Fraud and Misconduct by Stock Brokers and Financial Planners By Aaron Larson Law Offices of Aaron Larson July, 2004 Contents Churning - The Excessive Trading of Stock Unsuitable Investments Excessive Concentration Misrepresentations Failure to Follow Instructions Misappropriation When you use a stock broker or financial planner to help manage your investments, you place a great deal of trust in that individual. In working with your financial planner, you should be aware of common acts of fraud and misconduct which may occur with your investment account:
Churning - The Excessive Trading of Stock As a stock broker profits by making commissions on each purchase or sale of stock, a stock broker may engage in "churning" in order to obtain higher commissions from your account. While it is not always apparent from a review of trading records if a stock broker has engaged in excessive trading or has reaped excessive commissions, it is possible to determine whether the growth in the account was sufficient to cover trading expenses, and whether purchases and sales of stock are made to the advantage of the investor - particularly where the amount of trading is excessive as compared to the amount of money invested. With enough questionable trading activity, it may be possible to establish that "churning" has occurred. You can protect yourself from "churning" by limiting the stock broker's authority to engage in discretionary trading.
Unsuitable Investments A stock broker recommends that an investor purchase securities which the broker knows or should understand are not suited to the client's needs or investment goals. For example, the stock broker may recommend high risk stocks to an older client whose actual needs are for stability and a consistent income. Sometimes a stock broker will encourage clients to purchase a particular stock which is being pushed by the brokerage firm, and may mislead the client about the quality of the investment.
Excessive Concentration Investors typically benefit from having a diversified portfolio, in which losses in one sector are offset by profits in another. If a financial planner or brokerage over-concentrates investment in a particular stock or sector of the market, an investor will typically face an excessive risk of loss.
Misrepresentations A broker misrepresents a material fact about an investment or trade, or fails to inform the investor of a material fact, resulting in the client's making an investment decision from which the investor would otherwise have abstained. By way of example, in conduct known as "touting", a brokerage firm might encourage a client to invest in "house stocks", essentially low-value stocks which are part of an investment scheme to achieve the artificial inflation of their value, knowing full well that no fully informed investor would make the recommended investment. Similarly, a stock broker may claim to have inside information about a "hot stock" - if true, the broker is likely engaging in illegal insider trading, and if not the broker is lying.
Failure to Follow Instructions The broker is instructed by the investor to engage in or abstain from a particular trade or activity, and either does not follow the instruction or ignores the instruction. For example, a stock broker may engage in trades in an account over which he has no discretion to make trades, or a stock broker doesn't follow an investor's instruction to sell a stock that the firm is touting.
Misappropriation The stock broker or financial planner steals money from the client's account, perhaps fabricating losses to cover the loss, or providing fake records to hide the deductions.
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