Welcome to #finraFridays!
This blog breaks down the mysteries of FINRA’s investigative and disciplinary process and FINRA’s rules. It is important for brokers and customers alike to be aware of how the securities industry is supposed to operate and how to respond when something appears to go wrong. In each posting, we explore a small piece of the process and explain how it impacts FINRA and you. If you want a topic covered on #finraFridays, feel free to contact Gary Carleton at gary@carletonlaw.net.
This Week:
Guarding Against Excessive Trading
in a Customer’s Account
In September 2022, FINRA published Investor Insights entitled 3 Ways to Guard Against Excessive Trading in Your Brokerage Account. It is a good read and a good introduction to the serious issue of account churning. You can find it here: https://www.finra.org/investors/insights/3-ways-guard-against-excessive-trading-your-brokerage-account
While the publication, by definition, is aimed at investors – customers with securities brokerage accounts with stockbrokers, it also serves as a good reminder for brokers and firm compliance personnel of the not always so distinct line between an aggressive investor and an abusive broker. In this blog, we take a deeper look into the issue of account churning, contributing factors, and how to stop it.
In its article, FINRA suggests that the first way to guard against excessive trading is for customers to carefully review the account documentation when opening an account. While that is good advice, it fails to take into account the basic problem that Brokers are from Mars, Customers are from Venus, or something like that. We don’t speak the same language and those brokerage opening account forms may as well be in a foreign language to most customers.
Most new account forms are going to identify a customer’s investment objective as “Speculation,” “Growth and Income,” “Protection of Principal,” and the like. One thing for sure is that they are not terms your average customer uses to describe what they want to accomplish when opening up a securities account. They are terms on an opening account form created by the brokerage firm.
Before checking off a box on a form reflecting a customer’s information, it is imperative that the broker listen carefully to the customer in his or her own words what their needs and expectations are in opening the account in order to properly reflect the customer’s “risk tolerance” and “investment objectives.”
Most firms have definitions of each of the categories of investment objectives. Sharing and discussing each of those definitions with the customer is the start but not the end of the customer and broker coming to terms with the account’s investment objectives. A customer should also feel free to submit a statement to the broker outlining in his or her own words what their expectation is for the account.
Next, FINRA’s article advises customers to “Check Your Trade Confirmations and Account Statements.” Again, good and indeed critical advice. However, if you are like me, you have been prodded endlessly to go “paperless” with your account statements and confirmations until you agreed to not receive the documents in the mail.
And while you may get email notifications that a new account statement is available if you log in to your account online (if you can remember your password), your chances of actually looking at your periodic account statements is likely a lot lower if it is not appearing in your snail mail.
In analyzing your trade confirmations and account statements, FINRA’s notice suggests that you “monitor your statements carefully and be aware of how much money you’re being charged for the activity associated with your account.” While that seems like good advice and customers should review for commission charges, it falls far short of determining a broker’s full compensation, and therefore the entire motive for recommending the security to a customer.
First, for initial and secondary (or add on) public offerings, it is much more difficult for customers to find out how much the broker is being compensated through sales concessions from the underwriter. Quite often, that figure can be a much higher amount than a commission earned for trading on a stock exchange.
That figure does not appear anywhere on a customer’s account statement or trading confirmation. It can only potentially be derived by a careful reading and calculations from the offering memorandum.
For stocks that are trading on a stock exchange, brokers do not disclose on trade confirmations or account statements the various other ways that they may be compensated for recommending and selling a particular stock to a customer. Both soft dollar arrangements for steering transactions to specific brokers, and office sales contests can be strong yet undisclosed motivations for a broker to recommend a security to a customer or have it executed in a particular manner.
Finally, FINRA suggests that if a customer sees something on their account documents that they are unsure of, they should always ask questions. Yes! Customers need to be sure to ask questions and not settle for answers that they do not understand. A broker or his or her supervisor or compliance officer needs to be able to answer a customer’s questions in plain English without simply stringing together a bunch of securities terms that the customer (and possibly the broker) do not understand.
If they cannot, then it is time for the customer to move their funds to a firm that can and will take the time to answer questions and explain investment strategy options in a manner that the customer can understand.
