What you need to know about stockbroker misconduct

By: Lori T. Williams, Owner/Managing Attorney of Your Legal Resource, PLLC

Attorney Peter Rageas is an experienced FINRA (Financial Industries Regulatory Authority) arbitration attorney, representing individuals who have been victims of negligence or willful misconduct by brokers, financial advisors, and brokerage firms.

Financial Advisors and other investment professionals are governed by a body known as FINRA (Financial Industries Regulatory Authority).  One of the many compliance rules advisors must follow is FINRA Rule 2310 on suitability, which provides that:

a.  In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

b.   Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual fund, a member shall make reasonable efforts to obtain information concerning:

  1. The customer’s financial status;
  2. The customer’s tax status;
  3. The customer’s investment objectives; and
  4. Such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.

According to Rageas, “Stock broker misconduct and investment fraud occur when the legally required duty of good faith is violated. Investment advisors and brokers – by law – owe the investor the duty to operate in good faith. The law requires them to place your financial interests ahead of their own or that of their brokerage firms.”

Prohibited conduct includes the following, according to FINRA Rule 2110: Standards of Commercial Honor and Principles of Trade:

• Recommending purchase or sale of unsuitable investments
• Misallocation of assets balance within portfolio
• Purchasing or selling unauthorized security
• Margin investment loss without full risk disclosure
• Mutual Fund switch which was unauthorized
• Failure to disclose material facts including fees
• Wrongful removal of investor’s funds
• Excessive commissions
• Making predictions and or guarantees of security associated profits
• Failing to use reasonable diligence to see that an investor’s order is executed at the best possible price


Rageas notes the following examples of  actionable claims of stockbroker misconduct that his clients, and others, have successfully pursued:


  • Churning/Excessive trading


Churning refers to the excessive buying and settling of securities by a broker for the purpose of generating commissions and or fees and without regard to your investment objectives.



  • Fraudulent Material Misrepresentation


The broker falsified fact(s) about an investment.  If you had known the truth you would not have agreed to purchase the investment.


  • Fraudulent Material Omissions


The broker failed to inform you of facts concerning an investment.  If you had known these facts you would not have agreed to purchase the investment.


  • Unsuitable Recommendations


Brokers have an obligation to learn their client’s financial needs, objectives and circumstances before recommending an investment.  Unsuitable recommendations occur when the broker recommends an investment inconsistent with the client’s financial needs, circumstances and objectives.  For example, it would be unsuitable if the client wanted safety of principal and the broker recommends a risky stock or option strategy.


  • Auction Rate Securities Misrepresentations


A broker represents that that certain securities are cash equivalents or an alternative to money markets that can be liquidated on short notice without any risk to principal.  The broker fails to inform the client that the liquidity of the market in which the securities are traded depends on the brokerage houses participating in those markets.  The broker fails to inform you that auction rate security markets have failed in the past.


Brokerage houses and other financial institutions can elect not to participate in those markets thus preventing you from selling your securities.


  • Civil Theft of Funds or Securities


A broker simply steals money from a client’s account for his/her own use.  Some examples are;


  1. The Broker borrows money from you and never pays it back;
  2. The Broker recommends a non-existent security and keeps the purchase price;
  3. The Broker transfers the money out of an account without permission; and
  4. A check is sent to the client from a brokerage account.  The client did not ask for the check.  The client calls the broker to inquire why the check was sent and the broker claims it was a mistake and asks the client to send the check back to him/her directly.  The broker endorses the check upon receipt and deposits it into another account.



  • Failure to Follow Instructions


The broker is instructed to buy or sell a security or follow a particular investment strategy.  The broker ignores the instructions and does nothing or buys something else entirely.


  • Failure to Protect Profits


The account has appreciated significantly.  The broker fails to recommend or implement a strategy to protect the account profits.


  • Unauthorized Trading


The broker buys or sells securities without written or verbal permission.  Mutual Fund Abuses including, Mutual fund churning, Mutual fund switching.


