West Palm Beach Securities Arbitration & Litigation Lawyer
Rabin Kammerer Johnson represents investors and members of the public in claims against brokerage firms, investment advisors, and other investment professionals who have mismanaged their clients’ assets and caused investment losses. These claims are typically subject to mandatory arbitration before the Financial Industry Regulatory Authority or FINRA.
- Brokerage Firms
- Churning & Excessive Trading
- Margin Claims
- Omitting or Misrepresenting Information
Filing a case with FINRA is not like filing a case in court. FINRA cases are not decided by judges or juries. Instead, FINRA cases are decided arbitrators, usually a panel of three. The parties select these arbitrators through a ranking process.
FINRA conducts arbitrations all over the United States and even in foreign countries. The arbitration is usually scheduled in a location close to the investor’s home.
Preliminary hearings are commonly conducted by telephone, and the final arbitration hearing takes place in person. The final arbitration hearing is conducted much like a trial. The lawyers make opening statements, call and cross-examine witnesses, and give closing statements. The arbitrators usually issue their decision in writing within 30 days of the final arbitration hearing.
If you believe you have a claim against an investment professional, contact the West Palm Beach securities arbitration & litigation lawyers of Rabin Kammerer Johnson It is important to find a lawyer who is skilled in the securities arbitration arena. The FINRA arbitration forum is no place for a lawyer to “learn as he goes.” The Wall Street firm, regional broker-dealer, or investment bank you are trying to sue will have an experienced arbitration attorney, and you should have the same.
Florida Securities Arbitration FAQs
How do I check out my stockbroker?
The easiest way to check out your broker is at www.brokercheck.com, which is a free database run by the Financial Industry Regulatory Authority (FINRA). FINRA is the non-profit entity, supervised by the U.S. Securities & Exchange Commission, responsible for regulating securities broker dealers that do business in the United States.
You can use ABroker Check@ to investigate the background of your broker or the brokerage firm.
When investigating a broker or a potential broker that you are considering, you want to review the following factors:
1. With which brokerage firm is the broker registered?
It is often confusing to figure out which securities brokerage firm is responsible for supervising your broker or potential broker. This is often the case when the broker runs an Aindependent@ office and is only affiliated with a firm as an independent contractor. Knowing the firm responsible for supervising the broker, including the firm’s disciplinary history, is important information to have in deciding whether to go with or stay with your broker.
2. Where is the broker registered to buy or sell securities?
If you live in Florida, for example, you want to check Broker Check to ensure your broker has a registration in Florida. Brokers often move around or do business in numerous states. You want to make sure your broker has the proper licensing in the state in which you reside.
3. The broker’s employment history.
Broker Check will reveal the broker’s employment history, including dates of registration and current employment. One red flag to look out for is a lot of turnover or changing brokerage firms by the broker. This often will show a broker who is not stable or one who may have had disciplinary or performance issues at a prior firm. When hiring a broker, you might consider asking for other customer references or a reference from a former supervisor.
4. The broker’s customer complaint and disciplinary history.
The most important thing to look at on Broker Check is the broker’s customer complaint and disciplinary history. Most complaints by prior customers are required to be disclosed on Broker Check, including ones that result in a FINRA arbitration proceeding. Broker Check also requires a description of the complaint and whether the complaint resulted in a financial settlement or recovery. Likewise, regulatory discipline against the broker also must be disclosed on Broker Check, including suspensions or regulatory sanctions that the broker incurred.
What are the Top 10 Signs of Possible Stockbroker Abuse?
1. Vulnerable Client
Vulnerable clients frequently fall victim to stockbroker abuse or misconduct. Common features include: elderly, lack of financial sophistication, lack of understanding about account activity, and placing blind trust or faith in broker.
Recent research also shows that fraud and Ponzi schemes often have the following traits:
- Above–average financial knowledge
- College educated
- Recently suffered a financial or health setback
- Open to new ideas and sales pitches
2. Big Losses
All losses do not equal wrongdoing, but big losses could be a sign of trouble. The S&P 500 lost 30% in the second half of 2008. But should the client have been invested in S&P 500 stocks? Or did the client suffer above–market losses?
3. Too Many Transactions
Many firms charge commissions on a per–trade basis. Excessive trading or “churning” is trading designed to generate commissions for the broker rather than to achieve any legitimate investment goal of the client.
Look for thick account statements and lengthy Schedule D attachments.
4. Transactions Not Approved by the Client
Unless the account is discretionary, the client must approve every transaction. If the client reports that a broker handles all trades and the client learns the details only after the fact, the broker may have taken unlawful discretion.
5. Too Many Eggs in One Basket
The old expression “too many eggs in one basket” can apply in 3 contexts:
- Too Much in One Stock. Most firms recommend no more than 5%–10% in any single position.
- Too Much in One Sector. Example: technology sector or banking sector.
- Too Much in One Asset Class – Stocks, Bonds or Cash.Most firms have published “asset allocation” recommendations based upon investment objectives and risk tolerance. As an example, one major firm recommends that a “conservative” investor’s portfolio should hold 20% stocks, 55% bonds, and 25% cash.Stockbrokers often fail to follow their own firms’ published asset allocation advice.
6. Use of Margin
A client who uses margin is borrowing money from the brokerage firm to buy more investments, usually stocks. Stockbrokers often fail to explain the full risks of margin. It can be extremely dangerous, especially in a declining market. When the value of the account falls, the firm has the right to demand more collateral, via margin call, or to sell the account holdings, via liquidation.
For more on margin, see FINRA Investor Alert, Investing with Borrowed Funds: No “Margin” for Error.
7. Options – Put and Calls
Trading options is extremely sophisticated and can be very dangerous. A “call” option gives the buyer the right to buy a given stock at a “strike price” over a set number of months. A “put” option does the reverse, giving the buyer the right to sell at the strike price over a set number of months.
Both types of option contracts allow the investor to speculate about which direction the stock price will head. This type of investing can be very close to gambling, and the full risks are frequently not explained by the broker.
8. Investment Names You Do Not Recognize
You can easily recognize “blue chip” stocks like Coca Cola and IBM. But if a client’s statements are loaded with names you do not recognize, this may be a sign of trouble. High risk or “alternative” investments might include penny stocks, private placements, promissory notes, structured notes, derivatives, etc. Also, if an investment does not appear on the brokerage firm’s regular monthly account statement, this could be a sign of trouble.
