Office of the Investor Advocate and the Investor Advisory Committee

For example, the law establishes the Office of the Investor Advocate and the Investor Advisory Committee within the Securities and Exchange Commission (SEC). The mandate for these entities is to protect investor’s interests and assist investors but that will largely depend upon how they are funded and staffed. What voice will they have in decision and policy making at the SEC? What services will they provide to investors and how can they assist investors? We will have to watch and see how this unfolds.

Fiduciary Duty Standard of Care

Traditionally, stockbrokers do not owe their clients a fiduciary duty. A fiduciary duty is generally defined as a duty of loyalty, duty of care, a duty to avoid conflicts of interest and put the client’s interests first. Registered investment advisors have these fiduciary duties under federal law.

Stockbrokers generally have transactional duties such as duty to perform the customer’s orders promptly after receiving the customer’s approval. They also have the duty to recommend investments only after studying it, to inform the customer of the risks, and to not misrepresent any material facts to the transaction. Finally, they also have a duty to recommend investments that are suitable for the investor.

Under the new legislation, the SEC has the authority to impose the fiduciary duty standard on brokers. SEC must first study the issue and deliver a report to Congress. This will be a heavily lobbied report and review by Congress as brokers have historically fought hard to avoid the duties of being a fiduciary.

Also of note in the law is the power of the SEC to limit or prohibit mandatory predispute arbitration clauses in brokerage account agreements. Some advocates argue that mandatory arbitration is not fair for retail investors. They argue that biased industry arbitrators and unfair arbitration rules favor brokers and their firms. Conversely, the cost and efficiency of the arbitration process generally benefits retail investors over traditional state and federal courts. It will be interesting to whether the SEC will limit or give retail investors the choice to arbitrate or go to court.

Just because an account or an individual investment has decreased in value does not necessarily mean that a broker or financial adviser has acted inappropriately. At Crary Buchanan, we provide consultations concerning negligence arising from improper financial advice. If you have questions regarding your account or the duties owed by your broker, we invite you to call us to discuss your rights and remedies under the law.

Preferred stocks are a class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. Technically, they are equity securities, but they share many characteristics with debt instruments. There are different types of preferred stocks such as preferred trusts, cumulative preferred stocks, callable preferred stocks, and others. As with any securities, there are advantages and disadvantages and differing types of risk associated with preferred stocks.

Many times preferred stocks are sold as a safe, stable fixed-income investment. For example, Fannie Mae and Freddie Mac preferred shares were touted as suitable for retired individuals who wanted an investment designed to generate income. However, the risks associated with preferred shares were not disclosed or understood by many retired investors.

Just because an account or an individual investment has decreased in value does not necessarily mean that a financial adviser has acted inappropriately. At Crary Buchanan, we provide consultations concerning negligence arising from improper financial advice. If you experienced substantial losses as a result of overconcentration in a preferred stock such as Fannie Mae or Freddie Mac or were not advised about the risks of investing in preferred shares, we invite you to call us to discuss your rights and remedies under the law.

Most investors think of risk in terms of what is the possibility that I will lose some of my money over time after purchasing an investment. Risk and return tend to work together. The higher the level of risk that greater potential return on the investment and the lower the level of risk generally equates with the lower rate of return.

An investor’s risk tolerance varies based upon age, investment experience, net worth, income, age, investment time frame, investment objective, liquidity needs, and other factors. Risk tolerance tends to be viewed in categories such as conservative, moderate, or aggressive. Generally, investors with a conservative risk tolerance are adverse to loss of principal and tend to have high need for liquidity in their investments. For example, many retirees have a conservative risk tolerance because they have limited resources for income, need to access funds for health care and other living expenses, and generally do not have time to recover from large losses sustained in their retirement account.

There are many risk tolerance questionnaires available from financial advisors and on the Internet. When establishing an investment or retirement account, you and your advisor should have a discussion about your risk tolerance and how to manage risk in your account.

Properly assessing risk tolerance can reduce the risks associated with investing in securities.  Just because an account or an individual investment has decreased in value does not necessarily mean that a financial adviser has acted inappropriately. At Crary Buchanan, we provide consultations concerning negligence arising from improper financial advice. We invite you to call us to discuss your rights and remedies under the law.

What is a structured product?

Structure products are complex securities derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance, and/or a foreign currency. Structured products usually have two components – a note and a derivative. These products are often marketed as debt securities and sometimes recommended as a substitute for other traditional fixed income investments.

