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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 predomaintly 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.

"Your broker’s job is to serve you, and if you can not trust him/her then it is time to find a new broker." -- MH&A

 

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, lessor 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.