NEW YORK (Dow Jones)–A new client comes into your office. A 50-something 

man in the market for financial advice, he just sold his successful business 

for millions of dollars. Clearly, this guy knows what he’s doing. 

  Not necessarily. Assume the business was a heating and air-conditioning 

company, or a chain of car washes. A smart businessman doesn’t have to be 

well-versed in investment decisions, and a large amount of wealth doesn’t 

always translate to financial sophistication. 

  That basic tenet of assessing suitability may have more relevance in a world 

of baby boomers made newly wealthy by selling their businesses, selling their 

real estate, inheriting money or cashing out of their savings plans. (A 

Practice Management column, also published Wednesday, addresses how to serve 

clients with new wealth.) 

  From a compliance perspective, it’s essential for brokers and advisors to 

really know their customers - not just how much they have in the bank, but how 

they got it and what that means about their financial savvy. 

  “More people coming out of the workforce…  have just put away money every 

month in their 401(k)s and leave with $2 million to $3 million,” said Todd 

Taylor, managing director in charge of financial advisor recruitment and 

development at Morgan Stanley (MS). He added that those investors may have 

invested sums only in the thousands of dollars in the past. “This newfound 

wealth is a large account by any standard…  but sophistication may or may 

not be there.” 

  Although the Financial Industry Regulatory Authority’s suitability rule 

doesn’t name sophistication as a factor that must be considered when brokers 

recommend investments, it has a broad requirement that brokers “make 

reasonable efforts to obtain” information that may factor into what’s 

appropriate for a particular customer. 

  Suitability is always a regulatory concern, but it’s become an especially 

hot topic given regulators’ current emphasis on protecting seniors, retirees 

and those nearing retirement. A broker who misjudges a client’s sophistication 

and comfort level and therefore makes an unsuitable recommendation can find 

himself in big trouble. FINRA’s November disciplinary actions show that it 

barred one registered representative and fined and suspended another for 

making unsuitable recommendations. 

  “It’s easy for advisors to assume that because someone has a lot of money 

that they are more sophisticated,” said Craig Rappaport, author of “Live Long Live Rich “It’s also easy to 

assume those people are willing to take extra risk.” 

  Research released this spring by marketing and research consulting firm 

Harrison Group Inc. and American Express Publishing Corp., a division of 

American Express Co. (AXP), shows that wealth doesn’t necessarily correlate 

with investment experience. 

  More than 1,300 people with household discretionary incomes of at least 

$125,000, or incomes after mortgage and taxes, participated in the late 2006 

survey. 

  Almost 80% of respondents grew up middle class or below and nearly 70% have 

been wealthy for less than 15 years. About one-third run their own business 

and one-third run someone else’s business. 

  Sixteen percent of respondents’ wealth was earned through financial 

investments. 

  That’s why it’s critical to ask certain questions upon meeting a new client: 

“Have they invested in securities, mutual funds, different asset classes? How 

often? Were they the primary decision-makers? All these tests are designed to 

assess sophistication and suitability,” said Andres Vinelli, chief economist 

at FINRA. “Financial sophistication is very different from being a 

sophisticated person in general.” 

  Many brokerage firms include these types of questions as part of the basic 

information customers provide when they open accounts. 

  At Morgan Stanley, financial advisors are taught to dig deep into their 

clients’ investing experience as part of a “discovery process,” Taylor said. 

They don’t just find out how many years the client has been investing, but 

they gauge the depth of that experience: In the firm’s “investor style 

questionnaire”, financial advisors ask clients to say whether they agree or 

disagree with statements such as “investing intimidates me” or “I follow the 

stock market on a regular basis.” 

  Beyond that, Taylor said, FAs might ask about a client’s best and worst 

investments in the past, or their previous relationships with advisors. 

  “It’s very important they understand what the clients know and don’t know 

about investments,” Taylor said. “As products become more complex and clients’ 

needs become more complex, there are a lot more issues out there for an 

advisor to uncover…. It takes a more thoughtful approach.” 

  Not only will being thoughtful in considering clients’ sophistication help 

advisors build rapport, but it will also help keep them out of regulatory hot 

water. 

  “Sophistication and being wealthy are just not one concept,” Vinelli said. 

“Representatives should be attuned to that reality. (There are) pretty 

intelligent and sophisticated individuals who don’t have a clue how to 

evaluate products on the market.”