The Financial Industry Regulatory Authority (FINRA) recently reminded investors to carefully review their brokerage account statements and trade confirmations. Reviewing these account documents rather than simply placing them in a file cabinet makes sense. Such reviews can detect possible fraud, stockbroker negligence, or broker misconduct, such as unauthorized trading, excessive trading, and lack of diversification. Below is a discussion of certain key information that should be reviewed.
The front page of some account statements shows your investment objective - for example, "preservation of capital," "income," "growth," or "speculation." Account statements also may state your supposed risk tolerance, such as "conservative," "moderate," or "high risk." (If your monthly account statements do not show this information be sure to review the form that was completed when you opened your account, which will reflect your stated investment objective and risk tolerance. Brokers often complete this information without consulting with the investor.)
Make sure the investment objective and risk tolerance on your statements or new account form accurately describe your true goals and risk tolerance. Brokers rely on them to determine if investments are suitable for you. If the brokerage firm's records do not reflect your true objective or risk tolerance the broker may recommend investments that are too risky for you.
If your account documents do not accurately reflect your investment objective or risk tolerance you should immediately give written instruction to the brokerage firm to correct their records.
After entrusting your money to a broker, you can take steps to avoid becoming a victim of broker misconduct. Review all trade confirmations and account statements when you receive them in the mail. Do not rely on summaries prepared by your broker, rather than the actual statements and trade confirmations. In addition to reviewing the value of your account, including whether the value increased or decreased, pay attention to the account holdings and the specific trades in your account. Below are red flags to look for when reviewing your account documents.
A. Unauthorized Trading
Your broker generally must obtain your approval before making a trade. Review your trade confirmations and account statements for securities purchases or sales that your broker had not discussed with you and that you had not authorized.
B. Solicited Transactions
Trade confirmations should indicate whether trades are unsolicited (initiated by you) or solicited (initiated by your broker). Treat as a red flag an investment that was the broker's idea, but that is reflected on the confirmation as an unsolicited trade.
Churning, also known as excessive trading, occurs when a broker makes trades for the primary purpose of generating commissions. Repeated securities purchases and sales within a short period of time are a sign of churning. The commissions charged for these trades can make it difficult or nearly impossible for the client to obtain a long-term profit.
D. Over-Concentration/Lack of Diversification
Your account is undiversified when a significant percentage of your money is invested in only one or a few stocks, or in one sector of the economy. This creates significant risk, which can be reduced by investing in a sufficient number of stocks of companies in different economic sectors, such as banking, healthcare, utilities, and consumer products.
E. Improper Asset Allocation
Asset allocation is the distribution of investments among asset classes, such as cash, stocks, bonds, and real estate. Studies show that 90% or more of a portfolio's performance is attributed to asset allocation rather than the selection of the "right" stock or bond. An appropriate asset allocation is based on your investor profile, e.g., a retired person relying on their investments for income typically should invest primarily in conservative, interest-paying bonds, rather than in stocks.
"Margin" is when you borrow money from a brokerage firm to buy securities. The securities in your account serve as collateral for the loan. If the securities drop in value too much, you must deposit more money into your account as additional collateral. Otherwise, the firm can sell your securities to pay down the loan. The firm can do this without contacting you and has the right to decide which securities to sell. If the securities in your account decline so far in value that their value is insufficient to pay off your margin loan, you are responsible for the loan balance remaining after all securities in your account are sold.
You are required to sign a margin agreement before a brokerage firm is permitted to loan you money to buy securities. When you review your account statements look for margin balances that you have not authorized.
Don't Be Shy
If a review of your account statements or trade confirmations reflects a substantial decline in account value, reveals any of the above red flags, or contains information that you do not understand you should contact your broker to discuss the issue. Address the issue with the branch manager if you are not satisfied with your broker's response.
If your concern is that your account suffered substantial losses, you may be told that the losses are the result of "market losses." That is not always the case. Account losses can be much greater than general market losses. If you receive such an explanation you should request documentation reflecting the performance of the appropriate market index as compared to your account.
For example, if you wanted to be invested in a diversified stock portfolio, you should request that your account performance be compared to the S&P 500 Index. If you had a conservative income objective you should request that your account performance be compared to a conservative bond index. If your account performed significantly worse than the comparable index, your losses might be the result of stockbroker misconduct rather than the consequence of "market losses."
Always check to see if there are inaccuracies or discrepancies in any of your statements - and, if so, contact your broker or brokerage firm as soon as possible. If the problem is not resolved, you should seek the advice of a lawyer who has expertise in the area of securities arbitration and litigation. Most consultations are free, and the lawyer should have the knowledge to determine if you have a valid claim to recover your investment losses. Importantly, investors often obtain little to no benefit from contacting regulators, such as FINRA or the SEC. While these regulators are charged with policing the securities industry, they generally do not help investors recover investment losses.
If a lawyer believes you have a valid claim to recover your losses, you likely will have to pursue your claim through FINRA arbitration, rather than through a lawsuit in court. Arbitration is more time and cost efficient than t
he court system. A case typically takes 12 to 18 months to be completed.
Ultimately, while not all stockbroker misconduct can be prevented, investors can take certain steps to avoid becoming a victim of misconduct. If you believe that you have been victimized you should know that remedies exist. Investors who hire a competent lawyer well versed in the field of securities arbitration stand a much better chance of obtaining a favorable resolution of their claims.