While I’m not a big fan of how many people quickly jump on the litigation bandwagon for almost anything nowadays, there are legitimate situations where you may have a case against a bad broker or advisor. Even so, keep in mind that you can’t sue just because you lose money on an investment they have recommended. Certainly, losses may be a part of underlying illegal activity, but the fact that you lost money is not enough to seek legal action. There are a few instances where you may have a case:
Omission and Misrepresentation
If you sit down with someone, and they explain to you that a particular investment guarantees a certain return and fails to perform as such, the broker may be misleading you. In fact, any time someone tells you that an investment is guaranteed and they aren’t talking about something like a certificate of deposit or other guaranteed fixed income instrument, be very cautious. Even if there are guarantees for the investment, it probably comes with significant fees and/or long holding periods which are not in your best interest.
There is also the case where a broker may simply omit information altogether. A common example of this is when they advise you to purchase a mutual fund that has a front-load, yet they fail to mention it prior to the sale. Any time they don’t properly disclose the fees or commissions associated with a product, you may have a case of omission.
This isn’t as common unless you have an account where the broker or advisor has authorization to place trades within your account on your behalf. For most people, these types of accounts aren’t something to be concerned with, but a lot of people want a completely hands-off approach and give their advisor the ability to make trades as needed. Generally speaking, the broker or advisor then makes a commission on each sale, which can lead to excessive trading within your account so that they can generate higher commissions. Even if the returns are good, this excessive trading is prohibited.
This is where it can become a bit subjective, but that is what makes it an area that is easily abused. Unless you specifically tell your broker or advisor to buy X number of shares of ABC stock, any recommendations that they make must be within your suitability. There are a few different criteria that can be used to determine investment suitability:
- Time horizon
- Risk tolerance
- Investment objective
For example, let’s consider a 65 year old retired person that seeks investment advice regarding a way to generate a relatively steady stream of income with the ability to access their principal at any time. Just by looking at the client’s age, investment objective (to generate income), and need for a liquid investment, it is pretty clear what type of investment vehicles would be suitable. Even so, the advisor may make an argument for adding stocks or mutual funds to their portfolio, or even worse, lock the person into an annuity which generates fixed income, but lacks liquidity for a number of years. In cases like this, the advisor is probably not following suitability requirements.
Most brokers and financial advisors will do a basic suitability test and gather information about your financial situation and goals before making any recommendations. If you meet with someone and they hardly ask you any questions about your income, investment objectives, risk tolerance, or anything of that nature, be extremely cautious. How can someone honestly make a suitable recommendation if they know little or nothing about you?
Of course, good brokers and advisors will keep meticulous notes during your meetings and will keep risk tolerance and other suitability information in your file. So, if they have gone through the suitability process and you find yourself with an investment that just isn’t performing as well as you’d like, you may be out of luck. This is only when the broker completely disregards or doesn’t even consider your situation before making a recommendation.
What to do if You Experience One of These Offenses
There are two ways you can go about it–through the legal process with a securities lawyer or through arbitration. Attorneys who specialize in securities law can certainly help determine whether or not you have a case, but they can be expensive. Most attorneys will require an up-front, or contingency fee before taking your case. In addition, they will likely seek somewhere between 20 and 40 percent of the damages collected.
What you may not know is that when you open an investment account with a broker or advisor, you probably entered an agreement to go to arbitration in the event something goes wrong. Arbitration is a dispute resolution process, which is an alternative to the traditional lawsuit in court. Rather than have a matter decided by a judge and jury, participants to an arbitration proceeding have their dispute resolved by impartial persons who are knowledgeable in the areas in controversy. Those persons are called arbitrators.
Arbitration is generally a much cheaper and quicker process than the traditional legal process. Not only that, but you can generally represent yourself during arbitration, which can save a lot of money on legal fees. Once both sides present their case, the arbitrators make a final decision. Neither side can rebuke or appeal. For more information, visit the American Arbitration Association.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
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Zook, it is a shame that so many people ruin it for the good guys. Part of the problem comes from the ability for virtually anyone to put the title of Financial Advisor or Planner or whatever on their business card. You have insurance brokers who take their Series 6 and can now sell mutual funds touting their financial planning services. Just like you have basic stock brokers who will use any title other than stock broker to make it look like they have all-encompassing expertise.
