This article is authored by Timothy Lyons with the assistance of John Marinan, Esq.
Investments and securities trading are carefully regulated by various governing authorities, primarily for the purpose of protecting investors. The violation of such regulations, particularly through various deceptive actions and schemes to cheat or take advantage of investors, is commonly known as securities fraud.
The financial services industry is under increased regulation by such agencies. For example, there is a proposal by the Department of Labor for a new fiduciary rule for brokers. In addition, the Financial Industry Regulatory Authority (“FINRA”) is suggesting that pricing on alternative investments, specifically non-traded real estate investment trusts, be made more transparent for investors. The Securities Exchange Commission (“SEC”) has focused on sales strategies, trading activities and disclosures from ETFs and Variable Annuities. Leverage ETFs (complex ETFs) in particular, would be under microscopic analysis regarding suitability standards, and to the extent they are used by brokers in client portfolios.
SEC Chairwoman Mary Jo White has stated: “Through information – sharing and conducting comprehensive examinations, OCIE (Office of Compliance Inspections and Examinations) continues to promote compliance with Federal Securities Laws to better protect investors in the markets.”
During 2015 FINRA also levied fines for “unsuitable” mutual fund transactions, especially where brokers and broker-dealers failed to provide break point discounts and take measures to control improper “switching”. FINRA Conduct Rule IM-2310-3, relating to Fair Dealing with Customers, specifically provides that the trading of mutual fund shares, which are not proper trading vehicles particularly on a short-term basis, is a violation of the FINRA rules.
Against this landscape investors must clearly take an active role in checking their transactions and trading activity which appear on their account statements, especially transactions they do not recognize or did not authorize. Despite the fact that you may pay careful attention to the recorded activities on statements received for your accounts, there may be instances when a broker fails to set up your account under suitable guidelines. Additionally, failure by a brokerage firm to supervise a broker or advisor may result in fines or censure by the regulatory agencies against the broker and the brokerage firm.
Two instances in which an investor may have cause to pursue a securities fraud action against a broker and/or brokerage firm to recover realized losses on their account, are: (1) Suitability; and, (2) Misrepresentation and Omissions.
Suitability - FINRA Rule 2111 and Regulatory Notice 12-25
In making an investment recommendation to a client, a broker’s recommendations must be consistent with the client’s risk tolerance, needs and investment objectives. A broker has an affirmative duty to know his or her client’s financial profile and life stage and only recommend investments and trading strategies that are suitable for that particular client.
If a broker breaches their duties and makes an unsuitable recommendation(s), the broker may be liable to that client for any losses realized. An investment may be “unsuitable” if a client does not have the financial ability to incur the risk associated with a particular investment. If the investment was not in-line with the client’s financial needs or if the client did not know or understand risks associated with certain investments, an action may lie against the broker and/or brokerage firm.
A broker must also have a “reasonable basis for the recommendation” made on a client’s trading account. The broker’s source for the recommendation may be the firm’s research, in which case the firm must also have had a reasonable basis for its own recommendations made.
Misrepresentation and Omissions - FINRA Conduct Rule 3010
FINRA Conduct Rule 3010 specifically provides that:
“Each member shall establish and maintain a system to supervise the activities of each registered representative and associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with the Rules of this Association.”
A brokerage firm or broker can be held liable if the firm and/or broker misrepresents material facts, or fails to disclose information, to the client regarding an investment where the client subsequently incurs losses. Often the misrepresentations or omissions disguise the risk associated with a particular investment. A broker, and the brokerage firm, have a duty to fairly disclose all of the associated risks to the client prior to the transaction of the investment.
Many investors who have been defrauded are unaware of what happened to their investment until it is too late, and only realize afterwards that losses have occurred in their account. Some typical warning signs of potential securities fraud and/or broker misconduct include the investor is unable to recognize what trades were made in the account; the broker’s recommendations do not make sense to the investor; clear misrepresentations by the broker; high pressure sales trading tactics by the broker; the inability for the investor to liquidate funds from the account; surprise margin calls made by the broker; and, unsatisfactory answers by the broker to explain certain trading transactions to the investor.
Fortunately the law provides recourse for investors to recover trading losses which were caused by the broker’s fraud and/or misconduct. If you believe that you have been a victim of securities fraud or other broker misconduct, you have certain rights you should be aware of which may provide you the opportunity to recover the value of the losses incurred. In such situations you should consider seeking legal counsel to assess whether you have any potential claim(s) to recover any account losses.
Author: Timothy Lyons