FINRA Arbitration


The Financial Industry Regulatory Authority (FINRA) was formed on August 6, 2007 to combine the regulatory resources of the New York Stock Exchange (NYSE) and National Association of Securities Dealers (NASD). FINRA is charged with the responsibility to resolve disputes between public investors, member firms and firm employees. FINRA is subject to oversight by the Securities Exchange Commission (SEC). FINRA establishes rules and regulations for the standards of care required for the handling of customer accounts. Brokerage firms and its financial advisors are required to submit themselves to binding arbitration as a way of resolving disputes the firms have with customers of theirs. The FINRA arbitration dispute resolution process is designed to protect investors from brokerage firms and its financial advisor misconduct, known as sales practice violations which results in investment losses.

Failure of brokerage firms and its financial advisors to comply with FINRA sales practice rules and regulations may result in a legal cause of action for the recovery of investment losses. Brokerage firms and financial advisor misconduct can be classified according to various types of activities which may result in a legal cause of action against them. The FINRA sales practice violations are often classified according to the following types of misconduct.

Unsuitable Investment Advice

Brokerage firms and its financial advisors are required to only provide suitable investment recommendations. A recommended investment and/or investment strategy is evaluated based on the securities industry “know your customer” rule which requires that brokerage firms and their advisors are aware of all factors which affect an investor’s financial situation. The considerations which determine the suitability of investment recommendations include the investor’s age, employment status, tax rate, education, investment experience, investment objectives and risk tolerances. The evaluation of the suitability of an investment and/or investment strategy is to be determined based on an investor’s ability to understand and assume the risks associated with an investment and/or investment strategy. Investment losses that are the result of unsuitable investment advice can be a legal cause of action in a FINRA arbitration claim for damages. Read more.

Negligence

Brokerage firms and its financial advisors are considered negligent when they fail to act in a reasonable and prudent manner when providing investment recommendations. Negligence occurs from the failure to adhere to the standards of care established by the securities industry rules and regulations promulgated by FINRA. A negligent act does not have to be intentional to result in a viable securities arbitration claim for damages. A negligent act may not be a willful or intentional act, but simply an omission or failure to act. A brokerage firm and its representative cannot assert that it was unaware of the securities industry standards. Securities industry requires brokerage firms should have knowledge of standards of care related to the economic and financial matters at issue. A negligent act which results in Investment losses may be a legal cause of action in a FINRA arbitration claim for damages. Read more.

Excessive Trading/Churning

Excessive trading or “churning” is considered any trading activity in an investment account for the sole purpose of generating commissions. An investor will need to prove that the level of activity is excessive in light of the investment objective. The financial advisor must be in control of the account activity which resulted in excessive commissions paid to the brokerage firm and its financial advisor. An investor whose account has been churned may be eligible to recover the excessive commissions paid and any investment account underperformance relative to a suitable investment portfolio as a legal cause of action in a FINRA arbitration claim for damages. Read more.

Misrepresentation or Omission of Material Facts

Brokerage firms and its financial advisors are required to make full disclosure of all material information related to an investment. Financial advisors who fail to disclose all of the material facts related to an investment can be held liable for losses sustained from that investment. Material information includes, but is not limited to, all costs and risks associated with the investment. An investor must receive full disclosure in order to evaluate an investment recommendation. When brokerage firms and its financial advisors intentionally misrepresent or withhold material information concerning an investment recommendation, an investor may have a claim of fraud in a legal cause of action in a FINRA arbitration hearing. Read more.

Breach of Fiduciary Duty

Brokerage firms and its financial advisors are required to provide more than trade execution. When investors rely upon the direction and advice of a brokerage firm and its financial advisor, a fiduciary relationship is formed. In this instance, a financial advisor is considered to have client control in a fiduciary relationship. In a fiduciary relationship, brokerage firms and its financial advisors have an affirmative duty to place the investor’s best interest before their own economic interests. This requirement requires the utmost diligence when making investment recommendations. Investment losses that are the result of a breach of fiduciary duty can be a legal cause of action in a FINRA arbitration claim for damages. Read more.

Unauthorized Trading

Brokerage firms and its financial advisors in non-discretionary brokerage accounts are required to obtain prior approval from their clients before the execution of any transactions. An investor who realizes a loss from an unauthorized trade may be able to recover damages. It is important that an investor dispute the transaction within a reasonable period of time. Receipt of a trade confirmation or account statement without a subsequent dispute from investors on a timely basis can be considered an approval of the transaction. A claim of an unauthorized trade requires an examination of the facts surrounding the transaction, including whether there were phone or email records between the financial advisor and client prior to the transaction. Read more.

