Stockbroker Negligence, Stockbroker Fraud

The federal securities laws do not create a scheme of "heads I win, tails you lose" investors' insurance. There is risk inherent in investing in any security. Your broker and your brokerage firm are not the guarantors or insurers of investment decisions.

Hindsight is always twenty-twenty, and making the wrong investment decision may be merely the result of bad judgment, and not the result of intentional or reckless conduct.

If, however, you have been the victim of securities fraud, here are some common claims or causes of action against stock brokers and investment professionals.

Suitability

Suitability is based on a customer's age, income, net worth, education, stated investment objectives and prior investment experience. NASD Conduct Rules require that in recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to their other security holdings and as to their financial situation and needs. Despite the temptation to realize excessive returns in the stock market, investors should be aware of risk. Those seeking to double their money in the stock market ought to be prepared to lose it all.

Among other things, however, if your broker has willfully disregarded your stated investment objectives and has failed to properly diversify your investment portfolio, or has over concentrated your portfolio in volatile, or speculative securities, or has recommended, low priced or speculative securities, including stocks, junk bonds, or mutual funds, or has misstated or omitted the risks inherent in a particular investment, and thereby took chances with money you could not afford to lose, you may have a claim for suitability.

Excessive Activity or "Churning"

Securities brokers are typically compensated by each transaction effected in your securities account. Sometimes brokers effect these transactions in your account, not for the purpose of reasonably fulfilling your stated investment objectives, but instead in an effort to generate excessive commissions for themselves and their firm. Such conduct is called churning and is actionable under the federal securities laws.

Churning or Excessive activity is examined in light of the customer's investment objective and the type of securities being traded. For example, it may be inappropriate to pay a sales charge by buying and selling a mutual fund in a period of, let us say, a year. However, during this same period, it may not be inappropriate for a person seeking to trade options turn over their account twenty times.

Churning is often marked by short holding periods without any appreciable change in securities prices. Churning is often measured by the account's "turnover rate," or the total purchases divided by the average value of the account, and the "Goldberg rate," which is the commissions charged divided by the average value of the account. On an annual basis, these calculations show the number of times your account was turned over and how much your account had to return just be break even after paying commissions. Once again, what is reasonable depends on your acceptance of risk and measure of anticipated returns.

However, if you think that you may have been the victim of excessive activity, you should have your account reviewed by a professional.

Margin Account Fraud

"The imposition of a duty to investigate the financial capability of an investor entering a margin transaction and to inform that investor of the implications of a margin purchase can also be justified as part of a stockbroker's professional responsibility." Piper, Jaffray & Hopwood, Inc. v. Ladin, 399 F. Supp. 292; 1975 U.S. Dist. LEXIS 16441 (S.D. Iowa August 26, 1975).

Even many experienced investors do not understand margin accounts. When you purchase securities on margin, your brokerage firm is lending you money to pay for these securities. Initially, you may use cash equal to half the securities purchased, or pledge certain fully paid securities. Either way, you owe the brokerage firm, or most likely its clearing agent, the debit balance, or the amount borrowed to pay for these securities.

Trading on margin increases the risk of loss to a customer for two reasons. First, the customer is at risk to lose more than the amount invested if the value of the security depreciates sufficiently, giving rise to a margin call in the account. Second, the client is required to pay interest on the margin loan, adding to the investor's cost of maintaining the account and increasing the amount by which his investment must appreciate before the customer realizes a net gain. At the same time, using margin permits the customer to purchase greater amounts of securities, thereby generating increased commissions for the salesperson.

In general, unless you purchase more securities or pay down the balance, the debit or the amount borrowed does not change. Stock prices, however, change and if the market value of the securities in your account declines in value, you will be required to meet margin calls and will be called upon to deposit additional cash, or fully-paid securities, into your account. If you fail to meet a margin call, or if your account falls below minimum maintenance levels, even in the absence of notice of a margin call, by contract, your broker is able to liquidate your investments. Under most circumstances, such conduct is not actionable.

