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Types of Stock Broker Misconduct

Churning \ Excessive trading

          Churning refers to the excessive buying and selling of securities by a broker for the purpose of generating commissions and or fees and without regard to your investment objectives.

Fraudulent Material Misrepresentation

          The broker falsified fact(s) about an investment. If you had known the truth you would not have agreed to purchase the investment.

Fraudulent Material Omissions

          The broker failed to inform you of facts concerning an investment. If you had known these facts you would not have agreed to purchase the investment.

Unsuitable Recommendations

          Brokers have an obligation to learn their client’s financial needs, objectives and circumstances before recommending an investment.  Unsuitable recommendations occur when the broker recommends a investment inconsistent with the client’s financial needs, circumstances and objectives.  For example, it would be unsuitable if the client wanted safety of principal and the broker recommends a risky stock or option strategy.

Front Running

          A stock broker buys or sells securities for their own account before executing orders previously submitted by their customers.  After the broker has filled his client’s orders, the broker closes out their position at a profit based on the new price level created the buying or selling of the clients orders.

Auction Rate Securities Misrepresentations

          A broker represents that that certain securities are cash equivalents or an alternative to money markets that can be liquidated on short notice without any risk to principal. The broker fails to inform the client that the liquidity of the market in which the securities are traded depends on the brokerage houses participating in those markets. The broker fails to inform you that auction rate security markets have failed in the past.

          Brokerage houses and other financial institutions can elect not to participate in those markets thus preventing you from selling your securities.

Civil Theft of Funds or Securities

          A broker simply steals money from a client’s account for his\her own use.  Some examples are;
          1)      The Broker borrows money from you and never pays it back,

          2)      The Broker recommends a non-existent security and keeps the purchase price.

          3) The Broker transfers the money out of an account without permission. (see forged statements below)

          4) A check is sent to the client from a brokerage account.  The client did not ask for the check.  The client calls the broker to inquire why the check was sent and the broker claims it was a mistake and asks the client to send the check back to him\her directly.  The broker endorses the check upon receipt and deposits it into another account.

Failure to Follow Instructions

          The broker is instructed to buy or sell a security or follow a particular investment strategy.  The broker ignores the instructions and does nothing or buys something else entirely.

Failure to Protect Profits

          The account has appreciated significantly.  The broker fails to recommend or implement a strategy to protect the account profits.

Unauthorized Trading

          The broker buys or sells securities without written or verbal permission.
Mutual Fund Abuses including, Mutual fund churning, Mutual Fund switching, Mutual Fund Class B shares ,and Break point Selling.

          Mutual fund commissions can be as high as 5% of the amount invested. These commissions give unscrupulous brokers significant incentive to sell you a fund regardless of whether it is suitable for you.

Mutual Fund Churning \ Switching

          Mutual funds are considered long tem investments. Mutual Fund churning is the practice and buying and selling mutual funds for the purpose of generating a commission.  

          Mutual Fund switching involves the replacement of a mutual fund with the same type of fund in another mutual fund family for the purpose of generating commissions.

Multiclass Mutual Fund Abuses

          Mutual funds typically have different share classes typically called A, B and C. Class A shares are front end loaded, meaning you pay commissions upon purchase. However class a shares have lower ongoing annual fees.  Class B shares are back end loaded meaning that you pay a commission if you sell the fund within a certain number of years. .  The longer you hold the fund the lower the back end commission.  Class C shares have a fixed annual commission that is typically 1 % of the amount invested.  Class B and C shares annual fees can be more than double that of Class A shares. Therefore depending on how long you hold a fund it may be less expensive to pay the up front commission.  Regardless of the share class the broker gets paid a commissions when the fund is purchased. 

Break Point Selling

          Most mutual funds offer commission discounts that depend on the amount of the investment.  The investment amounts are called the break points.  For instance, a purchase of $24,999 would require a commission of 5%.  However, if the purchase were one dollar more or $25,000, the commission would be lowered to 4.5%. 

          Fund families also do not require that the investment be in the same fund.  For example if a fund family offers a large cap fund and a small cap fund you would be entitled to the discounted commission if you invested  $12,500 both funds of the fund family.

          Some Funds families will also give you the benefit of the break point discount if you agree to invest the entire $25,000 over a period of time, usually 13 months.