9. Variable or Equity–Indexed Annuities
An annuity is a contract between the client and an insurance company, whereby the insurance company, in exchange for a lump sum payment, promises to make periodic payments to the client over an extended period of time. Annuities come in many varieties, including fixed, variable, and equity–indexed.
Annuities can be good investments for many clients, but they are extremely complicated and often misunderstood by the client. Moreover, annuities carry high commissions for brokers, creating an incentive for abusive sales practice.
For more on annuities see, NASD Notice to Members 00–44, and FINRA Investor Alert, Should You Exchange Your Variable Annuity? both at finra.org.
10. Problem Brokers
Finally, you can check out their broker’s regulatory history through FINRA “Brokercheck”
What is the blue sky law?
A blue sky law is a state law regulating the offering and selling of securities. The purpose of these laws is to protect investors from broker fraud or bogus investments. The name “blue sky” comes from a quotation cited by the U.S. Supreme Court in Hall v. Geiger-Jones Co., 242 U.S. 539 (1917) describing the kinds of frauds the laws are intended to stop. The Court wrote that “[t]he name that is given to the law indicates the evil at which it is aimed; that is, to use the language of a cited case, ‘speculative schemes which have no more basis than so many feet of ‘blue sky[.]”
Most blue sky laws were enacted prior to the passage of the federal Securities Act of 1933. The first blue sky law was passed in Kansas in 1911, and by 1933, forty-nine states had passed blue sky laws. Today, the majority of states with blue sky laws have modeled their statutes on one of the Uniform Securities Acts drafted by the Uniform Law Commission.
When Congress enacted the various federal securities laws, Congress decided not to preempt the state blue sky laws. Thus, state blue sky laws are valid, and states are free to create their own regulations on the offering and sale of securities, so long as those regulations do not conflict with a federal statute.
Blue sky laws typically require various forms of registration in order to deter fraud. Most brokers, brokerage firms, and securities issuers must be registered with the state securities agency. Likewise, most securities sold within a state (unless falling within an exemption) must be registered. In addition, blue sky laws generally make issuers or brokers liable for fraudulent statements or omissions made in the sale of securities.
Individuals may be able to sue the broker or issuer for rescission of the sale or for damages, depending on the state. For instance, Florida’s blue sky law allows an individual to sue, in most instances, for rescission only. Some state blue sky laws, such as New York’s Martin Act, do not give individuals the right to sue; instead, only the state securities agency may take legal action for a violation of the statute.
You can read more information about Florida’s blue sky law at Statutory Damages Under the Florida Securities and Investor Protection Act: How to Calculate and Apply Rescission Damages.
What is FINRA?
FINRA stands for Financial Industry Regulatory Authority, a private organization that regulates brokers and brokerage firms. FINRA, the successor to the National Association of Securities Dealers, Inc., was formed in 2007 by order of the Securities & Exchange Commission. FINRA has two primary missions – to protect investors and to ensure the integrity of financial markets. FINRA accomplishes these goals in a few different ways. FINRA regulates roughly 4,000 firms employing over 600,000 registered representatives.
First, FINRA sets its own rules for how brokers and brokerage firms should operate. Brokers are required to pass tests on FINRA rules and federal securities laws in order to work in the industry. FINRA conducts routine audits of brokers and their firms, and FINRA reviews all advertising to make sure that brokerage firms present honest and fair information to the public. Brokers and firms who do not obey the rules are subject to discipline. In 2014, for instance, FINRA brought roughly 1,400 disciplinary actions, levied fines of over $130 million, and ordered restitution of $30 million to defrauded investors.
Second, FINRA provides free research tools and educational materials to help investors make better financial decisions. For instance, FINRA’s BrokerCheck tool allows investors to research the background and qualifications of individual brokers and investment advisers. FINRA also provides other data on different types of investments, as well as Investor Alerts about potential frauds and scams.
Finally, FINRA has a Dispute Resolution arm, which is charged with resolving disputes between investors and brokers. In lieu of a lawsuit, all FINRA member brokers and firms are required to submit to binding arbitration with FINRA. FINRA’s dispute resolution branch is the largest arbitration forum in the United States. In 2014, roughly 3,822 cases were filed with FINRA, with the vast majority of those cases involving allegations that a broker breached fiduciary duties, recommended unsuitable investments, made misrepresentations, or committed negligence.
Can an arbitration award be vacated or appealed?
In a word, yes. Whether an arbitration is governed by the Federal Arbitration Act (which covers contracts involving interstate commerce) or the Revised Florida Arbitration Code (which covers only intrastate matters), a party can petition a court to vacate the arbitration award.
Code provisions governing the procedure for vacating an arbitration award, however, are designed to discourage parties from challenging the award. For instance, under Florida law, only a handful of grounds exist for vacating an arbitration award:the award was procured by fraud, corruption or other undue means; the arbitrator displayed “evident partiality” to one side, was corrupt, or committed misconduct; the arbitrator refused to continue the hearing upon showing of sufficient cause; the arbitrator exceeded his or her powers; the parties never agreed to arbitrate and maintained their objection throughout the proceeding; and the arbitration was conducted without proper notice of the hearing.
Under federal law, four grounds exist for vacating an arbitration award, as set forth in 9 U.S.C. § 10(a):the award was procured through corruption, fraud, or undue means; the arbitrator displayed “evident partiality” or corruption; the arbitrators are guilty of misconduct for refusing to postpone the final hearing; or the arbitrators exceeded their powers. While certain courts previously concluded that additional grounds exist for vacating an award, in 2008, the U.S. Supreme Court held in Hall Street Associates, L.L.C. v. Mattel, that these statutory grounds were exclusive, and no other justification for vacating an arbitration award exists.
A petition to vacate should be approached with great caution. The Eleventh Circuit Court of Appeals, the federal appellate court for Florida, has held that the arbitrator is intended to be the “last decision maker in all but the most unusual cases.” As such, it has instructed federal trial courts in Florida to impose sanctions against parties who seek to vacate arbitration awards without an objectively reasonable basis to do so. Courts have not shied away from doing so. The lesson here is that a petition to vacate should not be filed as a matter of course, and a party must carefully consider the pros and cons of filing a petition before doing so.
