Some investor claims are easy to see, such as when money is simply missing from an account or a financial advisor has been arrested for securities fraud. In other cases, a financial advisor has been negligent. The financial advisor did not commit fraud, but he did make mistakes that caused investment losses. These cases are more difficult for an investor to spot. Here are the three things we see in most of the investor claims we file against financial advisors for malpractice or negligence.
1) The investments do not “fit” the investor.
Sometimes a recommended investment is a bad fit for an investor. Financial advisors do not need to predict the future, but they do need to make sure that their recommendations are a good fit for their clients.
This process has two parts.
First, just as a tailor takes measurements before he begins to tailor a suit, a good financial advisor needs to take his client’s financial measurements. He should know an investor’s age, income, net worth, tax bracket, investment objectives, and risk tolerance. Only then should a financial advisor make an investment recommendation.
Second, once a financial advisor knows his client’s financial measurements, he should only recommend investments that are suitable (pun intended), that actually fit his client’s needs.
For example, recommending high risk stock in a new startup company could be unsuitable for an elderly widow who primarily needs safe income. Speculative stock in a new company probably does not pay a dividend and, while it could go up, it could also tank. It is not a good fit for her, so if it declines in value, the widow could have a claim against her financial advisor.
2) The investment portfolio has too much of a good (or bad) thing.
Unless an investor wants to gamble with his portfolio, it should be properly diversified. It should hold a wide variety of investments so that no single investment can cause significant harm to the portfolio. Another term for lack of diversification is excessive concentration in an investment.
Returning to our example of an elderly widow who primarily needs income, you could make the argument that investing in a risky startup could be appropriate for her, but only if it is a very small sliver of a well-diversified portfolio. If this investment is, say, just .5% of her portfolio, and the portfolio holds a broad selection of well-established, blue chip stocks and high quality bonds, then it could be appropriate for her. On the other hand, if this speculative investment is 5%, 50%, or even 100% of her portfolio, then the recommendation would be unsuitable.
This holds true for investments that squarely meet an investor’s objectives and risk tolerance too. You can have too much of a good thing! For example, what if a financial advisor met this widow’s needs by using her entire portfolio to purchase a single, high quality bond issued by IBM? This bond might be low risk and even provide good income, but the portfolio is still undiversified. Suddenly, this widow’s entire financial future depends on the future prospects of IBM, a single company! That is too risky. Instead, the widow should hold a number of smaller bonds, issued by several companies. This diversification reduces her risk, even though a basket of bonds might pay the same interest as a single bond from IBM. Diversification reduces risk without reducing investment yields, so there is no excuse for failure to diversify. Consequently, failure to diversify often supports a claim against a financial advisor.
3) Once you have purchased the investment, it is difficult to sell.
There are many investment products that are so good, that the company selling you the investment makes you keep it! (We are being sarcastic here.)
Investments that are illiquid—meaning there is not a strong public market for them so there are not enough potential buyers to make selling easy—are often a bad fit for investors. Investments could also be hard to sell because they carry surrender charges.
Unfortunately, illiquid investments often pay financial advisors high commissions. Your financial advisor gets a big check—and you are stuck in an investment that does not fit you. Common investments that fit into this category include:
a. Variable Annuities;
b. Equity-Indexed Annuities;
c. Non-traded REITs;
d. Business development companies (BDCs);
e. Oil & gas limited partnership interests; and
f. Private placements.
If you invested in any of these products, there is a good chance you can sue your financial advisor. Depending on the type of financial advisor you have, you may need to bring your claims in FINRA arbitration rather than going to court. To learn more about FINRA arbitrations, click here.
If you have questions about investment losses, the securities litigation attorneys at Investor Defense Law LLP may be able to help, and offer free initial consultations.
Investor Defense Law LLP is a law firm dedicated to helping investors in California, Georgia, and Washington State recover investment losses.
We understand investment fraud and financial advisor malpractice. Our lawyers know how to sue investment advisors, brokerage firms, and financial advisors. To receive a free case evaluation, contact an investment fraud attorney at 800.487.4660.