White Plains CitizeNetReporter - Merrill Lynchies Take the 5th. Can You Recover Losses From Broker Misconduct?

WPCNR VOX POPULI. By Wayne M. Josel, Esq. July 30, 2002. On the day when two top Merrill Lynch executives chose to plead the 5th Amendment before a congressional committee seeking information, a Mamaroneck attorney examines investors' opportunities for claims against the giant. Just last week, in a suspicious coincidence, the Goldman-Sachs semi-conductor analyst recommended semi-conductor stocks, just one day after a massive buy of semi-conductor call options by Goldman-Sachs.

Wayne M. Josel, a Mamaroneck attorney advises WPCNR on Merrill Lynch vulnerability to investor lawsuits over market manipulation. Here is his view:

In the wake of the recent settlement between Merrill Lynch and New York’s Attorney General regarding the independence (or lack thereof) of Merrill’s research department, and recent allegations about the conduct of Salomon Smith Barney’s renowned telecommunications analyst, many investors who suffered losses in the recent downdraft of the stock market (whether or not they are Merrill or SSB customers) may be wondering whether or not they have a claim for damages based on the improper conduct of their brokers.

At the heart of the Merrill case was the discovery that some of Merrill’s analysts had engaged in what its top executives called “unprofessional behavior.” The analysts privately ridiculed the “Strong Buy” recommendations they made on several stocks, particularly in the technology and internet sectors.

Conflict of interest?

The recommendations of a brokerage firm’s research analysts are, in many ways, the life’s blood of a broker or advisor. Customers view their brokers as experts with access to data and the tools to analyze such data that the customer lacks.

The revelation that these recommendations were suspect may provide many investors with an opportunity to closely examine their accounts and losses and try to determine if they have a claim against their broker or analyst.

7 Types of Misconduct

There are generally seven types of misconduct for which an investor may have a claim for damages against his or her broker. These are: misrepresentations and omissions; unsuitable recommendations; over-concentration; inappropriate use of margin; excessive trading or “churning”; unauthorized investments and failure to execute an order.

The other side of the story?

Securities laws make it unlawful for anyone to make a misrepresentation, or omit critical information, in connection with the sale of a security. Brokers must have a reasonable basis for the statements they make to customers in recommending investment strategies.

If a broker recommends that a customer purchase the stock in a company based on a research analysts’ dubious rating of that stock, the customer may have a claim to recover any losses.

Guarantees as to return on investment or other assurances or promises, as well as failure to disclose information to an investor like fees involved or risk may be actionable.

Grounds for Claims

Brokers, investment advisors and financial planners have a responsibility to know their customers and their investment goals. They are supposed to make recommendations and develop strategies based on their client’s financial status and needs, both current and future. Where a broker makes an unsuitable recommendation that leads to losses, a claim may be made.

What constitutes an unsuitable recommendation.

Examples of unsuitable recommendations involve excessive risk, over-concentration, illiquidity and failure to heed tax considerations. A broker should not recommend a risky investment to a customer who takes a conservative approach to investing and cannot afford losses.

It is also improper for a broker to recommend a portfolio that is overly concentrated in a small number of stocks or industries, or in one asset class or a highly illiquid portfolio. In addition, brokers must take into consideration the tax implications of any recommendations made to a customer.

Excessive Margin Trading.

The inappropriate use of margin is another cause of sometimes avoidable losses. A broker is required to inform customers of the potential risks involved in the use of margin (borrowing money from the brokerage firm, using securities as collateral, in order to purchase additional securities) and have the customer sign a disclosure document prior to implementing any margin transactions.

Too frequently, brokers permit or encourage customers to take on too much margin debt, resulting in greater losses in a down market. Some customers, wittingly or not, give their brokers discretion to trade for their accounts.

Churning.

Many customers believe that, with the added freedom, the broker will be able to make faster decisions on when to buy and sell securities, generating higher returns. Many times, however, the broker, who earns a commission on each trade regardless of whether there are gains or not, will be tempted to execute too many trades, generating higher commissions but not necessarily higher returns.

This “churning” of an account is illegal and losses that result from excessive trades may be the basis of a claim.

The unauthorized investment.

Another potential claim that arises where the broker has discretion on a customer’s account is the unauthorized investment. A customer may give the broker strict instructions to avoid certain securities (for example, options or futures), but the broker may disregard those instructions. Losses caused by such unauthorized investments may be recoverable.

Untimely Execution.

Finally, a broker is obligated to follow a customer’s instructions with respect to transactions in the account. If a customer calls and asks his broker to buy or sell a particular security, the broker must carry out those instructions in a reasonable and timely manner. Failure to do so may result in a claim by the customer to recover any resulting losses.

Merrill Lynch whistles past the grave yard.

As many commentators have stated, the Merrill Lynch case and resulting settlement do not, in and of themselves, provide additional bases for customers to recover losses they may have suffered. However, they did provide an opportunity for investors to re-examine their accounts to determine if any losses may have been the result of broker misconduct.

Wayne M. Josel is an attorney with offices in Mamaroneck, NY and New York City.


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