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Five Tips To Prevent A Suit Against a Stock Broker

Five Tips To Prevent A Suit Against a Stock Broker


Times are great.  The market is soaring.  Stocks are generally doing well.  And the woes of 2007 and 2008 are a faded memory.  And, of course, all customers are singing the praises of their registered representatives – until the next crises. 

As we certainly know by now that next crises can hit tomorrow or in five years.  We also know that it will hit and those wonderful profits that the customers are experiencing will, at that time, turn into red.  So, what does the broker do now – today – to make sure that when the customer who he or she is hitting golf balls with, does not turn around and blame the broker for any unexpected and unfortunate losses?

No one asks these questions in good times.  Why not?  The answer is simple.  Because few brokers prepare themselves for such an event and, when things are flying, many brokers don’t even think that far ahead. 

Well, take it from me – an attorney who represented dozens of brokerage firms after the debacles in, among other times, 1987, 2000 and 2008.  I will tell you that when the market turned in 2000 (do we even remember the tech bubble bursting or the presidential election debacle with Bush and Gore), that turn resulted in thousands of securities arbitrations brought by customers who were soaring in 1999.  And if you are one of the lucky ones who did not experience being in the conference room at a FINRA hearing (then the NASD or NYSE) being cross examined by a customer’s attorney, then you really do not know how badly your actions can be contorted by an unscrupulous attorney; even though the losses in the accounts were the result of nothing other than the downfall of the market.  And those hearings were not in 2000.  Nor were they in 2003.  They mostly occurred in 2004 – 2005, long after the market crashed.

Back to today; the question is how can you -- the registered representative -- prevent that arbitration from coming.  The answer is not that difficult and can be summarized in five easy tips.

Tip Number 1: Make Sure Your Documents in the Account Are in Order

The first place a customer's attorney looks, before even checking out the monthly statements, are the Customer Agreement and New Account Form, each of which set the relationship parameters between the customer and his broker.   A broker should go back and look at every one of those documents and go through them closely to insure they accurately reflect what the account is doing today.  For example, with the rise in the markets, many customers want to become more aggressive.  Does the New Account Form reflect that change?  New Account Forms for the stock picker, or the client looking for the big hit, must be marked with an investment objective of “speculative” and a trading delineated as “short term.”  I cannot tell you how many times customer list “income” or “capital appreciation” as their objective when, over time as they make more money, that should be changed.  When they are not, their attorney will cleverly claim that the parameters defining the relationship are not consistent with what the broker did for the customer – known as a suitability claim.  So, go back and look at those forms.  Make sure they are signed.  Make sure they accurately reflect your current relationship with the customer.  Also, make sure the Margin Agreement is signed.  And assure yourself that, if the proverbial s—t hits the fan, your account documents are in order.

Tip No. 2: Really Know Your Customer

Of course, under Rule 2090 and 2111, every rep must know his or her customer.  But what does that mean?  It technically means that the broker must know the suitability requirements on the New Account Form.  But frankly, that is not enough.  Because a broker speaks with his customer regularly, that call should not simply be about stock selection.  Get to know the customer; his family, his hobbies, his likes/dislikes, what he does over the weekend and everything else you can learn.  Certainly knowing that the customer has an income of $250,000 and a net worth of $1,000,000 is important, but you have to dig deeper.  Let me give you one example to drive home this point.

Several years ago my firm represented a broker and a brokerage firm that had a strong relationship with its customer.  The market turned and (not so) surprisingly, he sued before the NASD.  The customer claimed he was risk averse and never wanted to invest in the risky securities that his broker put him into.  Well, the broker spent countless hours on the telephone during the relationship understanding his customer.  One of the things they discussed was gambling and the customer explained that he loved gambling and had accounts in Las Vegas and Atlantic City.  During discovery in the arbitration, we obtained the names of every casino in both cities and blasted every one with a subpoena for documents.  Surprise, surprise!   While several of the casinos never knew the customer, over six knew him well and produced documents detailing his spending tendencies and the tremendous amount he gambled at those casinos.  Thus, Mr. Risk Averse was lying and we caught him.  Let’s just say that the customer withdrew the arbitration after the first hearing date, when I informed the panel that we were going to learn about what he did and that he had accounts at some of the largest casinos in the world.  Had my client not had those conversations, we would never have been able to open that door. 

