Securities Concentration/Failure to Diversify


Financial management theory and practice dictates the avoidance and/or risk management concentrated securities positions. The risks of securities concentration are diametrically opposed to a well-diversified portfolio which is considered optimal for most investors. The economic reason for this paradigm is investors are not compensated for the increased risks of exposure to catastrophic loss when they maintain a concentrated stock position over an extended period of time. Financial industry standards of care support the need to avoid securities concentration in a single asset, asset class or investment product as a foundation for what is considered suitable for investors. As a rule of thumb, securities concentration exists to the extent that any portion of a portfolio’s holding exceeds 10% of the portfolio’s value.

According the Financial Industry Regulatory Authority (FINRA) , brokerage firms and financial advisors are required to disclose the risks associated with a particular investment or investment strategy. Any investment recommendation should consider the total composition of securities held in an investment portfolio. Failure to recommend a strategy to manage the risks associated with securities concentration can be considered financial advisor negligence for providing unsuitable investment advice or the failure to recommend risk management strategies for a concentrated position. An investor might be unwilling or unable to establish a diversified portfolio which results in exposure to the risks of securities concentration. Investor portfolios may be concentrated as the result of one or more of the following reasons:

  • Inherited Legacy Stock;
  • Employee Stock Option Plan (ESOP) Participant;
  • Financial Advisor Recommendation;
  • Founding Member of Publicly Traded Company;
  • Restricted Stock Rule 144 Stock;
  • Corporate Lock-Up Agreement;
  • Closely-held Stock Acquired through Merger or Acquisition; and
  • Low Cost Basis with Substantial Capital Gains.

Securities concentration in stocks might be caused by an employer restriction, tax avoidance, psychological and emotional attachment to the company stock. No matter what the reason for maintaining a concentrated stock position, a brokerage firm and its financial advisors must recommend suitable risk management strategies to protect the value of any concentrated stock position held in a financial brokerage account. Brokerage firm customers that hold concentrated positions and do not receive when appropriate a recommendation for risk management strategies may be able to recover investment losses through a FINRA arbitration award. In some instances, financial advisors might recommend risk management strategies such as complex hedging strategies to reduce the risk of a concentrated stock position. Unfortunately, the brokerage firm’s failure to supervise financial advisor’s who failed to implement the strategy properly, the brokerage firm may be held accountable for negligence.

The Klayman & Toskes, P.A. can help you determine whether an investment loss is the result of securities concentration and/or failure to recommend risk management strategies to protect concentrated position. If an investor suffers losses as the result of the failure to recommend risk management strategies for securities concentration may be able recover their losses in a FINRA arbitration claim for damages.

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