However, many unscrupulous brokers use margin to increase the purchasing power in your account in order to facilitate excessive activity or churning. Aside from this practice, unless you are able to make and meet margin calls, and have the financial ability to satisfy the debit balance in your account, based on your overall financial condition, you may be unsuited for a margin account.

While a broker may have no duty or liability with respect to purely unsolicited transactions, the purchase of a security, on margin, even without any recommendation by the broker is actionable. 17 CFR Part 275 SEC Release No. IA-1406; File No. S7-8-94)(Suitability of Investment Advice) 59 FR 13464 (March 22, 1994).

With the advent of on-line discount brokers, the NASD has become increasingly concerned about the extension of credit, particularly with respect to "unsolicited" transactions on margin. According to the NASD, "[t]he recent growth in the level of customer margin account balances, coupled with the increase in customer inquiries and complaints to NASD Regulation and SEC staffs relating to the handling of margin accounts, has raised concerns as to whether investors understand the operation and risks associated with margin trading. NASD Regulation believes that investors' misconceptions about margin requirements, particularly with respect to maintenance margin, may cause them to underestimate the risks of margin trading." [Release No. 34-44223; File No. SR-NASD-00-55].

In fact, NASD Regulation is particularly concerned that:

Certain firms may arrange for and/or facilitate loans between customers that are used to finance securities trading and/or meet margin requirements. Customers borrowing funds may incur additional finance charges when credit is arranged by the member, and customers lending funds may face additional, and perhaps undisclosed, credit risks when they extend credit to other customers. NASD Regulation believes that questions arise regarding investor protection and disclosure practices when members become involved in the extension of credit between customers. In addition, such lending activities can result in a conflict of interest between the customer and the member, particularly when such lending activities allow customers to continue to trade when they would not otherwise be in a financial position to do so, thereby generating more commission income to the member.

NASD Notice to Members 01-06 (emphasis added).

If your broker has placed your account on margin, and you do not understand, or are unwilling to trade on margin, you should have your account evaluated by a professional. Such practices are usually the warning sign of other inappropriate activity in your account.

Unauthorized Trading

Unless you have signed discretionary papers giving your broker permission to trade your account without your authorization, your broker is required to obtain your permission before buying or selling securities in your account. Many unscrupulous brokers place transactions in customer accounts without authorization, and when the client calls to complain, they may convince you to retain the shares because they have increased in value, or will increase in value. Sometimes, this activity may be also blamed on a "computer error." In either event, if your broker has entered unauthorized transactions in your account, chances are you have fallen prey to other fraudulent devices by this person. If you have been the victim of unauthorized trading, take action. The failure to act may be deemed tacit approval of these acts, and you cannot be said to have complained later, knowing that you own a particular security, when its price goes down.

Breach of Fiduciary Duty

The relationship between a broker and his customer is one of principal and agent by virtue of which a broker is subject to certain fiduciary obligations to the client. Securities brokers are fiduciaries that owe their customers a duty of utmost good faith, integrity and loyalty. A fiduciary relationship exists between a securities broker and customer because broker is a licensed professional who holds himself out as a trained and experienced person to render a specialized service. A a securities broker has a fiduciary duty to customer where broker knows or should have known that trust has been placed in him); See Gouger v. Bear , Stearns, 823 F. Supp. 282, 288 (E.D. Pa. 1993) ("the broker handling account has an unequivocal fiduciary duty to the customer with respect to the broker's investment activities and to any facet of their relationship that pertains to the customer's money"). The court in Lieb v. Merrill Lynch, 461 F. Supp. 951, 953 (E.D. Mich. 1978), enumerated a number of duties of a broker maintaining an account:

Such a broker. . . must (1) manage the account in a manner directly comporting with the needs and objectives of the customer as stated in the authorization papers or as apparent from the customer's investment and trading history [citation omitted]. (2) keep informed regarding the changes in the market which affect the customer's interest and act responsively to protect those interests [citation omitted]; (3) keep his customer informed as to each completed transaction; and (5) [sic] explain the practical impact and potential risks of the course of dealing in which the broker is engaged.