Florida state courts have not taken the same hard line against petitions to vacate arbitration awards. Florida law does permit a party to move for sanctions when an opposing party’s claim or defense is not supported by material facts or then-existing law. Nevertheless, Florida courts have found that “merely attempting to relitigate issues submitted to arbitration is not sufficient to satisfy the required finding, essential to liability under that [sanctions] statute, that there was a ‘complete absence of a justiciable issue of either law or fact . . . .'”That being said, a party should still consider carefully any plan to challenge an arbitration award, to avoid fighting a costly sanctions battle.
552 U.S. 576 (2008).
B.L. Harbert Int’l, L.L.C. v. Hercules Steel Co., 441 F.3d 905, 913 (11th Cir. 2006), abrogated on other grounds by Frazier v. CitiFinancial Corp., 604 F.3d 1313, 1321 (11th Cir. 2010).
 Harris v. Haught, 435 So. 2d 926, 929 (Fla. 1st DCA 1983).
What is rescission of a trade?
It is a remedy that can be awarded by a court or arbitration panel instead of damages. Generally speaking, the plaintiff suing for rescission must be able to give back to the defendant everything he or she received in the transaction. In exchange, the plaintiff will receive back all money or other property he or she gave to the defendant. The goal of rescission is to put both parties back into the positions each was in prior to the transaction. In other words, the purpose is to restore the status quo ante (Latin for “the way things were before”).
While there are no hard and fast rules as to when rescission is available (it largely depends on the law of a particular state), rescission is often granted when a transaction was induced by fraud or misrepresentation. Historically, rescission was considered an “equitable” remedy, such that a plaintiff had to show that he or she had no adequate remedy at law in order to have a transaction rescinded. In layman’s terms, this means that if an award of damages will fully compensate a plaintiff, rescission may not be available.
In the securities context, rescission may be available to a defrauded investor pursuant to a statute. For instance, Florida’s Securities and Investor Protection Act bars misrepresentations in the sale of securities and other investments. Any investor who purchases a security or investment in violation of the statute has a right to rescind the transaction. The purchaser may recover the amount paid for the investment, plus interest, while the seller receives the investment back, plus interest. Sometimes, this money is called “rescissionary damages,” though it is not the same as more typical “compensatory damages. “Compensatory damages are not available under this kind of statute, unless the purchaser sells the security or investment prior to filing the lawsuit. The sole point is to put the investor back in the same position that he or she would have been, had the investment never been made.
What is an investment objective?
An investment objective is a customer’s primary and secondary goal for his investments. A securities brokerage firm is required to determine what a customer’s investment objective is when the customer opens a brokerage account with the firm. Indeed, the broker is responsible for gathering the customer’s investment objective on the customer’s new account form. The main purpose of the investment objective is to ensure the customer’s goals for the account are met, to ensure the purchase or sale of securities are suitable for the customer, and to determine the proper portfolio mix for the customer.
During the life of a securities account with a brokerage firm, a customer’s investment objective often changes based upon the customer’s age or financial circumstances. It is, therefore, important for a broker to get regular updates from a customer as to the customer’s current investment objective. The investment objective is one of the key factors in evaluating whether a customer has a valid claim against a brokerage firm for a broker’s recommendation of unsuitable investments.
Who may be considered a vulnerable client?
Cases involving stockbroker abuse frequently turn on whether the investor is a vulnerable client. As discussed elsewhere in this website, stockbrokers have a duty to give “suitable” investment advice to their clients. This means stockbrokers must “know the client” and recommend investments that are appropriate for the client given the client’s investment objectives, level of sophistication and other background facts and circumstances.
Investment cases frequently turn into battles of “he said – she said,” with the investor and the stockbroker giving vastly different accounts of what happened. The stockbrokerclaims the investor wanted risk, while the investor claims the opposite.
In such cases, the arbitration panel (or the court if there is no arbitration clause) will frequently evaluate whether the investor has been abused or taken advantage of by the stockbroker. The following are potential signs of a vulnerable client.
The client is elderly. Like it or not, most people begin to lose the ability to handle their financial affairs as they age. In areas with large retirement populations, like Florida, unscrupulous brokers can take advantage of the elderly.
The client is unsophisticated. Does the client have any background or training in investment or business? Or is the client a retired widow whose experience consists of little more than balancing the family checkbook? Keep in mind that wealth does not always equal sophistication. Many professionals, doctors for example, can achieve financial success while understanding little or nothing about investing.
The client relies solely on the broker’s advice. Does the client have many financial and investment advisors or just one?Does the client come up with his or her own investment ideas? Does the client ever reject investment ideas brought to him or her by the broker, or does the client follow the broker’s advice 100% of the time. If the latter is true, the client might be a vulnerable client.
The client does not understand his or her investments. Many people fall guilty to simply opening their account statements and looking at the bottom line. They do not look more closely to make an effort to understand the investments they own. If a client cannot understand his or her account statements, however, or understand or explain the investment strategies being pursued, this may be a sign of a vulnerable client.
Every case is different, of course, and there is no single test of a vulnerable client.
What is insider trading?
Insider trading is the trading of shares of stock or other securities on the basis of material information about the security or the company that is not known by the public. Under federal regulations issued by the Securities and Exchange Commission, the term “on the basis of” means that the person making the trade was aware of the non-public information when the purchase or sale was made. In other words, a plaintiff or prosecutor need not show that the person used the information; possession of the information is sufficient.
“Insiders” are usually corporate executives, officers, directors, or major shareholders, though they may also include employees with access to non-public information. Trades by these individuals in their company’s own securities, based on information not known to the general public, are considered fraudulent. This is because corporate officers, directors, and employees owe fiduciary duties to shareholders to put the shareholders’ interests first. By trading on information not generally known to the public at large – including shareholders – the “insider” has put his or her own interests first.
One should note that “insider trading” also includes trades made on advice received from a corporate insider. Thus, if a corporate executive tells a neighbor that his company is about to merge with another corporation, if the neighbor then buys or sells shares in the company on the basis of the information, the neighbor may also be liable for insider trading.
