Before investing, your stockbroker must provide you with all the material information needed in deciding whether to invest. FINRA Rule 2020 specifically prohibits brokers from misrepresenting investments and omitting material facts. “Material facts” are facts that could help an investor decide whether an investment is right for them. The rule states: “No member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.”
If your broker misrepresented or omitted information, your next call should be to an investment attorney.
What Happens When a Broker Violates FINRA Rule 2020?
In 2021, FINRA reported that misrepresentation and omission were among the top five most common FINRA arbitration disputes. Many of these disputes feature a broker who informed an investor of a security’s potential for gains but did not tell them about the significant fees, the likelihood of losses, or the amount they could save on sales charges.
Brokers may also fraudulently omit any conflicts of interest associated with an investment. For example, on June 29, 2021, the SEC alleged that a broker recommended that his clients enter into service agreements with three companies without disclosing his ownership of those companies. The SEC alleged that this is a material conflict of interest that should have been disclosed. Further, the broker allegedly misrepresented and over-stated the funds’ assets, allowing him to charge higher fees.
Types of Misrepresentation Investment Disputes
Misrepresentations may be either fraudulent or negligent. Fraudulent misrepresentation could be outright lies. But stockbrokers could make negligent misrepresentations by simply not knowing enough about an investment. Stockbrokers have a duty to understand the securities they recommend. If they recommend an unsuitable product with risky features that they simply did not bother to review, they may have made a negligent omission.
Misrepresentation Violates More Than One FINRA Rule
FINRA Rule 2020 overlaps with several other FINRA rules, all of which are designed to add layers of protection for investors.
- FINRA Rule 2020 bolsters the requirements of FINRA Rule 2111, which requires that stockbrokers only recommend investments that suit their investor’s financial goals and risk tolerance.
- FINRA Rule 2210 states that broker communications with the public should be fair. Fair representations highlight the risks associated with an investment as much as they focus on the potential for gains.
- Investors can also cross-reference FINRA Rule 2020 with FINRA Rule 5210, which prohibits brokers from publishing false information about certain securities: “No member shall publish or circulate… communication of any kind which purports to report any transaction as a purchase or sale of any security unless such member believes that such transaction was a bona fide purchase or sale.” In other words, investors are not allowed to create the false impression that there is more excitement around a particular stock than there actually is.
Communications with Investors
FINRA’s Regulatory Notice 20-14 issued a warning regarding sales practice obligations for oil-linked Exchange-Traded Products (ETPs). Exchange-traded products are designed to track a particular index. In this case, they tracked oil futures. These speculative investments generate a return for the investor if the strategy employs a correct guess about the future price of oil.
FINRA Notice 20-14 cited FINRA Rule 2210 and pointed out that brokers must state in sales communications that oil-linked ETPs are short-term products that are not designed to be held over the long term. In the notice, FINRA underlines that burying information in a dense prospectus is not enough. Brokers must make sure that they clearly state these risks in the marketing material as well: “FINRA reminds firms that providing risk disclosure in a separate document such as a prospectus does not cure otherwise deficient disclosure in sales material, even if the sales material is accompanied or preceded by the prospectus.”
Investment Fraud Example of Misrepresentation and Omission
In 2016, FINRA fined MetLife Securities for $25 million following allegations that they made negligent misrepresentations and omissions related to variable annuity replacement applications for thousands of customers. Variable annuities are complex products that even experienced financial professionals may struggle to comprehend, making them especially easy to misrepresent to investors. FINRA’s chief of enforcement stated, “Variable annuities are complex and expensive products that are routinely pitched to vulnerable investors as a key component of their retirement planning. Firms engaging in this business must ensure…that their registered representatives are sufficiently trained to understand and explain the risks and complex features of what they are selling.”
According to FINRA, the misrepresentations made the replacements appear more beneficial than they truly were. The new variable annuities were more expensive than the original contracts, and FINRA alleges that MetLife did not accurately describe the differences between the new variable annuities and old variable annuities. Notably, a substantial portion of the firm’s marketing efforts involved switching their investors out of variable annuities. In a six-year period, the variable annuity replacements allegedly generated at least $152 million in commissions for brokers.
FINRA specifically alleged the following omissions:
- MetLife represented to investors that their existing Variable Annuity was more expensive than the recommended variable annuity. In truth, the new variable annuities were more expensive.
- MetLife Securities failed to disclose that the proposed variable annuity replacement would reduce or eliminate features like an accrued death benefit and guaranteed income benefits. Features like these are material facts that may induce an investor to accept or reject a contract.
- Metlife Securities representatives allegedly understated the death benefits of the existing variable annuities.
Misrepresentations Regarding Taxes
Stockbrokers should always accurately describe the tax implications of a securities transaction. An investor recently alleged that her broker told her she could pay for a life insurance policy using funds from her IRA without any tax penalty. The investor alleged that she has since learned this is not the case. She filed an investor dispute and is seeking to recover her losses.
What Can I Do About Misrepresentation and Omission?
The misrepresentation cases mentioned above are just a few examples. If you believe your broker employed any type of manipulation or deceit, you may have a case for FINRA arbitration. Securities lawyers can help make the case that you relied on your stock broker’s recommendation. You may need to work with a lawyer to ensure that you can prove your case to a FINRA arbitration panel. Contact Patil Law today for a free case evaluation. Call 800-950-6553 or tell us how we can help with our online contact form.
