Before you get agitated about the subject of this blog, here are some caveats: I don’t believe all brokers are bad. Not all losses are caused by broker misconduct. And I am not trying to drum up business for securities arbitration lawyers. (The good ones already have more cases than they can handle.) Securities arbitration is a minefield for investors. It should not be undertaken lightly.
Nevertheless, there are circumstances where your losses have been caused by broker misconduct. Rather than just accept those losses and try to move on, here's how to tell when you have a legitimate claim against your brokerage firm.
Unsuitable investments. Most brokers don’t understand how to measure risk. As a consequence, many investors have a portfolio that is unsuitable for them because it is too risky (and sometimes too conservative). Brokers are legally obligated to recommend only suitable investments, given the investment objectives and tolerance for risk of their individual clients.
Unsuitable investments can include investments that are so risky they are not suitable for anyone (like some unsecured promissory notes) and investments that are too risky for a particular investor. Inadequate diversification of a portfolio and improper asset allocation are also common examples of unsuitable investments.
Churning, or excessive trading in an account for the primary purpose of generating commissions, is a form of unsuitability. You will need a forensic expert to analyze the trades in your portfolio to measure and quantify the trading activity. Most securities arbitration lawyers regularly use experts who know how to run this analysis.
Unauthorized trading. It is surprisingly common for brokers to make trades in an account without receiving permission to do so. Typically, they defend these cases by claiming you agreed to it or ratified the trade by getting a confirmation and raising no objection at the time. If you believe there has been unauthorized trading in your account, you should consider filing a claim.
Misrepresentations and omissions. Misrepresentations and omissions occur when the broker does not disclose the risk inherent in an investment recommendation he or she makes or in a recommended trading strategy. To prevail on this claim, you need to prove not only the misrepresentation or omission, but its materiality. You need to show you would have acted differently if the true facts had been disclosed to you. The most common misrepresentation is the failure to disclose the risk of an investment.
Other claims. There is other conduct giving rise to a claim against your broker. These include forgery, front running (where the broker buys or sells for his account before doing the same for your account), order failure, selling away (where a broker sells securities or other investments outside the scope of his employment), failure to supervise, and activity relating to margins accounts.
If you believe you have been a victim of broker misconduct, you should consult with a securities arbitration lawyer. A good resource is the Public Investors Arbitration Bar Association, which is an association of securities arbitration lawyers who represent investors. If you have a smaller claim you might qualify for free representation by one of the clinics sponsored by law schools. For those who want a more in-depth discussion, you will find details in my book, Does Your Broker Owe You Money?.
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book, The Smartest Money Book You'll Ever Read, was published on December 27, 2011.
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