Martindale-Hubbell
State Bar of Georgia
PIAMBA
Atlanta Bar Association

Red Flags of Possible Securities Account Mismanagement for Accountants

Accountants are in an excellent position to recognize when their client’s investments are being mishandled. Various financial and structural issues in the securities industry play a role in why some securities brokerage firms and their representatives mishandle their customer’s investments. One problem involves how the securities industry gets compensated. The traditional commission model creates a potential conflict of interest that is seen in cases of excessive trading or churning, while the assets-under management model incentivizes asset gathering and risk-taking by the broker/adviser. Another problem is the proliferation of complex non-traditional investment products. These risky products (equity linked notes and other structured products, non-traded REITs, leveraged and inverse-leveraged exchange traded products, etc.) are illiquid, non-transparent and often sold to retail investors for much more than they are worth.

Securities brokers and investment advisers are governed by state and federal securities laws and regulations, as well as and self-regulatory organization (SRO) rules. These laws and rules impose significant duties on securities brokers and investment advisers. A breach of any of these duties provides legal grounds for the customer to recover investment losses and damages flowing from the breach. These duties include, but are not limited to:

  • The duty to fully disclose all material facts and risks about a proposed investment;
  • The duty to not misrepresent any material fact or risk about a proposed investment;
  • The duty to only recommend investments and investment strategies that are suitable for the customer based on a numbers of factors such as the customer’s age, financial situation, investment objective, risk tolerance, time horizon, and liquidity needs; and
  • The duty to refrain from buying or selling a security without the customer’s prior authorization.

Red flags may not always be warning signs of account mismanagement or fraud, but they should be looked into. Accountants can do this or they can contact a securities arbitration attorney to speak with the client and review the relevant documents. The following list of red flags, though not exhaustive, includes a number of situations that should be scrutinized:

  • There is a significant decline (realized or unrealized) in an account or a particular investment;
  • Significant underperformance of an appropriate benchmark such as the Vanguard S&P 500 Index Fund (VFINX) or the Vanguard Balanced Index Fund (VBINX);
  • The client or a family member complains or raises a question about an account or a particular investment;
  • The client is cognitively impaired;
  • The client is a senior, retiree or nearing retirement age;
  • The client is wealthy but not sophisticated in investment matters, or does not have the time to closely monitor the handling of his or her investments (e.g., small business owners, doctors);
  • The account holder is a small business company pension/profit sharing plan (the small business owner is almost always an ERISA fiduciary and is obligated to take all appropriate legal actions on behalf of the plan beneficiaries in the event of a loss);
  • The broker has one or more disclosure events (e.g., customer complaints, arbitrations, regulatory actions, employment terminations, bankruptcy filings, etc.) on FINRA’s BrokerCheck;
  • The brokerage or advisory firm has a bad reputation or is not an old line firm (for a non-exhaustive list of problem firms, see e.g., Rating Brokerage Firms by Their Complaint Histories Rather Than by Their Brokers’ Histories, 2017-08-09 by Craig McCann, et al.);
  • The investment portfolio appears to be overly concentrated (5% or more) in a particular security or financial sector;
  • The investment portfolio consist of many unfamiliar names;
  • The investment portfolio contains non-conventional investments such as non-traded REITs, structured products, microcap stocks, private placements, promissory notes, etc.
  • The trading activity appears to be too frequent (more than a couple of trades a month) in light of the client’s financial needs, resources, investment objectives and risk tolerance.

If any of these red flags are present, consider referring the matter to an experienced securities arbitration and litigation attorney, who should evaluate the matter and make a recommendation on how to proceed at no charge.

Do not delay because statutes of limitations may be running. Each state’s laws impose various time limits for filing various claims in court (i.e., statutes of limitation). They generally range from one year to six years. The clock may start ticking on the date of purchase or later if the state has a discovery rule (e.g., after the customer discovered or should have discovered the wrongdoing). Claims that are not filed within the applicable time limits are generally disallowed. In addition, the Financial Industry Regulatory Authority (FINRA) rules provide that claims older than six (6) years are ineligible for arbitration in that forum.