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Margin Abuse

Brokerage account margin greatly increases the risks associated with any investment strategy. Brokerage firms and its financial advisors are required to disclose to the risks of margin in a brokerage account. A margin balance occurs when securities are purchased or withdrawals are made by borrowing against brokerage account assets. During market declines, account equity declines rapidly due to the effects of margin which could result in a margin call. A margin call may require additional deposits of cash, or the sale of securities at a significant loss. Brokerage firms have the right to liquidate any securities held in the brokerage account it chooses to reduce the loan balance and protect its own interests. The unsuitable use of margin which results in substantial losses may be a legal cause of action in a FINRA arbitration claim for damages. Read more.

Securities Concentration
Failure to Diversify

Securities concentration is considered an investment portfolio that is not adequately diversified and subject to the specific risks of a sector, stock or type of investment product. Diversification is an essential tool used to control and manage risks in an investment portfolio. Failure to diversify across all asset classes including stocks, bonds and cash may result in the unintended exposure to risk. Security concentration occurs when invested assets are over-weighted in a particular stock or sector relative to the overall securities market. Financial industry standards of care which is supported by academic studies consider any portion of an investment portfolio that exceeds 10% percent of an investment portfolio to represent securities concentration. Investment losses that result from securities concentration and/or the failure to diversify may be a legal cause of action in a FINRA arbitration claim for damages. Read more.

Mutual Fund Sales Practice Violations

Securities industry sales practice rules related to the sale of mutual funds require that investors receive full disclosure concerning any sales commission discounts that are available, known as sales breakpoints. Failure to offer these sales breakpoint discounts result in greater commissions paid by investors which unduly enrich brokerage firms and its financial advisors. Mutual funds sales proceeds that are reinvested into a different mutual fund family with similar investment options is prohibited unless there is an economic benefit to the investor. If there is no clear economic benefit to the investor, the sole reason for the recommended transaction is considered to be the generation of commissions. According to mutual fund sales practice rules, this transaction is considered a mutual fund “switch” transaction and may be a legal cause of action in a FINRA arbitration claim for damages. Read more.

Variable Annuity Switching

Variable annuity sales proceeds that are reinvested into another variable annuity with similar features and investment options is prohibited unless there is an economic benefit to the investor. If there is no economic benefit to the investor, the recommendation is considered solely to be for the enrichment of the financial advisor. In these instances, the transaction is considered a variable annuity “switch” transaction and is a violation of state insurance laws and securities industry rules and regulations which may be a legal cause of action in a FINRA arbitration claim for damages. Read more.

Failure to Supervise

The securities industry requires compliance to standards of care which are promulgated through the Financial Industry Regulatory Authority (FINRA) sales practice rules and regulations. The member firms are required to supervise all activities of firm employees, including financial advisors. Failure of a financial brokerage firm to adequately supervise the activities of financial advisors is a violation of securities industry conduct rules which may be a cause of action in a FINRA arbitration claim for damages. Read more.

Conflicts of Interest

According to FINRA rules and regulations, brokerage firms and its financial advisors have a duty to disclose potential conflicts of interest to their customers. FINRA rules rely upon full disclosure as an important tool to reduce the effects of any conflicts of interest with customers they serve. Brokerage firms have an obligation to identify any conflicts of interest specific to a brokerage firm’s business and disclose all relevant facts to investors to enable customers to better understand the costs and risks associated with a recommended investment or investment strategy. Read more.

Excessive Markups/Markdowns

Brokerage firms and its financial advisors are required by securities industry regulations to refrain from charging customers excessive markups and markdowns for the purchase or sale of securities. Accordingly, brokerage firms and its financial advisors must adhere to the principles of fairness and honesty when charging costs and fees, including commission, markups and markdowns, for principal and agency transactions. Brokerage firms and its financial advisors are required to consider many factors in the determination of whether the costs and fees charged for the execution of securities transaction is reasonable and fair. Read more.

Private Placements (Reg D)

Private placements (Reg D) are non-registered, non-traded securities that are sold to investors through Private Placement Memorandums (PPMs) that are used to communicate details of a particular securities offering. Brokerage firms who recommend private placements to accredited investors have a duty to recommend limited portion of an investor’s net worth and no more than 10% of ation the private placement investment after a reasonable investigation has been conducted concerning the accuracy of the information contained in the private placement memorandum related to the investments risks, economic viability and audit financial statements. Read more.

Selling Away (Private Securities Transactions)

Brokerage firms prohibits financial advisors from “selling away” which is considered any activity where they are engaged in “private securities transactions” that have not been approved by the brokerage firm. Additionally, the financial advisor expects to receive “selling compensation” for his involvement in the transaction. Brokerage firms are responsible liable for all of their financial advisors’ business activities whether disclosed or not and are required to take supervisory steps to monitor and uncover any unapproved outside business activities, including activities related to private securities transactions. Read more.