A famous example of an insider trading prosecution was the case involving Martha Stewart’s sale of ImClone Systems stock. Stewart sold her stock on December 27, 2001, after her broker gave her non-public information that the price of the stock was about to fall. The next day, the FDA released information that it was not approving a drug ImClone sought to market, causing the value of its shares to drop. Stewart saved roughly $45,000 by selling her stock one day earlier, on the basis of the “insider” information. Though indicted for securities fraud, that charge was dismissed at trial for lack of evidence.
Trades by insiders are not always illegal. For instance, an employee of a corporation with a stock option plan may trade in the company stock, so long as the trades follow company policy and SEC regulations.
What must an investor prove to bring a claim in FINRA?
Most legal disputes between investors and brokerage firms must be brought in arbitration before the Financial Industry Regulatory Authority, also known as FINRA. Cases brought in arbitration differ greatly from cases brought in court. Arbitration cases are not decided by judges or juries, but rather by a panel of three arbitrators. Discovery, i.e., the ability to gather documents and learn facts from the other side, is much more limited in arbitration. Also, the losing party in arbitration has very limited rights to appeal an unfavorable ruling.
To prevail in an arbitration claim, an investor must generally prove some form of misconduct on the part of the brokerage firm or one of its brokers. FINRA cases usually involve one or more of the following types of legal claims:
Suitability Violations. Under FINRA Rule 2111, brokers and brokerage firms cannot make investment recommendations to customers unless those recommendations are “suitable.” Generally, this imposes three requirements on the broker. First, the broker must know the client. This means the broker must learn about the client’s background, investing history, financial situation, investment risk tolerance and investment objectives. Second, the broker must know the investment product that he or she is recommending to the client. The broker must know the risk level and essential facts regarding the investment product being recommended, whether it is a stock, bond, or some other form of investment. Third, the broker must match the investment recommendation to the client, such that the recommendation is suitable for the client based upon the client’s particular facts and circumstances.
Misrepresentations and Fraud. Brokers must tell the truth about investment recommendations and disclose all material facts affecting an investment recommendation. Failure to do so gives rise to a legal claim.
Unauthorized Trading. In most brokerage accounts, a broker must secure the client’s express permission before buying or selling any position in the account. When a broker buys and sells without first securing a client’s permission, this is unauthorized trading.
Churning. Many brokerage firms charge clients a commission for each and every trade. This provides brokers with a financial incentive to place more trades. The more trades the broker places, the more money he or she makes. When a broker recommends trades in order to generate more commissions, rather than to pursue a legitimate investment strategy, this is called churning.
Breach of Fiduciary Duty. As a general rule, a broker owes a fiduciary duty to act in the client’s best interests rather than in his or her own best interest. A broker violates this fiduciary duty by recommending unsuitable investments, making misrepresentations, engaging in unauthorized trading and churning the account.
Florida Broker Negligence Attorney
Unauthorized transactions are the purchase or sale of securities that a broker makes for a customer without the customer’s permission. The Financial Industry Regulatory Authority (FINRA) has a specific rule that prohibits any broker from making unauthorized securities trades without prior approval from the customer. See FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade).
Two primary exceptions exist where a broker may place a trade for a customer without the broker getting approval from the customer for the specific transaction. First, when a customer’s account is designated as a “discretionary account”, the broker does not need to get the customer’s specific consent to make a trade. This is because any discretionary account requires the customer to sign a written agreement that pre-authorizes consent for the broker, in his discretion, to make trades in the customer’s account consistent with suitability rules. Second, if the customer has a margin account and the value of the margin account falls below the brokerage firm’s requirements, the customer has signed a written agreement that authorizes the brokerage firm to sell securities as needed to cover any margin balance.
In non-discretionary accounts, FINRA rules require the broker to make a contemporaneous note of an order based upon the approval of the customer. The brokerage firm must then send the investor a confirmation within three days that confirms the details of the order. These details include the name of the security, whether the investor bought or sold the security, the date of the order, and the price at which the customer bought or sold.
What are market adjusted damages?
Market-adjusted damages are a type of damages often applied by courts and arbitrators in securities cases. This model of damages enables a customer to compare a market benchmark with the actual losses incurred in an account to show the customer’s losses compared to a market index or a hypothetical portfolio that is near the asset allocation in which the customer should have been invested.
An example of a market-index benchmark would be comparing the S&P 500’s performance over a certain time period with the actual losses in the customer’s account during the same time period. When you compare how the S&P 500 performed to the actual losses in the customer’s account, the question is, would the customer’s accounts have performed better had they been invested in line with the S&P 500?If so, the customer may be able to recover not only his or her actual losses, but also the gains that would have been achieved had the portfolio been invested in line with the S&P 500.
Another type of market-adjusted damages is called well-managed or model portfolio damages. An example of a well-managed or model portfolio for a moderate growth investor may be a portfolio consisting of 60% stocks and 40% bonds. If you compare how a 60/40 stock-bond portfolio performed during the same time frame as the customer’s actual losses were incurred, you would then add the additional gains that would have been received from the 60/40 portfolio to the actual losses suffered to increase the spread. In many cases, this makes the damages recovery larger than just the actual losses incurred.
All damages theories, however, must be examined on a case-by-case basis as to what is most beneficial to the customer.
What is a Private Placement?
The Financial Industry Regulatory Authority (“FINRA”) has issued a new investor alert Private Placements-Evaluate the Risks Before Placing Them in Your Portfolio. As investors search for yield in a low-rate environment, more investors are being drawn to private placements.
A private placement, also called a non-public offering, is an offering of a company’s securities that typically is not registered with the Securities and Exchange Commission and is not available to the general public. The majority of private placements are offered pursuant to Regulation D of the Securities Act of 1933 (“Reg D”). Reg D specifies the amount of money that can be raised, and the type of investor that may be solicited to invest in a non-public offering.
In general, participants in private placements are institutional investors e.g., banks, insurance companies, and pension funds, or “accredited investors.” An accredited investor has an individual or joint net worth with his or her spouse exceeding $1 million, exclusive of primary residence; or had income exceeding $200,000 ($300,000 jointly with a spouse) in each of the two most recent years, and has a reasonable expectation of the same income level in the current year. In theory, an individual who meets the definition of an “accredited investor” is financially sophisticated and better equipped to understand and accept the risks of investing in private placements.
With the passing of the 2012 JOBS Act, companies will now be allowed to conduct general solicitation and advertising for non-public securities offerings. As a result, all potential investors, accredited or otherwise, will likely be the recipients of private placement sales pitches.
