Stockbroker Liability

Stockbroker Liability

If you have suffered losses in the stock market, it can be through your own fault, but very often, you may have been improperly treated by your stockbroker, often called an “investment advisor,” or “investment consultant.” This is a misnomer, because they are just salesmen, interested in generating commissions for themselves and their firm. They do not always have their clients’ best interests in mind. Here is a little synopsis of what to look for:

Claims by investors against their stockbrokers and other investment advisors fall into several different categories.

The most common claims are:

  • Unsuitability
  • Churning (excessive trading)
  • Lack of diversification
  • False Representations, omitting material facts
  • Failure to execute (follow instructions)
  • Misappropriation

Unsuitability

In making an investment recommendation to a client, a broker must make recommendations that are consistent with the customer’s risk tolerance, needs and investment objectives. A broker has a duty to know his client and only recommend investments and trading strategies that are suitable for that client. An investment may be unsuitable if a customer does not have the financial ability to incur the risk associated with a particular investment, or if the investment was not in line with the investor’s financial needs; or if the customer did not know or understand risks associated with certain investments.

A broker has a duty to understand the risk tolerance of an investor, the tax considerations for the client, the client’s prior experiences and appetite for risk, and the level of return desired. It is the duty of a broker to make recommendations that are appropriate and suitable given his client’s circumstances. If a broker breaches those duties and makes unsuitable recommendations for a client, the broker may be liable to that client.

Churning

A broker trades your account excessively, generating commissions without regard to the welfare of the investor. Often, the broker will sell the profitable stocks and keep the losing ones, showing a small profit, but the customer would have been much better off if the stock had remained in the portfolio. Churning requires a showing that the pattern of trading activity in your account was excessive, including calculations to determine the annualized rate of return that would be necessary to cover the commissions charged in your account; the number of times the equity in your account is turned over to purchase securities; and the purchase and sale trading activity that occurs in your account. If a broker is buying and selling securities in your account to generate commissions that seem excessive, and he always has some reason why you should take quick profits, there is a strong possibility that your account is being churned.

Lack of Diversification

One of the most important rules of investing is diversification. If a broker concentrates your portfolio in any individual investment or type of investment, then the risk of losses with that portfolio is dramatically increased. Its the old adage that it is unwise to place all of your “investment” eggs in one basket. A broker who does not diversify his client’s portfolio is potentially liable if that investment declines in value.

Misrepresentation or Omissions

A broker is liable to a client if that broker misrepresents material facts or omits to disclose material facts to the investor regarding an investment, and that client loses money as a result. Often these misrepresentations or omissions disguise the risk associated with a particular investment. A broker has a duty to fairly disclose all of the risks associated with an investment.

Failure to execute

Brokers have a duty to their customers to execute instructions to trade stocks and if they do not follow the instructions of the client, resulting in a loss to the client, they are liable for those losses.

Misappropriation

A broker may simply misappropriate an investor’s funds. This often occurs in situations where the broker is not reporting a particular transaction to his employer. This practice is known as “selling away.” In connection with selling away, it is important to remember that, even if the firm employing the broker is unaware of the transaction in question, or even of the existence of a particular customer, the investor often recovers from the firm on a theory of respondeat superior, controlling person liability under both the state and federal securities laws, or negligent supervision.