If a broker has discretionary authority in your account, they may not live up to their obligations.
A broker violates FINRA rules when they recommend a security or type of investment strategy that results in overconcentration. If you have lost money because of overconcentration, the stockbroker fraud attorneys at Rikard & Protopapas can help. Contact us today for a free initial consultation.
The Dangers of Overconcentration
Asset allocation is perhaps the most important factor in determining how your investment portfolio performs. For example, if you were invested exclusively in internet stocks in 2001, your portfolio would have been almost completely wiped out from losses.
Similarly, if you were invested in only financial sector stocks, your portfolio would not have survived the financial meltdown in 2008. Diversification is one of the key tools to help your investments weather all types of markets.
Overconcentration is one of the biggest risks that you may face in your portfolio. Below are some ways that a portfolio may be overconcentrated:
- You are overinvested in a particular asset or asset class.
- One of your assets has performed extremely well, and it has grown to become an unreasonably large part of your portfolio; for example, if you bought shares in an electric car company a decade ago and held them, they could become too large of a part of your investments.
- You have all of your retirement assets invested in shares of your employer.
- Your assets in your account are all correlated, and they will all perform the same exact way.
- Your portfolio is entirely concentrated in illiquid investments.
For example, our firm has helped investors who lost money in GWG L-Bonds. One of the largest abuses that brokers committed was allowing their customers to put their life savings in these bonds.
To be perfectly clear, nobody should ever put their life savings in any one type of investment, whether it is crypto or speculative bonds. One of the major problems with the GWG junk bonds is that the market was extremely illiquid. This is a recipe for financial disaster, and many people have been completely wiped out when things go wrong, as they invariably do.
Overconcentration completely detaches your own personal investment portfolio from that of the overall market. You are essentially gambling, as opposed to investing with a long-term horizon. You could even lose all your money in a strong market.
How Diversification Protects Your Portfolio
On the flip side, diversification protects you in a number of ways. There are times when one particular investment underperforms the market or even loses money. There is practically no investor alive who has never made an investment that they regret. Diversification spreads out your risk, and it allows you to sustain an inevitable loss.
Diversification will smooth out your investment returns. You may not have an unlimited upside, but you will preserve your money. Your investments will likely be there when you need them, and you will be able to take advantage of new opportunities in the future.
FINRA Rules Prohibit Overconcentration
Your broker has a multi-faceted obligation to perform a suitability test before they recommend a security to you. Even if a broker does not owe you a fiduciary duty, they must still follow suitability rules. If not, they could be liable if you choose to file a FINRA arbitration claim against them.
Your broker may put their own financial interests ahead of yours. They may simply want to keep the commissions coming in, or direct you to what makes the most money for them.
FINRA Rule 2111 describes the broker’s suitability obligations. There are three different tests that they must perform. The third part of the test is a quantitative suitability obligation. Under this test, a broker who has discretion or control over a customer’s account must:
“have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile.”
There is never any type of situation where a broker should recommend that an investor put all their money into one particular type of investment. The broker may disregard the rules because they will be handsomely paid for selling one particular type of security. For example, brokers were earning huge commissions for selling GWG L-bonds, so they tried to convince their customers to load up on them.
There is no one set formula for determining whether a broker has violated quantitative suitability rules with regard to overconcentration. Everything depends on a customer’s individual situation and investment profile. However, there are some practices that will almost always result in a quantitative suitability violation.
You Can File an Arbitration Claim for Losses Due to Overconcentration
If you have lost money because your broker violated the duties that they owe you under securities laws and FINRA rules, you can take legal action to recover compensation. While your brokerage agreement may keep you from suing your broker, you can file a FINRA arbitration claim against your broker.
When you file a claim regarding overconcentration, your arbitration will be heard by a single arbitrator or a panel of three, depending on the size of your claim. You will have a role in selecting the arbitrator.
While the proceedings may not be as formal as a court case, you will still have a chance to develop your case and prove that your broker violated the rules. The arbitrator has the authority to order your broker to pay losses, and their ruling cannot be appealed. You should hire an experienced FINRA arbitration lawyer to put you in the strongest possible legal position to recover after becoming a victim of overconcentration.
Contact a Lack of Diversification Lawyer Today
The investment fraud attorneys at Rikard & Protopapas are experienced litigators who have a deep familiarity with FINRA rules and its arbitration forum. We can get down to the bottom of what your broker did and help you take effective legal action.
The first step that you need to take is to reach out to us for a free initial consultation. You can send us a message online, or you can call us today at (803)-805-7546.