Structured products have the following traits:

• Structured products may offer full, limited, or no principal protection;
• Most structured products pay an interest or coupon rate substantially above prevailing market rates;
• Structured products frequently cap or limit the upside participation in the underlying asset;
• Structured products may have a fixed maturity, may be listed on a national exchange but may be thinly traded.

Are structured products suitable for my account?

Structured products may be appropriate for certain investors.  These are complex products with different types of risks such as loss of principal risk, liquidity risk, credit risk, and interest rate risk. There is a credible debate as to when and under what circumstances structured products are suitable for individual investors.  When considering a structured product, the financial advisor is required to:

• provide a balanced disclosure;
• deal fairly with customers;
• perform a suitability determination of the product; and
• perform a customer-specific suitability determination.

The risks and complexity of structured products has prompted regulators to issue guidance to financial advisors that offer these products. For example, when describing “reverse convertibles,” Finra stated “reverse convertibles are complex investments that often involve terms, features and risks that can be difficult for retail investors and registered representatives to evaluate.” Thus, when considering structured products – buyer beware.

Just because an account or an individual investment has decreased in value does not necessarily mean that a financial adviser has acted inappropriately. At Crary Buchanan, we provide consultations concerning negligence arising from improper financial advice. We invite you to call us to discuss your rights and remedies under the law.

Stop-Loss Orders

A stop-loss order is a tool to protect investors by triggering a sale when a stock reaches a certain price. A stop-loss order is placed with your financial advisor to sell a stock when it reaches a certain price. It is designed to limit an investor’s loss on a stock. For example, to reduce the risk of loss on a stock purchased at $100.00 per share, a stop-loss order for $90.00 per share or 10% below the price paid for the stock should limit your loss to 10%.

However, stop-loss order is also known as a stop market order. It becomes executable once a set price has been reached and the order converts to a market order that is then filled at the current market price. Because a stop-loss order is filled at the market price after the stop price has been hit, it’s possible that you could get a sell order entered well below the set price in fast-moving markets. This is what happened on May 6, 2010.

Stop-Limit Order

A stop-limit order is an order placed with a financial advisor that combines the features of stop order with those of a limit order. A stop-limit order will be executed at a specified price after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to sell at the limit price or better. The benefit of a stop-limit order is that the investor has control over when the order is filled. The downside of a limit order is that there is no guarantee that the order will be executed. Because a stop-limit order is filled at the limit price after the limit price has been hit, it’s possible that you may not get a sell order executed because in fast-moving down markets, the price has fallen below the limit price before any trade could be filled.

How does this affect your account? If you are trying to reduce the risk of loss on a stock position in your account, your financial advisor should explain the differences between a stop-loss order and a stop-limit order and understand what your investment objective is for the stock position and the account. A stop-loss order says stop the loss and sell at the stated price or lower. A stop-limit order says sell at this price but don’t sell if the price drops below the set limit price. In a fast moving market that occurred on May 6th, if you had stop-loss orders pending, your orders may have been filled at a price well below the expected trigger price. If you had stop-limit orders entered, your orders may not have executed at all.

There are other strategies to reduce the risks associated with investing in securities. Just because an account or an individual investment has decreased in value does not necessarily mean that a financial adviser has acted inappropriately. At Crary Buchanan, we provide consultations concerning investment, retirement and trust account losses . We invite you to call us to discuss your rights and remedies under the law.

State and federal prosecutors and defense attorneys presented the securities litigation and criminal review panel.  The panel discussed the rising number of securities fraud cases, victim rights, prosecution issues and sentencing guidelines.  The most important advice provided was on how and when to cooperate with prosecutors in providing information and advocating for your client. 

The securities litigation civil, SEC, and FINRA panel addressed the advantages and disadvantages of eliminating mandatory arbitration of investor disputes.  There are two different pieces of legislation in Congress that would impact securities arbitration.  The Arbitration Fairness Act of 2009 and the Consumer Financial Protection Agency Act of 2009.  Both pieces of legislation address would likely eliminate mandatory arbitration of securities disputes.  The fairness of mandatory arbitration is being challenged because:

• Classification of arbitrators and the use of industry arbitrator creates an actual bias or perceived impression of partiality;
• Some mandatory arbitration provisions requires the individuals waive substantive and procedural rights and requires that arbitration hearings be held in a state other than the investor’s home state;
• Arbitration has reduced and undermined the development of case law because there is limited or no judicial review of arbitrator’s awards.

While FINRA has tightened its arbitrator classification requirements, restricted the use of motions to dismiss, and required the production of certain documents, advocates for investors argue that arbitration should not be mandatory and investors should have the choice of traditional court litigation or a private dispute resolution forum such as arbitration.  As a practical matter, there is a consensus among securities litigators that arbitration will continue to have a role in resolving disputes between investors and financial institutions.

