The High-Stakes World of Alternative Investments and FINRA Rules

Alternative investments — including hedge funds, REITs, private placements, and structured products — can offer clients diversification and higher returns. But they also carry complex risks, low liquidity, and strict compliance requirements.

For brokers and financial advisors, even minor errors like failing to assess suitability, omitting key risk disclosures, or misrepresenting investment terms can trigger:

• FINRA arbitration claims
• Regulatory investigations
• Investor lawsuits

If you’re facing a FINRA claim or regulatory action, legal defense is critical.

What Are Alternative Investments?

Alternative investments are non-traditional assets outside stocks and bonds. They often involve higher risks and unique tax implications.

Types of Alternative Investments Brokers Handle

• Private Equity & Venture Capital – Investments in privately held companies.
• Hedge Funds – Actively managed pooled funds with diverse strategies.
• Real Estate Investment Trusts (REITs) – Investments in income-generating real estate.
• Structured Products – Customized financial instruments tied to assets.
• Private Placements (Reg D Offerings) – Unregistered securities sold to accredited investors.

Because of their complexity, brokers must follow FINRA and SEC regulations closely when recommending these investments.

Common Broker Mistakes in Alternative Investments

1. Recommending Unsuitable Investments (FINRA Rule 2111)

• Mistake: Ignoring client’s financial goals, risk tolerance, or liquidity needs.
• Problem: Violates FINRA Suitability Rule 2111.
• Legal Consequences: FINRA arbitration claims, fines, or suspensions.
• Defense: Prove risk disclosures were provided. Show recommendations were suitable.

2. Misrepresenting Investment Risks (FINRA Rule 2020)

• Mistake: Exaggerating returns or downplaying risks.
• Problem: FINRA Rule 2020 prohibits misleading statements.
• Legal Consequences: Investor misrepresentation claims; regulatory fines.
• Defense: Written risk disclosures. Signed client acknowledgments.

3. Overconcentrating Portfolios in Alternative Investments

• Mistake: Allocating too much of a portfolio to risky or illiquid alternatives.
• Problem: Overconcentration magnifies losses and undermines diversification.
• Legal Consequences: FINRA negligence claims; firm liability for poor supervision.
• Defense: Show client knowingly accepted allocation. Provide eligibility documentation.

4. Failing to Provide Proper Disclosures (FINRA Rule 5123)

• Mistake: Not filing offering documents or providing private placement memoranda.
• Problem: Violates FINRA Rule 5123, requiring timely filings and disclosures.
• Legal Consequences: Fraud allegations, fines, license suspension.
• Defense: Prove risk disclosures and acknowledgments were provided.

5. Using Non-Compliant Marketing Materials (FINRA Rule 2210)

• Mistake: Using unapproved, misleading, or exaggerated promotional materials.
• Problem: Violates FINRA Rule 2210 governing advertising.
• Legal Consequences: FINRA enforcement actions, investor lawsuits.
• Defense: Show compliance with marketing rules. Prove investors understood risks.

Protecting Brokers and Investors in Alternative Investments

Alternative investments are attractive but high-risk, making FINRA compliance essential.

For brokers: Maintain clear documentation, follow compliance processes, and provide written disclosures.

For investors: Understand risks and ensure brokers align recommendations with your financial objectives.

If disputes arise, FINRA arbitration or mediation may be the fastest way to resolve claims.

Facing allegations? Contact an experienced securities attorney today to safeguard your career and reputation.

FAQs About Alternative Investments and FINRA Rules

1. What are alternative investments?

They are non-traditional assets like hedge funds, REITs, private equity, and private placements.

2. Why are alternative investments risky?

They often have low liquidity, high fees, and complex risks compared to traditional securities.

3. What FINRA rules apply to brokers handling alternatives?

Key rules include:

• Rule 2111 (Suitability)
• Rule 2020 (Misrepresentation)
• Rule 5123 (Disclosures)
• Rule 2210 (Advertising)

4. What legal claims do investors file against brokers?

Common claims include unsuitability, misrepresentation, negligence, and fraud.

5. How can brokers defend against allegations?

By proving risk disclosures, suitability assessments, and regulatory compliance.

6. Should investors hire a lawyer if they lost money in alternatives?

Yes. A securities attorney can file FINRA arbitration to recover losses.

External Resource

For more details, see FINRA’s Guidance on Alternative Investments.