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Common Stockbroker Misconduct

Breach of Fiduciary Duty

Brokers and brokerage companies always have a duty to deal with their customers in a good faith manner and to execute all direct orders in a precise and accurate fashion. The duty that is owed to the customer, often considered to be a fiduciary duty, creates varying levels of broker responsibility based on the sophistication of the customer, the customer's prior investment experiences, the representations of the broker, and the ability of the customer to verify the broker's representations.

If a customer, due to lack of sophistication, places a great deal of faith in the broker's investment recommendation, the duty of the broker in that relationship increases, most likely to the level of fiduciary duty. As the level of sophistication of the customer increases to a point where it equals or exceeds the level of sophistication of the broker, the duty of the broker may decrease. The obligation of the broker, nevertheless, is to always act in the best interest of the customer.

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Brokerage Registration

Most states require both a brokerage company and broker to be registered to sell securities in that individual state in an effort to police who has the ability to sell securities to the individual citizens of that state. Many states will not allow brokers who have disciplinary histories to sell securities to citizens of their state. If a broker is not registered to sell a security in an individual state and
does so, the customer would have a claim against that broker and the brokerage company for their failure to be properly registered.

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Churning/Excessive Trading

When a broker engages in excessive trading in a customer's investment account to generate additional commissions, it is called churning; and he or she typically earns a commission on every trade, regardless of whether you made or lost money. To prove that your broker has churned your account, you can evaluate the pattern of trading activity in a number of ways, including calculations to determine the annualized rate of return that would be necessary to cover the commissions charged in your account; the number of times the equity in your account is turned over to purchase securities; and frequency of the buying and selling activity that occurs in your account.

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Federal Securities Laws

The federal securities laws generally require a broker to fully and fairly disclose all pertinent information in relation to a security before selling that security to a customer. If a broker makes untrue statements of important facts or omits important facts in the sale or purchase of a security; engages in acts, practices, or courses of business that operate a fraud or a deceit; fails to follow the specific selling instructions of a customer; or employs any device, scheme, or artifices to defraud a customer, then that broker would be in violation of the federal securities laws.

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Failure to Sell

The price of a security should be determined by supply and demand. If there is no demand to sell a security but there is a demand (created or actual) to purchase a security, the price will increase.

It is common practice for companies manipulating the price of a security to simply refuse any attempts to sell a security. If your broker fails to follow your explicit instructions to sell a security, they have violated federal and state securities laws and the rules and regulations of FINRA, the Financial Industry Regulatory Authority. There is a strong possibility that you are involved with a company that is manipulating the price of a security. (The National Association of Securities Dealers, NASD and the New York Stock Exchange, NYSE became FINRA in July 2007.)

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FINRA Rules and Regulations

The Financial Industry Regulatory Authority, (FINRA), formed by the consolidation of NASD and NYSE member regulation panels, has many rules and regulations relating to the sale of investments to customers. A broker and his brokerage company are required to understand the investment needs of their customers. This includes understanding the amount of risk an individual customer can take in purchasing a security, the investment objectives of the customer, and the financial background of a customer.

The FINRA rules and regulations require that a broker or a brokerage company's investment recommendations be suitable for an individual investor. FINRA requires that a brokerage company establish and maintain systems to supervise the activities of their brokers, which must be reasonably designed to achieve compliance with applicable securities laws and regulations and with the rules of FINRA. It is a violation of these rules to induce the purchase or sale of a security by any manipulative, deceptive or fraudulent device; to fail to follow specific selling instructions of the customers; or to engage in acts, practices or courses of business that would operate as a breach of such responsibilities. In connection with the purchase and sale of securities, a broker and his brokerage company have the responsibility to ensure that reasonable grounds exist for believing that the recommendations presented to the customer were suitable for that customer. A broker and a brokerage company have the responsibility to observe the high standards of commercial honor and just and equitable principles of trade when engaging in brokerage activities with their customers.

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High-Pressure Sales/Fraud

Penny stock firms (in today's environment these stocks can be traded in the $1 to $20 range) and their employees engage in a variety of abusive and fraudulent sales practices, which generally include high-pressure sales tactics in the purchase and sale of securities, misrepresentation of certain facts, the omission of negative information concerning recommended NASDAQ over-the-counter stocks (hereinafter referred to as “House Stocks”), engaging in unauthorized trading in customer accounts, and simply refusing to sell house stocks.

These firms defraud unsuspecting investors by employing high-pressure sales tactics utilizing misrepresentations and omissions in the sale of securities and establishing credibility through misrepresentations about themselves and their companies. In the initial series of calls, these brokers will make a relatively small investment recommendation in a well-known blue chip company. Shortly after this account-opening initial transaction, it is not uncommon for the account-opening broker to refer the client to a “senior account executive” that has the “experience and expertise” to handle the client's accounts. In reality, the second broker is generally a seasoned, skilled, high-pressure salesperson. After the initial transaction, the brokers in these companies only recommend house stocks. It is often the case that once you send this organization money, it is virtually impossible to get it back.

These house stocks are traded over-the-counter, may be quoted on NASDAQ and are almost exclusively unseasoned companies with low revenues and insignificant or negative earnings. House stocks are extremely speculative securities. The house stocks are solicited through the use of high-pressure boiler room sales tactics, misrepresentations, and omissions of important facts. Among other things, these firms and their registered representatives make predictions to customers about future prices of house stocks that do not have a reasonable basis in fact. It is common practice for brokers to make exorbitant, usually unfounded predictions of increasing stock prices over short periods of time. In some cases, these house stocks are not registered for sale in the individual's state or exempt from registration.

