Identifying Securities Claims From Your Client’s Prior Broker

Even experienced brokers and advisors can have a difficult time evaluating whether the activity in their customers’ accounts with their prior brokers was appropriate or not. Below are some of the more common red flags to look for. By no means are any of these, in isolation, dispositive, but if you see these types of things in your client’s account, and certainly if you see more than one of them for the same client, it is a good idea to refer them to a qualified attorney that can review their claims and see if they have an opportunity to recover some of their losses. 

Losses or gains that do not track major market indices. An obvious red flag is during a time period that the market is up, your client’s accounts from the prior broker are way down (often a reason they might have switched to a new broker or advisor). However, a less obvious situation is when the clients’ gains are simply flat or below the market average. The securities laws (and blue sky laws in Wisconsin) are transactional in nature, meaning that a client can have a claim on a specific set of securities or strategy even if their account as a whole did not lose money. We often see that the performance of a client’s other more traditional holdings will mask the unsuitable or fraudulent nature of other trades in the account until a downturn in the market,

“Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffett

Beta on transferred in securities does not match the client’s stated risk tolerance. Most supervisory systems will now automatically calculate the beta of the investments being held in the account and raise a compliance flag if the beta or standard deviation is higher than the stated risk tolerance for the client should allow. If that is the case for the securities your client held upon transferring in from another broker, it is a red flag that their account was not being properly managed. 

Over-concentration. A sometimes overlooked facet of the suitability standard is that not only should an individual trade be suitable for that specific customer on its own, it has to be suitable taken into account with the entire mix of the customer’s investment portfolio. Over-concentration in a particular asset class or sector can be a red flag for an account that has not been properly managed by the prior broker. 

High commission products. Any time a client is holding a product, or products, that pay above average commissions, it is a red flag worth looking at. Of course these products are not always a problem, but many of them are extremely speculative and illiquid, and thus unsuitable for many retail investors. FINRA Chairman and CEO, Rick Ketchum, warns in his 2016 priorities letter about seniors and vulnerable investors that FINRA has been seeing “products recommended that are not suitable for elderly investor[s] but provide high commissions and payouts to the salesperson.” The most common examples of typically high-commission products are non-traded REITs, tax deferred annuities, municipal bonds (with high mark-ups), closed-end funds, options, structured notes, and Master Limited Partnerships. 

Private Placements. Most of these are sold under the Regulation D exemption. With the change in 2015 to Rule 506 that allows advertising of Private Placements, the above average commissions typically associated with them, and the generally illiquid nature of the investments,  many retired or soon to retire investors are at risk for being recommended these investments that are not suitable for them. FINRA has made is clear that just because an investor qualifies as accredited under Regulation D, it does not make the investment suitable for them. As stated by FINRA RN 07-43, “Simply put, eligibility does not equal suitability.”

Annuity Switching. If your client informs you that their prior broker had significant funds in a variable or equity indexed annuity and indicates that they had switched more than once that is a serious red flag. Typically the sales pitch to the client will be that the bonuses of the new variable annuity outweighed the surrender charges. A key red flag to look for is whether or not the exchange form and worksheet was filled out as part of the switch. Not only are suitability requirements implicated in the sale of variable and equity indexed annuities, but Wisconsin has a specific statute, 628.347 Suitability in Annuity Transactions, which requires that any switches from one annuity to another be specifically reviewed for suitability for the customer.

Churning and excessive trading. Any time a customer reports significant trading in their account, it is worth looking at and seeing if anything improper was happening in the account. Perhaps counter-intuitive, but it is not just commission based accounts that see churning. FINRA has reminded members in NTM 15-22 about the obligations for member firms to monitor for excessive trading in discretionary accounts as well. Regardless of the motivation of the broker, FINRA has established that over-active account management can cause underperformance and significant losses in an account. 

Tax-free securities in non-taxable accounts. Tax free securities always carry a cost, whether it is upfront or by virtue of lower returns. Rarely, if ever, can these investments meet a brokers suitability obligations if recommended for a tax free account. It is not suitable to recommend an investment that provides lower returns with no discernable benefit. This counterintuitive strategy can be especially troubling given the high mark-ups that are sometimes associated with municipal bonds sold to retail investors. 

Non-traditional ETFs. Despite FINRA’s repeated warnings that a strategy of buying and holding leveraged or inverse ETFs is almost always unsuitable for retail investors, retail brokers continue to recommend them to investors. As most non-traditional ETFs are specifically designed to accomplish their stated goals in a single day, holding them for any period of time can have unpredictable and usually negative effects on a client’s portfolio.  

Options. Obviously there are many types of options, and certain limited options strategies used correctly can actually minimize risk for investors. However, all too often the options trading strategies employed are wholly unsuitable for most retail investors exposing them to outsized risk and significant fees for little in the way of realized gains and often significant losses.  

If you have seen any of these red-flags from the activity in your clients account from his or her prior broker or advisor, they may have a claim to recover those funds. While the majority of the financial services industry tries their best to provide good advice and service to their clients, there is an underbelly that is simply out to make commissions at the expense of investors. 

Markets simply cannot function well if there is an undue risk—whether real or perceived—that one’s hard-earned savings could line the pocket of a fraudster instead of providing a good retirement, sending kids to college, or helping to start a new business – Robert W. Cook President and CEO, FINRA