Moreover, the duty of loyalty and good faith is further enhanced where, as here, there is a pre-existing personal relationship between the broker and the customer such that the broker knows that the customer will likely be less skeptical than in a traditional, arms-length, broker/customer relationship. These duties include:

. The duty to recommend a stock only after studying it sufficiently to become informed as to its nature, price and financial prognosis.
. The duty to inform the customer of the risks involved in purchasing and selling particular securities.
. the duty not to misrepresent or omit any fact material to the transaction.
. the duty to study, analyze, and/or otherwise become informed as to the nature,
price, and/or financial prognosis of the stocks purchased for Claimant's account;
. the duty to inform Claimant, and indeed misrepresenting the risks involved in
purchasing and/or selling speculative securities;
. the duty to follow Claimant's expressed investment objectives and conservative investment strategy;
. the duty not to engage in speculative trading or fail to properly diversify;
. the duty not yo place putting their own financial interests above those of their clients.

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Financial Suicide

Investment professionals, including stock brokers, have a duty to refuse unsolicited transactions when the transactions are inappropriate or unsuitable for a customer based on the financial condition of that customer. Cohen, The Suitablity Doctrine: Defining Stockbrokers' Professional Responsibilities , 1978 J. Corp. L. 533 (1978); In re Philips & Co. , 37 S.E.C. at 70 (representative's knowing recommendation of unsuitable security not excused by customer's belief that security was suitable); In re Powell & McGowan, Inc. , 41 S.E.C. 933 (1969)(registrant had obligation not to recommend a course of action even if he fully disclosed all risks to customer whose financial and physical condition made the recommendations unsuitable); In re Harold R. Fenocchio , '34 Act Release No. 12194 (given the advanced age of customer, representative had a duty "to make a serious inquiry into the situation of the customer's investments and to prevent the dissipation of the customer's capital by excessive turnover"); In Board of Trustees v. Chicago Corp., No. 88-C-3855 (N.D. Ill. 1988) (1988 U.S. Dist. LEXIS 14031)( the court held that a broker had a duty to monitor a client's investment decisions, which were effected by client's trustee, and to advise client of soundness of the trustee's decisions); Duffy v. Cavalier , 215 Cal. App. 3d 1517, 264 Cal. Rep. 3d 740 (1989) (court held that as a fiduciary, the broker had a duty to tell a client that the client's investment objectives were improper and unsuitable and "to refrain from acting except upon the customers express orders"); Nobrega v. Futures Trading Group, Inc., [1999] Sec. L. Rep. (BNA) Vol. 31, No. 28, p. 950 (CFTC 1999) (broker sanctioned for failing to correct client's "erroneous beliefs" about safety of commodities trading and failing to stop client from continued trading once aware of these erroneous beliefs).

It is well established that a broker has a duty to provide adequate warnings about investment strategies particularly when trading on margin. See, e.g. Gochnauer v. A. G. Edwards & Co., 810 F.2d 1042 (11th Cir. 1987) (holding broker liable when he advised and assisted customers with conservative investment objectives in establishing a speculative options trading account); Beckstrom v. Parnell , 730 So.2d 942 (La. App. 1998)(imposing liability on broker for failure to warn elderly customer about high costs of switching mutual funds when broker aware of customer's diminished capacity); Nulph v. First Security Investor Services, Inc., 1998 WL 1179858 (N.A.S.D. Nov. 19, 1998)( unsophisticated divorcee awarded $70,000 for failure of broker to warn of speculative information gathered from internet chat rooms and then placed trades on the telephone without any recommendations).

Under these circumstances, the broker has an affirmative duty to cut a customer off, and stop what has become to be known as "financial suicide." See, e.g., J. Gross, Economic Suicide: A Primer for Securities Arbitration Lawyers , Securities Arbitration 2003 Vol. I at 387 (PLI 2003).

See also, Problem Gambling in the Stock Market and Extent of Brokerage Firm Responsibility for Prevention , Marvin A. Steinberg. Ph.D., Connecticut Council on Compulsive Gambling, Judah J. Harris, J.D., Milford, Connecticut, 1994; Gambling and Problem Gambling in the Financial Markets, Marvin A. Steinberg, Ph.D., Connecticut Council on Problem Gambling, July, 1998; Investing and Gambling Problems, "Some Investors May Be At Risk For Gambling Out Of Control In The Stock Market And Other Financial Markets"; See also, Model Employer Management of a Case of Stock Market Gambling , Judah J. Harris, J.D., Milford, Connecticut, Marvin A. Steinberg, Ph.D., Connecticut Council on Compulsive Gambling, 1994.