For investors who are invited to participate in a private placement, FINRA offers some tips to evaluate the investment and determine whether to add it to their portfolio.
- Do your homework on the company’s business operations. Many private placements are offered by companies that are not required to file financial reports, so investors may have difficulty finding out how the company is doing. Ask your broker what information he or she reviewed about the company.
- Ask how and when you may be able to liquidate the investment. Private placement securities are considered “restricted” securities and have specific limitations on how and when they can be resold.
- Consider how the investment fits in with your overall investment profile and risk tolerance.
- Be extremely cautious about non-public offerings you hear about through unsolicited emails, social media, or cold calling.
When considering whether to participate in a private placement, investors should consult an investment professional and tax adviser for a thorough and beneath-the-surface explanation of the investment’s risks, benefits and potential tax consequences before adding it to their portfolio.
FINRA’s Investor Alert: Private Placements-Evaluate the Risks Before Placing Them in Your Portfolio can be read by clicking here.
What is an ETF?
According to the Investment News, the exchange traded fund (ETF) market passed a key milestone in 2011 when the total assets invested in ETFs crossed the $1 trillion mark. Despite their growing popularity, many investors are still not sure exactly what ETFs are. As with any investment, it pays to be an educated investor.
An ETF is a basket of investments such as stocks, bonds, commodities, currencies, options, swaps, futures contracts or other derivative instruments that tracks the performance of an underlying index or sector. Like a mutual fund, an ETF pools investors’ assets and is managed by a professional fund manager who invests the fund’s assets according to a specified strategy.
However, not all ETFs are created equal. Some traditional ETFs may be appropriate for long-term holders, but others, such as synthetic leveraged and inverse ETFs, are complex, come with additional risk, and may require daily monitoring.
According to some investment professionals, traditional, fixed-income ETFs may effectively be used to balance a portfolio of mutual funds and individual bonds.
A fixed-income ETF is a special type of mutual fund designed to track the performance of a specific bond market index. Unlike bonds that generally pay interest semi-annually, fixed income ETFs usually distribute monthly dividends. In addition, most ETFs have no maturity date. The bonds in a fixed income ETF will mature eventually, but the proceeds are reinvested in new bonds rather than returned to investors. Fixed income ETFs are traded on the securities exchange and can be traded just as any listed stock. Also unlike bonds, an ETF’s trading history and price quotes are readily available.
Some additional reasons why it may pay to add fixed-income ETFs to a bond portfolio:
Maintaining Market Exposure: Investment grade and municipal bonds are thinly traded. As such, the right fixed income product may not be readily available. Cash can be put into a fixed-income ETF to maintain exposure to the bond market, and then easily be liquidated once an appropriate bond is found to purchase.
Diversification: Bonds trade in larger lot sizes than stocks so it is more difficult to build a diversified bond portfolio. Fixed-income ETFs are diversified by nature.
Liquidity: Individual bonds can be a good source of income, but they are not very liquid. Fixed-income ETFs, on the other-hand, are very liquid, allowing investors to quickly adjust their portfolio exposure to take advantage of new opportunities.
Management fees: Although trading ETFs may result in brokerage commissions, fixed-income ETFs tend to have significantly lower management fees and are more cost effective to trade than individual bonds.
Synthetic ETFs, such as leveraged and inverse ETFs explained below, are generally not appropriate for “buy and hold” investors. An ETF may reset each day, and if held longer than one day, its performance may quickly deviate from the underlying index it is attempting to mirror.
Leveraged ETFs use financial derivatives and debt to multiply the returns of an underlying index. Leveraged ETFs aim to keep a constant amount of leverage during the investment period, such as a 2:1 or 3:1 ratio. For example, for a leveraged ETF with a 2:1 ratio, if the underlying index returns 1%, the fund will theoretically return 2%. The ratio impacts the losses in a similar fashion, a drop of 1% in the index would result in a 2% loss in the ETF. Leveraged ETFs are often marketed as a way for investors to hedge their exposure to downward moving markets.
Inverse ETFs, also called “short” funds, use various financial derivatives to profit from a decline in the value of an underlying index. Investing in an inverse ETF is similar to holding various short positions in order to profit from falling prices. An inverse ETF that tracks a particular index seeks to deliver the inverse of the performance of that index.
Leveraged inverse ETFs, also called “ultra short” funds, seek to deliver a return that is a multiple of the inverse performance of the underlying index. For example, a 2:1 leveraged inverse ETF that tracks a particular index seeks to deliver double the inverse of that index’s performance.
Most leveraged and inverse ETFs are designed to achieve their stated objectives on a daily basis. As such, they are not meant to be held for longer periods of time – weeks, months or years. If held for more than one day, their performance can differ significantly from their stated performance objectives.
In addition, leveraged and inverse ETFs may be less tax efficient than traditional ETFs due to daily resets requiring more frequent trading. Frequent trading could possibly result in short-term capital gains that may not be offset by a loss. On the other hand, traditional ETFs may provide greater tax efficiency through fewer capital gains distributions.
Because ETFs are traded like stocks, each purchase and sale may result in the assessment of a brokerage fee or commission, usually on a per transaction basis. Since leveraged and inverse ETFs are traded more frequently due to their volatility, an investor could easily incur substantial brokerage fees and commissions.
As with any investment, investors should consult an investment professional and tax adviser for a full explanation of an ETF’s risks, benefits and potential tax consequences before adding it to their portfolio.
The Florida securities lawyers at Rabin Kammerer Johnson represent investors nationwide in FINRA arbitration matters. The Firm’s attorneys seek to assist investors who have incurred recoverable investment losses due to specific failures by stockbrokers and brokerage firms.
What is the difference between a broker and a registered investment advisor?
As a general rule, investors deal with two types of investment professionals: (1) brokers, and (2) Investment Advisors. The two positions are different and require different types of licenses.
Brokers: The entry-level position in the investment world is the “registered representative.”Most investors commonly think of this position as a “broker.”Brokers meet with clients and recommend purchases of individual stocks, bonds and the like. Brokers are called “registered representatives” because they are authorized and licensed by the SEC and FINRA to act on behalf of their employers, i.e., licensed broker-dealer firms, such as Merrill Lynch, Smith Barney, etc.
