Broker-Dealers May Be Held Liable, If Found To Have Misled Brokers About a Product

Broker-dealers may be held liable to brokers who they threatened, misled, and/or lied to about the features and relative safety of an investment sold to their customers.

The stockbroker and broker-dealer relationship can be characterized as one of agent-principal, respectively.   While many understand that an agent has a duty to his or her principal, frequently overlooked in this capacity is the duty of the principal to the agent.

In the securities world, it is known that a broker has certain and specific obligations to his firm both contractually and as agent.  Yet many industry participants are unaware of the duties the firm can be said to have to its brokers beyond those bargained for in their employment contracts.

For examples, we can look at the Restatement (Third) of Agency, which is a set of principles issued by the American Law Institute, that is meant to clarify the current state of the law of agency. The Restatement Third tells us that “[a] principal has a duty to deal with the agent fairly and in good faith.”  This includes “a duty to provide the agent with information about risks of physical harm or pecuniary loss that the principal knows, has reason to know, or should know are present in the agent’s work but unknown to the agent.”

Because stockbrokers largely rely upon their firm for research on different products, this can be important in the securities context.  For example, there may arise a situation where a firm has knowledge that a product its brokers are selling is toxic.   Another example may be a situation where a firm or group of firms supports a market in a particular security, and has made the decision to no longer support that market. In either of these situations, if the brokers do not know the product is toxic or will no longer be supported, the firm, as principal, could be held liable for failing to disclose those facts to its agents, the brokers.

As many have seen in the recent ARS (auction rate securities) cases, and now are beginning to see in the cases involving the UBS Puerto Rico closed end funds, when a toxic or unsupported product collapses, brokers may be “left holding the bag.”

Such market disasters have the potential to cost customers millions upon millions of dollars in losses and lost liquidity.  When those customers file suit against the firm that sold them the product, the customers usually take their business elsewhere.  Therefore, the broker(s) on those customers’ accounts find themselves in a situation where they have lost customer business and gained customer complaints on their CRD – not a good swap for the broker.  Customer complaints are commonly known as a “mark” on a broker’s license, which appears on their Form U-4 employment record or Form U-5 termination record if they are fired.

Losing customers and gaining “marks” on their license can cause the broker significant pecuniary (monetary) loss even if they remain with the firm, and even more so if they lose their job completely.  If that broker’s firm fed them false information or told them nothing was wrong with the product before the product collapsed, they may feel “set up” by their firm.

When the number of a broker’s customer complaints grows, it becomes less and less likely that the firm will continue to support that broker.  Oftentimes, firms will set unrealistic asset gathering, production, and/or other requirements to create a pretext to force such brokers out the door.

Under the laws of agency, contract, tort and others, brokers who were threatened, misled, or lied to by their firm may be able to recover for their losses.

Malecki Law is experienced in representing registered brokers and financial advisors in expungement proceedings and in arbitrations for lost wages and compensation against the current or former firm.