A Tale of Trouble
Unauthorized Trading and Unsuitable Recommendations

 You have spent much of your financial planning career dealing with the risks and rewards of investments. As an attorney, I have spent much of my career dealing with the risks and rewards of your career—and because I focus on lawsuits, arbitrations and regulatory actions, most of my focus is on the risks.

 Where are your risks? Many are rooted in simple, day-to-day habits and practices, where a good and conscientious financial advisor gets a little sloppy or bends a rule to supposedly help a client. A scenario I have seen repeatedly has a plot something like this:

 C.E. Olson, the founder of a thriving regional manufacturing company, has been your client for years. He has a number of securities accounts, including a joint account with his wife, and he trades them aggressively.

 In 1996, his wife inherits $100,000. Mr. C.E.O. mentions it to you and asks if you could open a securities account for his wife. He suggests you invest it all in municipal bonds. You check, and suggest three bonds. You talk to Mrs. C.E.O. on the phone, and open the account. This is the first time you have ever talked to her. She tells you that she never understood much about investments. She says her husband said she should buy municipal bonds and tells you to invest it in the municipal bonds you had suggested to her husband.

 You fill out the new account form, mark her investment objective as “Income” and buy the bonds.

 Three years pass. The account sits.

 In 1999, one of the bonds is called. During one of your frequent phone calls with the husband, you mention this. He says to buy $40,000 of Acme Corp. with the proceeds from the bond. You say you need to talk to his wife first. He says she is out of town. You say you will call her later. You keep trying, making somewhat of a pest of yourself trying to catch her, to the increasing annoyance of C.E.O.

 Finally she calls you, after the cash has been sitting for over a month. She does not even want to discuss it and in fact does not give you a chance to discuss it: “I don’t know about these things. Just do what my husband told you to do.” In the meantime, Acme Corp. has increased from $10 to $14 per share.

 Three weeks later, C.E., quite perturbed, remarks that you cost his wife $16,000.

 Another of the bonds expires in 2000. You let C.E. know. He says buy Boomer Corp. You remember the last fiasco, and to avoid offending, you do the trade without calling Mrs. C.E.O. When the third bond expires, you again invest it in another stock, Cookin’ Corp, at C.E.’s instruction.

 By 2002 the stocks have tanked. They are now worth only $25,000.

 Also in 2002, Mrs. C.E.O. finalizes her divorce.

 Today, you are in an NASD arbitration, brought by the former Mrs. C.E.O. You are the respondent, under cross examination. Consider how you will answer these questions from the former Mrs. C.E.O.’s attorney:

• This new account form has your signature on it, right?
• You filled it out?
• I see that you indicated Mrs. C.E.O.’s objective was “Income” and her risk tolerance was “Conservative”? Does Acme Corp. pay income? It is a pretty speculative stock, isn’t it?
• Did you ever discuss with Mrs. Olson whether her objectives had changed?
• Who told you to buy Boomer Corp? Did you ever talk with Mrs. Olson? Who told you to buy Cookin’ Corp?
• Mrs. Olson never authorized you to buy them, did she?
• Take a look at this paragraph from your brokerage firm’s compliance manual. It requires a written authorization for you to accept instructions from anyone other than the account owner, doesn’t it?
• Did you ever get a written trading authorization from Mrs. Olson allowing her husband to trade her account?
• You do not know, do you, whether Mr. Olson ever talked to her about the account?
• You do not know, do you, whether she ever saw a monthly statement?
• You have no idea, do you, whether she ever knew she had lost $75,000?
• You have no idea, do you, whether she ever knew you were trading her account without her authority?

The forms are your friends. Keep them current and accurate.

Regulators and arbitrators will hold you to what the new account form says. Do you keep the form current when investment objectives change? Do you get your client to sign updates? Do you send your client a copy?

Never forget who your client is. Not even your client’s spouse nor her accountant nor her attorney can instruct you to do a trade, unless you have a written trading authorization or power of attorney.

Never bend a rule to help your client. You put yourself at risk for any losses.

Ted Meikle has served as an attorney since 1980, including 4 ½ years as general counsel for a securities broker/dealer. He is now in private practice. This column is provided as general educational material and not as legal advice.

 © Ted S. Meikle