole class of purchasers, and they say nothing about whether this holding, at this size, serves this customer. The recommending firm still owes its own care obligation, which reaches the customer's other holdings, his liquidity needs and how much of the portfolio the position would represent. Clearing the gate and being well served by the recommendation are separate findings, and the first never supplies the second. Had the representative proposed a modest position consistent with the rest of the portfolio, the concentration objection would fall away while the gate requirement stayed exactly where it was.

A representative previously determined that a program was suitable for a customer based on a profile showing stable salaried employment and a meaningful cash reserve. Before the customer's next subscription to an additional program, the representative learns the customer was recently laid off and has been drawing down that cash reserve to cover living expenses. May the representative proceed with the next subscription based on the customer's original profile?

1. A.Yes, because the original profile was accurate and complete at the time the account was opened.Wrong. Accuracy at account opening does not excuse ignoring a material change the representative has since learned about.
2. B.Yes, provided the new program is similar in structure to the one previously found suitable.Wrong. Similarity between programs does not address the customer's changed financial circumstances.
3. C.No, but only because firms must refresh every customer's profile on a fixed annual schedule regardless of any change.Wrong. The obligation here arises from the specific material change the representative learned about, not from a routine annual refresh cycle.
4. D.No, because the representative must incorporate the material change she has learned about before recommending a further subscription.Correct. Suitability must be assessed against currently known facts, not the original profile alone.

Why: No. A customer's investment profile is not a one-time record established at account opening and then fixed; it must be updated when the representative learns of a material change, and a job loss combined with drawing down the cash reserve that previously supported the customer's liquidity needs is exactly that kind of change. Proceeding with an additional illiquid commitment based on a profile that no longer reflects the customer's actual financial situation ignores information the representative now has, which defeats the purpose of maintaining a current profile in the first place. The original determination was reasonable when it was made, but reasonableness is evaluated against what the representative knows at the time of each recommendation, not what was true when the account was first opened. The representative needs to reassess suitability in light of the updated facts before recommending the next subscription.