- ACCOUNT MISMANAGEMENT: Except in the case of discount brokers serving as mere order-takers, broker-dealers typically advertise themselves as financial advisors who possess great skill and knowledge in the art of financial planning and investing. In our experience, it is common for an investor to follow the advice of a trusted stockbroker or financial advisor. When an investor entrusts the decision making process to a professional advisor, the advisor assumes a legal obligation to exercise due care for the financial well-being of the investor. Mismanagement of the account by such an advisor will render the brokerage house liable for all of the financial losses caused by the advisor's negligence or breach of fiduciary duty.
- ARBITRATION: In most cases, brokerage houses now require their customers to sign a written arbitration agreement at the time that the account is opened. Later, if the customer brings a complaint against the brokerage house, the broker will insist that the matter be submitted to arbitration. The vast majority of such arbitrations are conducted by the Financial Industry Regulatory Authority ("FINRA"). The FINRA is an organization of brokerage houses that provides arbitration services for investors and brokerage houses. Such arbitrations are typically decided by a panel of three arbitrators appointed by the FINRA, with hearings held in the vicinity in which the investor resides. While many attorneys who represent investors feel that the FINRA is biased in favor of brokerage firms, they regularly file claims for their clients with the FINRA. If an arbitration agreement has been signed, there may be no other viable alternative. An investor with a good case should not be daunted by the fact that the matter must be submitted to FINRA arbitration. Also, under limited circumstances there may be good cause for a Court to order that an investor dispute proceed in Court rather than in FINRA arbitration.
- BOILER ROOM: A boiler room refers to the headquarters of a group of salesmen who cold call investors and use high-pressure tactics to sell dubious investments, usually across state lines. Such boiler room operations are illegal and typically stay in operation only a brief period of time before the participants close up shop and disperse. An investor should always be reluctant to purchase securities based solely upon information obtained from a previously unknown caller, regardless of the apparent merits of the investment being recommended.
- BREACH OF FIDUCIARY DUTY: A fiduciary duty is a legal obligation to treat another person fairly and honestly, and to act only in the best interests of that person. Stockbrokers, financial advisors and investment sponsors owe investors a fiduciary duty. Acts of fraud and negligence obviously breach this fiduciary duty, as can the failure to carry out instructions and the failure to disclose all material facts regarding an investment. The person breaching a fiduciary duty can be held liable for damages caused by the breach.
- CHURNING: It is illegal for a broker to engage in excessive trading activity merely for the purpose of maximizing his own commissions. In order to succeed on a churning claim, a customer must establish that his broker directly or indirectly controlled the account and that the purchases and sales of securities were excessive in size and frequency in view of the financial resources of the customer and his or her investment objectives.
- CLASS ACTION: A class action is a representative lawsuit that allows a representative or named plaintiff to sue a defendant or defendants on behalf of other people who have suffered the same type of harm. A class action is filed when the issues in a case apply to a larger number of people and it is not practical for all of them to file their own individual actions.
- CONCEALMENT AND NON-DISCLOSURE: Stockbrokers and financial advisors, as well as investment sponsors, have an obligation not only to refrain from misrepresenting the facts of an investment, but also must disclose all important negative information they know about an investment. The failure to disclose negative information regarding an investment can be a form of fraud, which can render the brokerage house or investment sponsor liable for losses caused as a result of the failure to disclose negative facts.
- DUE DILIGENCE: All investment professionals, whether they be stockbrokers, insurance agents, financial planners, or fund managers, are required to exercise reasonable care with regard to client funds. This means that the professional must conduct a due diligence investigation into any transaction, investment product, financial plan or strategy, or security, contemplated, solicited or recommended, to make sure that it has a reasonable basis in reality and is not merely a speculation, scheme, scam or sham. Courts have held that in conducting due diligence, the professional must look beyond the claims of promoters or sponsors and act as sort of a watchdog or gatekeeper for the well being of clients, who are presumed to rely upon the expertise of the professional. When a financial professional blandly accepts false information provided by an investment promoter or sponsor and without conducting an adequate due diligence investigation, or ignores red flags indicating something is amiss, the professional can be held liable for investor losses caused by the inadequate due diligence, which is really a form of negligence.
