Common Abuses

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Churning/Excessive Trading
Unsuitability
Selling Away
Unauthorized Trades
Mismarking Order Tickets
Misrepresentations and Omissions
Breach of Fiduciary Duties
Insider Trading and Front Running
Mutual Fund Switching
Overconcentration

Churning/Excessive Trading

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Churning occurs when a broker or broker-dealer encourages and engages in transactions that are designed to generate commissions rather than benefit the client’s account. Churning can occur even if the client made money on all the transactions for the account.

Investors should also be very careful when signing any activity letters for their accounts. Unless you fully understands the nature of all the transactions executed in your account, do not sign anything without consulting an attorney first. Churning cases are extremely difficult to win when a broker or broker-dealer has several signed letters indicating that the client knew that his/her account had high activity.

Another sign of excessive trading can be revealed by the cost/equity ratio in an account. If your account's annualized total costs of doing business exceed the amount of return on your investments, you might have a problem.

Unsuitability

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In making an investment recommendation to a client, a broker must make recommendations that are consistent with the customer's risk tolerance, needs and investment objectives. A broker has a duty to know his client and only recommend investments and trading strategies that are suitable for that client. An investment may be unsuitable if a customer does not have the financial ability to incur the risk associated with a particular investment, or if the investment was not in line with the investor's financial needs; or if the customer did not know or understand risks associated with certain investments.

A broker has a duty to understand the risk tolerance of an investor, the tax considerations for the client, the client's prior experiences and appetite for risk, and the level of return desired. It is the duty of a broker to make recommendations that are appropriate and suitable given his client's circumstances. If a broker breaches those duties and makes unsuitable recommendations for a client, the broker may be liable to that client.

Selling Away

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Because of the many investment opportunities that are available to brokers and their clients, the NASD and regional stock exchanges have enacted strict rules regarding the selling of investments outside the brokerage firm.

For example, a broker can not sell his client a partnership in an oil well outside his brokerage firm, unless the broker follows strict guidelines prescribed by the Stock Exchanges, the NASD and his firm. These rules are designed to protect clients from relying to heavily on a broker's funneling his client's funds to his friends business.

Be very careful of investing in outside private placements and initial public offerings that are recommended to you by your broker when the transactions are executed outside the brokerage firm or his employer. When in doubt, check it out!

Unauthorized Trades

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Under the Rules and Regulations of the Securities Industry, a broker must have you or an appointed agent give him/her the order for your account.

A broker cannot except an order unless a person who you have given limited or full power of attorney to, in writing, or yourself the gives broker the order for your account.

Just because you are married, your spouse can not place an order in your account if the account is listed solely in your name.

Oral discretion, as to time and price, can be granted, however no other orders can occur in your account without your prior approval. If a transaction occurs in your account and you did not initiate it, contact the branch manager immediately in writing and request that the order be canceled. Remember, time is always on your broker's side.

Even if you have a discretionary account, your broker is supposed to follow your instructions with respect to the exercise of that discretion. If you have told him, for example, that you do not want to buy anything risky or on margin, the broker has an obligation to respect your instructions

Mismarking Order Tickets

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The Rules and Regulations of the Securities Industry requires that order tickets and the corresponding confirmations be marked either Solicited or Unsolicited when the broker or broker-dealer executes a trade in a clients account.

Too frequently orders are improperly marked as unsolicited when the broker or broker-dealer solicited the order directly, or the order was solicited by operation of law.

Some states require that the orders be marked solicited whenever the client acts upon a brokers recommendation within sixty(60) days of the brokers original favorable recommendation. (Check your State’s Requirements)

This can even hold true if the broker first favorable mentions five stocks and his client acts on one of the stocks within two weeks.

Another factor that can contribute to the intentional mis-marking a confirmation ticket occurs when a broker or broker-dealer attempts to avoid State Blue Sky Rules or for securities that his/her firm does not recommend. Check your confirms, and if you broker or broker-dealer solicited the order, make sure the confirmation is correctly marked SOLICITED. These markings can come back and haunt you if you have a dispute.

Misrepresentations and Omissions

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A broker is liable to a client if that broker misrepresents material facts or omits to disclose material facts to the investor regarding an investment, and that client loses money as a result. 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.

Breach of Fiduciary Duties

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It is important for every investor to understand that his broker owes him a fiduciary duty. Listed below are the basic fiduciary duties a broker has with his client. The duties associated with a non-discretionary account include:

Most of the abuses listed on this page also constitute a breach of the fiduciary duty,

Insider Trading and Front Running

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It is against the Rules and Regulations of the Securities Industry to make any use, or enter into any securities transactions while in possession of nonpublic information or to place an order on the basis of "nonpublic" information regarding pending orders in the marketplace.

While the most obvious cases occur when a corporate executive passes along a secret to some friends, Insider trading can occur on a much local basis. For example, if your broker purchases or sells a particular security on the same day that he solicits his/her clients to purchase or sell that same security, he might be front running the market, or trading on insider information. In most cases, when a broker transacts in the same security as his clientele the broker must take pay the highest price or take the lowest sale on that day.

Be very wary of brokers who use sales pitches saying that his/her family has a position in that security, as they might have other reasons than good financial sense for you to trade this security. If your broker has a position in the same security as you, remind him that he is obligated to inform you when he liquidates his position.

Mutual Fund Switching

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Mutual Funds are typically long term investment vehicles, and the switching of funds within a family of mutual funds can often be a sound financial decision, depending on the times and different investment philosophy of the particular fund. In fact, most mutual funds families allow their investors to reallocate their investment throughout their family of funds for free or for a small transaction fee. This ability to shift assets within the same family of funds allows the investor change their financial objectives without generating large sales charges.

Notwithstanding, some brokers will induce their clients to switch funds outside their initial funds family. These type of switches can generate larger commissions and sales charges for the broker. Usually, these type of switches are accompanied by a letter from the brokerage firm informing the client that another commission will be charged. Nonetheless, be very careful when jumping from different mutual fund families, as the commission available to the broker are substantially increased.

Additionally considerations that you as investor must consider while investing in mutual funds are that there are certain monetary breakpoints where commissions can be reduced. Sometimes investing the extra $1,000.00 can reduce the brokers commission by a full percent. Always read the mutual fund’s prospectus as it applies to commissions and expenses.

Overconcentration

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One of the most important rules of investing is diversification. If a broker concentrates your portfolio in any individual investment or type of investment, then the risk of losses with that portfolio is dramatically increased. Its the old adage that it is unwise to place all of your "investment" eggs in one basket. A broker who does not diversify his client's portfolio is potentially liable if that investment declines in value.