There are between 3,000 and 9,000 arbitration claims filed with FINRA against brokerage firms every year. The most frequently filed complaints allege that a broker breached his/her fiduciary duty, made misrepresentations, or sold investments that were not suitable for the client’s needs or investment objectives. For every case that actually gets filed in arbitration there are probably hundreds more that do not, where aggrieved customers make oral or written complaints and become discouraged when the firm refuses to assume responsibility. In our experience representing investors we have seen that brokerage firms typically rely on one or more of the following defenses in attempting to avoid responsibility for client losses:
1. “We didn’t cause your losses, the stock market did.”
This might be a reasonable defense if you intended to take stock market risk with your investments and your portfolio performance was about the same as the market. So if you wanted to take the risk of the S&P 500 and you could afford to do so, market risk is a valid defense if the losses you sustained were consistent with the S&P’s performance while you held your investments. On the other hand, sound investment strategy requires diversifying your assets, so that a downturn in any one area (such as large cap US stocks) does not wipe you out. That’s why most investors need a well diversified portfolio of stocks and bonds. A diversified portfolio reduces risk and does not meaningfully diminish gains. Also, since many older investors need to protect their principal, they should only have a small portion of their assets in stocks and should not be exposed to significant market risk.
2. “You are a sophisticated investor who fully understood the risks.”
Whenever Wall Street sells you a security by assuring you that it is safe and it then blows up, the firm defends itself by claiming that you were a sophisticated investor who understood the risks before you invested. There are at least three problems with this defense. First, the sophisticated investor defense is raised no matter who you are and what your investment experience actually is. Second, even if you have owned stocks, bonds, or mutual funds for many years and are well-educated, chances are you delegated the job of assessing the risks and returns of investments to the broker who gets paid to recommend them to you. Most investors rely on their broker to recommend good investments just as they rely on their doctor to diagnose and treat them. In both scenarios, you hired professionals and assume you don’t need to second guess their every decision because they, not you, are the expert. Finally, the sophisticated investor defense rings hollow in an era in which Wall Street peddles products that are so complex that even the individual brokers who sell them have no real understanding of their risks. This was very often the case with products like principal protected notes and auction rate securities that brokerage firms promiscuously sold to their clients over the past decade.
3. “The prospectus warned you about all the risks.”
A prospectus is a formal legal document required by and filed with the SEC that provides details about an investment product. It is supposed to contain all the facts that an investor needs to make an informed investment decision. Unfortunately, the legal language and complexity of prospectuses can be daunting, to say the least. Lawyers who draft prospectuses tend to be very cautious and warn about every conceivable problem. This makes it very hard to figure out what the most significant risks are and which ones are just thrown in as legal boilerplate. Here again, investors expect their brokers to analyze prospectuses, explain risks, and give appropriate advice. The doctor analogy applies here just as it does to the sophisticated investor defense. Finally, according to numerous SEC and FINRA cases, simply handing a client a prospectus does not “cure” an oral misrepresentation; neither will it justify a broker in recommending an unsuitable investment.
The bottom line is that Wall Street has lots of excuses when things go wrong in your portfolio. Certainly, clients are not entitled to recover whenever they lose money on their investments just like every bad outcome for a patient does not warrant a suit for damages for medical malpractice. That being said, in many situations catastrophic client losses are not the fault of the client or the market. The fault belongs to the broker for recommending defective investment products or unduly hazardous investment strategies, and also to his or her firm which is legally responsible for the broker’s misconduct. Brokers have a duty to understand the investments they recommend to you and to only recommend investments that are suitable for you in light of your investment objectives, your needs, and your resources. So, if you think you have been wronged by broker misconduct, don’t take those excuses at face value.