Mutual fund commissions can be as high as 5% of the amount invested.  These commissions give unscrupulous brokers significant incentive to sell you a fund regardless of whether it is suitable for you.


  • Mutual Fund Churning/Switching


Mutual funds are considered long term investments.  Mutual Fund churning is the practice and buying and selling mutual funds for the purpose of generating a commission.


Mutual Fund switching involves the replacement of a mutual fund with the same type of fund in another mutual fund family for the purpose of generating commissions.


  • High Yield Junk Bonds and High Yield Junk Bond Mutual Funds


High Yield Bonds bond funds are rated below investment grade and are more susceptible to default.  Clients are typically not informed that these investments are known in the industry as “Junk Bonds”.  Given that most people would not put their lifesavings into anything called “Junk”, brokers rename these securities by calling them high yield and fail to inform the client of the significant risk they pose.  High Yield is attractive sounding but high yield means high risk.


  • Failure to Diversify.  Over-Concentration of Individual Securities or Asset Classes


It is almost universally accepted that a portfolio’s performance is dependent on diversification.  Over-concentration occurs when the portfolio is invested in too few securities or asset classes such as bonds, stocks, real estate, cash, etc.  For example, in the late 1990’s brokers recommended that more and more of their client’s portfolios be invested in technology related securities.  These recommendations caused portfolios to become over concentrated in technology stocks.  When the technology crash occurred in 2000-2001, individual’s life savings evaporated.


  • Selling Away


A broker will sell an investment that is not sold or authorized by his/her firm.  The broker almost always receives a special commission or finder’s fee for selling an investment outside of his firm.


  • Annuity Abuse


Annuities command some of the highest commissions and fees available for a broker.  Annuities are also expensive to hold or redeem early.  Early redemption penalties can be as high as 20% or more of the amount invested.  The amount of the withdrawal could also have significant tax penalties for early withdrawals.  As such, these investments are ripe for abuse.


The high commissions and fees provide significant incentive for brokers to misrepresent their benefits when recommending annuities to their clients.  One example is when brokers claim a variable annuity is guaranteed and that the client cannot lose money.  However, the broker fails to inform the client that the underlying securities in the annuity are subject to market risk.  The guarantee will not pay off during the holder’s lifetime unless the underlying securities appreciate in value.  The death benefit is the only guarantee in an annuity where the client’s heirs will receive the amount originally invested.


  • Option Fraud


Options are complicated and extremely risky investments suitable for individuals who understand the enormous risk of options and can afford to lose a significant part of their investments.


  • Margin Abuse


Margin accounts are a significant source of profits for a brokerage firm.  The client borrows money from the brokerage house using the equity in his/her account as collateral.  The broker then uses the money to purchase additional securities for the client.  The client pays commissions on the additional stock purchased in the account as well as interest on borrowed money.


Margin also doubles the risk on investments.  Accounts can be liquidated if stocks drop in value, even if the drop is temporary.


  • Negligence


Brokers have a duty of care to be reasonably diligent and prudent in the handling of client accounts.  Negligence occurs when the broker failed in his duty to be reasonably diligent or prudent and did not act as a reasonable and prudent broker would have acted in the same situation.


Stockbroker misconduct claims are usually handled through an arbitration process, and typically the attorneys are paid a contingency fee. This means if they are successful in recovering damages for the client, the attorney receives 1/3 of the settlement or collected judgment as his or her compensation, and the client receives the remainder, less any costs involved in the process.

For more information about stockbroker misconduct or Attorney Rageas, visit his website. Or for a referral to an attorney that can represent you in an action against your financial advisor for stockbroker misconduct, contact Your Legal Resource for a free consultation.

Lori T. Williams

Lori T. Williams is an attorney based in Birmingham, MI, licensed in 1989.  As owner of a legal referral business called Your Legal Resource, PLLC, Lori personally assists individuals and small businesses in need of legal advice or representation in Metro Detroit by connecting them with the right legal specialist to meet their needs.