What Investors Need to Know About the Most Common Forms
When you invest, you are accepting certain risks. The market is inherently unpredictable, and there are never any guarantees that an investment will work out in your favor. There’s always a possibility that you will lose money.
Even still, your broker owes you certain duties when investing your money. Unfortunately, stockbroker misconduct — negligence or even downright fraud — is a very real and a very serious problem in the United States; one that costs investors hundreds of millions annually.
The Financial Industry Regulatory Authority (FINRA) reported that more than 2,500 arbitration claims were filed in the first seven months of 2018.
The true extent of broker negligence is far higher: stockbroker misconduct and securities fraud are notoriously underreported. Broker misconduct comes in many different forms.
Here, I’ve provided an overview of the most common forms of stockbroker misconduct that investors need to be aware of.
11 Common Forms of Stockbroker Misconduct
- Unsuitable Investment Recommendations
- Material Misrepresentation or Omission of Material Facts
- Lack of Proper Diversification
- Excessive Trading (Churning)
- Breach of Contract
- Unauthorized Trading
- Stockbroker Selling Away
- Breach of Fiduciary Duty
- Broker Negligence
- Outright Fraud
- Violation of Blue Sky Laws
1. Unsuitable Investment Recommendations
The single most common form of stockbroker misconduct is the violation of FINRA Rule 2111 (the suitability rule). Stockbrokers and investment advisors have a duty to refrain from pushing unsuitable investments on customers.
All brokers are required to recommend securities, financial products, and investment opportunities that are appropriate for the needs and goals of their individual customers. Before making an investment recommendation, stockbrokers must consider an investor’s:
- Financial status;
- Investment objectives;
- Financial experience;
- Retirement goals;
- Risk tolerance;
- Understanding of the investment; and
- Overall portfolio holdings.
If a stockbroker makes unsuitable investment recommendations and an investor loses money as a result, that investor may have a viable legal claim for compensation. In this situation, the investor should consult with an experienced stockbroker misconduct lawyer.
2. Material Misrepresentation or Omission of Material Facts
When you work with a stockbroker or investment advisor, you are entitled to accurate information regarding any proposed investments. Financial professionals must refrain from making material misrepresentations to investors.
Before you can make a sound investment, you have to know a considerable amount of information about the security or financial product that is in question. Beyond the requirement to refrain from misrepresenting material facts, brokers must also disclose all relevant information. If a broker omits material information, and they knew or should have known that the information was relevant, then they may be held responsible for misconduct.
Unfortunately, some brokers attempt to market complex, risky financial products by simply failing to inform investors of the ‘downsides’. All material information should be disclosed so that investors can make an informed decision.
In some cases, brokers make material misrepresentations that are simply lies. Stockbrokers have a duty to provide good faith, accurate, and reasonably comprehensive information to investors. If a stockbroker makes a material misrepresentation regarding a certain investment opportunity, that is a form of misconduct. However, in other cases, a material misrepresentation could be a set of statements that are technically true, but that is so misleading as to put false information into the mind of a reasonable investor.
It could potentially be actionable. In addition, brokers cannot cover up or decline to disclose adverse information about an investment. A misrepresentation by omission of a material fact is still a very serious form of broker misconduct.
3. Lack of Proper Diversification
One of the very first things that most people learn about investing is that they should not put their eggs in one basket. As simple as this advice may sound, it is incredibly important. It is the key to protecting your nest egg. Of course, actually applying this to real-world situations can be far more complicated than many people realize.
Stockbrokers have a professional obligation to ensure that they are not over-concentrating the financial assets of an investor. If an investor loses money due to lack of diversification in their brokerage account(s), they may have been a victim of broker misconduct.
4. Excessive Trading (Churning)
One of the best ways to increase your overall investment returns is to limit your costs and fees. On a purely practical level, there are costs associated with making securities trades and other financial transactions. When considering the advisability of a certain opportunity, investors must always be aware of the impact of commissions and fees. Likewise, stockbrokers are not permitted to recommend or execute trades unless there is a legitimate reason to do so.
Making frequent trades is generally a poor strategy, as it will result in you paying additional transaction fees, which will eat away at your profits. Your broker must have a good reason to make every trade.
