How Did This Happen?

Anthony V. Trogan, Esq.
Lysa Postula-Stein, Esq.

CLAIMS AGAINST SECURITY BROKERS
AND FIRMS FOR MISCONDUCT

By Anthony V. Trogan, Jr. - From Hall's Consumer Guide to Legal Services,
The DANKRIS Publishing Co., pp. 62-63.

An individual fortunate enough to accumulate enough wealth to allow investment activity in securities markets is faced, usually unwittingly, with choices he or she is ill-equipped to make. Experience, study and even formal training often does no more than instill a false sense of security. The range of investment instruments and sophisticated strategies available today far surpasses historical alternatives.

Most investors turn to investment specialists (brokers, financial advisors, financial planners) for their advice. Fortunately, most investors are able to locate honest agents with a high degree of respect for their customers' money and who are able to formulate sound strategies to achieve their clients' investment goals. Unfortunately, and far too often, investors rely upon advisors who are insensitive to or who are unaware of the risks they expose their clients to, or who are outright charlatans interested only in the commissions they can earn.

Securities brokerage firms have become more aggressive in seeking new business and have forsaken their traditional role as investment counselors in favor of marketing. After several years of bull market activity, competition for the retail investor dollar became intense. Firms and their employees became lax in their advisory function as rising market prices concealed bad advice and new industry sponsored products, often misunderstood by the brokers themselves, allowed expansion into new, never before tapped investor groups.

Claims by clients against securities firms and their broker employees for misconduct are not new. There is a well established body of statutory, regulatory and case law which supports the right of customers to recover losses. New abuses are generally covered with dispatch when discovered. What has changed is an increasing awareness by customers that they may seek redress and an increased volume of claims resulting from the forces already mentioned, and the crash of October 1987.

There are several types of claims which can be made. The nature of the claims overlap and a broker who transgresses in one category will often do so in several.

Foremost in the relationship between securities broker and investor is the requirement that the broker fully disclose all material information regarding the investment before it is made.

Inadequate risk disclosure most often forms the basis of a claim when high risk investment formats are employed such as margin trading, options and commodities. However, even more conservative investments all involve risk which must be disclosed adequately. For instance, fixed rate bonds are interest rate sensitive and a substantial loss of principal can result if the bonds are sold prior to maturity and at a time when market interest rates exceed the fixed rate. Also, not all bonds are the same. Some highly rated unsecured municipal or corporate bonds are far safer than other fully secured bonds.

All investments are not appropriate for all investors. Some investors have more money to put at risk than others and are more willing to accept a loss in the hope of achieving a high return. Your securities broker is charged with the responsibility of gearing your investments to your financial and emotional ability to afford the activity and the losses which might result. For instance, retired investors on pensions should not trade any substantial portion of their assets in volatile high risk strategies. Investors should not put borrowed money or his home equity into the market in the hope of a quick score. A broker who encourages or allows this may be forced to cover the loss himself.

Unless you have given you broker a binding power of attorney, he may not trade in your account absent your express prior approval. He is responsible to you if he does.

Do not be sweet talked into accepting a trade you have not authorized. If you allow this, it is as if you authorized the trade before it was made.

Excessive trading results when a broker, interested in commissions, and who controls you or the account, trades excessively for his and not for your benefit. This is called churning. This type of claim is usually associated with activity which is unsuitable for the customer.

A good guide to whether an account has been churned is to examine the turnover ratio. Divide the total value of newly opened positions by the average equity in the account. If the account has been turned over more than four times during a twelve month period, the account probably has been churned. Depending on suitability, a lower ratio may support a churning claim.

Brokers sometimes make a mistake when entering an order or fail to enter an order altogether. Beware when a broker says we made a mistake - but - we'll trade our way out of it. If you go along with the broker, a court may later say that you ratified or forgave the error. If your broker makes a mistake, complain orally and in writing immediately. It is his problem, not yours.

A myriad of regulations govern a broker's conduct. Violation of these rules can get your broker and you in trouble. Be cautious when your broker says I'm really not supposed to do this - but _________. Do not let him do it.

Millions of dollars are lost each year by investors who become involved in outright frauds. They are too numerous to mention and new ones are created each day.

Do not give your investment dollars to telephone solicitors in distant cities. Checking with the Better Business Bureau is a waste of time.

If the scheme sounds too good to be true - it is.

Claims against brokers are made almost exclusively through arbitration rather than in courts of law as the result of recent court decisions. However, you can be forced to arbitrate only if you sign a contract to arbitrate. Read your account opening agreement carefully and cross out the arbitration clause if you want to retain your right to sue in court.

Treat your investment dollars with utmost care. You worked hard for this money. Do not waste it carelessly or in the wild hope of spectacular short term gains.

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