Applicable law/agency: Securities and Exchange Commission (SEC), National Association of Securities Dealers (NASD)
Related topics: Securities, Stock Market Losses, Breach of Fiduciary Duty, Edward Jones, Securities Unsuitability, Selling away, Theft, Unauthorized Trading
The Securities Act of 1933 requires publicly traded companies to disclose financial and other important information to investors and potential investors and prohibits misrepresentation or fraud in the sales of securities. Brokers must disclose the risks associated with investments to their clients. The National Association of Securities Dealers (NASD) dictates that all members send account statements to clients at least once every financial quarter. Statements should include purchases, sales, interest credits or debits, charges or credits, dividend payments, transfer activity, securities receipts or deliveries, and journal entries detailing funds or securities controlled by the broker. All information provided should be true and free of deception.
Full Disclosure is a Cornerstone of Investing
Often referred to as the “truth in securities” law, the Securities Act of 1933 has two basic objectives:
1. Require that investors receive financial and other significant information concerning securities offered for public sale.
2. Prohibit deceit, misrepresentations, and other fraud in the sale of securities.
The cornerstone of the financial markets is full disclosure. A broker has a duty to accurately represent investments. As such, a broker cannot misrepresent or fail to disclose the nature or the risks associated with a given investment. A broker cannot omit to tell an investor material or important information about recommendations. Information that is material would include the risks associated with a plan of investing, or the costs associated with an investment.
Brokers owe their customers a duty of fair dealing. This fundamental duty derives from the Securities Exchange Commissions (SEC) antifraud provisions. Under the so-called “shingle” theory, by virtue of engaging in the brokerage profession (from hanging out the brokers’ business sign or “shingle”), a broker represents to its customers that it will deal fairly, consistent with the standards of the profession.
Based on this important representation, the SEC, through interpretive statements and enforcement actions, and the courts and through case law, has set forth specific duties for brokers. These include the duties to execute orders promptly, disclose certain material information (information the customer would consider important as an investor), charge prices reasonably related to the prevailing market, and fully disclose any conflicts of interest.
Failure to disclose information to the customer, about investment decisions, commission rates or other fees, certain risks and conflicts of interest are all violations of the SEC and considered omission or misrepresentations of material facts.
The National Association of Securities Dealers (NASD), the New York Stock Exchange (NYSE) and other registered exchanges are Self Regulatory Organizations (SROs). Each of these SROs is overseen by the SEC and has additional rules that reflect the importance of fair dealing. For example, NASD members/brokers must comply with the NASD’s Rules of Fair Practice. In general, these rules generally require brokers to observe high standards of commercial honor and just and equitable principles of trade in conducting their business.
Specifically, the NASD defines misrepresentation as a false representation of a matter of fact that should have been disclosed, which deceives another, so that they act upon it to their injury. NASD Rule 2340 states that every member/broker shall, with a frequency of not less than once every calendar quarter, send a statement of account (“account statement”) to every customer. The statement must contain a description of any securities positions, money balances, or account activity, money balance, and/or account activity during the period since the last statement was sent to the customer.
The statement must include detailed account activity that includes, but is not limited to:
• Interest credits or debits.
• Charges or credits.
• Dividend payments.
• Transfer activity.
• Securities receipts or deliveries.
• Journal entries relating to securities or funds in the possession or control of the broker.
Any customer who receives an account statement that does not disclose this information should be concerned about possible fraudulent activity.
The duty of best execution, which also stems from the SEC’s antifraud provisions, requires a broker to seek to obtain the most favorable terms available under the circumstances for customer orders. If a broker fails to accurately represent an investment, or omits material information about an investment, the broker may be liable for a client’s losses.