What if only people with CFPs could call themselves planners/advisors, and everyone else had to use the title "Investment Salesman". I'm guessing there would be a lot of people out of work since anyone with average intelligence would rather not talk to a salesman about their finances.
There are plenty of financial advisers who don't pull this baloney. I know it wasn't even hinted at, but I feel it necessary to make the point for effect.
If you pass the CFP test and have passed all of the other exams and you won't to be successful, you will WANT to tell your client where they can look you up online to verify. You will WANT to act on their behalf to make them life-long clients.
This is a no-brainer. I am amazed that so many fools out there ruin it for the good guys.
That's a great point, especially about the fixed annuities; very true. The problem with annuities (esp. variable) is most investment companies, broker/dealers do a pathetic job of putting them together and presenting them.
Thanks again for the post.
That is a good point Working Dollar. Although there is one area where they can begin to throw around the guarantees, and that is when talking about annuities, either fixed or variable. With fixed annuities, obviously there is a guarantee of principal, and generally a guaranteed rate of return for at least a specific amount of time.
Where it can get a bit more shady is when they are pitching variable annuities. By nature, they are investments in mutual funds and generally don't have any sort of guarantee, but now there are many riders you can put on these products that can guarantee principal, rates of return, lifetime benefits, etc.
Of course, people should steer clear of these investments to begin with, but these variable annuities with the various guarantee riders are what a lot of advisors/brokers use to push someone into something more risky. They tout the fact that they can participate in the market and realize those gains, or if it doesn't perform as well, they can add a 6% interest rider or something for another 50 basis points each year.
"If you sit down with someone, and they explain to you that a particular investment guarantees a certain return and fails to perform as such, the broker may be misleading you. In fact, any time someone tells you that an investment is guaranteed and they aren’t talking about something like a certificate of deposit or other guaranteed fixed income instrument, be very cautious."
I would be more than cautious, I would report them to the principal at their investment firm. No matter what the investment is, no broker can make a "guarantee statement" of any kind for any investment. This is forbidden by the NASD/SEC.
2 other key things to look for when working on investment options with a broker:
1) If they tell you the past performance of a fund or investment indicates what it will do in the future - be cautious. Past performance never guarantees future results.
2) If they are unwilling to give you additional material upon request. They have to discolse all information about investments.
Great post! I'm going to reference it at my blog, thanks for putting this out there!
Another good website is http://www.finra.org/index.htm, the home of the Financial Industry Regulatory Authority - you can check out your broker, file an arbitration claim, and learn about common scams and other interesting investor education things. Also, some law schools (including my alma mater, Northwestern Law) offer clinics that help victims of investor fraud through the arbitration process.
I definitely agree that the easier path is to find a good advisor upfront. It helps to get everything in writing, because then there's a paper trail of everything you were told. On face this shows that an advisor has put at least some thought into your needs. But if things should go sour later down the road, this will help you document your claims for arbitration.
I did learn in the March issue of Kiplinger's, though, that you shouldn't necessarily send every minor concern to your broker in writing. Written communication is apparently usually considered to be formal complaints, which will go on brokers' permanent records. While some suspicious activity certainly require documentation like this, it's possible that poor portfolio performance may just be due to bad market conditions.
Granted, it sounds like this was a stockbroker that wrote in, but it might be worthwhile to talk to the broker and his or her supervisor in person first before submitting a request on paper. No reason to jeopardize a broker's career if he or she hasn't truly done something wrong.
That's true, Ron. Arbitration, which is often binding in investment situations, is better served for relatively small claims. I think the limits are around $75,000 in damages. If you're looking at losses higher than that, you certainly want to seek legal counsel before entering sort of agreement.
But as you said, the best course of action is to avoid these problems in the first place.
Arbitration can be scary, especially binding arbitration. If you don't want to go that route, there are mediation companies that can also help settle problems. Mediation is not binding and the company can simply refuse to follow the mediator's recommendations, but it could be an alternative for those worried about binding arbitration.
The best defense though, is to do your homework on the front end and not get into this kind of mess!