It is also important to memorialize conversations between customers and brokers about investment strategy and what was agreed to. If the customer and broker had a conversation regarding investment strategy, it is in the interests of both parties to document the discussion in an email or shared memo.
Conclusion
FINRA’s article presents customers with a good start on ways of maintaining control of their accounts and building investor confidence. Customers should also be aware of the more nuanced potential undisclosed motivators that brokers have in recommending stocks to their customers, as outlined in this blog. If customers don’t understand what is going on in their accounts, they need to be proactive and ask questions and get answers or more their money to somewhere else where they will follow, understand, and agree with the account activity.
Gary Carleton focuses his practice representing both customers in FINRA Arbitrations, and individuals and firms facing FINRA investigations and disciplinary proceedings and appeals. He also serves as co-counsel with attorneys who have clients facing a FINRA investigation or disciplinary proceedings Contact Gary Carleton at 202.744.6297 or gary@carletonlaw.net to set up an initial consultation.
In Case You Missed It – You can find prior blogs on the FINRA investigative and disciplinary process at www.carletonlaw.net and go to the Blog tab. #finraFlashback blogs in which we discuss notorious FINRA disciplinary proceedings can also be found at www.carletonlaw.net.
The prior topics include:
* Keeping Stockbrokers Out of Trouble by Updating Their FINRA Form U4 Filings
https://carletonlaw.net/keeping-stockbrokers-out-of-trouble-by-updating-their-finra-form-u4-filings/
* Why FINRA’s Disciplinary Decisions are so “Appealing”
https://carletonlaw.net/why-finras-disciplinary-decisions-are-so-appealing/
* FINRA Flashback – FINRA’s Investigation Uncovers Stock Manipulation
https://carletonlaw.net/finra-flashback-finras-investigation-uncovers-stock-manipulation/
* FINRA Flashback to Stratton Oakmont
https://carletonlaw.net/finra-flashback-to-stratton-oakmont/
* Where have all the FINRA Members (and disciplinary actions) gone?
https://carletonlaw.net/where-have-all-the-finra-members-and-disciplinary-actions-gone/
* Special Considerations for Small Firms when Negotiating Settlements with FINRA
* Receiving that First Request for Information (a Rule 8210 Request)
https://carletonlaw.net/receiving-that-first-request-for-information-a-rule-8210-request/
* Pre-Wells Notices – An Early Opportunity to Discover FINRA’s Evidence and Present Your Case
* Understanding the Significance of FINRA’s Limited Jurisdiction
https://carletonlaw.net/315-2/ and
* How Old is Too Old for a FINRA Disciplinary Action
https://carletonlaw.net/how-old-is-too-old-for-a-finra-disciplinary-action/
About Carleton Law PLLC
Getting a call from FINRA or SEC Enforcement telling you that your work as a securities broker is under investigation could be the worst day of your life. You have worked hard for years building your business. Now, with one wrongful allegation you can see it all swept away. But with expert counsel, it does not have to end that way.
For more than 30 years, Gary Carleton was the attorney conducting those investigations at FINRA and SEC and now his firm, Carleton Law PLLC, brings that savvy experience to bear to advocate for brokers and FINRA firms who find themselves in that dreaded position. Carleton Law focuses on the individual needs of each client to guide them through the maze of the investigative and disciplinary process.
Carleton Law PLLC | 2001 Massachusetts Avenue NW, Washington, DC 20036 | info@carletonlaw.net
The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information is for general informational purposes only. Readers of this article should contact their attorney to obtain advice with respect to any particular legal matter. No reader should act or refrain from acting on the basis of information contained herein without first seeking legal advice from counsel in the relevant jurisdiction. Only your individual attorney can provide assurances that the information contained herein – and your interpretation of it – is applicable or appropriate to your particular situation. Use of, and access to, this article does not create an attorney-client relationship between the reader or user and the article author or law firm.
Attorney Advertising – Gary Carleton, Principal of Carleton Law, is admitted to practice law in the State of New York and the District of Columbia. This article may be considered attorney advertising.