Investment firms that are members of the New York Stock Exchange (NYSE) are governed by many stringent regulations that may not apply to other investment firms.
For example, NYSE rule 405, the "know your customer" rule, requires registered representatives of NYSE-member firms to obtain pertinent facts about every customer's security holdings, financial condition and investment objectives. This information helps identify potential investments that may or may not be compatible with the customer's needs.
If an investor wishes to purchase a security that the investment representative believes is incompatible with the customer's stated objectives and risk tolerance, the investment representative is likely to ask the investor to read and acknowledge a "risk letter" prior to purchase.
Risk letters give investors an opportunity to seriously consider their positions before making investments. A risk letter is typically a standard form that the investment representative and client complete together. The form includes the amount and description of the purchase and a brief statement explaining why the customer wants to buy the security. If the security is sold by prospectus only, the investor also must acknowledge in the risk letter that he or she has received the prospectus and has been informed of any fee, commission or surrender charge that may apply to the transaction.
The risk letter also emphasizes potential risks, such as market fluctuation or overconcentration in one industry or sector. If, after reading the letter, the investor still wants to make the purchase, he or she and the investment representative sign the risk letter, and it becomes part of the investor's file.
Many investors question the need to sign risk letters when they can make other investments without question. Risk letters are required by most brokerages whenever a proposed investment is not consistent with the customer's stated objectives or with his or her normal investments.
Risk letters are designed to ensure customers understand the risk of certain investments and are willing to accept that risk before an investment is made.
About the Author
For twenty years Adam Starchild has been writing books about investing and related subjects, and they are published by a variety of publishers. They are available in many bookstores and public libraries.
For more information on asset protection, see
Asset Protection &
Becoming Judgment Proof.
Copyright © 1995 by Adam Starchild
The Investor's Library has reprinted this copyrighted article with the permission of the author.