Risk Management Strategies
Full Service Brokers Required to Provide Risk Management Strategies
Financial advisors and full-service brokerage firms are required by sales practice rules and regulations promulgated by the Financial Industry Regulatory Authority (FINRA) to provide suitable investment advice to their clients. Among other things, this may include a duty to recommend risk management strategies sufficient to protect investors from catastrophic losses in their portfolio and a duty to disclose the risks associated with an over-concentration in particular bank holding company stock, or in the banking sector. Investors who had a substantial portion of their assets invested in bank stocks could have protected their investments through strategies including diversification and hedging. Brokerage firms are obligated to give, and investors are entitled to rely upon brokerage firms for, competent, suitable investment advice in accordance with FINRA Rules and Regulations. Recommendations of unsuitable investments and/or failure to recommend adequate risk management strategies are both causes of action that form the basis for securities arbitration claims filed by investors with FINRA.
Frequently Asked Questions:
Q: What duties and obligations do stockbrokers have to recommend diversification and implement risk management strategies for concentrated positions on behalf of their clients?
Stockbrokers have many duties owed to their client, one of which is to only make suitable investment recommendations based on relevant facts concerning the client’s age, net worth, income, tax status and investment experience. When an account is concentrated, it is considered unsuitable and the only suitable recommendation is to implement risk management strategies to protect the value of the concentrated position. Since brokerage firms are required to supervise the activities in brokerage accounts, losses from securities concentration can be attributed to the failure to adequately supervise the stockbroker and the brokerage account. Brokerage firms are obligated and investors are entitled to rely upon brokerage firms for competent, professional investment services in accordance with the Financial Industry Regulatory Authority (FINRA) Rules and Regulations.
Q: Why is it unsuitable to concentrate my investments in the banking and financial services sector?
Investors control portfolio risk through diversification which reduces diversifiable risk. This diversifiable risk is also known as business risk which is the risk specific to a particular business industry, such as a bank’s exposure to sub-prime loan losses, residential loan losses and commercial loan losses. When a portfolio is considered non-diversified or over-concentrated there is an increased exposure to a specific security or sector of the economy. It is this concentrated exposure to the banking and financial services sector which has led to, for many investors, catastrophic losses.
Q: What if a concentrated stock position was maintained and certain constraints precluded diversification as an option?
Many concentrated stock positions are held by investors as the result of situations such as Rule 144 corporate stock grants, employee stock option, potential tax liabilities, or any number of considerations. There is a specific risk management strategy that is suitable for each investor holding a concentrated stock position. If the financial adviser fails to recommend a suitable risk management strategy for an investor’s particular circumstance, there is a potential claim for negligence and a failure to supervise the activities in the account.
Q: What risk management strategies could have protected against these losses?
The following risk management strategies are widely known and can represent suitable investment advice for an investor with a concentrated portfolio. The risk management strategies below are available through full-service brokerage firms:
- Stop loss limit orders
- Short sales
- Protective puts
- Zero-cost option collars
- Synthetic “proxy” hedge transactions
- Variable prepaid forward contracts
- Equity swaps
- Exchange funds
Q: How do I know if I have a viable claim and what steps do I take to file an arbitration claim?
Take the following steps to begin the recovery of your investment losses:
- Contact our legal team to complete a case facts summary
- Schedule a time for an interview with an industry expert
- Gather critical case documents
- Complete risk tolerance assessment
- Assess account damages and financial adviser misconduct
- File statement of claim for securities arbitration