As a securities attorney and former stockbroker focusing my practice on disputes between investors and investment advisers (or stock brokers), over the years I have received referrals from many sources.  For example, I often receive referrals from attorneys who do not practice in securities law, or in particular, securities arbitration before the Financial Industry Regulatory Authority (“FINRA”) (   On occasion, I have received calls from potential clients who were referred to me by their accountant or bookkeeper or tax adviser.

For those clients who reach me through another attorney or another acquaintance (other than their accountant), it is not uncommon for me to discover that not only is there wrongdoing by the investment adviser, but that the wrongdoing has been going on literally for years.   That really bothers me because it compounds the problem and costs the client money.  When I ask the client why they did not come to see me sooner, a very common response is that they a) did not realize that the adviser had done anything wrong because they cannot read or understand their monthly statements; or b) they do not realize that they have a right to bring an action to recover damages for an adviser’s wrongful conduct.  Many of these clients have CPAs or tax advisers that are intimately aware of their clients’ finances and probably could have caught the investment adviser’s misconduct earlier, but those in the accounting profession all too often do not know their clients’ rights either.

Now I am not suggesting that a CPA or tax preparer has any obligation to review their clients’ financial situation or investments and notify their clients of potential misconduct by their investment adviser.  But sometimes when you do something you are not “obligated to do”- clients really appreciate it.  Can you imagine how satisfied your clients will be if you point out a potential issue that results in your client a) preventing further losses; and/or b) recovering past losses.  And in any business, whether it’s the practice of law, accounting or the Home Depot, satisfied customers lead to a stable customer base and growth through referrals.

I am here to help you recognize the typical kinds of misconduct to look out for when working with your clients.  This is by no means an exhaustive list, but it covers the more common kinds of claims.  Obviously, the first place to start is – has your client lost money from investments or is he paying an excessive amount of money in commissions.   The next step is to recognize the cause of your clients’ losses.  The most common kinds of claims against an investment adviser are as follows:

Common Securities Fraud/Negligent Misrepresentation: By far the most common type of investments that involve common fraud (and negligent misrepresentation), in my experience, are what are called private investments or private offerings.  A private investment is one that is not offered through a registered offering with the Securities and Exchange Commission and are not traded on a national stock exchange.  A private offering normally involves the use of a Private Placement Memorandum (PPM) or other disclosure document that typically explains the investment, identifies management, and discloses the terms of the investment and the risks.  While private investments can be lucrative, they are also fertile ground for fraud.

The typical fraud case involving a private offering will involve an offer of outrageous returns.  For example, I had a case where the return on investment promised was 6% per month.  It also either involves land or a real property investment (such as a tenant in common investment) or an extremely complex investment scheme.  The first kind engenders confidence because it is an investment in real estate, and everyone thinks (or thought before 2009) that is safe.  The latter kind is mysterious and not easy to understand, but creates excitement and because of the complexity – the high return is believable to many people.  In other words, the seller of the investment has a special program that allows for incredible returns.   The types of investment used for fraud run the gamut, but this is typical.

Other signs of potential trouble are where the company: a) appears to be owned and operated by essentially one person; b) fails to communicate (including failure to provide K-1s) c) fails to pay promised interest; or d) regularly asks for more money.

A recent trend I have noticed is that registered investment advisers are getting more and more into the private investment arena.  Investment advisers often refer to private investments as “alternative investments.”   They place their clients into these private investments and occasionally the investment turn out to be fraudulent.  The problem is that your clients are relying on their investment advisers to conduct due diligence prior to recommending the investment.  Many investment advisers simply do not do any due diligence or they do a fairly poor job of it.  The result is substantial losses for their clients.  If an investment adviser places their client in an investment that turns out to be fraudulent and they failed to conduct due diligence prior to recommending the investment to their client, the investment adviser may be liable for the full amount of their clients’ losses.

If you recognize these signs and let your clients know sooner rather than later, their chances of recovery can improve significantly.   In the best-case scenario, perhaps you can help your client avoid such fraudulent schemes.