Investors are often surprised to learn how little time, effort and study it takes to become a broker. There is no educational background, college degree or similar requirement. Instead, a broker candidate must sit for and pass a single exam known as the Series 7 exam. If the candidate passes this exam, he or she receives a Serial 7 license and is authorized to make investment recommendations on behalf of the firm.
Importantly, however, brokers cannot take power of attorney or discretion over customer accounts. They can only make individual investment recommendations and then place those trades only after securing the client’s consent on a trade-by-trade basis.
Investment Advisors. Investment Advisors are different. These professionals must sit for and pass a higher level of examination, known as the Series 65 exam. In the investing world, these professionals are known as Investment Advisors, IA’s, Registered Investment Advisors or RIA’s. Investment Advisors can work for broker-dealer firms or they can work on their own. In fact, many Investment Advisors hang their own shingle, set up their own business and manage accounts for clients by way of a power-of-attorney.
As with brokers, it takes no specific educational background, college degree or training to become an Investment Advisor. Instead, the candidate must pass the Series 65 exam, albeit a more difficult exam then the Series 7.
Unlike brokers, Investment Advisors may take discretion over accounts and manage portfolios on an ongoing basis. This means the Investment Advisor need not obtain client consent for each and every trade. They can buy and sell securities as they see fit, without the express consent of the client. Because Investment Advisors have more power and authority over client accounts, they owe higher levels of fiduciary duties to their clients.
What is a discretionary account?
As a general rule, there are two types of brokerage accounts: discretionary and nondiscretionary. The legal duties that a brokerage firm owes to its client often depend upon which type of account is held by the client.
In a discretionary account, the client has given his or her broker the power and authority to make trading decisions without first consulting with the client on a trade-by-trade basis. In other words, the broker has discretion to trade the account, as he or she sees fit, in accordance with the investment objectives and other information provided by the client. The broker does not need to call the client before placing each and every trade.
In a nondiscretionary account, in contrast, the broker must consult with his or her client before placing every trade. The broker does not have authority to make trading decisions without the client’s express permission. The broker must mark each trade as either “solicited,” which means the trade was the broker’s idea, or “unsolicited,” which means the trade was the client’s idea.
As a general rule, a broker who handles a discretionary account owes a higher level of fiduciary duty to his or her client. This is because the client places more trust and control in the hands of the broker. In a discretionary account, a broker must not only recommend suitable and proper trades, the broker must also monitor the account and sell positions that become unsuitable due to changing market conditions.
In nondiscretionary accounts, courts have held that brokers owe a lower level of duty. The broker must recommend suitable and appropriate trades on a trade-by-trade basis, but generally has no ongoing duty to monitor the account once the trade is made. This duty can change based on the facts and circumstances of the case however. For example, if a broker develops a relationship of high trust and confidence with the client, such that the client never rejects the broker’s advice and the broker begins to make trades without the client’s prior permission, courts have found that a de facto nondiscretionary account can exist, thus giving rise to higher level of fiduciary duty.
What is overconcentration?
Overconcentration is a type of suitability violation often alleged by investors in claims against brokerage firms in FINRA arbitration.
As a general rule, most investment professionals agree that investors should seek to build diversified portfolios. This follows the old adage, “don’t put all your eggs in one basket.”The logic behind this policy is simple: the more money an investor has invested in one single stock, the more risk he or she faces if that stock fails. If an investor has 50% of his or her entire net worth invested in the stock of ABC Company, for example, the investor could lose 50% of his or her entire net worth if ABC Company declares bankruptcy.
For this reason, most brokerage firms have internal policies or published recommendations that advise brokers not to recommend that any customer hold more than 5% – 10% of their overall portfolio in any single stock or other position, absent unusual circumstances.
Overconcentration violations need not be limited to specific stocks or individual positions. A portfolio can also be over concentrated in a single sector of the economy. As an example, during the technology bubble of the late 1990s many brokers committed suitability violations by recommending that clients build portfolios that were over concentrated in the technology sector. Even though these portfolios had many individual technology stocks, the portfolios were still over concentrated in one sector of the economy – technology.
Many brokers fall victim to recommending whatever stock or sector of the economy is hot at any given time. In doing so, these brokers ignore sound investing principles and may be committing a suitability violation by advising their clients to place too many eggs in a single basket.
How can accountants identify securities claims?
Certified public accountants and other professionals who perform tax services often find themselves in a good position to identify stockbroker abuse against their clients.
Accountants do not normally review brokerage account statements on a monthly basis. However, in connection with tax services, accountants frequently review year-end statements or other documents necessary to prepare the IRS Schedule D. This is a listing of all gains and losses from investments, which must be reported to the IRS for purposes of calculating capital gains taxes.
Here are some common red flags an accountant might notice.
1. The client is vulnerable. Accountants are in a good position to know the background and life circumstances of their clients. Is the client sophisticated? Is the client elderly? Is the client vulnerable to being misled or abused by a stockbroker?
2. The Schedule D is long. As every accountant knows, the longer the Schedule D, the more trades are being placed in the account. Does the client understand these trades?Is the account being churned?
3. The Schedule D shows big losses. Has the client sustained large losses in the account? If so, why?Did the client understand the nature of the risks he or she was facing?
4. The Schedule D shows unusual investment names. Most accountants will be familiar with blue-chip stocks such as General Electric or Coca-Cola. If the client has stocks in companies the accountant has never heard of, however, this could be a warning sign. Is the client investing in thinly traded pink sheet stocks, alternative investments, or structured products?If so, does the client understand these investments and the risk he or she is facing?
5. The client does not understand his or her investments. Most importantly, the accountant is often in a position to recognize that the client does not understand the strategy behind his or her investments. If this is the case, the client may be vulnerable to stockbroker abuse and unsuitable investment advice.
What is margin?
Margin is an investing tool that allows customers to borrow money from a brokerage firm in order to purchase more investments, usually stocks. The theory behind margin is simple: by leveraging the account, the customer magnifies his or her opportunity to buy stocks and therefore realize more profits.
Margin sounds great. But in our experience, most investors have little understanding of the substantial risks that margin poses to their accounts. Just as margin magnifies the ability to make profits, it also magnifies the ability to incur losses – quickly.
