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Common Types of Investment Fraud

Unsuitable Investment Recommendations: Brokerage firms, brokers and registered investment advisors have a duty to make appropriate and suitable investment recommendations. Each state defines what is a suitable recommendation differently. Classic unsuitable recommendations?

  1. The sale of speculative, high risk stocks to a retired investor or a client with limited financial resources;
  2. Concentrating an investor’s portfolio in one or a few securities or types of securities;
  3. Failing to asset allocate a client’s portfolio;
  4. Utilization of margin for a client with limited financial resources.

Failure to Diversify: Brokers are obligated to diversify and asset allocate a clients portfolio. Often brokers will concentrate client port in securities that pay them more in compensation Placing too much of a clients port in equities or high risk investments can make the firm liable to an investor for any losses that occur.

Selling Away and Ponzi Schemes: Unfortunately, brokers and financial advisors have engaged in hundreds of ponzi and selling away schemes at virtually every major and regional brokerage firm.

Churning or Excessive Trading: Churning and excessive trading is prohibited under most state securities act. While there are differences between churning and excessive trading, the hallmark of both is trading designed to generate fees and commissions for the broker and brokerage firm. We have written extensively on churning and excessive trading claims. For more information visit our related website.

Failure to Supervise: The failing to supervise a financial advisor is extreme common. Unfortunately, supervision is not a money making activity for brokerage firms. Therefore, while brokerage firms give lip service to the importance of supervision, usually there is little to no real supervision of financial advisors. For example, reasonable supervision requires a branch office manager to close an account down if the broker is recommending trading that is so aggressive and speculative, it all but guarantees the client’s account loses money. Since the firm and the branch office manager earn part of the churned fees, there is little incentive for a supervisor to close an account down. Typical supervision at brokerage firms means the firm will send a few generic happiness letters to try to cover the firm in case the client files an arbitration claim.

Breach of Fiduciary Duty: In some states, every broker at every brokerage firm owes a legal fiduciary duty to a client (California). In other states, courts have concluded if a client reposes “trust and confidence” in the broker, then he is a fiduciary (Illinois). Each state has different laws on whether a broker is a fiduciary or not. As a fiduciary, brokers and investment advisors have several obligations. First, he must asset allocate and diversify a client’s accounts. Second, he must manage accounts in a manner directly in line with the needs and objectives of the customer. Third, the fiduciary must keep abreast of all changes in the market, which could affect his customer’s interest, and they must act responsively and sensibly to protect those interests. There are many other duties of a fiduciary but these are the most common.

Misrepresentations and Omissions: All material risks must be disclosed to clients and a broker cant misrepresent material risks to clients. Classic misrepresentations and omissions in securities fraud suits include the following: Touting the stock of a company as a “guaranteed investment” or “secured” when in fact it isn’t; Failing to disclose the degree of risk associated with an investment; and making overly positive or optimistic statements about an investment.

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