Investors are bringing an increasing number of legal claims against brokerage firms as a result of inappropriate sales of preferred stocks issued by financial institutions. For example, Merrill Lynch has been hit with an arbitration claim filed by an elderly couple that lost $650,000 in the preferred stocks of financial companies according to Sue Asci in her August 16 article in InvestmentNews called “Merrill Lynch confronts arbitration claim involving financials’ preferred stock.” The claim, filed with FINRA, alleges that Merrill engaged in fraudulent sales practices, including self-dealing (more on that below).
Brokers and their firms have legal obligations to their customers not to recommend an investment or investment strategy that is unsuitable based on the client’s investment objectives, risk tolerance and financial situation, which brokers are required to know. In addition, they must fully disclose and not misrepresent all material facts and risks associated with any investment or investment strategy they recommend.
Based on those legal duties and obligations, brokers and their firms are required to diversify rather than concentrate most investors’ portfolios. A portfolio concentrated in one or a few financial sectors is unsuitable for most investors, and that is doubly true when the sectors themselves are inordinately risky.
By June 2007, there were articles in the financial press about Wall Street firms being hurt by the subprime crisis, two big hedge funds at Bear Stearns facing shut-down, how Bear Stearns itself was in trouble, and how Wall Street feared that Bear Stearns was just “the tip of the iceberg.” While it may have made sense for some risk-taking investors to own shares of financial stocks on the theory they were oversold and due for a rebound, it would defy common sense to concentrate the average retired couple’s portfolio in the financial sector, especially in and after June 2007.
Preferred shares are generally regarded as more “conservative” and brokers tend to recommend them for their retired clients seeking income, because they pay a higher dividend than non-preferred stocks. The preferred shares of financial companies had dividends that were higher than many other preferreds. However, a concentration of financial preferreds in mid-to-late 2007 was extremely risky and, therefore, unsuitable for most investors, and especially so for retired couples and those nearing retirement.
Why did Merrill and other firms recommend these securities? As the article points out, the claim alleges that Merrill was an underwriter of the preferreds. The underwriter firms and their brokers make commissions on the sale of IPOs that are substantially higher than the commission paid on non-IPO shares. In addition, underwriters purchase the IPOs and, therefore, have inventories of shares to unload. By 2007, Merrill and other firms had reason not to continue to hold a large amount of securities of teetering Wall Street firms. If Merrill was conflicted in this way, recommending and selling such securities to unsuspecting clients would constitute self-dealing, and would violate a number of laws and FINRA rules, including, for example, FINRA Rule 2010, which states: “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”
Observers say that claims involving preferred stock of financial companies have doubled or even tripled this year. And that may be the tip of the iceberg. “I think people are still shell-shocked by what happened ‘ {a]nd not a lot of people have come forward yet,” said one observer.
Investors who believe their portfolios may have been over-concentrated in the securities Wall Street firms and other financial companies may have compelling claims to recover their losses, and should consult with experienced counsel to evaluate their circumstances and determine their options.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and corporate investors in securities cases. For further information, please contact us.