This is because margin accounts are subject to margin calls. Under the rules that govern brokerage firms, a firm cannot lend more than 50% of the initial purchase price of a given stock. If a customer purchases $10,000 worth of stock ABC, for example, the customer must have at least $5,000 in cash to make the initial purchase, while the brokerage firm can loan the remaining $5,000. At that point, the customer has $10,000 worth of stock and a debt of $5,000 to the brokerage firm. The customer’s equity interest in the stock is $5,000, or 50%.
As we know, however, the value of stocks can fluctuate. Sometimes they go up; sometimes they go down. As the market value fluctuates, so does the investor’s equity interest in the stock.
Every brokerage firm sets minimum equity percentages that investors must maintain in their accounts. These are called house maintenance requirements. House maintenance requirements are intended to protect the brokerage firm; the firm wants to make sure that it has sufficient collateral at all times to secure the loan it has made to the customer.
In the above example, suppose the firm maintains a 40% maintenance requirement, and the value of ABC stock drops to only $7,500. The customer’s equity interest has now dropped to only $2,500, i.e., ($7,500 market value minus the $5,000 outstanding debt to the brokerage firm). This means the customer’s equity percentage has dropped to 33% ($2,500 ÷ $7,500).
The customer will now face a margin call. This is a demand by the brokerage firm that the customer immediately deposit sufficient cash or securities or sell existing securities necessary to bring the equity interest back up to 40%.
The easiest way to satisfy the margin call will be to deposit additional cash or stocks equal to $500. (A deposit of $500 brings the equity interest up to $3,000, which is 40% of $7,500).
But what if the customer does not have additional cash or stocks to deposit?Then, the investor must sell enough of his or her existing ABC stock to generate $500 in cash. This is a problem for two reasons. First, it forces the investor to sell the ABC stock while it is low, thus realizing a loss. Second, the investor must sell more than $500 worth of ABC stock order to generate $500 in cash. This is because the ABC stock is still leveraged. When an investor liquidates securities to satisfy a maintenance call, he or she must sell an amount equal to the call divided by the maintenance rate on the securities being liquidated. To satisfy the above $500 call, therefore, the customer needs to sell $1,250 worth of ABC stock, since it carries a 40% maintenance requirement: $500 ÷ .4 = $1,250.
This means the investor must lock in even more losses to satisfy the call. And this is just the beginning. If ABC stock keeps going down, the margin calls will spiral even further.
What if the investor does not wish to sell at this low price and realize these losses?It doesn’t matter. The brokerage firm has the ability to sell the stock anyway. This is called a margin liquidation. In a declining market, heavily margined accounts frequently end with a “margin blow out.”The firm liquidates the account to make sure its outstanding loan is satisfied, and the customer ends up with little or nothing left.
On top of all this, the brokerage firm does not loan its money for free. Customers must pay margin interest rates for the privilege of taking on these additional upsides and downsides of margin.
Oftentimes, brokers do not fully explain all of these risks when recommending that their customers invest on margin. Instead, the broker only explains the upside, the chance for greater profits, and the potential benefits of using margin. Clients who have been misled about the risks of margin as an investing tool may have a claim against their brokers. Please Note: Rabin Kammerer Johnson, P. A. provides these FAQs for informational purposes only, and you should not interpret this information as legal advice. If you want advice as to how the law might apply to the specific facts and circumstances of your case, please contact one of our attorneys.
Can I bring my investment loss case in court?
Most, but not all, cases for investment losses are subject to mandatory arbitration. This means these types of cases cannot be brought in state or federal courts, but rather, they must be brought before arbitration forums such as FINRA Dispute Resolution or the American Arbitration Association.
Whether a particular dispute is subject to arbitration depends on the contract between the customer and the investment firm or professional. Most customers receive investment advice from one of two places: (1) major broker-dealer firms such as Merrill Lynch, Smith Barney, UBS, etc., or (2) smaller Registered Investment Advisor firms.
Almost all broker-dealer firms include mandatory arbitration provisions in their customer agreements. When the customer signs up for an account, he or she agrees to arbitrate any dispute with the brokerage firm before FINRA Dispute Resolution. Likewise, many Registered Investment Advisors also commonly include mandatory arbitration provisions in their contracts with customers, usually requiring arbitration before the American Arbitration Association.
Customers should be careful to read the fine print to understand the exact rights they are giving up when they open an account at a brokerage firm or investment advisor.
There are many pros and cons of arbitration. Although opinions on this matter are subject to wide variation, some of the common pros are as follows:
- Arbitration can be faster (but not always).
- Arbitration can be less expensive. This means that lawyers who work on a contingency fee can take smaller cases that could not otherwise be brought in court.
Some of the cons are as follows:
- Cases are not decided by a jury of your peers, but rather a panel of arbitrators.
- Discovery rights are limited. In FINRA arbitration, for example, there are no depositions allowed. Parties do not typically know what the other side plans to say until the actual arbitration hearing arrives.
- Appeal rights are very limited.
As a practical matter, investors do not typically have a choice between arbitration and court. If you want to open an account with the brokerage firm, you must agree to arbitration. If you have a potential dispute with a brokerage firm or Registered Investment Advisor, you should consult an attorney who is familiar with these types of disputes and the arbitration process.
Who are the typical defendants in a securities claim?
The defendants to a securities claim can vary based upon the type of claim being brought and the venue in which it is being brought. As a general rule, defendants fall into two categories: (1) issuers of securities; and (2) third parties who recommend, solicit or cause investors to purchase securities.
Issuers: The “issuer” is the company behind the security, whether a stock, bond, LLC membership interest, partnership interest or some other form of investment. As an example, Coca-Cola stock is “issued” by the Coca-Cola Company. The issuer need not be a major public company. Smaller companies, partnerships and other investment vehicles also issue securities to be purchased by members of the public in order to raise money.
When companies, regardless of size, seek to issue securities, these companies must provide investors with written information about the investment, usually called a prospectus or offering memorandum. Securities claims against issuers usually focus on lies or other fraud in connection with the prospectus or offering memorandum. In other words, the investor claims that the issuer fraudulently induced him or her to purchase the security based on fraudulent information in the prospectus or offering memorandum. These types of claims are often brought as class actions, depending on the number of investors. These types of claims are normally brought in court, not in arbitration.
