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What are the Top 10 Signs of Possible Stockbroker Abuse?

1. Vulnerable Client

Vulnerable clients frequently fall victim to stockbroker abuse or misconduct. Common features include: elderly, lack of financial sophistication, lack of understanding about account activity, and placing blind trust or faith in broker.

Recent research also shows that fraud and Ponzi schemes often have the following traits:

  • Self–reliant
  • Optimistic
  • Above–average financial knowledge
  • College educated
  • Recently suffered a financial or health setback
  • Open to new ideas and sales pitches

See Investor Fraud Study Final Report.

2. Big Losses

All losses do not equal wrongdoing, but big losses could be a sign of trouble. The S&P 500 lost 30% in the second half of 2008. But should the client have been invested in S&P 500 stocks? Or did the client suffer above–market losses?

3. Too Many Transactions

Many firms charge commissions on a per–trade basis. Excessive trading or “churning” is trading designed to generate commissions for the broker rather than to achieve any legitimate investment goal of the client.

Look for thick account statements and lengthy Schedule D attachments.

4. Transactions Not Approved by the Client

Unless the account is discretionary, the client must approve every transaction. If the client reports that a broker handles all trades and the client learns the details only after the fact, the broker may have taken unlawful discretion.

5. Too Many Eggs in One Basket

The old expression “too many eggs in one basket” can apply in 3 contexts:

  • Too Much in One Stock. Most firms recommend no more than 5%–10% in any single position.

  • Too Much in One Sector. Example: technology sector or banking sector.

  • Too Much in One Asset Class – Stocks, Bonds or Cash.

    Most firms have published “asset allocation” recommendations based upon investment objectives and risk tolerance. As an example, one major firm recommends that a “conservative” investor’s portfolio should hold 20% stocks, 55% bonds, and 25% cash.

    Stockbrokers often fail to follow their own firms’ published asset allocation advice.

6. Use of Margin

A client who uses margin is borrowing money from the brokerage firm to buy more investments, usually stocks. Stockbrokers often fail to explain the full risks of margin. It can be extremely dangerous, especially in a declining market. When the value of the account falls, the firm has the right to demand more collateral, via margin call, or to sell the account holdings, via liquidation.

For more on margin, see FINRA Investor Alert, Investing with Borrowed Funds: No “Margin” for Error.

7. Options – Put and Calls

Trading options is extremely sophisticated and can be very dangerous. A “call” option gives the buyer the right to buy a given stock at a “strike price” over a set number of months. A “put” option does the reverse, giving the buyer the right to sell at the strike price over a set number of months.

Both types of option contracts allow the investor to speculate about which direction the stock price will head. This type of investing can be very close to gambling, and the full risks are frequently not explained by the broker.

8. Investment Names You Do Not Recognize

You can easily recognize “blue chip” stocks like Coca Cola and IBM. But if a client’s statements are loaded with names you do not recognize, this may be a sign of trouble. High risk or “alternative” investments might include penny stocks, private placements, promissory notes, structured notes, derivatives, etc. Also, if an investment does not appear on the brokerage firm’s regular monthly account statement, this could be a sign of trouble.

9. Variable or Equity–Indexed Annuities

An annuity is a contract between the client and an insurance company, whereby the insurance company, in exchange for a lump sum payment, promises to make periodic payments to the client over an extended period of time. Annuities come in many varieties, including fixed, variable, and equity–indexed.

Annuities can be good investments for many clients, but they are extremely complicated and often misunderstood by the client. Moreover, annuities carry high commissions for brokers, creating an incentive for abusive sales practice.

For more on annuities see, NASD Notice to Members 00–44, and FINRA Investor Alert, Should You Exchange Your Variable Annuity? both at finra.org.

10. Problem Brokers

Finally, you can check out their broker’s regulatory history through FINRA “Brokercheck

This website contains information on past customer complaints, discipline, and the number of firms where the broker has worked. (Too many firms over a short period of time may be a sign of trouble).

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