The Financial Industry Regulatory Authority (“FINRA”) regulates brokers and brokerage firms in the United States. FINRA places substantial duties upon stockbrokers to protect their clients against the risk of substantial portfolio losses. When these losses occur, often it is the result of broker misconduct.
Recommendations to Purchase Securities
First, before a brokerage firm recommends that a client invest in any security, it must make every attempt to familiarize itself with the customer’s financial situation and needs, investment experience, and risk tolerance.
FINRA rules require a member broker to have reasonable grounds for believing that a recommendation is suitable for the customer based on other securities holdings, the customer’s financial situation, and investment needs.
Examples of a FINRA violation include:
- Recommending speculative securities without attempting to obtain information about the client’s financial situation, needs, and other assets
- Recommending trades that are too expensive, too risky, or beyond the client’s financial ability
- Borrowing or using customer’s fund or securities
- Failing to describe important facts and risks about the security to each client
- Fraudulent activity – making unauthorized transactions in a customer’s account or setting up fictitious accounts to disguise prohibited activities
- Making trades of excessive size in a client’s account
- Churning in a client account (making trades too frequently)
“Investment Strategy” Recommendations
A FINRA rule explicitly applies to recommended investment strategies involving a security or securities. The rule emphasizes that the term “strategy” should be interpreted broadly. The rule is triggered when a firm or broker recommends a security or strategy regardless of whether the recommendation results in a transaction.
Recommendations to Hold Securities
The Georgia Supreme Court has expressly held that Georgia financial advisors can be held liable for unsuitable recommendations to hold securities — as well as buy and sell them—when the recommendation amounts to intentional or negligent misrepresentation. In addition, under FINRA, the term “strategy” would capture a broker’s explicit recommendation to hold a security or securities.
Thus, losses resulting from a broker failing to have a reasonable basis for recommending that a client hold a security may be recoverable.
Over-Concentration in a Client Account
In many cases involving substantial losses from unsuitable investments, a claimant also has a claim for over-concentration. A broker is liable for a claim of unsuitability when he or she over-concentrates high-risk and speculative securities in a customer’s account. This broker liability for over-concentration arises even in the face of a broker claim that the client recognized the risk. Significantly, the SEC has declared that even if the client is aware of the risks, a broker can be liable for over-concentration. A security that is suitable at a small concentration may become unsuitable at large concentrations in an account.
For years, the SEC, FINRA and the New York Stock Exchange have routinely fined and sanctioned brokers for over-concentrating their clients’ accounts in as little as 20% in a single industry or security, including mortgage-backed securities.
Other Broker Misconduct
Fraud Recoverable portfolio losses may arise out of federal and state law fraud claims against a broker. The Georgia’s Uniform Securities Act provides a cause of action against a seller for making “an untrue statement of a material fact or omit[ing] to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.”
Breach of Fiduciary Duty Breach of fiduciary duty is an important theory of recovery for broker misconduct. A confidential, fiduciary relationship exists between a broker and his client. “[A] stockbroker’s duty to account to its customer is fiduciary in nature, so that the broker is obligated to exercise the utmost good faith.”
In Georgia, the fiduciary duties of an investment broker include:
(1) the duty to recommend [an investment] only after studying it sufficiently to become informed as to its nature, price, and financial prognosis;
(2) the duty to perform the customer’s orders promptly in a manner best suited to serve the customer’s interests;
(3) the duty to inform the customer of the risks involved in purchasing or selling a particular security;
(4) the duty to refrain from self-dealing . . .;
(5) the duty not to misrepresent any material fact to the transaction; and
(6) the duty to transact business only after receiving approval from the customer.
A broker’s violation of his regulatory duties does not create to a private right of action, but it may provide evidence in evaluating whether the broker properly exercised his or her required degree of care. Most customer agreements incorporate applicable laws, rules and regulations into the contract with the customer. Therefore, violations of industry rules by the broker can rise to a breach of contract claim.
Time Limits to Bring Claims for Broker Misconduct
Claims for broker misconduct must be brought in a timely manner. Virtually all broker-customer agreements require customers to bring claims against a broker exclusively through the FINRA arbitration process. FINRA arbitration claims must be brought against member broker within six years of “the occurrence or event giving rise to the claim.” However, FINRA panels have been known to apply much shorter state statutes of limitations regarding various causes of action so it is best to move to investigate all potential claims as soon as possible.
In summary, an observant accountant can provide his client with substantial additional value by spotting evidence of losses possibly caused by broker misconduct. By suggesting the client contact a qualified securities lawyer to investigate possible claims, the accountant may provide his client with the relatively rare opportunity to recover substantial portfolio losses.
To learn more about James Dunlap, visit www.jamesdunlaplaw.com.