FINRA Sales Practice Violations
Failure of a Financial Industry Regulatory (FINRA) brokerage firms and their financial advisors to comply with FINRA sales practice rules and regulations concerning the standards of care for customer accounts may result in a legal cause of action for the recovery of investment losses. Brokerage firms and stockbroker misconduct can be characterized by different actions which can take many shapes and different forms which can result in a legal cause of action against the wrongdoers. Such misconduct can often be classified in the following FINRA sales practice violation claims for damages.
The suitability of a particular investment and/or investment strategy is governed by the financial services industry “know your customer” rule which requires that brokerage firms and their advisors are aware of all factors which affect an investor’s financial situation. The factors which determine the suitability of an investment include the investor’s age, employment status, tax rate, education, investment experience, investment objectives and risk tolerances. The objective of the “know your customer” rule is to only recommend “suitable” investments and/or investment strategy to customers. The suitability of an investment and/or investment strategy is to be determined based on an investor’s ability to understand and assume the risks associated with an investment and/or investment strategy. Investment losses that are the result of unsuitable investment advice can be a cause of action in a FINRA arbitration claim for damages.
A full-service brokerage firm is required to provide an investor much more than trade execution. An investor who relies upon the direction and advice of a brokerage firm and its registered representatives (stockbroker) has a fiduciary relationship. An important characteristic of a fiduciary relationship is control. A fiduciary relationship requires that the brokerage firm and their representatives have an obligation to place the investor’s best interest before that of the brokerage firm. The subordination of their interests requires the utmost diligence when making investment recommendations. Investment losses that are the result of a breach of fiduciary duty can be a cause of action in a FINRA arbitration claim for damages.
Negligence is the failure of a brokerage firm and its representatives to act in a reasonable and prudent manner when providing financial advice. The negligence comes from the failure to adhere to the standards of care established by the securities industry promulgated through FINRA rules and regulations. The negligence does not have to be intentional to result in a viable securities arbitration claim for damages. A negligent act may not be a willful or intentional act, but simply an omission or failure to act. A brokerage firm and its representative cannot argue that it was unaware of the securities industry standards which require that it should have known based on widely held standards of care or based on the required knowledge of economic and financial matters at issue. A negligent act which results in Investment and can be a cause of action in a FINRA arbitration claim for damages.
Churning is considered any excessive trading activity in an investment account for the purpose of generating commissions. An investor will need to prove that the level of activity is excessive in light of the investment objective. The broker must be in control of the account activity which resulted in excessive commissions paid to the brokerage firm and its registered representative. An investor whose account has been churned may be eligible to recover the excessive commissions paid and any investment account underperformance relative to a suitable performance benchmark as a cause of action in a FINRA arbitration claim for damages.
Full disclosure is required of all material information related to an investment. Financial advisors who fail to disclose all of the material facts related to an investment can be held liable for losses sustained from that investment. Material information includes, but is not limited to, all costs and risks associated with the investment. An investor, who does not receive full disclosure, is considered unable to ratify an investment recommendation. When a financial advisor intentionally misrepresents or withholds material information that an investor relies upon, a claim for securities fraud can be filed.
In a non-discretionary account, brokerage firms and its stockbrokers are required to obtain prior approval from a client before the execution of any transaction. An investor who realizes a loss from an unauthorized trading transaction may be eligible to recover damages. It is important that an investor dispute the transaction within a reasonable period of time. Receipt of a trade confirmation or account statement without a subsequent dispute from the investor can be considered a ratification of the transaction. Facts surrounding the transactions at issue can support the claim of an unauthorized trade if there are no phone or email records between the stockbroker and client prior to the trade execution.
The use of margin greatly increases the risks associated with investments held in a brokerage account. In many instances, stockbrokers fail to disclose to investors that a brokerage account with margin can become many times more risky than the overall stock market. A margin balance occurs when securities are purchased or withdrawals are made by borrowing against brokerage account assets. During market declines, account equity declines rapidly due to the effects of margin which could result in a margin call. A margin call may require additional deposits of cash, or the sale of securities at a significant loss. The brokerage firm has the right to liquidate any securities held in the brokerage account it chooses to reduce the loan balance and protect its own interests. The unsuitable use of margin which results in substantial losses may be a cause of action in a FINRA arbitration claim for damages.
