In theory, if you have lost money because your broker (or any financial institution) gave you bad advice, mismanaged your investments, misled you, or took other unlawful or unethical actions, you can sue for damages. If these breaches of duty are provable, the "merits of the case" are strong, as a lawyer would say.
Unfortunately, these merits may not be enough to get you fair compensation at a fair cost to you within a reasonable time span. No matter how good the case, the road to financial damages is a rocky one.
Key Takeaways
- If you lose money in the market, it may be easy to quickly blame your broker or financial adviser for your predicament; but suing your broker is not as easy as you may wish.
- Financial firms take allegations of fraud or misconduct seriously and have deep pockets to defend themselves.Winning a case can be costly and time-consuming.
- Meticulous record-keeping and maintaining an audit trail of what happened are key to proving your case and that the fault of loss lies with your broker.
- Still, brokers are beholden to strict regulatory rules and an ethical code, and violations can carry stiff penalties.
Theory vs. Reality
Why is it so difficult to win a financial award in court from a brokerage? Because odds are that you signed a contract with the brokerage that includes an arbitration provision. You surrendered your right to sue, except under very narrow circ*mstances, when you signed on as a client. In brief, you may not be able to sue unless you did not understand your rights or your reason for suing lies outside the scope of the arbitration clause.
Now let’s suppose for a moment that you can sue. In an ideal world, if you have a good case, you or your lawyer would write to the broker explaining the situation and requesting that they pay a certain amount of compensation or make a fair offer. The broker would face the realities of the situation and act with integrity, offering you a reasonable sum.
If the broker believes you were mistaken, they would explain why, and back it up with financial or legal evidence.
Unfortunately, we do not live in an ideal world and nothing makes a broker's blood run cold (or perhaps hot) more than a damages claim. The amount of money involved is generally not trivial and there is often a fear of "the floodgates opening," as you are probably not the only client who felt themselves to be similarly deserving of restitution.
It is also human nature that people are reluctant to admit they are in the wrong, even more so when such a concession could hurt them financially. Finally, brokerages typically require clients to sign contracts that include a provision that sends most disputes–including those concerning investment–to arbitration rather than litigation. That process is customarily overseen by the Financial Industry Regulatory Authority. FINRA arbitrators are supposed to be neutral. But critics of the system point out that arbitrators often have ties to the financial industry. Critics also claim that arbitrators’ dependence on the financial industry for assignments can lead to industry-friendly arbitration outcomes.
So What Actually Happens?
In many or most cases, the broker will deny absolutely everything with arguments that will make your blood either boil or freeze. The defenses will range from blaming you, the market, or both, to distorting the figures or the laws, the logic, or anything else that shifts the liability for the losses away from the broker. This first response will generally be presented as one of injured innocence.
If you push further, it can get nasty. The unstated and sole objective of the broker is to avoid (or evade) liability by any means available.
Do not, therefore, expect fairness or sympathy and understanding. The brokerage will see you as an enemy and treat you accordingly. You will be told that "our position is clear," which means "we will admit nothing and offer nothing, and if you want one dollar back then sue us if you dare." The question is, should you dare?
Why It Would Indeed Be Daring
The odds are stacked against you, especially if you are dealing with a large firm. You will be stressed throughout the entire case and the firm will be as cool as the proverbial cucumber, because it will turn the case over to its compliance division–lawyers–who are familiar with all the tricks of the trade, have ample resources, and who know that the opposite likely applies to you.
Further, such cases are often complex, invariably very time-consuming, and truly draining on your resources; financial, mental, and physical.
The other side can and will run up massive legal fees, and if you back out part way you may well owe them a frightening amount of money if your contract contains a loser-pays-all-costs clause. The theory is that judges are infallible and if you lose, you were in the wrong, deserve no damages, and should, therefore, pay the costs of the other side.
Brokers are not typically held to fiduciary duty in the way that financial advisers are. Registered investment advisers are held to fiduciary duty while brokers are typically held to the suitability standard.
It is also common for the other side to try and avoid the real issues and merits of the case from ever being discussed. Thus, the brokerage’s alleged financial mismanagement is often not dealt with.
Furthermore, the less of a case the firm has, the more incentive it has to resort to obfuscation. The brokerage will probably believe it has a better chance of escaping liability by manipulating (or taking its chances with) the civil system than dealing with you fairly out of court, especially if you are in the right.