Finally, on that note, visit the customer.  I don’t care if he lives in Boise, San Diego or Memphis.  Take a one day trip to better understand the person on the other side of the telephone who is making trades in his account.   Then, when cross examined about the customer, you can talk in volumes about how well you knew him or her and how the trading activity was precisely what they signed up for.  And make sure you internally document everything you know about that customer, somewhere on your computer, so that those notes are never lost and form the basis of you “really knowing your customer,”

Tip Nos. 3, 4 and 5:  Communication, Communication, Communication

The final three tips are very simple.  In any securities arbitration, documents will win and/or lose the case for you.  Why is that?  Because the testimony is almost always a battle.   The customer will testify under oath that either he never approved the trades, didn’t know about the trades, didn’t realize that his activity was so high, or that one of the many duties the broker had to the customer was breached.  How do you defeat those claims:  documents, documents, documents.

Tip No. 3:  Send Summary/Activity/Comfort Letters

When times are good, documents are preventative medicine.  When I speak to many brokerage firms, I encourage them to regularly send out letters to their customers outlining the trades that were made, the customer’s equity in the account, the margin balance, the overall activity and asking the customer to contact you if there are any questions or concerns.  These letters are called Comfort Letters, Pillow Letters or Activity Letters.  I call them Negative Consent Letters.  I do so because so long as the letter states that the customer should contact the firm if the letter is in any way inconsistent with their understanding, and the customer does not do so, then he or she is deemed to be aware of everything contained in the letter and consents thereto. 

Additionally, it is important that these letters be sent from someone other than the broker; either the branch office manager or a compliance officer.  This way the customer not only has the opportunity to object to the contents of that letter, but can do so to someone other then his or her broker.  Many customers have testified that they received the letter and told their broker but that the broker told them not to worry about it.  If the letter is sent from someone else, that argument goes out the window. 

Tip No. 4:  Pre Trade Communication

As I said, communication is key to preventing a customer complaint or Statement of Claim.  These last two tips, especially tip number 5, are simply paramount to your practice. 

Before a trade is actually made, send the client information on the public company.  The more you send, the better.  Research reports, financial statements, discussions of the business, discussions of the industry and any other information you can provide to the customer should prevent that customer from stating that he or she did not know what the investment was in.  The broker, on the other hand, is at a tremendous advantage.  That is, it is very difficult for a customer to argue that he or she knew nothing about the security he purchased where the customer was provided that information before the trade was made. 

And on that note, send everything electronically.  You do not want to get into a battle over whether it was sent in the mail, who sent it, how it was sent and whether it was received.  While overnight mail is also preferential, that method can be expensive over time.  And when you send the correspondence by email, there is absolute proof that it was sent and presumably received.

Tip No. 5: Post Trade Communication

As important as it is to send correspondence before the trade is made, it is even more important to send communications after the trade.  What communication am I referring to?  First and foremost, every trade should be confirmed by email.  That’s right -- every trade.  Then you have a double confirmation of the trade; one by email and a second by regular mail.

Second, you should regularly communicate with the customer throughout the relationship, not only before the trade, but also after.  Call the customer a week after the trade was made.  Go through the account, its status, margin, activity and portfolio.  And again, note the call and what was discussed internally by electronic means, so there is a record of the call.  You should also email the customer on occasion to discuss issues, movement of the security and what to do next.  Tell him the other stocks you are following so that he can follow along.

You must also immediately inform the client if anything goes wrong.  For example, if a stock significantly decreases in value overnight, get on the telephone the very next morning and tell the client.  Any serious discussions should first be communicated personally by telephone and followed up with an email or an internal email to document that communication.  This is a must.  Some brokers run when the news is bad.  You have to face it and make sure that you immediately let the customer know, no matter how bad the news is.  Concealing a fact, transaction or occurrence is as bad – and some would argue even worse – as the news of the event.

In short, there is no assurance or guaranty that a customer will not turn on you.  It happens and it happens often.  However, because most of those cases are handled on a contingency basis, a good plaintiff’s attorney is going to ask to see the documents before taking the case.  And if you have solid account documentation, really know your customer and send emails and other communications regarding the account, the trades and the activity, not only are you in a better position to defend any arbitration that comes at you, but, in many instances, that plaintiff’s attorney will simply decide not to take the case. 

Richard Roth is the founder and president of The Roth Law Firm, PLLC, a boutique litigation firm that concentrates in litigating securities arbitrations and SEC/FINRA enforcement actions.

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