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Stockbroker Malfeasance

What Can You Do If Your Stockbroker or Investment Firm Swindles You?

When an investor believes that her stockbroker has broken a rule or cheated him out of money, by overcharging on commission fees, misappropriating investment funds, or giving false, exaggerated, or misleading information about a financial product, as examples, the investor has a remedy that is cheaper than going to court: she can demand arbitration of her claims.  Today nearly every contract between a stockbroker and investment client contains a mandatory arbitration clause.  If the written agreement states that arbitration is required and the dispute involves the securities business of the stockbroker or the investment firm, the investor must arbitrate.  Arbitration has become the primary means for the resolution of disputes between investors and their stockbrokers or investment firms.

The arbitration procedures for resolving claims by investors against their stockbrokers and investment firms are administered by the Financial Industry Regulatory Authority (FINRA), which is the successor entity to NASDAQ.  FINRA is an independent regulator for all securities firms in the United States and its purpose is to protect investors through its rules and procedures such as requiring brokers to be registered, examining securities firms, drafting and enforcing rules for securities brokers, and monitoring trading in stock markets in the U.S.  There are a many ways that investors can be defrauded or unfairly deprived of their money and investments, limited only by the ingenuity of the small minority of stockbrokers who are unscrupulous.  Some of the more common scams by unscrupulous stockbrokers are briefly discussed below.  FINRA oversees the arbitration process for making these claims, which begins with the filing of an arbitration demand and claim and ends with a formal arbitration hearing, decision and award by the panel of arbitrators.

Common Investment Scams and Claims against Stock Brokers and Investment Firms

Claims for Churning

Churning is an illegal and unethical practice that occurs when a stockbroker engages in excessive buying and selling of securities or other investments in a customer’s account chiefly to generate commissions that benefit the broker.  For churning to occur, the broker must exercise control over the investment decisions in the customer’s account, such as through an agreement giving the broker discretion on investment decisions.  Frequent purchases and sales of securities that don’t appear necessary to fulfill the customer’s investment goals may be evidence of churning.  Churning is a violation of both SEC and FINRA rules.

Unsuitable Investments

Some investments may not be appropriate for the needs and goals of different investors. For example, some investors may desire higher risk investments in the hopes of achieving above-average returns, while others may be satisfied with a lower rate of return but want less risky investment strategies to meet their financial needs. Stockbrokers have a duty to recommend only those investments that they believe are suitable for their customers’ financial situations. If a broker earns higher commissions on certain investment products, her investment recommendations may be influenced by the expected commissions from those products although those products may not be the proper investments based on the customer’s needs and goals. Such skewed and improperly founded broker recommendations violate the stockbroker’s fiduciary duties and can lead to significant losses and harm to the broker’s customers.

Claims for the Investment Firm’s Failure to Supervise the Stockbroker

FINRA imposes on investment firms a duty to supervise their registered stockbrokers. The failure to supervise a registered stockbroker may give an investor a cause of action against the brokerage firm due to the conduct of its registered representatives. The wrongful activities of registered brokers, such as the unauthorized taking of customer funds, falsifying account records, or engaging in unauthorized trades in customer accounts, can lead to the brokerage firm’s liability under tort law, SEC Rule 10b-5, and can be the grounds for an arbitration claim under FINRA.

Margin Disputes or Improper Margin Transactions

Trading on margin occurs when an investor or broker purchases securities worth more than the investor’s cash or equity in the account.  Due to the varying values of stocks and other securities, margin purchasing can cause significant losses if a security purchased on margin declines below the value of the investor’s equity and the investor is called on to repay the loan.  If a broker purchased securities on margin without the investor’s knowledge or consent, the broker may be liable to the investor for any losses on a claim of improper margin transactions.

Claims for Stockbroker Breach of Fiduciary Duty

Stockbrokers owe their customers a fiduciary duty which requires that they act with the utmost good faith, integrity and loyalty due to the position of trust or confidence that they hold in relation to their customers.  Under this fiduciary duty, brokers are required to act in the best interest of the customer, must use due care when recommending investment decisions, and must inform the customer of risks involved in purchasing or selling particular securities.

Claims for Stockbroker Breach of Contract

Contracts are legally enforceable mutual promises or agreements, which can be oral, written, or implied by the actions of the parties.  As part of the contract between the stockbroker and client, the broker may promise or agree to handle the account in a certain manner.  If an account is not managed in the manner promised by the broker and losses occur, the investor may have a cause of action for breach of contract against the broker and the brokerage firm.  In addition, principles of contract law require that the parties act in good faith and fair dealing to each other.

Rule 10b-5 Violations

SEC Rule 10b-5 prohibits fraud or deceit in connection with the purchase or sale of a security. This rule imposes civil liability on any person who makes a false statement, or omits to state a material fact, in connection with the purchase or sale of a security. A fact is material if it is likely that a reasonable investor would consider the fact or omission important in deciding whether to enter into the transaction. Private citizens can bring claims for violations of this rule. If a person recommending, purchasing, or selling a security knows non-public information that would likely affect the price of the security, that person cannot engage in any transaction involving that security without disclosing the information to the other party.

Arbitration under FINRA

What is arbitration?

Arbitration is an alternative to bringing a lawsuit in court to resolve a dispute.  It is a more informal dispute resolution process in which the parties (investors, brokers and investment firms) select a neutral third party called an arbitrator to hear the case and decide the outcome.  Under FINRA rules, arbitration panels are composed of either one or three arbitrators who are selected by the parties.

Arbitration of an investor’s claim against a stockbroker under FINRA begins with the filing of a statement of claim by the client that describes how she was harmed by her stockbroker or investment firm and the relief she is seeking.  The stockbroker or firm responds to the claim by filing an answer that sets up their defenses to the claim.  Next, the parties receive lists of potential arbitrators and select the panel to hear their case.  Prior to the hearing, the arbitrators and parties meet telephonically to schedule hearing dates and resolve preliminary issues.  There is a limited amount of discovery which allows the parties to obtain information such as by the exchange of documents and the interview of witnesses in preparation for the hearing.  The parties and arbitrators then meet in person to conduct the hearing in which the two sides present arguments and evidence in support of their respective cases.

After the hearing, the arbitrators deliberate and then prepare a written decision, which is called the award.  Arbitration decisions are final and binding on all parties. By arbitrating your claim, you forego the opportunity to have the same claim decided in court.

Advantages of arbitration

Arbitration is generally confidential, unlike cases decided in a court. However, if an award is issued at the conclusion of the case, FINRA posts the award on its database, which is publicly available. On average, the arbitration process takes much less time to complete than a court case, and the cost of arbitration is usually substantially lower.

If you have been believe that you have been scammed or swindled by your stockbroker or investment firm, and you live in the state of California, call me for a free consultation to discuss your case.