- FICTITIOUS INVESTMENT TRANSACTIONS: A fictitious investment is a security which purports to be something, such as an annuity issued by an insurance company, when in fact, the investment is merely a criminal scheme designed to obtain money by false pretenses. In order to pull off the scam, the perpetrator often will create realistic looking documents that show investment activity, profits, or growth in values, such as confirmations, policy documents, account statements, stock certificates, and the like. The sale of fictitious investments is a form of criminal fraud.
- FOREIGN EXCHANGE INVESTMENT FRAUD: Investments in the foreign currency exchange market (FOREX) is a relatively new fraudulent promotion being developed and sold across the country. Investors are led to believe they are investing in a currency futures market that is highly regulated and a market traded in by large banks and financial institutions whose commissions for trades are no more than two or three points. Foreign currency contracts may be legitimately traded either on a recognized futures exchange or in the "interbank market," which generally involves trading between large institutions such as banks and corporations, rather than individual or retail customers. Fraudulent currency trading firms often tell customers that their trading is done in the "interbank market" on their behalf. The victims of these fraudulent promoters have purchased a position in a currency forwards market, which is both completely unregulated and provides no guarantee that the promoter has secured the forward position in the traded currency. Investors are also not aware that they will pay a 50% commission on each deal and they have no chance to either make a profit or to recover their investment.
- ILLEGAL SECURITIES SALES BY UNLICENSED SALES PERSONS: As a general proposition, in order to legally sell securities the person doing the selling must be duly licensed, but this does not stop unlicensed scam artists from raising funds through the sale of securities. Under California law, when an unlicensed person gives financial advice, the advice must meet the standards required for licensed advisers, and the unlicensed adviser has the burden to prove that the standard has been met or pay damages to the buyer. See, Civil Code Section 3372. Also, if there has been a sale of a security by an unlicensed salesperson, the buyer has the right to rescind the sale and recover the purchase price and potentially attorneys fees. See, Corporations Code Section 25501.5.
- LULLING: Lulling is when a stockbroker repeatedly reassures an investor that the account is doing well when, in fact, losses are taking place. The purpose of lulling is to placate the investor with the hope that additional investments will be made on the advice of the stockbroker before the fraud is discovered. An additional purpose of lulling is to forestall legal action by the client.
- MARKET MAKER: Ordinarily, brokers merely act as agents for the purchase or sale of securities by others, earning a commission on each transaction or a fee for this service. In an ordinary stock transaction, the broker does not part with or acquire the stock that is traded. However, under certain circumstances, brokerage houses acquire large blocks of a particular stock and then resell the stock to investors, earning a profit from the difference between the purchase price paid by the brokerage house and the sale price to the investor. A market maker is a broker/dealer who is registered to trade in a given security on the NASDAQ. Market makers trade as principals and may actively try to encourage or discourage trading by deceptive practices, in violation of the fiduciary duties owed to investors.
- MISREPRESENTATIONS AND OMISSIONS: Misrepresentations and omissions are a form of fraud. Stockbrokers, investment promoters and financial advisers often convince unsophisticated persons to make investments based on promises of future performance or expected profits and returns. When this happens, they may be liable for losses that are suffered by the investor if their promises involve misrepresentations or omit key facts. Most people will not make an investment that they know involves serious risks. People who make a living selling investments are aware of this and to make a sale, they may exaggerate positive aspects of an investment and omit to mention, or downplay, negative information. However, the law requires investment professionals to provide full, complete and accurate information, whether positive or negative, regarding solicited investments. The failure of an investment professional to provide factually accurate information, or the concealment of negative information, constitutes a form of fraud that may entitle an injured investor to sue for damages.
