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Securities Concentration and Failure
to Diversify

The risks of securities concentration are well known and diametrically opposed to what is considered optimal for most investors, a diversified or balanced portfolio. The reason is investors are uncompensated for the risks of exposure to catastrophic loss when they maintain a concentration stock position over an extended period of time. Financial industry standards supported by academic research support the need to avoid securities concentration, the concept of not investing all your assets in a single asset or asset class is a foundation for what is considered suitable for all investors. Furthermore, some academic studies contend that securities concentration exists for any portion of a portfolio’s holding that exceeds more than 10% of the entire accounts value.

Failure to recommend a strategy to manage the risks associated with securities concentration can be considered a violation of FINRA sales practice rules and regulations.Brokerage firms and financial advisors are required to disclose the risks associated with a particular investment or investment strategy for securities held with the brokerage firms. Any investment recommendation should consider the total composition of securities held in an investment portfolio. Failure to recommend a strategy to manage the risks associated with securities concentration can be considered broker negligence, unsuitable investment advice or a violation of FINRA sales practice rules and regulations as a minimum standard of care for customer accounts. An investor may be unable to maintain a diversified portfolio resulting in exposure to the risks of securities concentration for various reasons. A portfolio may have been concentrated as the result of one or more of the following reasons:

  • Inherited Legacy Stock;
  • Employee Stock Option Plan (ESOP) Participant;
  • Stockbroker Recommendation;
  • Founding Member of Publicly Traded Company;
  • Closely-held Stock Acquired through Merger or Acquisition;
  • Low Cost Basis with Substantial Capital Gains;
  • Restricted Stock Rule 144 Stock; and
  • Corporate Lock-Up Agreement.

In some instances an investor might, be restricted by an employer from selling stock, want to defer taxes, or have an attachment to the company shares. No matter what the reason for maintaining a concentrated stock position, a brokerage firm and their financial advisors must recommend suitable risk management strategies to protect the value of any concentrated stock position held in a brokerage account. Customers of a brokerage firm who hold a concentrated portfolio without investment advice to manage the risks of securities concentration may be a FINRA sales practice violation. In many instances, financial advisors recommend complex hedging strategies using options intended to reduce the risk of a concentrated stock position. However, if the strategy is poorly implemented or does not perform as promised, the brokerage firm may be held accountable for negligence.

The Silver Law Group can help you determine whether an investment loss is the result of from the failure to securities concentration and a failure to diversify a brokerage account. If an investor suffers losses as the result of securities concentration or the failure to diversify they may be able recover their losses in a FINRA arbitration claim.

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