Since February 21, 2020, the stock market indexes have all been suffering from staggering losses and volatility seen only few times before. Investors have suffered losses across their portfolios with certain sectors affected worse than others. The cause: novel coronavirus (“COVID-19”). However, full-service brokerage firms may still be liable for your losses.
The securities industry is governed by rules and regulations to protect investors during historic periods of economic volatility, economic turmoil, and from external shocks, such as COVID-19. COVID-19 currently has no vaccine and has created a global health pandemic. As a result of the COVID-19 pandemic, the U.S. economy has suffered its largest decline in economic activity, including record jobless claims and declines in economic output during the month of March 2020.
The securities industry established the self-regulated organization known as the Financial Industry Regulatory Authority (“FINRA”), which is a dispute resolution process designed to protect investors against brokerage firms and their financial advisors during periods of economic upheaval from sales practice violations which resulted in investment losses.
Failure of full-service brokerage firms and their financial advisors to comply with FINRA sales practice rules and regulations may result in a legal cause of action for the recovery of investment losses. Brokerage firm and financial advisor misconduct can be classified according to various types of activities, which may result in a legal cause of action against the brokerage firm.
KlaymanToskes has been dedicated to the protection of investor rights for decades, from the Tech Bubble in 2000 to the Mortgage Crisis in 2008. Now, we can help you recover investment losses during the COVID-19 pandemic. KlaymanToskes is investigating specific types of sales practice violations which resulted in investment losses suffered during the COVID-19 pandemic that are related to the following types of misconduct:
According to securities industry rules and regulations, brokerage firms and financial advisors must only recommend investments that are consistent with an investor’s investment objectives, risk tolerance, and investment time horizon. These conditions must be determined considering market conditions, including the COVID-19 pandemic. Given the unique goals and needs of each individual investor, a suitable investment recommendation would depend on many investor characteristics, including age, retirement status, risk tolerance, time horizon, and sources of income.
Each customer should have his or her own specific determination of suitability based on his or her individual circumstances. For these reasons, the securities industry established the “know your customer” rule to govern investment recommendations. The FINRA “know-your-customer” rule begins with the opening of the customer account and requires gathering, through “reasonable due diligence,” all the “essential facts” concerning every customer of the brokerage firm. This information must also be periodically updated as it changes.
FINRA established a “suitability” rule which requires brokerage firms and their financial advisors to have a “reasonable basis” for recommending investments or investment strategies, based on a customer’s investment profile. The rule requires the financial advisor to conduct a “reasonable diligence” to answer basic questions about who the client is as an investor. The brokerage firm and financial advisor are charged to gather all necessary information to formulate the basis for recommendations. These recommendations are based on the investor risk tolerance, investment profile, and the information gathered from the “know your customer,” such as:
KlaymanToskes is investigating specific types of unsuitable recommendations relating to portfolio allocations which resulted in investment losses suffered during the COVID-19 pandemic:
According to securities industry rules and regulations, brokerage firms and financial advisors must make full disclosure of all risks related to the use of margin with an investment portfolio. This is especially important considering fluctuating market conditions, including COVID-19. The level of margin abuse in a portfolio requires an assessment of risks that are a function of various factors, including costs ratios, increased volatility, assets to meet margin calls, and the intended use of the borrowed funds.
Margin abuse can result from excessive use of margin loans or the failure to utilize risk management strategies to protect account collateral. Margin calls can wipe out an investor’s brokerage account equity in a short period of time. The use of margin exposes investors to greater risk and costs. Margin interest increases the breakeven rate of return required for a particular investment strategy. A higher required rate of return may result in a change to a riskier investment strategy that is unsuitable for the investor. Often, the greater return and its corresponding risks are not disclosed to investors. This fact must be weighed carefully with an investor’s risk profile and disclosed by brokerage firms and their financial advisors.
Many brokerage firms provide financial incentives to financial advisors who recommend the use of margin because the lending activities represent a substantial source of revenue for the firm. Margin loans are fully collateralized with no chance of default because of the protections provided to the brokerage firms in the margin agreements. For these profits, financial incentives are given to financial advisors whose clients’ accounts contain margin loans. These financial incentives include greater commissions because a margin loan increases the amount of assets the financial advisor can manage.
Nonetheless, in the pursuit of profits, brokerage firms and their financial advisors are required to follow securities industry rules and regulations to make full disclosure of all relevant costs and risks associated with the use of margin within a portfolio. Failure to fully disclose these risks supports a claim for damages for losses incurred during the COVID-19 pandemic. The required disclosures include that:
Margin abuse can result from excessive use of margin loans or the failure to utilize risk management strategies to protect account collateral. Margin calls can wipe out an investor’s brokerage account equity in a short period of time. The use of margin exposes investors to greater risk and costs. Margin interest increases the breakeven rate of return required for a particular investment strategy. A brokerage account cost ratio measures breakeven rate of return for the account to cover all costs, including commissions and margin interest. When margin is used, the required net rate of return needed to breakeven increases to pay interest charges. The higher required rate of return may result in a change to a riskier investment strategy that is unsuitable for the investor. This greater return and its corresponding risk are many times not disclosed to investors. This fact must be weighed carefully and disclosed by brokerage firms and their financial advisors. Some brokerage firms and financial advisors recommend the use of margin to diversify an account. However, the use of margin or other loans in many situations is considered unsuitable investment advice.
KlaymanToskes is investigating whether the excessive use of margin within a portfolio resulted in investment losses suffered during the COVID-19 pandemic. The following case facts can support a claim for damages:
Securities industry standards of care dictate the need to avoid securities concentration in a single asset, asset class, or investment product as a foundation for what is considered suitable for investors. The reason for this financial rule of thumb is that investors are not compensated for taking this risk. Securities concentration exists to the extent that any portion of a portfolio’s holdings exceeds 10% of the portfolio’s value in a single stock or sector.
According to FINRA, brokerage firms and financial advisors are required to disclose the risks associated with a particular investment or investment strategy. A financial advisor should consider the total composition of securities held in an investment portfolio. Failure to recommend a strategy to manage the risks associated with securities concentration can be considered financial advisor negligence for providing unsuitable investment advice or the failure to recommend risk management strategies for a concentrated position. An investor might be unwilling or unable to establish a diversified portfolio which results in exposure to the risks of securities concentration. Investors portfolios may be concentrated as the result of one or more of the following reasons:
Securities concentration in stocks might be caused by a financial advisor’s recommendation, an employer restriction on sale, tax avoidance, and psychological and emotional attachment to the company stock. No matter what the reason for maintaining a concentrated stock position in a single stock or sector, brokerage firms and their financial advisors must recommend suitable risk management strategies to protect the value of any concentrated stock position held in a financial brokerage account. Full-service brokerage firms that do not recommend a fully diversified portfolio to an investor, that results in concentration in a single stock or sector, may be liable to the investor for investment losses through securities arbitration. In some instances, financial advisors might recommend risk management strategies such as complex hedging strategies to reduce the risk of a concentrated stock position. In addition, a brokerage firm may be liable when it fails to supervise its financial advisors who fail to properly implement the strategy. The brokerage firm may be held accountable for the financial advisor’s negligence.
KlaymanToskes is investigating whether the securities concentration in a single stock or sector resulted in investment losses suffered during the COVID-19 pandemic. The following case facts can support a claim for damages:
For more information relating to recovering investment losses, visit us at www.klaymantoskes.com, or call our Attorneys at (561) 542-5131.