- OVER-CONCENTRATION: It is generally believed that diversification lowers overall risk. The opposite of diversification is over-concentration. The term "over-concentration" refers to a situation in which an investor has purchased too much of a particular security in relation to the investor's overall portfolio and suffers large losses when the value of that holding suddenly drops. Over-concentration becomes a real problem when an investor cannot afford to suffer a large loss in the over-concentrated security. When an investor has become over-concentrated in a particular security as a result of the faulty advice of a financial professional, the professional can be held liable based upon negligence or breach of fiduciary duty.
- PENNY STOCK FRAUD: "Penny stock" is defined as "low-price issues, often highly speculative, selling at less than $1 a share." (Black's Law Dictionary, p. 1021, 5th Ed. 1979). Often, these stocks are sold out of inventory by a brokerage house that has acquired the stock at a steep discount. The difference between the purchase price paid by the broker and the price at which the broker will sell the stock to investors is called the "mark-up." Federal law requires brokers to disclose the amount of the mark-up and to make certain other factual disclosures are revealed. Other rules exist which prohibit excessive mark-ups. Penny stock fraud occurs when an unscrupulous stockbroker uses pressure tactics to sell such low-priced stocks to unsophisticated investors with promises of quick riches. Shares that cost a brokerage house a few pennies may be sold to investors for several dollars each, resulting in huge profits to the brokerage house and correspondingly large losses to investors. Because there typically is no market for penny stocks other than the market created by the activities of the seller, investors can suffer huge losses on these marginal stocks.
- PONZI SCHEME: Ponzi schemes are named after a famous scam artist, Charles Ponzi. The term "Ponzi Scheme" refers to a criminal enterprise operating under the guise of a successful investment program. Money obtained from later investors is paid to earlier investors, giving the appearance that the program is a success when, in fact, it is steadily losing money. Because Ponzi Schemes do not usually conduct any form of legitimate business, it is inevitable that they will collapse, often in bankruptcy and criminal prosecutions, causing huge losses to investors. Promoters of Ponzi Schemes are frequently criminally prosecuted when the fraud finally comes to light.
- PRICE MANIPULATION: The price of securities is supposed to be the result of a complex set of legitimate economic factors. However, in the case of certain thinly-traded securities, it is possible for unethical market makers to manipulate the price of stocks and securities by engaging in sham transactions that result in an artificially-inflated share price. This type of conduct is deemed a serious form of fraud, and investors who have suffered losses due to price manipulation are entitled to recover their losses from those involved in the fraud.
- PRIVATE PLACEMENT INVESTMENTS (ALSO KNOWN AS OR AN UNREGISTERED OFFERING): Private placement offerings are not registered with the U.S. Securities and Exchange Commission (SEC). A private placement (or non-public offering) is sold through a private offering, normally to small number of chosen investors, who may be required to meet minimum income or net worth requirements or have some type of already existing relationship to the offeror. Most private placements are offered under the Rules known as Regulation D. Private placement securities are supposed to be sold only to accredited or sophisticated investors, but in many cases this rule is not strictly followed. Private placements can pay very high sales commissions and involve serious risks. There have been countless examples of fraud in connection with the sale of private placement investments, probably because these investments are not subject to the type of disclosure and oversight requirements associated with public offerings.
- PROMISSORY NOTE FRAUD: A volatile stock market and lower interest rates make investors especially susceptible to promises of high returns and low risk. Perhaps because of this, cases involving promissory note fraud have been popping up all over the country, but they're most heavily concentrated in areas where there are large numbers of retirees. Ironically, many of them, burned by the stock market, were looking for safer short-term investments. A promissory note is like a corporate IOU, a kind of loan to companies to raise money. The notes promise to pay back the buyer's principal while making fixed interest payments. The fraud comes in various forms. Either the company doesn't really exist, the note isn't a registered security, or the agent selling it is not licensed to do so. Or investors are told it's a safe investment, when in fact its highly risky, if not an outright fraud. The promissory notes are often sold by insurance agents who aren't educated about the products or licensed to sell them. In such cases, it may be possible for an investor to recover losses directly from the insurance company, which can be held liable for the actions of its agent. Even though the company is ignorant of the fraud, it may be negligent in supervising the agent.