This pattern of behavior is well documented by the NASD and the SEC in dealing with companies that promote house stocks. If you are dealing with a broker who is using high-pressure sales tactics, and/or making exorbitant predictions regarding the investments they are promoting, and/or refusing to allow you to sell your investments, you may be dealing with a broker and/or company that is attempting to perpetrate a fraud upon you. The best rule of thumb if you find yourself in this situation is to immediately get your money back from this organization and consult an attorney.

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Misrepresentation and Omissions

A broker may be liable to a customer if that broker misrepresents or fails to disclose certain important facts in the sale or recommendation of an investment. Often these misrepresentations or omissions disguise the risk associated with a particular investment. A broker has a duty to fairly disclose all of the risks associated with an investment.

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NASD Rules and Regulations

See FINRA Rules and Regulations.

Negligence/Incompetence

Negligence is conduct that falls below the “legal standard” established to protect others against unreasonable risk of harm. For an act to be negligent, the actor may not intend the consequence of his conduct, but a “reasonable person” in his position would have anticipated those consequences and taken “reasonable” precautions to guard against them. If, for example, all of your investments were in technology stocks, your broker would be considered negligent. (See also Over-Concentration).

If a broker has been negligent in the handling of your financial affairs, then you may have a claim against the broker.

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On-Line Trading Claims

A natural corollary of the explosive growth in on-line trading has been an increasing number of retail investors who have sustained substantial trading losses in their accounts. Recent pronouncements by federal, state and self-regulatory authorities, with respect to the responsibilities of brokerage firms that provide their customers with on-line trading capabilities, have focused on the following issues:

  • The suitability of the investor for the purchases and/or trading strategies that were effectuated in the account at issue (i.e., customers who are allowed to engage in activities that are grossly in excess of their disclosed financial resources and prior investment experiences);

  • The manner in which orders were executed or perhaps not executed (i.e., customers whose orders are either ignored or executed at prices far in excess of reasonable expectations);

  • The existing capacity of the computer infrastructure utilized by brokerage firms in times of both extreme market volatility and system unavailability and/or crashes as well as the appropriateness of any prior disclosures that may have been provided to customers (i.e., customers who are either unable to gain access to their on-line accounts and/or whose orders to purchase or sell securities are unreasonably delayed); and or

  • The potential creation of false impressions in the advertisement of the benefits and characteristics of the on-line services being offered.

Claims relating to on-line trading may have merit. Our law firm evaluates each of these claims on a case by case basis. Call us if you would like us to evaluate the facts and circumstances surrounding your online trading claims.

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Over-Concentration

One of the most important rules of investing is diversification. If a broker concentrates an investor's portfolio in an individual investment or type of investment, then the risk of potential loss associated with that portfolio is dramatically increased. Simply put, it is unwise to place all of your investment “eggs” in any one basket. A broker who does not diversify an investor's portfolio is potentially liable to that investor should that portfolio decline in value.

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Price Manipulation

When a broker or brokerage company manipulates the price of a security, they are in violation of state and federal securities laws and the rules and regulations of the Financial Industry Regulatory Authority. FINRA replaced the NASD and the NYSE in July 2007, as the enforcement and arbitration regulating agency.

Price manipulation artificially increases or decreases the price of a security for the purpose of generating profits to the group manipulating the price. This is often accomplished by fraudulently promoting an investment in an effort to make it seem more valuable. High-pressure boiler-room sales tactics designed to drive up the price of the security enable the broker to sell shares that they have previously purchased at dramatically lower values. It is also not uncommon to have that same company sell shares that they do not own when the price of a security has been dramatically increased in an effort to repurchase those securities at a later date after they have stopped artificially inflating the price of the security and the price has declined.

When companies are manipulating the price of a security, they will often refuse to allow an individual to sell his or her security, which may be cause for alarm.

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Securities Registration

Most states require that the securities sold to residents of their states be registered or properly exempt. If a security is sold to a citizen of a state that has certain registration requirements, the broker and brokerage company must abide by those registration requirements before selling a state's citizens those investments. If a citizen of a state buys a security that is not registered or exempt in a state requiring registration, then that citizen may have a cause of action against the broker and brokerage company who sold them securities in violation of those registration requirements. States have registration requirements in an effort to protect citizens from certain investments that the state has deemed necessary for registration.

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Statute of Limitations/Time Bar

In some states, certain time limits may affect your ability to bring an action against a broker or a brokerage company. For example, if the law states that a customer has one year to bring a claim for certain actions, and the customer were to wait 13 months before bringing the action, then the customer could potentially be blocked from asserting some or all of his or her claims.

Statutes of limitations or time bars vary depending on the claims and change from state to state; therefore it is important to consult an attorney upon learning that you may have an action against your broker or your brokerage company.

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Unsuitability

The broker's duty is to recommend investments that are appropriate and suitable given an individual investor's circumstances. To ensure that investment recommendations are suitable, a broker must understand the risk an investor can or cannot assume, the tax considerations associated with an investment, and the investor's prior experiences, appetite for risk, and desired level of return. An investment may be unsuitable if: a customer does not have the financial ability to handle the risk associated with a particular investment, the investment did not correlate with the investor's financial needs, or if the customer did not know or understand the risk associated with a particular investment.

If a broker breaches those duties and makes unsuitable recommendations, the broker may be liable to the customer for selling them unsuitable investments.

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