If a broker is trading frequently, simply to up their own fees, then they are churning your account. This is a serious form of misconduct. Stockbrokers must always take care to make sure that they are not making an unreasonable number of trades on behalf of a customer.
5. Breach of Contract
Brokers must comply with their obligations under FINRA industry rules and U.S. securities laws. In many cases, the relationship between a stockbroker and an investor is governed by a contract. In fact, the majority of investors are required to sign a customer agreement when they open a new brokerage account at an investment firm. This is a binding contract. This brokerage agreement grants rights and responsibilities to both parties. For their part, stockbrokers are required to follow the terms of the customer agreement.
If your broker deviated from this agreement in any manner, and you sustained financial losses as a result, you may be able to hold the broker legally liable for your damages.
6. Unauthorized Trading
Stockbrokers must have the proper authorization before they can execute a transaction on behalf of a customer. Unfortunately, unauthorized trading remains one of the most common forms of financial professional misconduct. While unauthorized transactions sometimes involve outright fraud, this is not always the case.
This authorization can come in two different forms:
- You can give a broker discretionary authority, meaning they must stick to a certain investment strategy specific trades without your express approval.
- Alternatively, you can open a non-discretionary account, meaning your broker must get your authorization for every single trade.
There are many examples of stockbrokers failing to seek proper authorization because they got lazy, sloppy, or believe that the investor would reject advice that the broker thought was best. In any circumstance, stockbrokers do not have the legal right to make unauthorized transactions. When dealing with a non-discretionary relationship, brokers must seek approval from an investor for every trade. When dealing with a discretionary relationship, brokers must follow the core instructions of the investor.
If a transaction was made without your approval, you can bring an unauthorized trading claim.
7. Stockbroker Selling Away
Broker selling away puts investors at serious risk. This type of stockbroker misconduct occurs when a financial professional improperly sells or offers an investment opportunity to an investor outside the bounds and supervision of their FINRA member firm.
Brokers must receive approval from their member firm before they can engage in a private securities transaction. When brokers fail to seek such approval, they are engaging in a serious form of misconduct. It does not matter how ‘good’ the broker feels the investment opportunity is; oversight from a registered FINRA member firm is always required. Investors deserve protection.
8. Breach of Fiduciary Duty
Under the Investment Advisers Act of 1940, registered investment advisors owe their clients a fiduciary duty. This means that they have a professional responsibility to put their customers’ best interests first, even above their own best interests.
In practice, a fiduciary duty requires an investment advisor to do many different things, including acting with adequate professional skill, avoiding conflicts of interests, and dealing fairly with the investors. Often, when this duty is breached, investors have multiple causes of action.
9. Broker Negligence
Brokers are licensed professionals. They have a basic duty to perform their job with adequate attention and skill. The failure to do so is negligence. Broker negligence comes in a wide variety of different forms. All financial professionals have a legal duty to ensure that they have done their due diligence before recommending an investment opportunity or financial product to their clients. If a broker fails to conduct proper due diligence, and the investor sustains serious financial losses as a result, the broker may be held legally liable for the investor’s damages.
10. Outright Fraud
Unfortunately, in some cases, brokers commit outright fraud against their clients. This can happen in many different ways. In the very worst cases, a broker may even steal money (conversion of funds) or forge an investor’s signature on documents. While this can happen to any investor, outright fraud schemes are often targeted at vulnerable investors. This includes elder financial abuse.
11. Violation of Blue Sky Laws
United States securities law is incredibly complex. Securities are governed by federal law, industry rules, and state regulations. Blue Sky Laws are state-level regulations that have been set up to protect investors. They typically require sellers to register their offerings with state-level securities regulators, such as the Florida Office of Financial Regulation or the New York Investor Protection Bureau.
Get Help From aStockbroker Misconduct Lawyer Today
Our legal team is standing by, ready to help.
At Sonn Law Group, our stockbroker misconduct attorneys are fierce advocates for investors nationwide. If you sustained significant losses due to stockbroker misconduct, we can help. For a free, fully private review of your stockbroker losses claim, please do not hesitate to contact our law firm today.