Investment Fraud Attorney Scott C. Ilgenfritz
When Does ‘Misconduct’ Become Fraud?
Some stockbroker misconduct constitutes investment fraud. Types of misconduct which constitute fraud include misrepresentations or omissions, churning, unauthorized trading, and selling away. Even the recommendation of unsuitable investments to a client has been recognized as statutory fraud under Chapter 517 of the Florida Statutes.
Investors may file a claim to recover losses resulting from many forms of broker misconduct, and fraud need not be alleged. However, the activities below are covered separately here because they are the most common types of fraudulent conduct. For a list of other types of misconduct, please see the stockbroker misconduct page.
Stockbrokers have a duty to treat their clients fairly and are required by the FINRA Conduct Rules to “observe high standards of commercial honor and the just and equitable principals of trade.” In addition, whether a stockbroker is handling a client’s account on a discretionary or non-discretionary basis, the stockbroker owes his client a fiduciary duty. Likewise, investment advisors are the fiduciaries of their clients.
Misrepresentation and Omissions
Unscrupulous brokers or investment advisors are liable to their clients for the losses suffered when they lie or utter half-truths to their clients about an investment or investment strategy, or fail to inform clients of material facts about an investment or investment strategy. Likewise, the firm for which the broker or investment advisor works is also liable.
Actionable misrepresentations or omissions include, but are not limited to a broker:
- Touting the stock of a company as a “sure thing” when the broker has information that the company is financially unstable;
- Failing to disclose that a recommended investment or investment strategy is high risk;
- Representing that an investment or investment strategy is low risk when the broker knows that it is high risk;
- Misrepresenting the features of an investment, such as its illiquidity or the expenses associated with it; and
- Making positive statements about a recommended investment when the broker knows little or nothing about it.
With respect to risk disclosure, a broker or investment advisor has the duty to accurately and completely disclose the risks associated with an investment or investment strategy to the client. However, disclosure of risk does not fulfill a broker’s or investment advisor’s duties to his or her client. A broker or investment advisor must not only disclose the risks, but he or she must make sure that the client understands and appreciates the risks and has the financial ability to take the risks posed by a recommended investment or investment strategy.
Churning
Churning involves excessive trading in securities by a broker in a client’s account. Churning occurs when a broker engages in excessive securities transactions to advance his own interests over those of his client.
To establish that churning has occurred in an investor’s account, the trading activity must be excessive in relation to the investor’s investment objectives.
Whether a client’s securities account has been churned is determined by a variety of factors, including the following:
- Whether a high annualized rate of return would need to be realized to compensate for the high commissions generated from the trading activity;
- Whether the average equity or value of the client’s account has been turned over excessively on an annualized basis, in light of the client’s investment objectives and the nature of the account;
- Whether there was a significant amount of short-term trading or in-and-out trading; and
- The percentage of the broker’s total revenue generated from the trading activity in the client’s account.
In analyzing whether a client’s account has been churned, the client’s investment objectives and financial situation are critical factors.
Highly active securities trading is generally inappropriate for clients whose investment objectives are preservation of capital, income, income and growth or long-term growth, as opposed to short-term trading profits or speculation.
Unauthorized Trading
Typically, a client’s account with a brokerage firm is handled by the broker in one of two ways: on a discretionary basis or a non-discretionary basis. An account is handled on a discretionary basis when the client signs a written authorization allowing the broker to engage in securities transactions without obtaining the client’s approval for each transaction. In other words, the broker exercises his discretion in making purchases and sales of securities in the account. With a non-discretionary account, which is the most common type of account, a broker must obtain the client’s approval before buying or selling any security.
Unauthorized trading occurs when a broker who is handling a client’s account on a non-discretionary basis, engages in securities transactions in the client’s account without obtaining the client’s approval. If the unauthorized trading occurs over a lengthy period of time, brokers and brokerage firms often take the position that the client has ratified the trading activity by failing to object to it in a timely manner. However, ratification occurs only when a client has full knowledge of all of the facts pertaining to the trading activity, including the right to reject the unauthorized trades, and demonstrates the intent to adopt the unauthorized transactions
Selling Away
When stockbrokers have outside business activities, such as insurance product sales when the brokerage firm does not offer insurance products, they are required to obtain approval from the brokerage firms for which they work. Likewise, a broker must obtain approval of the brokerage firm for which he works to sell investment products or engage in a transaction with a client which is outside the scope of the investment products or transactions engaged in by the firm.
Dishonest brokers from time to time sell unapproved investment products to their clients, such as promissory notes, viaticals, or stock in companies in which the broker owns an interest. Typically, clients are induced by the broker to purchase such investment products based on misrepresentations or omissions by the broker. If the client suffers losses as a result of such activity by a broker, both the broker and the brokerage firm with which the broker is affiliated can be held liable. When the brokerage firm places the broker in a position to cause the client to believe that the broker is acting on behalf of the firm in recommending the fraudulent investment, the brokerage firm can be held liable for the client’s losses.
Let an Experienced Florida Investment Fraud Attorney Evaluate Your Claim
If you are uncertain whether your investment losses may have been due to some form of stockbroker misconduct, we can help. Contact me for an evaluation of your potential claim. I will assess the merits of your case and if appropriate, arrange a consultation to discuss your options. There is no charge.