Stockbroker Fraud

Six months have passed since Betty’s husband Joe died. Betty always let Joe handle the money matters. He had always been a savvy investor, but in the last several years, it had become obvious that Joe really was not on top of his game.

Now, Betty asked her daughter Sarah to help her look through the couple’s financial papers. Things are a mess. There are piles of unopened envelopes from brokerage firms, mutual fund companies and banks. As Sarah opens the statements, she becomes distressed because the brokerage accounts have suffered some significant losses due to a downturn in the stock market or is something else wrong? How can she tell?

What To Watch Out For

Unauthorized Trading. Sarah notices that Joe’s stockbroker bought and sold stocks on days when Joe could not have spoken with him, including on days when Joe was traveling internationally and later when Joe was in intensive care.

Comment: Before a stockbroker or investment advisor can buy or sell a stock, he must speak to the client. The only exception to this rule is when a client has given his broker a written power of attorney authorizing the broker to buy and sell without first talking to the client. Without the client’s prior permission, the broker is engaging in illegal “unauthorized trading,” thus giving the client the right to recover losses, including out-of-pocket costs and possibly interest and attorneys’ fees.

Unsuitable Investments. Joe and Betty lived on a small monthly pension, a Social Security retirement benefit, and the interest earned from their tax-free municipal bonds. Six months before he died, Joe’s stockbroker recommended that Joe sell his municipal bonds to buy a hot stock –, which had great “growth” prospects, according to their broker. The start-up company had not yet turned a profit. After Joe bought the stock, it lost over 50% of its value.

Comment: Joe and Betty needed conservative investments, but their broker put everything in one very speculative stock. The broker may be liable because of the duty to only recommend investments that are “suitable” for his client. This means that the investment must be appropriate in light of the client’s age, income, financial needs, risk tolerance, and investment experience. In most instances, an elderly client’s life situation dictates a conservative investment approach designed to protect and preserve assets and generate income.

Frequent Buying and Selling. As Sarah goes through her father’s records, she is surprised at the number of envelopes containing buy and sell “confirmation” slips. She notices that there are numerous instances of a stock being bought one day and sold the next. In fact, this process occurs over and over again on the same stock. Trying to understand the activity in the account, she looks at the monthly account statement and is further perplexed because the monthly statements are 30-40 pages in length. Sarah knows that Joe could not have followed what was happening in the account because of his declining health.

Comment: As a fiduciary, a stockbroker is required to always put the client’s best interest first. Since a stockbroker is paid a commission each time a stock is bought or sold, a conflict of interest might exist between what is best for the client and what is best for the broker, and a broker who frequently buys a stock and sells it quickly may be “churning” the client’s account. Churning occurs if the broker buys and sells stocks in the client’s account for the sole purpose of generating commissions for himself.

Other Danger Signs

Selling away. Generally, borkerage firms want to keep your money in your brokerage account so they can make money off your investment. Certain brokers may try to convince you to move your money from your account into a “too good to be true” deal with a third party. The broker may be hiding the deal from his firm and taking a big commission for putting your money at risk. If you lose money in this outside investment, the brokerage firm will argue it is not responsible for your losses because it did not approve this investment for you.

Wrap Fee Accounts. Many brokerages offer “wrap fee” accounts where the client pays a fee based on a percentage of the account’s value (normally 1% to 3%). This arrangement sounds good because it reduces the incentive for churning, but wrap fees can also be abused. For example, a broker may convince a client to increase the size of her account by using margin (money borroweed from the brokerage) or loans from home mortgages. The higher the value of your account, the higher the wrap fee. While this structure may benefit the broker, it is probably bad for the client. Also, for a “buy and hold” investor who trades little, wrap fees may be a waste of money.

The securities industry has changed dramatically over the last twenty years. No longer does dealing with a reputable firm ensure that the client’s best interest is being put first. While television commercials still try to create the image that a broker is a trusted professional, the reality is that this can be a “buyer beware” market.

Be careful.


By J. Michael Bishop, JD
Smiley Bishop & Porter, LLP
Atlanta, Georgia

Caveat Emptor – Stockbroker Fraud was last modified: November 26th, 2022 by Phil Sanders