But wait–don’t you have a right of appeal if an outcome seems flawed? In a word, No. At least not usually. FINRA does not have an appeals process for challenging an arbitration award. Federal and state laws offer only narrow paths for taking a FINRA decision to court. Appeals to federal district court are limited to cases in which you can show corruption, fraud, or irrationality.
The ugly reality is that investors generally lose money because the investment was too risky, but trying to get damages out of the broker or firm is also fraught with financial and other risks. This all sounds daunting and rightly so. The emphasis must be made that you can still win, but you need to be aware of the harsh realities. Litigation, just like investments, can be mis-sold.
On the Other Hand…
If you are not dealing with a big firm, there is a far more level playing field and you have a much better chance. Likewise, if you have legal insurance that will cover most of the cost, you can proceed more easily. It is also sometimes possible to get "after-the-fact insurance," which is not cheap, but it does mean your potential losses have a ceiling.
Furthermore, if you do have a powerful case, are mentally and physically tough, relatively risk-friendly, or lost a lot of money (but hopefully still have a lot) and really want to see justice done, it may still be worth going for it, even against a big player.
Frequently Asked Questions
Can You Sue Your Broker?
Yes, you can sue your broker if you have had losses in your financial account. There are two primary ways of suing your broker: filing a suit or filing an arbitration. Keep in mind that you cannot simply sue your broker and be successful in doing so if you have suffered financial losses. Suing your broker can only successfully be done under a few circ*mstances, such as a breach of fiduciary duty (if they are a registered investment adviser), trading that was not authorized, information that was misrepresented, investments that were risky and not in line with your risk profile, and churning.
What Are Examples of Broker Misconduct?
Examples of broker misconduct include high levels of trading in your account (churning), unauthorized trading, investments that don't align with your risk profile, significant changes in your portfolio's composition, lack of diversification, high uses of margin, poor performance when compared to the market, and lack of proper communication.
Can a Broker Steal Your Money?
Yes, a broker can steal your money. A broker is meant to care for your money and financial health. Stealing your money is illegal. The way that a broker can steal your money is known as "conversion of funds," which is illegal under FINRA Rule 2150. This is a misappropriation of money in which they use several strategies to move money from your account to their account.
Does Brokerage Arbitration Have any Merits?
Yes. Arbitration is typically faster and less expensive than litigation. Arbitration claims in which the sides reach some sort of settlement usually take 12 months. Cases that go to an actual hearing–comparable to a court trial–take 16 months on average. The process is also less complex than litigation.
Further, there are far fewer grounds for appealing an arbitration decision. That helps limit the length of time that the battle with your brokerage can drag on. Likewise, by agreeing to arbitration, both sides largely surrender their right to pursue the beef in court.
Most cases settle. In 2021, 74% of investor arbitrations ended with some sort of settlement.
The Bottom Line
A financial damages claim is not for the fainthearted, but it may be worth it in the end. Make sure you think things through very carefully before the cost "clock" starts ticking, and bear in mind that you will probably not get objective advice from a lawyer who is keen to sell (or mis-sell) litigation. Suing a large firm is certainly difficult, but it is not impossible and it may be worth trying. The more level the playing field in terms of resources, the better your chances.
Either way, the unfortunate reality is that litigation is an investment in itself, with its own risks and rewards. There are substantial costs involved, both financial and non-financial. All these factors need to be weighed up in advance before a sensible decision is made.In some cases, it is better to live with the losses.
Retirement Security Rule: What It Is and What It Means for Investors
Many brokers go out of their way to avoid being designated as a fiduciary. If your broker is a fiduciary, then you need to know about the new Retirement Security Rule. Also known as the fiduciary rule, the rule’s purpose is to protect investors from conflicts of interest when receiving investment advice that the investor uses for retirement savings.
The rule was issued by the U.S. Department of Labor (DOL) on April 23, 2024. It takes effect on September 23, 2024. However, a one-year transition period will delay the effective date of certain conditions to 2025.
If an advisor is acting as a fiduciary under the Employee Retirement Income Security Act (ERISA), they are subject to the higher standard–the fiduciary best-advice standard rather than the lower, merely suitable advice standard. Their designation can limit products and services they are allowed to sell to clients who are saving for retirement.