Securities concentration is considered an investment portfolio that is not adequately diversified and subject to the specific risks of a limited number of stocks. Diversification is the primary tool used to construct a portfolio to manage the risks inherent in the securities market. Failure to diversify across all asset classes including stocks, bonds and cash may result in the unintended exposure to risk. The failure to diversify is also known as security concentration because the invested assets are over-weighted in a particular sector relative to the overall securities market. Financial industry standards supported by academic studies consider any portion of an investment portfolio that exceeds ten percent of account assets, as security concentration. Losses that result from this security concentration may be a cause of action in a FINRA arbitration claim for damages.
Mutual fund sales practice rules require that investors receive full disclosure concerning any sales commission discounts that are available, known as sales breakpoints. Failure to offer these sales breakpoint discounts result in greater commissions paid by investors that is necessary which represents a mutual fund sales practice violation. The sale of a mutual fund with the proceeds reinvested into a different mutual fund family with similar investment options is prohibited, unless there is an economic benefit to the investor. If there is no economic benefit to the investor and the reason for the recommendation was solely for the generation of commissions, the transaction is considered a mutual fund “switch” transaction and may be a cause of action in a FINRA arbitration claim for damages.
The sale of a variable annuity with the proceeds reinvested into a variable annuity with similar features and investment options is prohibited, unless there is an economic benefit to the investor. If there is no economic benefit to the investor, the recommendation is considered to be for the enrichment of the financial advisor. In these instances, the transaction is considered a variable annuity “switch” transaction and is a violation of state insurance laws and financial services industry rules and regulations which may be a cause of action in a FINRA arbitration claim for damages.
The securities industry requires compliance to standards of care which are promulgated through the Financial Industry Regulatory Authority (FINRA) sales practice rules and regulations. The member firms are required to supervise all activities of firm employees, including financial advisors. Failure of a brokerage firm to adequately supervise the activities of financial advisors is a violation of securities industry conduct rules which may be a cause of action in a FINRA arbitration claim for damages.
Brokerage firms and financial advisors have an affirmative duty to identify potential conflicts of interest to their retail customers which relates primarily to the pursuit of revenues by the brokerage firm and its financial advisors at their customer’s expense. FINRA rules are designed to reduce the effects of any conflicts of interest relies on the full disclosure of conflicts of interest to customers as an important tool. Brokerage firms have an obligation to identify any conflicts of interest specific to a brokerage firm’s business model and disclose all relevant facts to investors to enable them to better understand the costs and risks associated with an investment or investment strategy.
Brokerage firms and financial advisors are required by securities industry regulations to refrain from charging customers excessive markups and markdowns for the purchase or sale of securities. According to securities industry regulations, Brokerage firms and financial advisors must adhere to the principles of fairness and honesty when charging costs and fees, including commission, markups and markdowns, for principal and agency transactions. Brokerage firms and financial advisors are required to consider several factors in the determination of whether the costs and fees charged for the execution of securities transaction is reasonable and fair.
Private placements are investments that are non-registered securities, non-traded securities that are sold to investors through Private Placement Memorandums (PPMs) that are used to communicate the specific details related to the securities offering. Brokerage firms who recommend private placements to accredited investors have a duty to only recommendation the investment after a reasonable investigation has been conducted concerning the accuracy of the information contained in the private placement memorandum related to the investments risks, economic viability and audit financial statements.
Selling away is considered any activity where a financial advisor is engaged in “private securities transactions” with the investing public that concerns securities that have not been approved by the brokerage firm and there is an expectation by the financial advisor that “selling compensation” will be paid. Brokerage firms are responsible for all of their financial advisors’ business activities whether disclosed or not and are required to take affirmative actions to monitor and uncover any unapproved outside business activities, including activities related to private securities transactions.
Trading or investment seminars can provide a great deal of information, but they also provide the opportunity for fraudulent schemes. These schemes can lead investors to lose significant amounts of money when stockbrokers or financial advisors use seminars or a “free lunch” to promote fraudulent trading schemes or promote bogus investments and Ponzi schemes. In some cases, those committing investment fraud can be held responsible through legal action in securities arbitration or court.
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