Finally, the seminar ended with a luncheon discussion on ethical issues and considerations arising from the representation of multiple clients in the same dispute.  From the financial institution and financial advisors’ perspective, unless there is a clear conflict of interest, generally dual or joint representation is the preferred arrangement.  It is more efficient and cost effective.  However, the attorney representing multiple parties must be mindful of the potential conflicts and comply with the ethics rules. 

A stock borrow program is an agreement between the customer and his/her brokerage firm that allows the brokerage firm to borrow securities from the customer’s account for some form of compensation to the customer. The brokerage firm uses the borrowed securities for its other investment strategies to benefit itself and its other customers. There are a number of different programs and investment strategies that employ borrowed stock to be used in short selling strategies or option trading strategies.

According to FINRA’s investigation, between Jan. 1, 2005, and Nov. 30, 2008, Citigroup’s stock borrow program borrowed “fully paid hard-to-borrow securities” owned by the firm’s retail customers. The borrowed securities went into a pool of securities to facilitate short-selling strategies for Citigroup’s other customers.

FINRA found that Citigroup failed to disclose adequately certain material information to customers participating in the stock borrow program, such as:

• the securities were hard-to-borrow;
• the interest rates could be reduced by the firm;
• the brokers received commissions for the duration of the loan;
• while the securities were on loan, dividends were paid as “cash-in-lieu” of dividends and were subject to higher tax rates; and,
• shares on loan could be sold by the customers at any time.

FINRA also found that the stock borrow program operated without a system or procedures specifically designed to supervise the activities of the Citigroup’s employees and to adequately monitor the accounts of customers who participated in the program.

Is a Stock Borrow Program Suitable?

This is an example of a structured investment program offered to retail customers that allegedly was not presented fairly and fully.  A financial advisor has a duty to disclose material information about the product being offered.  Stock borrow programs are not suitable for all customers and must be recommended only when considering the customer’s financial status, the customer’s tax status, and the customer investment objectives.  A financial advisor has a duty to recommend investments suitable for the customer based on these and other factors such as the client’s risk tolerance, investment experience, and liquidity needs.

Know Your Customer – more than their name.

• the customer’s financial status,
• the customer’s tax status,
• the customer investment objectives, and
• such other information used or considered to be reasonable in making recommendations to the customer.

A financial advisor has a duty to recommend investments suitable for the customer based on these and other factors such as the client’s risk tolerance, age, and investment experience. These factors are not static but change over time. A material change in a client’s financial and personal circumstances can make a suitable investment unsuitable and depending upon the nature of the relationship between the financial advisor and customer create a potential basis for an arbitration claim.

Know The Product – more than its name.

• what the securities is that they are recommending (i.e. common stock, bond, note, structured product, etc.),
• the risks associated with owning the security (i.e. risk of loss of principal, liquidity risk, credit risk, interest rate risk, etc.); and
• the costs of purchasing or selling the security (i.e. commissions, fees, exchanges, surrender charges etc.)

There are other features and attributes of securities that might impact the product’s suitability generally and as it is being considered for a specific customer that need to be understood and considered before a financial advisor makes a recommendation.

Finally, financial advisors are prohibited from “effect[ing] any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.” FINRA Rule 2020. Financial advisors have a duty to disclose all material information about the security and not fail to omit or misrepresent facts relevant to the transaction.

Securities litigation generally arises from the alphabet soup of issues related to a financial advisor’s duty to know his or her customer and understand the securities being recommended to their customer. If you have a client who believes that their advisor has breached their duties that resulted in losses, the client should seek advice from a lawyer with expertise in securities litigation.

The blog provides information on investment advisory services and their regulation. In my posts, I will cover three main areas:

• financial advisor and client relationships
• investment and insurance products
• resolution of disputes arising from the sale of investment and insurance products

I became interested in these subjects when I was a registered representative who provided financial advice on insurance and investment products. As an attorney, I have represented individual investors, financial advisors, and financial institutions in disputes involving claims for breach of fiduciary duty, churning, discretion, ponzi scheme thefts, unsuitability, unauthorized trading, and others.

I have worked with and know some of the finest lawyers representing investors and the industry, and serving as mediators of securities litigation. I am a former member of SIFMA – Securities Industry and Financial Markets Association, a securities industry organization.

Using my investment and legal experience and background, I will provide readers of this blog with a better understanding of how the profession of investment advisory services works and how the regulatory framework protects investors and provides for an efficient dispute resolution process.

I look forward to your comments, suggestions and questions.