Customer Suing? How to Protect your Bank when Stocks PlummetApril 20, 2009
Poor client management, rather than malfeasance, could be the root cause of problems that many financial institutions soon will face with in-house and affiliated brokerages - but that still could mean lawsuits, warns attorney Joshua Horn, partner with Fox Rothschild in Philadelphia and co-chair of the firm's Securities and Financial Institutions Compliance and Defense practice.
"The seeds of many potential problems are sown at the initiation of the relationship or innocent missteps in client management," Horn says. "Most of the time, advisers are lazy" and fail to maintain regular communication with clients, he says. This is not as potentially explosive in a bull market. But when stocks tank, a failure to keep clients informed can doom brokers - and their affiliated banks - to recrimination, severance and legal action.
"Banks have an added risk of supervisory liability," Horn says. Although banks are not regulated by FINRA or the SEC, the adviser who works for them as an employee or for a partner brokerage that uses bank facilities is regulated. And clients of the investment adviser (IA) could sue you for any monetary loss and loss of opportunity. "It depends on how creative the [client's] lawyer is. Are you the supervisor? It could be negligent hiring."
Above all else, financial institutions need an effective compliance program. "The big headache at the moment is that risk is not as well understood as it should have been: employee risk, counter-party risk, investment product risk," says securities attorney David Z. Seide, a partner at Curtis, Mallet-Prevost, Colt & Mosle in Washington, D.C. "If you're the CEO, you want to have a strong compliance regime in place. You need to have a general counsel and senior risk officer who line report to you and who understand compliance and risk management issues."
The most important IA/broker dealer rules for financial institutions to be aware of include:
- NYSE rule 405A: "Non-Managed Fee-Based Account Programs - Disclosure and Monitoring." This rule requires stock exchange members to provide a disclosure document so the customer can make sure the investment is appropriate, including eligibility, fees, cost estimates and pros/cons.
- FINRA rule 2310: "Recommendations to Customers (Suitability)" This rule requires FINRA advisers only to recommend securities that are suitable based on the customer's investment mix and financial situation, including tax status, tolerance for risk and investment objectives. It also covers issues such as churning and unauthorized transactions.
Indeed, says Horn, "You have to know your customer. The theory is that you then can recommend the proper investment."
Securities lawyer Mark Raymond, the managing partner of Broad and Cassel in Miami, says bankers should put themselves in their customers' shoes. "You have to be hypersensitive as the banker, even though you don't get any compensation, as to what is going on in the broker end. A customer doesn't see it as two separate entities."
Remember that you answer to different constituencies: the board, shareholders, customers, investors, regulators and outside auditors, reminds Seide. "Each will expect a robust process in place so you can mitigate the risk,'' Seide warns.
© 2009 FinCriAdvisor.
Read the original posting of this article in the April 20 issue.