Breach of the Suitability Rule:  Probably the most common type of claim I see against investment advisers and investment brokerage firms is what is called breach of the suitability rule.  To varying degrees, an investment brokers owes a fiduciary duty to their clients.  One aspect of that duty is an obligation on the part of the broker to know their client.  Knowing their client means more than simply knowing their name and number to call to place an order.  It means, for example, knowing the clients’ age, employment status, retirement status and plans, income and expenses, sources of income, years left until retirement and risk tolerance.  This list is not exhaustive, but you get the idea.  Another aspect of the duty is to know the investments brokers intend to recommend to their clients.   In other words, the broker must understand what the investment is, the soundness of the investment, what income it pays (if any), and the risks of the investment.  Brokers must not only know the individual investments, they must also understand the benefits and risks of the proposed investment strategy or program.  For example, an aggressive trading program may be suitable for one client and not another.  Or one client may need a highly diversified portfolio, while other investors may not.  By knowing their clients and knowing the investments and the investment strategies, brokers can make a recommendation to their client of the investments and investment strategies that are suitable for the particular client.

If your client’s broker violates the so-called suitability rule, your client has the legal right to seek a recovery of their losses, most likely in FINRA arbitration.  An example I often use in demonstrating a breach of the suitability rule is: Grandma is a 67 year-old widow who has expenses of $2500 per month.  She has $150,000 in a savings account and receives $700 per month in social security and other benefits.  She relies upon the $150,000 to cover her additional expenses.  She has had moderate health issues and is concerned that she may see an increase in health care costs over the coming years – which would potentially result in a substantial increase in her monthly expenses.   She has never invested in the stock market because it scares her.  She prefers a safe investment with income.  If the broker recommended three investments – $50,000 in a private non-liquid investment, with a maturity period of 20 years, that pays no income; $50,000 in a relatively small speculative oil and gas stock that pays no dividend; and the rest in an ETF (representing the Russell 2000 – small cap stocks) that pays no dividend.   In my opinion, the under-diversified portfolio that pays no income and locks up 1/3 of her money for twenty years, and puts the rest in speculative and risky investments is clearly not suitable for Grandma.  If Grandma lost money she would have a claim for damages.  In addition, she would have a potential claim to rescind the purchase of the $50,000 private investment.  This is an extreme example – but you get the picture.

Churning:  The not-so-common securities fraud case.  Most major brokerage firms no longer charge a commission per transaction.  Instead they charge a fee based upon a percentage of “assets under management” – just like most investment advisers do.  The primary reason they charge a fee instead of a commission is that it reduces that chance of a broker being accused of churning.  That is certainly beneficial to clients.  But I also believe that it can result in a disservice to the client because the broker no longer has much of an incentive to be actively involved in their account.  They could simply get the account set up and essentially ignore it and earn a nice fee for doing nothing.  Lets leave that discussion for another day.

What is churning?  Churning is a form of fraud in which a broker engages in buy and sell transactions for the sole or primary purpose of running up sizable commissions.  In other words, when the broker buys 1,000 shares of IBM stock for the primary or sole purpose of charging a $1,200 commission – that is fraud.  But how do you know when the broker is engaging in churning or good faith transactions?  Well, my rule of thumb is that you know it when you see it.  For example if your client has a $200,000 account and the broker has charged $30,000 in commission on total purchases of $2.5 million – there is a good chance that your client is the victim of churning.  Another rule of thumb is that if the “turn over ratio” (total purchases for the year/average account balance for the year) is more than 4, there is a good possibility that your client is the victim of churning.   In the example above, if the broker made a total of $2.5 million in purchases in an account with an average value during the year of $200,000, the turnover ratio would be 12.5.  That would be a fairly clear case of churning.

There are other claims that can be brought against a brokerage firm or investment adviser, but the above claims are most common.  The key is to identify whether or not your client has significant investment losses and ask them: What happened?  It amazes me that so many people who work hard their entire lives to save and invest their money lose it because they trusted a careless or fraudulent investment adviser or broker, and fail to realize that they have the legal right to seek a recovery.  If you can lead them to that recovery, you will have more satisfied clients.  More satisfied clients means a more stable business and more referrals.

By:  Vincent D. Slavens