The alphabet soup of securities litigation starts with the broad variety of investment securities offered by financial advisors. For example, CDO (collateralized debt obligation) SIVs (structured investment vehicles), MBS (mortgage backed securities), and trust preferred securities were common investments held by large financial institutions and owned in client investment accounts. Investors of all risk tolerances and investment objectives are faced with the simple and not simple securities when investing their investable assets. Wall Street is always developing new financial products to offer clients. Financial advisors have a duty to know their clients and know the products they are recommending.
Know Your Customer – more than their name.
Financial advisors are primarily regulated by a self-regulatory organization known as FINRA(“Financial Industry Regulatory Authority”). FINRA promulgates rules governing business conduct, communications with customers, and many other aspects of the financial services industry. Under Rule 2310, financial advisors have a duty to know:
- the customer’s financial status,
- the customer’s tax status,
- the customer investment objectives, and
- such other information used or considered to be reasonable in making recommendations to the customer.
A financial advisor has a duty to recommend investments suitable for the customer based on these and other factors such as the client’s risk tolerance, age, and investment experience. These factors are not static but change over time. A material change in a client’s financial and personal circumstances can make a suitable investment unsuitable and depending upon the nature of the relationship between the financial advisor and customer create a potential basis for an arbitration claim.
Know The Product – more than its name.
Financial advisors “in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.” FINRA Rule 2010. Fair dealing with customers involves a number of basic principles that will be the subject of a future article. At a minimum, financial advisors shall know the produce they are recommending by understanding:
- what the securities is that they are recommending (i.e. common stock, bond, note, structured product, etc.),
- the risks associated with owning the security (i.e. risk of loss of principal, liquidity risk, credit risk, interest rate risk, etc.); and
- the costs of purchasing or selling the security (i.e. commissions, fees, exchanges, surrender charges etc.)
There are other features and attributes of securities that might impact the product’s suitability generally and as it is being considered for a specific customer that need to be understood and considered before a financial advisor makes a recommendation.
Finally, financial advisors are prohibited from “effect[ing] any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.” FINRA Rule 2020. Financial advisors have a duty to disclose all material information about the security and not fail to omit or misrepresent facts relevant to the transaction.
Securities litigation generally arises from the alphabet soup of issues related to a financial advisor’s duty to know his or her customer and understand the securities being recommended to their customer. If you have a client who believes that their advisor has breached their duties that resulted in losses, the client should seek advice from a lawyer with expertise in securities litigation.