- RECOMMENDATION OF UNSUITABLE INVESTMENTS: Stockbrokers are required under the rules and regulations of the stock exchanges and the National Association of Securities Dealers to use reasonable measures to understand the financial condition and needs of an investor, and to recommend investments that are suitable for the investor. When a stockbroker recommends an investment that is unsuitable for an investor, he/she can be held liable for losses caused by the investment under the law of negligence or breach of fiduciary duty.
- RELIGIOUS OR ETHNIC GROUP FRAUD: Many scammers use their victim's religious or ethnic identity to gain their trust - knowing that it's human nature to trust people who are like you - and then steal their life savings. From "gifting" programs at some churches to foreign exchange scams targeted at Asian Americans, no group seems to be without con artists who seek to exploit others for financial gain.
- SECURITIES CLASS ACTION: A securities class action is a class action filed by investors who purchased a company's debt or equity offering within a specific period of time, known as a "class period". The investors have also suffered economic injury because a significant negative public disclosure about the company during that class period caused a serious drop in the company's stock price. Securities class actions generally are brought under the anti-fraud provision of the federal securities laws including Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 and the Securities Act of 1933.
- SECURITIES FRAUD: State and federal laws prohibit any person from selling securities by means of any fraudulent scheme, material misrepresentation of fact, or any other practice that operates as a fraud or deceit upon the buyer. A broker will generally not be liable for losses caused by reasonably-given advice, even if the advice turns out to be bad. However, if a broker acts negligently, or intentionally misleads his customer either by affirmative misrepresentations or omissions, he can be held responsible for all the damage caused by his misconduct.
- SPECULATIVE SECURITIES: It is surprising but true that unsophisticated investors, whose primary goal is to preserve their savings, will often engage in highly speculative transactions involving options, puts, calls and margin accounts on the advice of their stockbroker. An option is a contract that entitles the buyer to buy (call) or sell (put) a predetermined quantity of an underlying security for a specific period of time at a preestablished price. Buying on margin is when the brokerage house lends the customer money for purchases of securities or short sales. Customers must have enough equity in the account to pay for the purchases or deposit sufficient funds immediately if the value of the account declines. With a margin account, it is possible to lose not only all of the money put into the account, but also to end up owing a huge amount of money to the brokerage house. These types of securities transactions hold tremendous risks for the unwary and should never be used by investors who do not understand the risks or who cannot afford a large loss on the account. The recommendation of these types of highly-speculative securities may be a violation of the rule that requires stockbrokers to recommend suitable investments.
- SPECULATIVE TRANSACTIONS: It is considered speculative for investors to engage in a variety of securities transactions that fall outside the understanding of the unsophisticated investor. Examples of Speculative Transactions include the use of Options, Puts, Calls, Margin, as well as buying and Short Selling. An "Option" is defined as the right (ability), but not the obligation, to buy or sell a stock. A "Put" is defined as the option of selling shares at a fixed price on a given date. The Put may have a period of time before it can be exercised, or it may expire if not exercised before a specified date, or it may remain in effect virtually indefinitely. A "Call" is more or less the reverse of a Put. It confers an option to buy stock at a fixed price on a given date. An investor who purchases an Option, whether a Put or a Call, must exercise it within the allotted time or lose the price paid for the security. A "Margin Account" is a type of account that allows investors to use the marketable securities held in their accounts as collateral for a loan to purchase more securities. Interest is charged to the account on a monthly basis on the amount that is borrowed. The use of margin allows an investor to take advantage of the principal of "Leverage". That is, if the securities purchased on margin increase in value, the investor realizes a greater return on the money invested. However, the use of margin greatly increases the risk to the investor, as the principal of leverage also works in reverse. A decline in the market value of the securities purchased on margin can cause the investor to lose not only everything in the account, but to also owe potentially large sums to the brokerage house. "Selling Short" is defined as the sale of securities that the seller does not own. The investor uses the margin device to "borrow" stock from the brokerage house, betting on the hope that the stock will drop in price, at which time the investor can buy the stock at a lower price to repay the brokerage house. If the stock goes up instead, the investor suffers a loss. As a general proposition, unsophisticated or conservative investors should never be involved in these types of Speculative Transactions. Such Speculative Transactions generate higher fees and commissions for brokers. A stockbroker who recommends these types of Speculative Transactions to conservative, unsophisticated investors may be held to Breach the Fiduciary Duty owed to his clients.