          Mutual fund fraud arises when brokers, in order to maximize their commissions, recommend fund purchases at just below the break point or fail to recommend a suitable share class given the length of time a client anticipates holding the fund or sells a share class that is inconsistent with the client’s objectives.  Unscrupulous brokers maximize their commissions by failing to inform the client of the various methods commissions and expenses can be reduced.

High Yield Junk Bonds and High Yield Junk Bond Mutual funds

          High Yield Bonds bond funds are rated below investment grade and are more susceptible to default. Clients are typically not informed that these investments are known in the industry as “Junk Bonds”.  Given that most people would not put their lifesavings into anything called “Junk”, brokers rename these securities by calling them high yield and fail to inform the client of the significant risk they pose.  High Yield is attractive sounding but high yield means high risk.

Failure to Diversify. Over-Concentration of Individual Securities or Asset Classes

          It is almost universally accepted that a portfolio’s performance is dependant on diversification. Over-concentration occurs when the portfolio is invested in too few securities or asset classes such as bonds stocks real estate cash etc.  For example in the late 1990’s brokers recommended that more and more of their client’s portfolios be invested in technology related securities.  These recommendations caused portfolios to become over concentrated in technology stocks. When the technology crash occurred in 2000 – 2001 individuals’ life savings evaporated.

Fraudulent Asset Transfers

          A brokerage firm operates under one name and incurs significant debts, liabilities and lawsuits.  When the firm reaches a point they have to liquidate assets to pay their liabilities they close their doors and transfer the assets to a newly created firm with a different name.   Both firms will have the same employees and principals.

Forex Trading Fraud

          Forex trading refers to trading in foreign currencies.  Investing in foreign currencies is extremely risky.   The vast majority of individual investors do not understand it or the risk involved.  Further, Forex trading is unregulated.  Most “Brokers” who engage in foreign exchange trading are unregistered by any agency. The CFTC warns that anyone making the following statements are trying to defraud you:

  • Guarantees of profits or claims of high performance.
  • These claims and claims like these can be false:
    • Whether the market moves up or down, in the currency market you will make a profit.
    • Make $1,000 per week, every week.
    • We are out-performing 90 percent of domestic investments.
    • The main advantage of the forex markets is that there is no bear market. We guarantee you will make at least a 30-40 percent rate of return within two months.

Forged Account Statements and Documents

          With the advent of desktop computers and color printers, it has become relativley easy for Stock Brokers to reproduce account statements.  These Brokers send forged account statements, confirms and other official looking documents to their clients that reflect fictitious positions and money balances   By engaging in this fraud, brokers make the client believe that his\her investment strategy is working and that they have nothing to be concerned about or to hide the fact that the broker has withdrawn all of the client's funds from the account.

Selling Away

          A broker will sell an investment that is not sold or authorized by his\her firm.  The broker almost always receives a special commission or finders’ fee for selling an investment outside of his firm.

Annuity Abuse

          Annuities command some of the highest commissions and fees available for a broker.  Annuities are also expensive to hold or redeem early.  Early redemption penalties can be as high as 20% or more of the amount invested. The amount of the withdrawal could also have significant tax penalties for early withdrawals.  As such these investments are ripe for abuse.  

          The high commissions and fees provide significant incentive for brokers to misrepresent their benefits when recommending annuities to their clients.  One example is when brokers claim a variable annuity is guaranteed and that the client cannot lose money.  However, the broker fails to inform the client that the underlying securities in the annuity are subject to market risk.  The guarantee will not pay off during the holder’s lifetime unless the underlying securities appreciate in value, The death benefit is the only guarantee in an annuity where the client’s heirs will receive the amount originally invested.

Option Fraud

          Options are complicated and extremely risky investments suitable for individuals who understand the enormous risk of options and can afford to lose a significant part of their investment. 

Margin Abuse

          Margin accounts are a significant source of profits for a brokerage firm. The client borrows money from the brokerage house using the equity in his\her account as collateral. The broker then uses the money to purchase additional securities’ for the client.  The client pays commissions on the additional stock purchased in the account as well as interest on borrowed money. 
          Margin also doubles the risk on investments. Accounts can be liquidated if stocks drop in value, even if the drop is temporary.


          Broker’s have a duty of care to be reasonably diligent and prudent in the handling of client accounts  Negligence occurs when the broker failed in his duty to be reasonably diligent or prudent and did not act as a reasonable and prudent broker would have acted in the same situation.


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