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Types of Claims Against Brokers

Margin is the term used in the financial industry when a customer borrows money either to purchase investments, or to use those investments as collateral for a loan. In many instances, investing on margin is not suitable, and exposes the investor to risk that is unsuitable for the investor. Margin investing adds considerable risk to your portfolio, and you should understand it thoroughly before signing any agreement that permits margin, or permitting margin investing in your portfolio.

Brokers have a duty to investigate the ability of an investor to afford the financial risks inherent in a margin transaction, and to determine whether the investor understands the risks in a margin transaction before recommending a client sign a margin agreement and before entering into such a transaction. If they fail to investigate an investor’s ability to incur the risk in a margin account, or if they fail to make certain that the investor understands the risk in a margin transaction, the broker has violated certain duties owed to you, and you may be able to recover any damages incurred as a result of the margin transaction.

When you use a margin account to purchase securities, your brokerage firm is lending you money to purchase these securities. Whether you put up cash equal to some portion of the initial purchase (50%), or if you deposit other stock into the margin account as security for the margin loan, you are borrowing money from your brokerage firm (or its clearing firm) in order to invest. If your account overall or the investment purchased on margin decline in value, you may be required to deposit more funds or securities in your account, or the firm can sell your investments in order to protect their interest. This can cause significant damage to the investor.

Just like at a bank, when you borrow money, you are charged an interest rate. However, the interest rate does not pose the most risk to investing on margin, the volatility of the stock market and/or your portfolio does. If the securities in your margin account decline in value sufficiently, your brokerage firm will require you to immediately deposit more collateral to secure the loan due to the decrease in the value of their collateral–the securities in the account. This is called a margin call. When you receive a margin call, you will either have to deposit additional money into the account, or additional securities. Or, as in most cases, the investor does not have additional securities or money to deposit and the firm will sell enough securities to cover the margin call and meet the required equity maintenance levels. This can be devastating to an account and can often result in all of the securities in the account being sold.

While the use of margin can be an effective use of leverage to an investor who is capable of affording and understanding the risks, it is not typically a prudent tool for the average retail investor. When investors are wrongfully encouraged to use margin, possibly so that the broker can charge commissions on larger transactions, this amounts to a violation of industry rules and broker fraud.

Many investors don’t fully understand margin investing, and this may cause them to underestimate the risks of margin trading. It is up to the broker to make certain customers understand the risks before entering into a transaction. If you underestimated the impact margin can have on your accounts, or you do not understand margin, you should investigate whether your broker failed to fully inform you of the risks or that margin was not appropriate for you at any level. Such activity may be the sign that other inappropriate activity has taken place in your accounts.

Brokers and investment advisors may only make investment recommendations that are “suitable” for you, the investor. What is suitable for you may not be suitable for your spouse, co-worker, friend, etc. Your suitability now may differ from your suitability a year from now. A broker’s failure to inquire and learn about your investment profile is a violation of the suitability rules and can be the basis of your recovery in arbitration.

ESMA requires that brokers have a reasonable basis to believe that any transactions or investment strategies involving securities are suitable for a customer. Brokers should base this reasonable basis on information obtained through due diligence to ascertain the customer’s investment profile. Meaning, before making any recommendations, a broker must investigate your financial situation, your prior investment experience, your tax status, your investment objectives, and your tolerance for risk to determine whether a particular investment or investment strategy is suitable for you. Other factors for a broker to consider include your age, income, net worth, liquid net worth, education, understanding of risk, ability to afford the risk, other investments, and financial needs. All these factors are essential to a broker’s due diligence and must be considered before they make any recommendations. The totality of these factors makes-up your investment profile.

A broker’s failure to disclose the known or discoverable risks about a particular investment or investment strategy may violate of the suitability rules, resulting in fraud or other actionable misconduct. Generally, it is not necessary that the broker intend to conceal facts from you. It is only necessary that the broker failed to disclose easily discoverable facts pertinent to your decision to invest in the security.

It is important to note that suitable does not inherently mean risk-free. Just as unsuccessful investments are not necessarily unsuitable. No one can accurately predict the rise and fall of the market, and financial loss may occur from suitable investments. As an investor, hold your broker accountable for his or her recommendations and inquire as to how those recommendations are suitable for your investment profile.

If you believe your broker is recommending investments not suitable to your financial objectives, you may have a claim against your broker and/or the brokerage firm for suitability. If you experienced losses due to unsuitable investments, you may be entitled to damages.

When discussing investments with your broker or advisor, he or she should discuss with you the risks associated with any investment opportunities. Discussions of risk include the likelihood of your losing money in the transaction, any potential risk to your portfolio overall, and other associated risks that could possibly result from the investment. If all your broker or advisor wants to discuss with you is the tons of money you will receive from the investment, your broker is misleading you and leaving out important information necessary for you to make an informed and educated decision concerning the purchase or sale of an investment. A broker’s failure to advise you of the risks of any investment is negligent and a violation of ESMA rules and regulations, and your broker’s negligence potentially entitles you to a recovery of your damages.

A broker’s use of false or misleading facts is an affirmative action made by the broker to convince you to invest in what the broker is selling. False statements often include (unrealistic) guaranties, price predictions, or purported special information regarding an important contract, approval, earnings announcement, or other newsworthy event. Be wary of any promises made by your broker. Brokers have a duty to disclose all material facts and information when recommending stocks, securities, investment strategies, or financial products.

Unauthorized trading involves any trades that an investment advisor or brokerage firm makes for a customer without getting their express permission.

Before conducting any transaction on your investment account, your broker must have the proper authorization. If they fail to do so, they are violating industry rules, and can be held legally liable for any investment losses.

As was mentioned, the industry rules and regulations on unauthorized trading are clear. If you have a non-discretionary brokerage account, your investment advisor cannot, under any circumstances, take it upon themselves to conduct a transaction without your express consent. There is no implied consent on this issue. Yet, despite how clear this rule is, far too many brokers and brokerage firms still violate this rule. Worse yet, if something goes wrong, many then try to bully the victims into accepting the consequences.

If you sustained losses due to unauthorized trades, you are entitled to financial compensation for the full extent of your losses. Your broker had no right to make that transaction, and, as such, they must bear the liability for the trade that went wrong.