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.