Unsuitable Recommendations (Suitability) -
All brokers are required to "know their customers." The NASD and NYSE have
specific rules which require your broker to make recommendations based on their clients
financial objectives, financial resources and risk tolerance. If the investment
does not let you sleep at night then you should stay away.
For Example: An unsuitable investment would be placing a person on fixed income with
a small "nest egg" into commodities futures; where the potential risk far
exceeds the risk tolerance of the individual investor.
Insider Trading and Front Running
- It is against the Rules and Regulations of the Securities Industry to make any use, or
enter into any securities transactions while in possession of nonpublic information or to
place an order on the basis of "nonpublic" information regarding pending orders
in the marketplace.
While the most obvious cases occur when a corporate executive passes along a secret to
some friends, Insider trading can occur on a much local basis. For example, if your broker
purchases or sells a particular security on the same day that he solicits his/her clients
to purchase or sell that same security, he might be front running the market, or trading
on insider information. In most cases, when a broker transacts in the same security as his
clientele the broker must take pay the highest price or take the lowest sale on
that day.
Be very wary of brokers who use sales pitches saying that his/her family has a position in
that security, as they might have other reasons than good financial sense for you to trade
this security. If your broker has a position in the same security as you, remind him that
he is obligated to inform you when he liquidates his position.
Churning or Excessive Trading - Churning
occurs when a broker or broker-dealer encourages and engages in transactions that are
designed to generate commissions rather than benefit the client’s account. Churning
can occur even if the client made money on all the transactions for the account.
Investors should also be very careful when signing any activity letters for their
accounts. Unless you fully understands the nature of all the transactions executed in your
account, do not sign anything without consulting an attorney first. Churning cases are
extremely difficult to win when a broker or broker-dealer has several signed letters
indicating that the client knew that his/her account had high activity.
Michael Huberman and Associates can perform account analysis to check for
churning or excessive trading. Just contact us of
more details
Another sign of excessive trading can be revealed by the cost/equity ratio in an
account. If your account's annualized total costs of doing business exceed the amount of
return on your investments, you might have a problem.
If it is costing your account 22% of your yearly's net equity in margin fees and
commissions, you need a 22.01% return just to start and make a profit.
Rumors, Knowingly False and Misleading Statements - It is
against the Rules and Regulations of the Securities Industry to induce a client to buy or
sell a security based on a "hot tip" or on some significant
favorable or unfavorable event that the broker thinks might happen.
A broker is required to perform some due diligence prior to is recommending a security
to his client. Besides the fact that any recommendation must be consistent with the
client's stated financial objectives and goals, most states, require that the broker must
have a reasonable basis for making the recommendation to his clients.
While a reasonable forecast based on empirical data is acceptable and a reasonable
basis to make a recommendation, a feeling or rumor on pending news is not a sufficient
basis to recommend a security to his client.
Additionally, the withholding of information from a client can be considered fraudulent
conduct. Whether good or bad, the client is entitled to know all the facts first.
Unauthorized Transactions - (Non
Discretionary Accounts) Under the Rules and Regulations of the Securities Industry, a
broker must have you or an appointed agent give him/her the order for your account.
A broker cannot except an order unless a person who you have given
limited or full power of attorney to, in writing, or yourself the gives broker the order
for your account.
Just because you are married, your spouse can not place an order in your account if
the account is listed solely in your name.
Oral discretion, as to time and price, can be granted, however no other orders can
occur in your account without your prior approval. If a transaction occurs in your account
and you did not initiate it, contact the branch manager immediately in writing and request
that the order be canceled. Remember, time is always on your broker's side.
Switching of Mutual Funds
- Mutual Funds are typically long term investment vehicles, and the switching of funds
within a family of mutual funds can often be a sound financial decision, depending on the
times and different investment philosophy of the particular fund. In fact, most mutual
funds families allow their investors to reallocate their investment throughout their
family of funds for free or for a small transaction fee. This ability to shift assets
within the same family of funds allows the investor change their financial objectives
without generating large sales charges.
However, some brokers will induce their clients to switch funds outside their initial
funds family. These type of switches can generate larger commissions and sales charges for
the broker. Usually, these type of switches are accompanied by a letter from the brokerage
firm informing the client that another commission will be charged. Nonetheless, be very
careful when jumping from different mutual fund families, as the commission available to
the broker are substantially increased.
Additionally considerations that you as investor must consider while investing in mutual
funds are that there are certain monetary breakpoints where commissions can be reduced.
Sometimes investing the extra $1,000.00 can reduce the brokers commission by a full
percent. Always read the mutual fund’s prospectus as it applies to commissions and
expenses.