Third Parties: Next, investors may have claims against third parties (apart from the issuer), who advise, recommend or cause the investor to purchase the security. These defendants often have a financial motivation to induce the investor to purchase the security at issue. Common third-party defendants include:
- Broker-dealer firms, such as Merrill Lynch, Smith Barney, UBS, etc.
- Registered Investment Advisors
- Banks and Bankers
- Trust Companies and Trustees
- Insurance Companies and Agents
- Securities Underwriters
- Securities Promoters
Third-party claims usually focus on fraud or negligence in connection with the recommendation to purchase a given security or with information provided in connection with the security. The venue for third-party securities claims usually depends on whether or not an arbitration contract exists between the plaintiff and the defendant. Almost all broker-dealer firms, for example, require their customers to sign an arbitration provision when the customer opens an account with the firm. This means that claims against broker-dealer firms must usually be filed in arbitration rather than in court. If no arbitration contract exists, claims can be filed in court.
Can victims outside the United States sue for investment losses?
The answer depends on whether the case is brought before the Financial Industry Regulatory Authority (FINRA) arbitration forum or in court.
Florida Securities Claim Attorney
If the customer’s claims will be brought against a securities brokerage firm based in the United States, the customer may sue in the FINRA arbitration forum. Likewise, if the violations of the law were by a broker of a brokerage firm within the United States, the customer typically may sue the broker or the brokerage firm in the United States before the FINRA arbitration forum. Sometimes the arbitration case will be administered in the United States with the arbitration hearing occurring in the foreign country, if FINRA conducts arbitrations in that specific country.
The rules governing where a victim may litigate a case may differ, however, if the action must be brought in court, i.e., there is no arbitration agreement between the investor and the brokerage firm. Both federal and state courts in the United States have rules regarding personal jurisdiction over a defendant. For example, a customer’s claim may be subject to dismissal for lack of personal jurisdiction if the cause of action occurred outside of the United States or the defendant lacks “minimum contacts” within the United States.
Likewise, both federal and state courts have the discretion to dismiss a claim under the doctrine of forum non-conveniens, if a foreign court would be more convenient for the parties to litigate a case or if there is a stronger nexus, including witness availability, between the foreign country and the customer’s claims.
How do securities attorneys get paid?
The rules that govern how attorneys can be paid are complex and vary from state to state. The information below is a general guideline and may not be applicable in your state. As a general rule, attorneys who handle securities cases on behalf of investors can be paid in one of four ways.
Hourly Fee. First, the attorney and client can agree to an hourly fee arrangement. This means the attorney will track and record all of the time he or she spends on the case and will send the client a bill, usually monthly, to be paid based upon hours worked. The attorney and client must agree to an hourly rate, which can vary substantially depending upon the area of the country in which you live.
Hourly fee agreements normally require retainers. A retainer is an amount of money to be kept in the attorney’s trust account as a cushion. This cushion protects the attorney from getting “stiffed” if the client refuses to pay a bill.
Hourly fee agreements might also require a trial retainer. As a trial approaches, the client must normally deposit a large amount of money to cover the expected upcoming fees. Again, the attorney needs to protect himself or herself from expending a large amount of time at trial and then not getting paid.
Attorneys can never guarantee success in a given case. Good cases are sometimes lost. Bad cases are sometimes won. In hourly fee arrangements, the client pays regardless of whether the client wins or loses.
Contingency Fee. Alternatively, the attorney and client can agree to a contingency fee arrangement. This means the client pays the attorney a percentage of whatever sum is recovered from the defendant, whether through settlement, trial or arbitration. The client pays the attorney’s fee at the end of the case. If the client recovers nothing, the client pays nothing in attorney’s fees.
Contingency fee arrangements carry substantial benefits and risks for both the attorney and the client.
From the client’s point of view, the client receives a substantial benefit because he or she receives no monthly bills throughout the course of the case, and he or she pays no attorney’s fees at all if the case is not successful. On the downside, however, contingency percentages can be high, and in a successful case, the client normally pays more than he or she might otherwise have paid on a traditional hourly-fee arrangement.
From the attorney’s point of view, he or she takes the risk of getting paid nothing if the case is not successful. The attorney takes this risk in order to gain the benefit of the higher fees offered by contingency fee arrangements.
Keep in mind that attorney’s fees are not the same as costs. Every legal case requires the attorney to expend out-of-pocket costs to third parties, such as court filing fees, deposition fees paid to court reporters, expert witness fees, and the like. The attorney and client must also come to an agreement as to who will pay these costs.
Hybrid Fee. A hybrid billing arrangement is a mix between hourly-rate and contingency. The client agrees to pay one half of the attorney’s normal hourly billing rate and one half of the attorney’s normal contingency fee percentage. This is a way for both attorney and client to minimize the risks posed by the hourly fee arrangement and the contingency fee arrangement.
Flat Fee. Finally, the attorney and client can agree to an up-front flat fee for the entire case. These are not common in securities cases since investors who have suffered losses are usually not in a position to pay a large, up-front flat fee at the beginning of the case.
Regardless of the type of fee arrangement, most attorneys will reduce their fee agreement to writing to be signed by the client. This is known as a Retainer Agreement or an Engagement Agreement. You should make sure that you understand this agreement in full before signing it.
How long is the securities arbitration process?
Securities arbitration is a process, administered through FINRA, that is relatively expedited compared with a normal court case. The securities arbitration process usually takes approximately 12 to 18 months from the filing of the Statement of Claim through the issuance of an arbitration award after a final hearing.
One major benefit of the securities arbitration process is that there’s typically no, or a very limited, appeal after an arbitration award is issued. This is unlike a typical court case that may go on for many years at the trial level. Then, after the trial is concluded, post-judgment appeals can last even longer.
Compared with the length and unpredictability of the court process, the 12 to 18 months it takes to go through the FINRA process is comparably expedited. Moreover, when the claimant is a senior citizen, Florida law allows the claimant to seek earlier arbitration dates, potentially making the process even faster.
In sum, a claimant filing an arbitration claim should expect the process to take a year to a year and a half. Much of the timing depends on the arbitrators’ availability is in scheduling the final hearing.
Contact Our Experienced West Palm Beach Securities Arbitration & Litigation Lawyers Today
If you would like to consult with an attorney at Rabin Kammerer Johnson regarding a securities matter, please contact us online or call 561-659-7878 or Toll Free 877-915-4040.