Some investors like to take a hands-off approach to investing and leave the decision-making to their brokers or investment advisers. Others want to be advised about every transaction in their account and daily updates about the status of their portfolios.
Whatever the case, brokers and financial advisors must adhere to their clients’ wishes. In most cases, however, they must have the customer’s permission before purchasing or selling securities in a client’s account. A violation of this rule is grounds for unauthorized trading.
Financial professionals who engage in unauthorized trading, whether or not the investor lost money in the transaction, must be held accountable for breaking industry rules and federal laws prohibiting such activity.
What Is Unauthorized Trading?
Even if a broker had good intentions when making an unauthorized transaction, it would still be considered unauthorized trading if the broker did not first obtain the client’s permission.
Unauthorized trading can occur with any financial product or security. For example, an investment adviser may believe a transaction is in a client’s best interest, so he or she makes the trade without informing the account owner.
Examples of Unauthorized Trading
Unauthorized trades can come in different forms. Here are some of the most common:
- The broker marks unauthorized trades as unsolicited, making it appear that the investor requested the transaction.
- The broker will execute a trade and then try to get the client’s permission after the fact.
- The broker agrees to an investment strategy but feels he or she does not need to contact the client before every trade.
- The broker forges his or her client’s signature or uses a photocopied signature, making the trades appear to be authorized.
Unfortunately, many investors victimized by unauthorized trading have the tables turned on them. Brokerage firms often claim that the investor did not immediately object to the trade or that the client approved it upon receipt of the monthly statements reflecting the transaction.
Laws and Rules Prohibiting Unauthorized Trading
FINRA Rule 3260, which is incorporated into the Financial Industry Regulatory Authority (FINRA) manual, states that a broker must get the client’s consent before trades are executed unless the former was given express, written permission to make discretionary trades for the account.
FINRA Rule 4512 also imposes several record-keeping requirements, including keeping a list of people with trading authorization for the account.
Unauthorized trading also violates FINRA Rule 2020, which prohibits fraudulent, manipulative, and deceptive practices, and FINRA Rule 2010, which sets the standard for commercial honor and fair trade principles.
Making unauthorized transactions in a securities account is also considered securities fraud under federal law. The Securities and Exchange Commission (SEC) Rule 10b-5, codified at 17 C.F.R. § 240.10b-5, prohibits misrepresentations or omissions, fraudulent schemes, and deceitful practices relating to the purchase or sale of a security.
Discretionary vs. Non-Discretionary Accounts
Whether or not a broker can trade on behalf of customers depends on the type of account his or her client has.
A broker may place buy, sell, or exchange securities for a client without prior approval from the latter if the account is a discretionary account. This means the investor has given the broker a limited power of attorney that allows such activity.
The investor must sign a discretionary disclosure agreement with the broker and his or her brokerage firm to document the consent. Without it, a broker will not have discretionary authority over the account.
It is important to note that a broker with discretionary authorization does not have complete control over the account. He or she must still make trades suitable for the client and ensure they align with the client’s financial strategy.
Although a broker has some autonomy over a discretionary account, unauthorized trading can still occur. For example, if the client instructed the adviser to include a mix of bonds, mutual funds, and stocks in the account, but the broker concentrated the account with only bonds, that is grounds for unauthorized trading.
In a non-discretionary account, the customer makes the final decision about every trade. A broker may recommend trades for the client, but he or she will only be allowed to execute transactions in the account if the client authorizes them.
Agreements don’t have to be black and white; investors and brokers can freely negotiate any arrangement. For example, a client may give a broker consent to make discretionary trades up to a specific monetary limit.
Ways to Protect Against Unauthorized Trading
Investors must take immediate action at the first sign of an unauthorized trading event. Waiting too long to address the issue may give the impression that the investor consented to the trades executed. The sooner someone files a complaint, the greater the chance of making a successful unauthorized trading claim.
Here are some ways to protect an account against unauthorized trading:
- Perform a background check of the broker. If red flags, such as customer complaints or disciplinary actions, appear, a different advisor may be warranted.
- Ensure agreement with the broker when discussing a transaction.
- Keep note of all conversations with the adviser.
- Review all confirmations, monthly account statements, and other important account files upon receipt. Keep all documents for future reference.
Remedies Available to Investors
Depending on the specifics of the case, investors whose brokers engaged in unauthorized trading may pursue an arbitration claim or a lawsuit. In either case, the investor could seek actual damages, including out-of-pocket losses caused by the unauthorized trade.
If the transactions caused losses during an upward-trending market, the investor may also seek market gains that would have been experienced had an unauthorized transaction not been made.
Penalties for Unauthorized Trading
Brokers who make trades without their customers’ permission may have to pay a fine and face FINRA suspension.
Once the FINRA starts an investigation, brokers must submit any information related to a suspected unauthorized trade. At FINRA’s request, brokers must provide documentation and testimony.
Brokers who fail to fulfill FINRA requests may be suspended until they comply. The suspension can escalate into a bar if the broker concerned refuses to cooperate.
What to Do if Your Broker Executed Unauthorized Trades
If you are a victim of unauthorized trading, you must contact an attorney immediately.
The Serafini Law Office will evaluate your situation and determine whether or not you have a viable unauthorized trading claim. Having a seasoned lawyer represent you will significantly increase your chances of recovering losses and winning a fair settlement.
Mr. Richard A. Serafini has been practicing law for 40 years and is well-equipped to handle your investment fraud case.
The Serafini Law Office currently offers legal services to the following cities and states: Miami, Fort Lauderdale, Boca Raton, West Palm Beach, Florida, Pennsylvania, and New York.
Contact us at (754) 223-4718 for a free consultation.