Mutual Fund Fraud

It is a fraudulent and deceptive practice to engage in the sale of back-end loaded, Class "B" mutual fund shares, where a customer would otherwise be entitled to quantity discounts or "breakpoints" from the sale of front end loaded Class "A" shares.

For example, if a client purchased five different funds totaling $100,000 within any particular family of funds, by investing $25,000 in each fund, in Class B Shares, the broker will receive fees or commissions of typically 5% or $5,000. Should the client sell these Class B shares, there is a surrender penalty associate with the sale of these securities, and this penalty decreases each year. Typically after 5 years, there is no penalty. However, the broker gets paid upon the initial purchase of these shares, in this example, $5,000 or the 5% commission.

Had this same customer purchased $100,000 of Class A shares, and sought to purchase five different funds, within a particular family of funds that customer would otherwise be entitled to quantity discounts, or "break-points" and could pay a commission, albeit front end loaded of less than 2% or in our example, $2,000.

In an effort to maximize commissions, at the expense of a customer, a broker may purchased back-end loaded or "B" shares, as opposed to front-end loaded "A" shares, where the customer would be eligible to earn "break-points." This practice has been declared "fraudulent and deceptive," per se, by securities regulators. ( See, e.g. NASD Press Release, June 25, 2003 ("NASD Brings Enforcement Action For Class B Mutual Fund Share Sales Abuses")).

False Statements or Omissions

State and federal securities laws prohibit brokers from making false statements or omissions of material fact in connection with the sale of securities. False statements often include guaranties, price predictions, or purported special information regarding an important contract, approval, earnings announcement or other newsworthy event. Fraud, however, may also take the form of omission by failing to disclose, among other things, the broker's relationship with the issuer, the domination and control of the market for the security by the brokerage firm, the limited market for the company's stock, or the lack of any appreciable assets or operating history of the company. However, information is only material if a reasonable investor would rely upon it. Remember, if something is too good to be true, it definitely is.

Failure To Execute

Actions based on the failure to execute are difficult, and your broker has a reasonable time to enter orders. However, actions may exist based on your broker's failure to execute limit orders, or stop loss orders. Actions may also be based upon your broker's refusal to sell particular securities, or based upon their dissuading you from selling particular securities. If you think that you may have a claim for failure to execute, contact us.

Failure To Supervise

Brokerage firms have a duty to supervise their brokers and the sales practices of their brokers, and to review customer statements for, among other things, evidence of suitability, unauthorized trading, or excessive activity. But for the performance of these duties, most cases of securities fraud may be reasonably prevented. The failure to supervise is a violation of self-regulatory rules. Courts have recognized a cause of action for the negligent failure to supervise, and brokerage firms are liable for the acts of their registered representatives under the common law doctrine of respondeat superior, and as control persons under Section 20(a) of the Exchange Act.

Selling Away

If your broker solicits you to purchase securities away from the brokerage firm, your broker is "selling away," which is a violation of self-regulatory rules and federal securities laws. Typically, these investments are in the form of private placements, or other non-public investments. If you are the client of a brokerage firm, and your broker solicits the sale of these securities away from the brokerage firm, under certain circumstances, you may recover from the brokerage firm.

Damages

Claimants in securities arbitrations are entitled to compensatory damages in the form of their out-of-pocket losses. However, in addition to out-of-pocket losses, investors in certain cases may recover opportunity costs in the form of what their portfolio would have been worth if managed properly. In churning cases, the amount of commissions or other fees realized from the broker's improper conduct may be reclaimed as well. Punitive damage awards are rare in arbitration, except for the most egregious cases, but are available. In addition, under the anti-fraud provisions of the laws of many states, investors may recover exemplary damages, costs, and reasonable attorneys' fees.