Investors who lose money as the result of careless mistakes or intentional fraud by their stockbrokers or financial advisors may be eligible to recover their losses through a process known as arbitration.
Arbitration claims can involve all types of investments, including stocks, bonds, annuities, and mutual funds.

Most customer claims against stockbrokers and financial "advisors" or "consultants" are required to be brought in arbitration before the Financial Industry Regulatory Authority, also known as "FINRA." rather than in court. The cases take about one year to complete and are decided at a hearing before either one or three arbitrators, depending on the size of the claim. Hearings are held throughout the United States.

Seven ways that stockbrokers and investment advisors lose money for their clients, and provide a basis for claims that may result in financial awards in arbitration, include:

Unsuitable Recommendations

These claims arise from recommendations by a stockbroker or "financial advisor" that result in losses in your account from investments that were not appropriate for your risk tolerance, overall financial situation, or investment objectives. Suitability claims frequently involve recommendations by stockbrokers to invest all of an investor’s money in stocks, to borrow money from the brokerage on margin, or to invest heavily in a single stock or mutual fund or a small group of stocks.

A fundamental concept of investing is diversification. If a customer’s account is concentrated in any individual investment or type of investment, then the risk associated with the customer’s portfolio is dramatically increased. A broker should never place all of the customer’s investment "eggs" in one basket. A broker who fails to diversify a customer’s account may be liable should the investment significantly decline in value.

Excessive Margin

Margin is a term for money that is borrowed by an investor from a brokerage firm. Firms sometimes charge as much as 9% interest on these loans, which are sometimes not even called to the customer’s attention. In addition to costing investors money because of the interest rate charged, margin debt has the effect of increasing an investor’s exposure to losses if the value of the investments owned by the investor decreases.

Investors who have been overcharged for margin without their knowledge or whose losses have been magnified due to the imprudent use of margin by a stockbroker or investment advisor may have valid arbitration claims.

Overconcentration/ "Exercise and Hold" of Stock Options/Employer Stock

For decades employers have sought to motivate, retain and compensate valued employees with stock options. Unfortunately, in recent years many stockbrokers have advised investors to unwisely exercise their stock options (with money borrowed from the brokerage firm) and then hold the underlying stock for more than one year to gain a more favorable tax treatment- often with disastrous results.

The two main types of employee stock option programs are Incentive Stock Options and Non-qualified stock options. The main difference between these types of plans for a participant concerns the tax treatment at the time of exercise and sale.

The Incentive Stock Option incurs no income tax at the time of exercise. However, in order for the investor to receive capital gains treatment upon sale, the holding period must exceed one year. Otherwise the gain is considered ordinary income for tax purposes. This particular tax preference given to the Incentive Stock Options requires that the exercise be considered for the AMT calculation. The AMT Income is the difference between the grant price and the fair market value on the date of exercise. The AMT tax rate is 28% of the gain described above and is due if it exceeds the tax using the standard method.

The Non-qualified stock option incurs an income tax at the time of exercise. The gain is taxed as ordinary income on the difference between the grant price and the fair market value on the date of exercise.

The risks faced by all employee stock options plan participants who have exercised options are the same- the loss of an inordinate amount of money if the employer’s stock’s share price drops. The concentration of an investor’s retirement "nest egg", which represents for many a lifetime of work, into a single stock can be disastrous in these circumstances. The losses experienced by many investors led by bad advice into such strategies in recent years were magnified by the margini debt that stockbrokers advised them to incur in order to exercise their options and hold shares of company stock.

There is a specific duty on the part of the stockbrokers and financial advisors (and the financial institutions they represent) to manage a concentrated portfolio and the unique risks associated with this type of an account. Many investors with losses resulting from improper "exercise and hold" strategies have won substantial arbitration awards.

Failure to Hedge

During the1990s, techniques known as "variable prepaid forward contracts" and "costless" or "zero cost" collars became commonly used to hedge the risk associated with an investor’s investment in a single stock. These techniques provide a relatively low-cost effective insurance policy against losses arising from a rapid drop in the share price of company stock owned by an employee who has exercised stock options. Unfortunately, many stockbrokers and investment advisors who should have recommended such strategies failed to do so, instead recommending the extremely high risk "exercise and hold" strategy discussed above.

In certain circumstances stockbrokers and investment advisors have a duty to recommend appropriate steps to investors to decrease their risk exposure to concentrated stock positions. Investors who have lost substantial sums due to their concentration of their investments in a single stock, without any hedging techniques being recommended, may have a valid arbitration claim against their stockbroker or investment advisor.

Unauthorized Trading

An unauthorized trading occurs when the broker executes transactions in a customer’s account without the customer’s permission and the broker has not been given discretion to make such trades. In order to prove the transaction was unauthorized, it is crucial to review the time stamp on the order ticket for the transaction and the client’s phone records.

Negligence and Inattention

A stockbroker has a duty to manage accounts and carry out customer instructions with reasonable care. Investors may have claims for recovery where stockbrokers, "financial advisors" or brokerage firms do not exercise reasonable care in managing an investor’s account.

Negligence is conduct which falls below the "legal standard" established to protect others against unreasonable risk of harm. Generally, negligence is the failure to use such care as a reasonably prudent and careful person would use under similar circumstances. Each state has its own standard of negligence and there are many types of claims for negligence. For an act to be negligent, the actor may not intend the consequence of his conduct but, a "reasonable person" in his position would have anticipated those consequences and taken "reasonable" precautions to guard against them. If a broker is negligent in his dealings with a customer, then the customer may have recourse against that broker.

The relationship between a stockbroker and a customer can also be a fiduciary relationship if the customer looks to the broker for advice, the broker is aware that the customer is depending on the broker, and accepts that responsibility. When a fiduciary relationship exists between a stockbroker and a customer, a stockbroker has an even higher obligation to use the utmost duty of loyalty, good faith and care toward the customer.

Churning

Churning is excessive trading of an investor’s account in order to generate broker commissions.
If an investor sees numerous stock trades on his or her monthly statements every month, the stockbroker may be trading the account just to run up commissions, possibly providing a basis for a valid arbitration claim.

To prove that the pattern of trading in the account was excessive, the account statements are analyzed to determine: the annualized rate of return that would be necessary to cover the commissions charged in the account; the number of times the equity in the account was turned over to purchase new securities; and the purchase and sale trading activity that occurs in the account. The customer must prove that the broker exercised actual control over the decision making in the account, the trading was excessive, and that the broker acted in reckless disregard of the customer’s interests.

To see if you may have a case to recover your financial losses, call or e-mail Christopher J. Gray, P.C. for a confidential, no-cost consultation: newcases@investorlawyers.net (212) 838-3221 or toll free (866) 966-9598