Blum Law Group represents investors in arbitration and mediation proceedings across the country and around the globe. To read more about the arbitration process, visit the FAQS page.
Securities Arbitration is how most disputes between customers and financial institutions are resolved. Though often perceived to be an informal arbitration process, they are actually highly specialized proceedings. The following areas are the more common conduct which may form the basis of liability:
Breach of Fiduciary Duty
A fiduciary duty is a duty to act for someone else's benefit, while subordinating one's personal interests to that of the other person. It is the highest standard of duty implied by law. When a fiduciary relationship exists between a stockbroker and a customer, a stockbroker has an obligation to use the utmost duty of loyalty, good faith and care toward the customer. Examples of other relationships where a fiduciary relationship exists are lawyer-client, therapist-patient and guardian-minor ward. The relationship between a stockbroker and a customer can be a fiduciary relationship if the customer looks to the broker for advice, the broker is aware that the customer is depending on the broker, and accepts that responsibility.
Churning occurs when a broker engages in excessive trading in a customer's investment account. A broker churns an investment account in an attempt to generate commissions. To prove that the pattern of trading in the account was excessive, the account statements are analyzed to determine: the annualized rate of return that would be necessary to cover the commissions charged in the account; the number of times the equity in the account was turned over to purchase new securities; and the purchase and sale trading activity that occurs in the account. The customer must prove that the broker exercised actual control over the decision making in the account, the trading was excessive, and that the broker acted in reckless disregard of the customer's interests.
Failure to Supervise
Brokerage firms have obligations pursuant to their own policy and procedures as well as the rules of the self-regulatory organizations (such as the FINRA and NYSE) to supervise the activities of their brokers and their firm. This duty includes among other obligations to review each transaction that is submitted by the broker to place a trade in a customer's account, review transactions in customer's account to determine whether the transactions are in accordance with the client's investment objectives, review incoming and outgoing correspondence and perform reviews to determine if trading in a customer's account is excessive. If the firm fails to investigate such wrongdoing and/or allows it to take place, the firm may be held liable for its failure to supervise its employees.
A customer who purchases securities may pay for the securities in full or may borrow part of the purchase price from his or her securities firm. If the customer chooses to borrow funds from a brokerage firm, the customer will open a margin account with the firm. The portion of the purchase price that the customer must deposit is called margin and is the customer's initial equity in the account. The loan from the firm is secured by the securities that are purchased by the customer. Customers generally use margin to leverage their investments and increase their purchasing power. At the same time, customers who trade securities on margin incur the potential for higher losses. As a result, there are additional risks involved with trading on margin that brokers must disclose to their customers. These risks include: You can lose more funds than you deposit in the margin account; the firm can force the sale of securities in your account; the firm can sell your securities without contacting you; and you are not entitled to an extension of time on a margin call. When the margin ratio in the account exceeds the requirements by the firm, the customer is susceptible to a margin call which could force the sale of the customers' securities.
Misrepresentations and Omissions
Federal and state securities laws prohibit salespersons from making any "material misrepresentation" about investments that they are selling to customers. The laws impose upon the brokers an obligation not to omit any information that a reasonable investor would want to know about in making a decision to invest. A broker may be liable to a customer if a broker misrepresents material facts or fails to disclose material facts to the investor in the sale or recommendation of an investment. This obligation requires brokers to fairly disclose all of the risks associated with an investment.
Negligence is conduct which falls below the "legal standard" established to protect others against unreasonable risk of harm. Generally, negligence is the failure to use such care as a reasonably prudent and careful person would use under similar circumstances. Each state has its own standard of negligence and there are many types of claims for negligence. For an act to be negligent, the actor may not intend the consequence of his conduct but, a "reasonable person" in his position would have anticipated those consequences and taken "reasonable" precautions to guard against them. If a broker is negligent in his dealings with a customer, then the customer may have recourse against that broker.
A fundamental concept of investing is diversification. If a customer's account is concentrated in any individual investment or type of investment, then the risk associated with the customer's portfolio is dramatically increased. A broker should never place all of the customer's investment "eggs" in one basket. A broker who fails to diversify a customer's account may be liable should the investment significantly decline in value.
An unauthorized trading occurs when the broker executes transactions in a customer's account without the customer's permission and the broker has not been given discretion to make such trades. In order to prove the transaction was unauthorized, it is crucial to review the time stamp on the order ticket for the transaction and the client's phone records.
A broker has an obligation when making an investment recommendation to a client to only make suitable recommendations that are consistent with a customer's investment objectives, risk tolerance and needs. This arises out of the concept of "Know you Customer", NYSE Rule 405 and NASD Rule 2310. An investment may be unsuitable if the investment is not in accordance with the customer's investment objectives; the customer does not have the financial ability to incur the risk associated with a particular investment; or the customer did not know or understand the risk associated with the particular investment.
A Ponzi scheme is criminal theft on a large scale. It is a pyramid scheme in which the money of new investors is used to make payments to earlier investors. Often there is no "investment" occurring — money is simply being shifted from one person to another, with the initiator of the investment scheme skimming money off the top. The Ponzi scheme will continue as long as new investors can be recruited to provide funding that goes to pay investment returns to early investors. The victims of Ponzi schemes are often confused about the nature of the fraud because the investment seemed legitimate at the beginning. Representations were made about the nature of the investment opportunity. Those representations may have been inaccurate, or they may have been true at the beginning. Some Ponzi schemes are fraudulent from their inception, while other Ponzi schemes were legitimate investment ventures that didn't work so the fraudster began using new investors' money to pay promised investment returns to earlier investors.
Subprime Mortgages/Asset-Backed Securities
Brokers and brokerage firms have a duty to invest wisely and in line with investors' risk profiles. Investing in high-risk investments can be a form of broker misconduct. In the case of subprime mortgages and asset-backed securities, the misconduct reached staggering proportions. With the collapse of the housing market, individual investors and pension fund investors lost millions, even billions, of dollars as a result of the collapse of subprime mortgage and collateralized mortgage obligations (CMOs) investments that most investors (and even many brokers) did not understand.