What Could Happen?

By Brian Francetich

Our firm is regularly in discussions with investment management firms that ask:  “What is really the risk?  We have been in this business for 20 years and not had a claim.  What could happen to me?”  We answer with real world claim examples.  As the saying goes, “Each time history repeats itself, the price goes up!” Some claims we have witnessed are described below:

Claim #1

Allegation(s): Unsuitable Trading, Breach of Fiduciary Duty
Claimant: Private Individual
Description of Event:
An advisory client with an IRA invested in traditional equities and bonds decided to invest a portion of the funds in a private hedge fund.  The advisor prepared the documents with the custodian to invest about $1MM into the private hedge fund.  As tax documents were being prepared the following year, it was discovered that the previously completed transaction was in fact a withdrawal and reinvestment of the funds resulting in an immediate tax bill of $250,000 to $300,000 for the client.   In short, the advisor had prepared the wrong document.  The client alleged damages of $300,000 and demanded indemnification.

Claim #2

Allegation(s): Failure to Disclose & Conflict of Interest
Claimant: Securities Exchange Commission
Description of Event:
An SEC investigation into separate, commonly owned RIA firms and a mutual fund managed by one of the firms resulted in allegations that the RIA failed to disclose multiple conflicts of interest in three areas: (1) receipt of undisclosed compensation, (2) misleading information regarding fee structure and (3) voting proxies in their own favor.  The SEC called for disgorgement of previously charged fees as well as civil money penalties.

Claim #3

Allegation(s): Breach of Contract; Failure to Supervise
Claimant: Three Separate Individual Clients
Description of Event:
Due to a computer software glitch, an RIA firm erroneously placed a block trade in leveraged funds which pulled funds from three client accounts which were under contract to not be traded and to remain in cash.  The market moved rapidly down (exponentially so due to a leveraged investment product) resulting in losses to the three clients.  The Clients brought suits against the advisor for breach of contract and failure to supervise properly totaling about $150,000 in damages.

Claim #4

Allegation(s):  Erroneous Trade
Claimant: Multiple Third Party RIAs
Description of Event:
An RIA firm functioning as a back-office service provider and model portfolio manager to outside, unaffiliated RIA firms routinely completed significant block trades.  On this occasion of rebalancing mutual fund portfolios, a roughly $7,000,000 rebalance from one fund to another was agreed to need to take place.  The RIA reported to their clients (other RIAs) that the rebalance occurred on a specific date.  It was found days later that the trade did not, in fact, occur.  The market moved by the time this was discovered resulting in a $200,000+ loss to the underlying accounts.

Claim #5

Allegation(s): Unsuitable & Risky Investment Recommendations
Claimant: Private Individuals
Description of Event:  
An RIA was engaged by clients as their discretionary asset manager to manage the clients’ assets in accordance with their specific investment needs, goals and objectives.  The clients noted that their primary goals were “Capital Preservation” and a “Low Level” of volatility.  Clients alleged that the actual portfolio constructed by the RIA was High Risk and Unsuitable.  The claim noted that the average standard deviation of the initial asset allocation was near 20 and that this was not consistent with the “Capital Preservation” goal.  The claim alleged that the gain of a “suitable portfolio” would have produced substantial gains over the time period.  Claimants not only requested the amount they had lost during the advisors management, but also the amount they would have gained should they have been invested differently.

Claim #6

Allegation(s): Unauthorized Transaction & Unsuitable Investment
Claimant: Private Individual
Description of Event:
An Investment Adviser Representative (IAR) presented the opportunity to a client to purchase pre-IPO shares of a social media company which were held within a private partnership.  The claimant alleged that the IAR invested funds in the private partnership without final approval of the claimant.  The claimant did sign forms to move forward with the investment, but alleged that they were rushed through the process and did not receive complete explanation.   The claimant alleged the IAR promised to call to further explain, yet did not call and purchased the investment regardless.  The Claimant also alleged that the investment was unsuitable due to his limited understanding of investments and his modest net worth.  The written demand requested the client be made whole by the advisory firm.

Claim #7

Allegation(s): Unsuitable Trading, Breach of Fiduciary Duty
Claimant: Private Individual
Description of Event:
The claimant was unhappy with the minimal returns which her funds were generating within a fixed annuity product.  On the advisors advice, the claimant liquidated the annuities and deposited cash into the advisors custodial account.  The advisor managed the claimants account on a discretionary basis from mid-2007 through the first quarter of 2009 (a period over which the S&P fell by about 40%).  The claimants approximately $750,000 account fell from market losses as well as significant client withdrawals.  The claimant alleged damages of $750,000 (the entire account) on the basis of unsuitable trading and breach of fiduciary duty.

These are just a brief review of claims scenarios faced by investment managers.   We would be honored to discuss how a firm can best protect themselves from these and other types of demands and lawsuits brought against fiduciaries.

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors.. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

At Golsan Scruggs, we believe it is incumbent upon us to earn the right to be appointed as your insurance and risk-management agent. Our RIASURE process exists to serve that purpose.

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