While the stock market and S&P 500 continue to hit all time highs, many investors still have the 2008 market collapse fresh in their memories and know that this historic bull run could, and likely will, come to an end. There are many signs that the market is overheated, leading some to have speculated that a correction is inevitable, if not imminent. One of many lessons from prior market collapses is that the investment portfolios most at risk are those which are not properly diversified and may be overly concentrated in either one security or one particular sector of the market. For retirees, in particular, it is possible to sue and recover such investment losses when following the advice of a licensed financial advisor.
The cratering of an investment portfolio can come as a shock to most investors, particularly retirees who have increased medical and age-related expenses, and are thus unable to afford a long wait until the market bounces back. In some instances, legal action may be necessary to recover the lost funds. While there is less legal recourse for investors who choose their own investments through a self-directed brokerage platform, the opposite is true for investors who still rely on licensed stockbrokers for financial advice. Both financial advisors and their brokerage firms can be held liable for recommending investment decisions that are poorly suited to the investor’s needs.
The brokerage industry is regulated by the Financial Industry Regulatory Authority (FINRA), which, until recently, has long imposed FINRA Rule 2111, known as the “Suitability Rule” on all licensed stockbrokers and the brokerage firms that employ them. Under Rule 2111, brokers were required to have a reasonable basis for recommending a transaction that reasonably considers a broad range of factors, which “includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.”
Consequently, when suing a brokerage firm to recover investment losses, proving that the suitability standard was not met has always had its challenges because there are so many subjective factors to consider under Rule 2111. The rule does not require that a broker must recommend the most suitable investment in the world, only that the investment be “suitable”; a much lower bar than the fiduciary standard, which requires the broker to place the customer’s interest ahead of its own. As of June 30, 2020, brokerage firms have had to comply with a new SEC rule, Regulation Best Interest (“Reg BI”), which falls short of this fiduciary standard, but in any event supersedes and is intended to improve upon Rule 2111 by requiring brokers to only recommend transactions that are in the financial “best interests” of the customer. Investments must still be suitable under this rule, as FINRA has been clear that a broker who has complied with Reg BI is considered to have complied with its predecessor suitability rule.
One of the most unmistakable signs of a suitability violation (which necessarily is also a violation under the newer rule, Reg BI, as an unsuitable investment is, by definition, not in a customer’s best interests) is when a broker overconcentrates a retiree in some way. The formula for protecting a retiree’s portfolio is one that very generally reduces costs and risk exposure, as seniors and retirees are typically out of the workforce and, thus, have the least opportunity to recover squandered assets. After the fact, an overconcentrated retiree portfolio can stick out like a sore thumb, but it is not always evident until there is a significant market event (e.g., collapse), as emphasized by FINRA in its “Concentrate on Concentration Risk” publication, which provides numerous examples of how an investment or investment strategy can pose a concentration risk.
In the context of unsuitably concentrated portfolios, published case law and regulatory enforcement decisions adhere to the the maxim that brokers must know and recommend suitable investments. In In re Chase, Exchange Act Rel. No. 34-47476 (Mar. 10, 2003), the broker was fined $25,000 and suspended from association with any broker-dealer for one year for unsuitably over-concentrating the client in one stock and then margined the account to buy more of that stock. When the stock price declined, the client lost most of the money in the account. In In re Stein, Exchange Act Rel. No. 34-47335 (Feb. 10, 2003), the broker was fined $25,000 and suspended for three months for placing the client’s money in unsuitable speculative investments after the client requested a conservative portfolio. It was further held in that case that even if the client understood Stein’s recommendations and decided to follow them:
that would not relieve Stein of his obligation to make reasonable investments. The test for whether Stein’s recommended investments were suitable is not whether [the client] acquiesced in them, but whether Stein’s recommendations to [the client] were consistent with her financial situation and needs.
So it should be clear, thus, that retirees and investors have a right to rely on their financial advisors for advice. And when that advice runs counter to the maxims of concentration, suitability, and ultimately the best interests of the customer, the broker and its firm can be held liable.
If you are a retiree or have suffered investment losses at the direction of your broker, the experienced, New York securities attorneys at Malecki Law can help you determine whether those losses are recoverable. We provide free consultations and typically work on a contingency basis, meaning we do not get paid unless you recover.