Broker Investigations

A stockbroker cannot sell you investments that are not sold to you by the brokerage firm. Typically, these outside investments are riskier and payout a higher commission to the broker. For instance, if your broker solicits you to purchase securities away from the brokerage firm, your broker is “selling away.” This is a violation of the Financial Industry Regulatory Rules, state securities laws, and federal securities laws. Usually, these investments are in the form of limited liability partnerships and private placements. If you are a victim of selling away, you may have legal rights against your broker and the brokerage firm.

Did your broker or financial advisor overconcentrate your portfolio into one or just a few sectors? Diversifying your portfolio helps create a buffer during turbulent economic times. Further, a broker's failure to diversify a customer's portfolio may result in an excessive amount of risk to the investor. Over-concentration of an account is rarely suitable for any investor, especially elderly customers and clients who have a low-risk tolerance. Therefore, if you have too much of one stock, one sector, or several mutual funds owning the same core holdings, you may have legal rights against your broker and the brokerage firm.

The landmark case of Piper, Jaffray & Hopwood, Inc. v. Ladin, 399 F. Supp. 292; 1975 U.S. Dist. LEXIS 16441 (S.D. Iowa August 26, 1975), holds that “The imposition of a duty to investigate the financial capability of an investor entering a margin transaction and to inform that investor of the implications of a margin purchase can also be justified as part of a stockbroker’s professional responsibility.” If you have been put on margin without your permission, were not fully warned of the risks of investing on margin, or do not feel that it was suitable for someone of your age, experience, risk tolerance or net worth to be placed on margin you may have legal rights against your broker and the brokerage firm.

Did your broker or financial advisor excessively buy and sell securities in your account? Generally, churning is the practice of executing trades in order to generate commission for the broker or financial advisor. For churning to occur, your broker or financial advisor must exercise control over the investment decisions in your account. Churning can be a violation of SEC Rule 15c1-7 and other securities laws, worthy of broker investigations.

The Financial Industry Regulatory Authority (FINRA) has rules prohibiting churning and excessive trading. Excessive trading is the same as churning, but without the requirement that the person engaging in the trading does so for the purpose of generating commissions. Churning and excessive trading can violate FINRA Rule 2310, and FINRA Rule 2310-2(b)(2).

It is also against state securities laws and federal securities laws to churn an account. If you are a victim of churning you may have legal rights against your broker and the brokerage firm. Contact us if you're interested in broker investigations due to churning.

Did you lose money due to a stock broker or financial advisor churning your account?

Broker-client disputes typically involve allegations that a brokerage firm and its registered representative churned or excessively traded a client’s portfolio in order to generate income for the broker and the firm and/or that the client was sold investments that were not suitable given the client’s investment objectives. At the root of churning cases is the question, “Was there a reasonable probability that the securities trading would be sufficiently profitable to cover its cost?”

Economists and securities industry professionals are often called as expert witnesses to assist arbitration panels in determining whether an account has been churned and, if so, what damages have been suffered by the client. Simple ratios and rules of thumb have long served as traditional economic analyses of liability and damages issues in churning cases. However, advances in computer technology and in our understanding of financial economics now allow for more thorough analyses.

The two common indicators of alleged excessive trading in churning cases: are 1) turnover ratios and 2) cost-to-equity ratios. Turnover ratios measure how often, on average, the securities in a client’s portfolio are traded in a year. Cost-to-equity ratios measure the annual cost of the trading as a percentage of the client’s investments.

There are three common measures of damages in churning and suitability cases: 1) out-of-pocket loss, 2) benchmark portfolio or well-managed account, damages, and 3) trading costs. Out-of-pocket loss is the change in a client’s equity less any net deposits made during the period. Out-of-pocket loss is an inappropriate measure of damages because it ignores the opportunity cost of invested funds. Also, general market movements that are unrelated to the alleged fraud significantly affect the out-of-pocket measure.

The benchmark portfolio measure of damages corrects the deficiencies in the out-of-pocket loss measure. The benchmark portfolio measure of damages is the difference between what the client’s equity would have been had the portfolio been appropriately managed and the client’s actual equity at the end of the disputed period. The benchmark portfolio measure of damages is most widely used in cases where the primary allegation is that unsuitable securities were purchased for the client.

Trading costs (commissions, bid-ask spreads, mark-ups and markdowns, margin interest, and fees incurred by the client) are a widely used measure of damages in churning cases. Although not generally understood, the simple trading cost measure suffers the same flaws as the out-of-pocket loss because, like out-of-pocket losses, it ignores the opportunity cost of invested funds. Fortunately, the adjustment necessary to correct the simple trading cost measure is straightforward and closely related to the benchmark portfolio measure of damages.

Your broker or financial advisor cannot make false statements or omissions. If your broker or financial adviser only talked about the “upside” and how much money you are going to make, without talking about the potential risk to your money, this may constitute a material misrepresentation or omission by your broker. Your broker has a duty to disclose to you known or readily available information such as the earnings and financial health of each company's stock.

False statements often include promises about future performance, price predictions, any guarantees, and special knowledge about the performance of a particular security. Omissions are the failure to disclose known or discoverable risks about an investment. If you are a victim of false statements or material omissions you may have legal rights against your broker and the brokerage firm. Contact us for broker investigations over false statements.

Did your broker or financial advisor recommend that you purchase an overly aggressive mutual fund? Did your broker or financial advisor disclose the underlying securities owned in the funds along with the inherent risks of the fund? Did your broker or financial advisor excessively trade your mutual funds? Did your broker or financial advisor explain the difference between share classes before you purchased your mutual fund? The difference between class A shares and Class B shares is that class A shares charge a front-end sales charge and class B shares do not impose a front-end sales charge. With class B shares a contingent deferred sales charge is used which is paid to the broker at the time of the sale. If you own class B shares you are generally charged a substantially higher annual expense than class A shareholders. Before purchasing class B shares in a mutual fund your broker or financial advisor should have carefully explained the difference in commissions between class A and class B shares. If you answered yes to any of the above questions or were sold class B shares without full disclosure of the risks and commissions you may have legal rights against your broker and brokerage firm.

Anyone who sells securities must also be registered under the Financial Industry Regulatory and the Securities Exchange Commission broker/dealer registration rules or find an exemption from registration. This is true for anyone who gives financial advice as to the purchase and sale of securities. Investment advisers must also be registered or find an exemption. When an investor purchases a security and the registration provisions have not complied with the investor may have a right to rescind the transaction and/or hold the unregistered party liable for damages. Federal securities laws and state “blue sky” laws require brokers, brokerage firms, and the securities sold to be either registered or exempt from registration. If your broker or financial advisor is not registered or sold you unregistered securities you may have legal rights against the broker and brokerage firm. Contact us for help with broker investigation.

http://smartcheck.cftc.gov/ Smart Check is an easy-access free tool to check the background of a financial professional and do your own quick broker investigations.  Smartcheck.gov shows pending actions and more.