When investments lose value, many investors assume that they must be at fault and that there is no recourse because nearly all investments include an element of risk. The truth is that, although not all investment losses are legally actionable, there are many instances where losses are the result of a broker’s negligence, recklessness, or willful misconduct. In such instances, an aggrieved investor can seek compensation by filing a securities arbitration claim.
Typical Claims in a Securities Arbitration
When making investment recommendations to a customer, a broker is obligated to recommend investments that are suitable, i.e., that are consistent with the customer’s risk profile, investment objectives, and overall financial situation. Specifically, FINRA Rule 2111 requires that a broker “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [broker’s firm] or associated person to ascertain the customer’s investment profile.”
Although some investors grant their brokers discretion to buy and sell securities in their account without obtaining the customer’s specific approval for each trade, the majority of brokerage accounts are non-discretionary. In non-discretionary accounts, a broker is required to obtain customer approval before each and every transaction. An unauthorized trade occurs when a broker executes a trade in a customer’s non-discretionary account without the customer’s permission.
Although each investor’s circumstance is unique, it is widely recognized that putting all of a person’s financial eggs in one basket is risky, and that diversification is key to protecting a portfolio from catastrophic loss. Over-concentration occurs when an investor’s assets (or a substantial portion of them) are placed into a single investment or class of investments. A broker may be liable if his recommendations exposed his customer’s account to substantial loss due to over-concentration.
Misrepresentation / Omission
The law prohibits brokers from making misrepresentations to customers about investments or from failing to disclose facts and risks associated with an investment. A broker may be liable if he misrepresented an investment or failed to disclose material facts that affected a customer’s investment decision. With respect to omissions, it may be difficult for a customer to know what material information his or her broker failed to disclose. An experienced securities attorney can assist by investigating an investment to determine what information should have been disclosed.
Churning / Excessive Fees
Many investors pay their brokers a commission every time the broker purchases or sells a security on the investor’s behalf. Churning occurs when a broker engages in excessive trading in a customer’s account primarily to maximize commissions. A churning claim may be established by analyzing the trading patterns and activity in an investment account.
In addition to churning, a broker may be liable for generating excessive fees if he recommends a more expensive product or service to a client when an equally suitable and less expensive alternative is available.
Margin Trading / Excessive Leverage
At many brokerage firms, customers may purchase securities with their own funds or they may borrow money from their brokerage firms to pay for their securities. Borrowing money to invest is called trading “on margin” and is inherently riskier than trading with existing savings. At the same time, margin accounts can be very profitable for brokerage firms, which collect interest on the loans extended to customers and increased commissions resulting from the customer’s leveraged trading. Using margin is a high-risk method of investing and is only appropriate for sophisticated investors who fully understand the risks. A broker may be liable if he encourages the use of margin in unsuitable situations or without fully and clearly disclosing the associated risks.
Breach of Fiduciary Duty
A fiduciary obligation exists whenever a relationship with a customer involves a special trust, confidence, and reliance on the fiduciary to use his expertise in acting for the customer. Stockbrokers and financial advisors are often considered to be fiduciaries of their customers, and thus obligated to act in their customers’ best interests. This duty is generally recognized where a broker is exercising discretion in a customer’s account or making recommendations to a customer. Liability may arise if the investment decisions or recommendations made by a broker are contrary to a customer’s best interests.
If a broker fails to adhere to industry standards while handling a customer’s account and fails to act as a reasonable and prudent financial professional would have acted, then the broker may be liable for negligence.
Failure to Supervise
Brokerage firms have obligations under FINRA’s rules and their own policies and procedures manuals to supervise the activity of their brokers. Among other things, brokerage firms are required to review customer account transactions to confirm that they are in line with the customer’s investment objectives, to monitor potentially excessive trading, and to review correspondence between brokers and customers. A brokerage firm may be liable if it fails to investigate wrongdoing by its brokers or otherwise fails to supervise their behavior.