Brokers: Breaking into Investors Wealth

Published on 5th December 2006

For anyone who has never traded in stocks, the stock market is a place where people buy and sell stocks and other securities. He will however be disappointed to realize that one cannot trade in stocks directly. Not just anyone can go to a stock exchange to buy and sell shares. One must get in touch with someone who is a member of the stock exchange; a stockbroker.

A stockbroker buys and sells stocks on behalf of another person or company. He also buys and sells shares for himself to make profit. At times, stock brokers offer advice to their clients on which stocks to buy. When all this is said and done, they are salesmen. They get a commission for every sale (trade), and they have their own opinions about what stocks their client should buy. 

Being salesmen makes them dodgy to deal with. Stock brokers are in a fiduciary position with their clients and at the same time they get involved in buying shares for themselves. This may lead to conflict of interests. Cases have been reported of brokers who have used clients’ monies to conduct their own business and do other unscrupulous deals.

In many instances, individuals and businesses have fallen victim to stockbroker malpractice. Too often, investors fail to carefully examine the opening account form; yet, it is one of the most important documents in ones relationship with the broker and brokerage firm. Every account form contains information that reflects what type of investment is suitable for one. This includes information on risk tolerance, time horizon for investment and net worth. If a broker does not explain these concepts to you while completing the account form, you should raise a red flag to his conduct.

At times, brokers will focus on actively trading a client’s account in order to create additional commissions. This conduct is called churning. If the commission you pay for a given year is more than 5 percent of the average value of the account, you may be a victim of churning. You should consult a securities attorney or investment professional to determine if your account has truly been churned.

Apart from churning, a stockbroker may make trades in a client’s account without discussing with him. This constitutes unauthorized trading, which is prohibited. The broker may even call the client afterwards saying he has just placed a particular trade in the account. As long as the broker did not inform the client in advance that does not make it acceptable. However, if the client accepts the trade, it may be viewed as ratification of the broker's act.

Investors should realize that there are no guarantees in the stock market and that brokers may be prone to a certain degree of exaggeration or puffery in their salesmanship. Although there is no black and white line, when a stockbroker's overly aggressive sales tactics go too far and the customer relied upon his representations, then such statements like “ this stock is a guaranteed sure winner,” may constitute unlawful misrepresentations if the client acts upon it.

A broker may say that he has information from certain sources within the company which is not available to the public. He may indicate that the stock will be going up based upon such information and urge the customer to invest on what he may describe as a "hot tip." This may constitute trading on "insider information", which is prohibited by law. The line between permissible tips and insider information may not be very clear, especially in emerging securities markets like East Africa.

Periodically a letter is send by a brokerage firm to their clients to confirm that the client is satisfied with the trading. This should not be ignored. Such a letter may be used as evidence against the client to show that he was satisfied with the manner in which the account was being handled and that he did not put the firm on notice incase problems arise. If an investor does not feel that he/she agrees with the way his account is being handled, he can proceed to seek a second opinion from an investment professional. Basing on what the second opinion will be, he can decide to go forth and sign the letter or not.

Brokers’ malpractices are an ugly fact of investment in stocks, but they are part of the risks involved in investing. Investors should be on the look-out for such defrauders and make sure they avoid them or opt for litigation. Such legal actions against one’s broker should be taken quickly since a belated legal action will not be effective. Investors should embrace the bourse with a shrewd fall back strategy.

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