Breach
of Fiduciary Duty - While most of sales abuses
constitute a breach of the fiduciary duty themselves, it is important for every investor
to understand that his broker owes him a fiduciary duty. Listed below are the basic
fiduciary duties a broker has with his client.
The duties associated with
a non-discretionary account include:
- the duty to recommend a stock only after studying is sufficiently to become informed as
to its nature, price, and financial prognosis.
- the duty to carry out the customer's orders promptly in a manner
best suited to serve the customer's interest.
- the duty to inform the customer of the risks involved purchasing
or selling a particular security.
- the duty to refrain from self-dealing or refusing to disclose any
personal interest the broker may have in a particular recommended security.
- the duty not to misrepresent any fact material to the transaction.
- the duty to transact business only after receiving prior
authorization from the customer.
Selling Away - Because of the many investment
opportunities that are available to brokers and their clients, the NASD and regional stock
exchanges have enacted strict rules regarding the selling of investments outside the
brokerage firm.
For example, a broker can not sell his client a partnership in an oil well outside his
brokerage firm, unless the broker follows strict guidelines prescribed by the Stock
Exchanges, the NASD and his firm. These rules are designed to protect clients from
relying to heavily on a broker's funneling his client's funds to his friends business.
Be very careful of investing in outside private placements and initial public offerings
that are recommended to you by your broker when the transactions are executed outside the
brokerage firm or his employer.
For Example: If you have an account with "Big Rock Securities" than all
investments your broker recommends should go through "Big Rock Securities" with
no exceptions. When in doubt, ask your broker's branch manager or regional
supervisor. Better yet, get it in writing.
Mis-marking of order tickets and confirmations - The
Rules and Regulations of the Securities Industry requires that order tickets and the
corresponding confirmations be marked either Solicited or Unsolicited when the broker or
broker-dealer executes a trade in a clients account.
Too frequently orders are improperly marked as unsolicited
when the broker or broker-dealer solicited the order directly, or the order was solicited
by operation of law.
Some states require that the orders be marked solicited whenever the client acts
upon a brokers recommendation within sixty(60) days of the brokers original favorable
recommendation. (Check your State’s Requirements)
This can even hold true if the broker first favorable mentions five stocks and his
client acts on one of the stocks within two weeks.
Another factor that can contribute to the intentional mis-marking a confirmation ticket
occurs when a broker or broker-dealer attempts to avoid State
Blue Sky Rules or for securities that his/her
firm does not recommend. Check your confirms, and if you broker or broker-dealer solicited
the order, make sure the confirmation is correctly marked SOLICITED.
These markings can come back and haunt you if you have a dispute.
Control and Domination-
Control and Domination occurs when real competition is not present in the marketplace, and
the wholesale and retail trading by a single market maker, or by two or more market makers
willfully acting together, accounts for a substantial percentage of the volume and
transactions of a particular security. In these circumstances, the result is that the
market for the security is arbitrarily established by the market makers and the individual
investor does not stand a chance.
A dominant and controlling market maker generally has the ability to set arbitrary and
non-competitive price quotations and spreads on a security and control trading, since
other market professionals have no real competitive interest or influence in the security.
In most cases, Control and Domination occurs with thinly traded,
lesser known stock
where the Controlling and Dominating broker-dealer may have participated in the securities
underwriting.
Additional Sales Abuses: In addition to the more prevalent sales abuses, investors
should be aware of some of the other abuses that can occur:
Sharing in Accounts: The sharing of profits and losses with a customer
and a broker is generally prohibited without the proper disclosure. Additionally, the
guaranteeing against losses is a clear violation and statement of misrepresentation.
Parking Securities: Holding or hiding securities in a clients account is
prohibited by the Rules and Regulations of the Securities Industry.
Disclosure of All Commissions: A broker or
broker-dealer are required to disclose all commissions. However, some of the disclosure
appears in the fine print on the back of the confirm.
Always ask how much your broker will be compensated on your
transaction. Nothing is for free. Many times the brokerage firm will pay additional
compensation to your broker that comes from the internal mark up/mark down the brokerage
firm's traders received. Do not let his/her compensation become a motivating factor for
his/her recommendation for you to engage in the transaction.
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can occur with any type of investor no matter the investor's sophistication. Experienced
investors may rely too much on the broker's word, while novice investors may just me to
naive. Take the time to review your account and each transaction. If you see something
wrong or suspicious in your account, please take the time and 
Most of the cases we review and analyze consist of your "garden
variety" type of fraud that can be seen is all areas of business. (i.e.
Misrepresentation of facts and information, failure to disclose all the risks and
pertinent information or unauthorized transactions). Although these
types of fraud are predominately most widely seen abuses in Securities Arbitration, there
are several sales practice that you, as an investor, should know about which also may
constitute a sales abuse.