- UNAUTHORIZED TRADING: If a stockbroker executes a transaction for his customer's account without the customer's permission, the broker may be held accountable for the consequences of such an unauthorized trade. Such liability can exist regardless of whether the unauthorized transaction was the result of an innocent mistake or from a deliberate act.
- UNLICENSED SALESMEN/UNREGISTERED SECURITIES: The federal government has enacted laws requiring the licensing of securities salespersons and the registration of securities. Simply put, it is not legal to sell investments if you are not a licensed stockbroker, and, except under limited circumstances, investments must usually be registered with a government agency in order to be mass marketed to investors. Shockingly, hundreds of millions of dollars have been raised in the past several decades from scam artists who blatantly violated these legal requirements by preying upon naive investors. Accordingly, investors should be extremely cautious when considering an investment promoted by someone who is not licensed with a reputable brokerage house. Extra care should also be given to any investment that is not registered with a state or the federal government.
- VIATICAL SETTLEMENT CONTRACTS: Viatical settlement contracts are designed to let terminally-ill patients, often people with HIV or AIDS, sell the benefits from their life insurance policies so they can use at least part of the money while they're still alive. The settlements allow an investor to buy a life insurance policy at a discount from the death benefit of someone with a short life expectancy. The policyholder receives quick cash and the policy's new owner collects the benefits after death. Unfortunately, these contracts are often resold to unsophisticated investors who do not understand the potential risks of the investment and, because the transactions are not regulated, the potential for fraud is high. In recent years, the industry has slowed down as life-prolonging drugs for AIDS patients hit the market. Con artists have flooded the industry with fraudulent deals that steal from both investors and policyholders. In some fraud cases, investors gave money to insurance agents who kept the funds rather than reinvesting them in policies. In other instances, policyholders claimed that life expectancies were shorter than they truthfully were.
The following terms are commonly used in the arbitration process:
ADMINISTRATOR - The person at the sponsoring organization who handles administrative matters in arbitration proceedings.
ANSWER - A respondent's written reply to a claim. This happens before the arbitration hearing.
ARBITRATOR - The person who decides disputes between parties. The arbitrator is typically appointed by the parties who rank lists of prospective arbitrators prepared by the arbitration forum. In some cases, there is only one arbitrator; in others, there is a panel of three.
AWARD - The written determination of the arbitrator. It specifies how much money is to be paid, by whom, and when.
CLAIM - A demand for money or other relief. An official claim is written and delivered to the respondent. It is like filing suit in court.
CLAIMANT - A person making a claim. This is analogous to a plaintiff in a lawsuit.
COUNSEL - An attorney who advises a party in an arbitration.
COUNTERCLAIM - A claim against the claimant.
CROSS-CLAIM - A claim by a respondent against a co-respondent previously named by the claimant.
FILING - Delivery to the Director of Arbitration of the Statement of Claim or other pleadings, to be kept on file as a matter of record and reference.
PANEL - The arbitrator(s) who decide(s) a dispute.
PARTY - A person or broker/dealer making or responding to a claim.
PLEADINGS - The claim, answer, counterclaim, and/or third-party claim and/or cross-claim filed in an arbitration.
RESPONDENT - The person against whom a claim is made. This is analogous to a defendant in a tort lawsuit.
SERVICE - Delivery of the Statement of Claim or other pleadings to those parties named in the arbitration.
SRO - A self-regulatory organization. In securities arbitration, an SRO is a securities association or securities exchange such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers (NASD).
THIRD-PARTY CLAIM - A claim by the respondent against a party not already named in the proceeding.
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