Securities Concentration and Failure to Diversify

The risks of securities concentration are well known. One of the most basic principles of modern portfolio theory and a key concept of investing is diversification. Diversification can be thought of most simply as not putting all of your eggs in one basket. This basic principle has been considered a best practice among financial professionals and the foundation of portfolio structuring for many years. By spreading investors’ money across several investments the risks associated with any single investment is reduced.

Concentration risks in a portfolio may not be so obvious at first glance. Sometimes a portfolio with several investments may appear to be diversified but in reality upon a closer look may be concentrated in a particular asset class, market segment, or geographic region. This increases the risks of the portfolio considerably in down markets.

Brokerage firms and financial advisors are required to disclose the risks associated with a particular investment or investment strategy when making recommendations. Any investment recommendation should take into consideration the total composition of the investment portfolio.

Diversification is not just a one-time exercise. Investment portfolios should be reviewed to ensure that market changes over time do not cause the portfolios to be more exposed to some assets than others. As some investments increase in value and others decrease in value over time due to constantly changing market conditions, this may result in securities concentrations and reduced diversification. It may be necessary to rebalance the portfolio to bring it back to the intended investment goals and appropriate level of risk for the investor.

Failure to recommend an overall strategy to manage the risks associated with securities concentrations and/or failing to diversify can be considered stockbroker negligence, unsuitable investment advice or a violation of FINRA sales practice rules and regulations.

For many years stockbrokers have held themselves out as “financial advisors” to their clients. When a financial advisor lauds their financial expertise to garner a client’s business and clients rely upon these representations, a fiduciary relationship may be formed whether in a typical “non-discretionary” brokerage account or a fee-based investment advisory account.

As fiduciaries financial advisors are held to a higher standard when making recommendations to customers. They must abide by financial industry standards of care and best-practices when making investment recommendations. They have a fundamental obligation to act in the best interest of their customers at the time of making investment recommendations. As such a securities concentration or failure to diversify an investment portfolio may be considered a breach of their fiduciary duty. Breach of fiduciary duty may be a cause of action in a FINRA arbitration claim for damages due to securities concentrations and failure to diversify.

The Silver Law Group can help you determine whether an investment loss is the result of a securities concentration and/or 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.