How Failure to Supervise Brokers Leads to Investment Loss

Did Your Brokerage Firm’s Negligence Cause Your Investment Loss

Failure to supervise is a law term for when stockbroker misconduct or actions result in investment and stock losses. FINRA, or the "Financial Industry Regulatory Authority," is the regulatory body that oversees all brokerage firms. A cornerstone of FINRA regulation is the mandate that firms must develop supervisory procedures to ensure consumer protection.

Branch managers and compliance personnel must review many reports, usually computer-generated, to determine and pinpoint any irregularities in their offices. This process is in place to protect clients from their financial advisors.

Examples of Failure to Supervise

There are many instances where an investor can file a failure to supervise a claim against a broker or their firm.

One standard check and balance is the exception report which is supposed to "red flag" any troubling occurrences. Though these reports exist, management routinely ignores them. In a particular example of failure to supervise, a broker churned a client's account.

Churning means the broker recommends continuously buying and selling securities, which is not in the client's best interest. The computerized supervisory system concluded the account had a high turnover rate. This is a technical term indicating the broker churned the account.

Though rare, this can happen when a firm fails to train a broker leading to failure to supervise incidents. Though compliance had the red flag alerts, they did nothing to supervise the broker. Besides suing the firm for churning and unsuitability, the client also had a case for failure to supervise.

In another matter, the broker recommended the same product to almost all his clients. Compliance personnel can run reports assessing the type of products/securities a financial advisor recommends for all his clients. Generally, an advisor will have different clients with different needs and risk tolerances.

Therefore, the advisor's "book of business" should be varied, with differing portfolios for clients who naturally fall into diverse categories. Here, the advisor had almost all his clients in the same product, regardless of age, objective and risk tolerance. That pattern should have been a red flag for the compliance department.

However, they neglected and did nothing about it, a perfect example of a case of a failure to supervise. The product in question resembled a Ponzi Scheme, and all the clients suffered considerable investment and bond losses.

FINRA Regulations for Client Account Supervision - RULE 3110

FINRA has many rules regarding the supervision of client accounts and financial advisors. These rules are set in place to avoid cases of failure to supervise. A prime example is Rule 3110. This mandates that FINRA members establish and maintain a system that ensures proper supervision of all financial advisor/broker activities.

Moreover, the established system must ensure that advisors/brokers follow all financially related laws, securities regulations, and FINRA rules.

The central tenet of 3110 mandates that financial entities have written supervisory procedures ("WSPs"). These procedures must include rules regarding the supervision of supervisors to ensure the supervisors are being supervised.

Rule 3110 also mandates the creation of a pyramided structure to secure these ends. That way, there would be supervisors supervised by someone who is also then supervised. The financial entity should write out and list all supervisory responsibilities in the hierarchy. The firm should structure and detail how to carry out the supervision properly.

The WSPs should provide procedures involving systems tests to ensure compliance and appoint principals to carry out the tasks. The WSPs must also appoint a Chief Compliance Officer ("CCO").

Another important tenet of 3110 is the yearly process that certifies the firm's compliance with its WSPs. The certification must be in writing and requires the firm's CEO to do the actual certification. The CEO affirms that policies and procedures are in place to ensure the firm complies with applicable regulations and laws.

The next step would be a formal report to the board of directors and relevant committees. Furthermore, the CEO must verify that they held a formal meeting with the CCO and discussed compliance and supervisory procedures. There must be an in-person meeting, not just memos.

FINRA'S Rule 2090, 2111, 2210 and 3270

Another set of important FINRA rules regarding supervision are Rules 2090 (Know Your Customer Rule) and 2111 (the Suitability Rule). To paraphrase 2090, all financial advisors/brokers must be diligent when opening and maintaining client accounts. They must also know and understand the essential facts of every client.

Rule 2090 ties into 2111, which mandates that an advisor/broker must have a reasonable basis for making a recommendation. They must prove the recommendation is a suitable transaction or strategy. This includes not only recommendations to buy or sell but also to hold a security or maintain a strategy.

Another important FINRA Rule involving supervision is 2210, and it deals with public communications by the financial advisor/broker. In the electronic world, diligence by supervisors over advisors' transmissions is of the utmost importance. The firm must approve all communications to ensure financial advisors/brokers are not making misrepresentations.

Given that the means of transmission could be emails, texts, Twitter and Facebook messages, supervisors must be extra diligent. They must be watchful of brokers’ communications to ensure there are no cases of failure to supervise.

Lastly, Rule 3270 deals with any Outside Business Activities by the advisor/broker. In summation, this rule requires disclosure of all business activities of the advisor/broker unrelated to their employment. This rule is so important because, in the past, some unscrupulous financial professionals have set up side schemes.

They get unsuspecting customers to invest by claiming it is a private placement created or endorsed by the firm. This activity is referred to as "selling away," and all financial firms forbid it.

In such cases, brokers will most likely not follow their firm's regulations leading to investment losses. Such unregulated activities could result in the client suing and filing a failure to supervise a claim against the broker.

Contact Our Team of Investment Loss Lawyers

Our team of stock loss lawyers and investment loss attorneys has over 30 years of experience handling failure to supervise cases. If you have suffered investment losses from stockbroker misconduct or broker fraud, you may have a case for a failure to supervise a claim.

Fortunately, our firm has the necessary resources and experience to prove a failure to supervise a claim. We are well versed in the complex process required to pursue such cases to get your desired results. Call us at (866) 931-7628 or contact us online to book an appointment with a broker misconduct attorney or stock loss attorney today.

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