Answers by Mason Alan Dinehart III of Financial Education Network Development  

Note: Mason Dinehart also appeard on CNN-Money on Feb. 9, 2006 

SIGNALS OF SECURITIES FRAUD

There are irrefutable “red flags” that investors need to be aware of to determine if their broker has committed securities fraud. Securities Fraud can be defined as the broker putting his or her own interests ahead of the client. This is known as a Breach of Fiduciary Duty. 

Here are the questions to ask to determine if securities fraud has happened to you:

1. Is your new account information incorrect? 

Whenever you open a brokerage account, a form (new account profile) is filled out with your personal information, including your income, net worth, prior investment experience, your investment objectives and risk tolerance. You may never have seen your form because firms are not required to send them to you, although some best practice firms do. Brokers have an incentive to inflate the figures on the form, because by doing so, they are able to signal supervisors that you are able to tolerate more risky investments. If you have not seen your form, ask the operations department at the brokerage firm to send it to you so you can determine if the information about you is correct. If its inaccurate, that could permit the broker to fraudulently implement your account with aggressive or speculative investments. That is brokerage fraud. 

2. Is your account being excessively traded or “churned”? 

If you could wallpaper a room in your house with the purchase and sale confirmations you received, then the broker may have churned your account. Another place to look is on Schedule D of your tax return to see if it is more than one page. If it is more than that and you were relying 100% on your brokers advice and recommendations, as opposed to trades which were solely your own idea, your broker might again be committing securities fraud. 

3. Has your broker been “negligent” with the handling of your account?

Conduct that is unreasonable is all you need to observe. Every broker has a duty to observe high standards of conduct or “fair dealing”, which means that he or she must disclose all material facts to you (omit nothing) and do what is right (fair) given your particular circumstances. In other words your broker owed you the obligation to make sure that you understood all the risks associated with your investments. If you didn’t understand fully that your investments could substantially decline, your financial advisor’s conduct was probably negligent. 

4. Did your broker mention or provide you with research reports or analyst ratings in order to convince you to buy a security or prevent you from selling it? 

Many brokers justified their recommendations to customers by reference to the firm’s analyst – both to get customers to buy particular stocks and to prevent customers from selling those stocks. This is known as “lulling” and is a fraudulent act. This is because that we now know that many firms had incredible conflicts of interest and a financial motive to make those recommendations. 

5. Did your broker fail to fully disclose the risks of margin trading?

Margin abuses have increased dramatically in recent years. If your broker used margin (leverage) in your account but did not explain the risks to you i.e. the downside of margin use, then you may have a claim against your broker and his or her firm. This is especially true when in your prior investment experience, you never used margin before. 

6. Did your broker place you in only suitable investments?

Suitable investments are those which take into consideration your age, income, net worth, tax status, health, investment objectives and risk tolerance. If you told your broker that you did not want to take much risk with your money or if you simply couldn’t afford to lose the money you have lost (because, for example you are retired or have limited irreplaceable assets) and you incurred significantly losses, then your broker violated the suitability rule. Further, if you have limited brokerage experience, part of the suitability obligation is to protect your account with “risk management” tools such as stop losses or protective puts to stop the bleeding. 

7. Did your broker ever mark your confirmations “unsolicited”?

Sometimes, brokers will mismark the confirmations for trades to show “unsolicited”, which means that the trade was solely your idea, without a favorable opinion of the broker. Brokers do this so that supervisors will not look so closely at the trades that are going into your account. This is a very serious violation because management would not be so concerned about 
your account from a risk standpoint if the trades were your, as opposed to the broker’s, idea. This practice is a violation of securities rules and another example of brokerage fraud. 

8. Is your broker making trades in your account without your “written authorization”?

Unless you give your broker written discretion to trade in your account, each and every single transaction must be approved by you. This means that it must be preceded by a conversation with you and for you to say “ok” to the trade. If this did not take place, than the trade is unauthorized and you may be entitled to undo the trade. However, you must complain in a reasonable amount of time or you will have “ratified” the trades. 

All of the acts described above could be fraudulent acts by a broker and are possible breaches of fiduciary duty. If you detect them, get a securities expert or securities attorney to review the activity to determine if you have a legitimate cause of action to take your broker and the securities firm to arbitration. 

Have you been taken advantage of by a stock brokerage firm? We asked Mason Alan Dinehart III of Financial Education Network Development, a popular securities expert witness arbitrator,  some frequently asked questions about securities fraud, stock brokers and what exactly is a securities expert witness. 

What is a securities expert witness? 

This is someone that has spent years in the securities industry and is familiar with all products related to the area of finance. Good knowledge of insurance and annuities is helpful. Finally, the expert should be licensed in securities (Series 7), preferably as a manager (Series 24) as well as in variable annuities and insurance. He should have experience testifying in arbitration forums as well as in the courts. Finally, it is helpful if your securities expert has been appointed as an Arbitrator for one or all of the arbitration forums i.e. NASD, NYSE., PSE or AMEX .

Why would someone need a securities expert witness? 

Any client who is contemplating proceeding against his or her broker or brokerage firm needs a securities expert witness. Once the case is analyzed, the expert is in a position to recommend the appropriate securities attorney to represent the client, usually in securities arbitration. Usually, representation by the attorney would be on a contingency basis. 

Can I sue my broker or brokerage firm in court? 

Not usually. Most new account agreements signed at all brokerage firms limit the customer’s action against the broker and firm to arbitration forums like the NASD, NYSE and PSE. 

Is it a good idea for an expert witness to be an advocate and “passionate” about his or her client, when representing him in litigation or arbitration? 

No this is not a good idea. A better idea is for the expert witness to be ‘passionate” and an advocate for his position rather than the client. This allows the expert to be more objective in client representation. 

Is an expert witness in arbitration always expected to be “objective” in his testimony on behalf of a client in arbitration? 

No, I don’t believe so. The only time an expert witness should be completely objective is when a court appoints him to represent a client in a litigation setting. In arbitration, when an objective expert takes a case based on its merits, he can be expected to defend his position vigorously. After all, the other side will normally put forth its own expert who can be expected to vigorously defend the opposing position. 

What should an expert witness do when he or she is uncertain of the answer to a question under cross examination by opposing counsel?

Admit that you don’t know. It destroys all credibility to be glib and fake an answer if you are unsure. One fall back position that can be useful is to leave that question to be answered by the arbitrators, the ultimate “trier’s of fact”. 

Should a securities expert witness in arbitration always be paid in advance of testimony? 

Yes, at all times. To do otherwise, is to imply to the arbitration panel that you, the expert, have a stake in the outcome of the hearing i.e. participation in any award granted by the arbitrators. This, of course, would remove any credibility from your testimony and label you nothing more than a “hired gun” in the process. 

Should an expert witness work on the basis of a retainer? 

Yes, always. The expert should utilize a retainer agreement that sets forth the amount of the retainer, how it will be applied, the hourly fee and any other terms or costs that will be considered. Most charges should be conforming to all activities It is often confusing to apply a different hourly rate for preparation time than for testimony. To charge a higher rate for testimony could well limit your attendance time at the arbitration. 

Should the securities expert attend the entire hearing in arbitration?

Yes, always! Experts are normally allowed to remain along with the parties in the arbitration forums. This is so the expert can gauge the credibility of the witnesses as well as to the reaction of the arbitrators to their testimony. Then if the arbitrator’s ask questions of the witnesses, it is critical for the expert to hear the answers and work these very points into his or her own testimony. Furthermore, only when the expert can hear, first hand, how his client handles questions under cross examination, can the expert refine and clarify his position for later testimony.

- Answers provided by Financial Education Network Development

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