Claims against a broker may be based on three separate types of laws:
- Federal securities law
- State securities law
- Common law
The Feds – Going to the Top
The most significant laws regulating the sale of securities – and the behavior of brokers, investment advisers, and mutual fund managers – are the Securities Act of 1933 and the Securities Exchange Act of 1934. These are the laws that set out the entire framework of federal securities regulation, including establishing the Securities Exchange Commission says California Business Attorney Steven C. Peck.
They, and the rules made under their authority, dominate U.S. securities regulations – though there are other laws, such as state “blue sky” laws or common law that also regulate the markets and the behavior of people in them. But they are nowhere near as important as the ’33 act and ’34 act and their rules.
Of the two, the 1934 act is more important if you feel that your broker did you dirty. So let’s start with the 1933 act, to get it out of the way.
The 1933 act primarily regulates the initial offering of stocks. It requires that most securities are registered before they can be sold, that a written prospectus containing certain critical information accompanies them, and that this information is accurate.
Section 12 of the 1933 act establishes civil liability for violations – in other words, it lets you sue if the broker didn’t provide you critical information, or if the information was untrue. However, most of the time, if your broker is buying or selling securities for you, it’s in the secondary market, which means after the securities were initially offered to the public. As a result, the 1993 act is usually less important for establishing liability against your broker.
The 1934 act regulates any purchase or sale of securities, including on the secondary market. Section 10 of the 1934 act says that it’s illegal to use or employ any manipulative or deceptive device or contrivance in connection with the purchase or sale of any security indicated California Business Attorney Steven C. Peck.
The most important rule under the authority of the ’34 act, Rule 10b-5 says it is illegal for anyone, while buying or selling securities, to:
- Employ any device, scheme or artifice to defraud;
- Make any untrue statement of material, or important, fact, or fail to say something necessary to avoid misleading or deceiving – basically, no lying by either commission or omission; and,
- Engage in any act, practice or course of business that intends to defraud or deceive an individual.
As you can see, Section 10 of the 1934 act and Rule 10b-5 cast a very broad net. Pretty much any deceit or trickery is forbidden. And since the Supreme Court has found that there is private right of action – i.e., you can sue – under the ’34 act, you can use this powerful and broad tool to sue if you feel you were deceived or tricked.
However, since liability under the ’34 act is based in fraud – deliberate deceit – you have to show what’s called scienter, or the intent to deceive. So you need to find evidence establishing a “bad state of mind” on the part of your broker.
Without evidence that your broker meant to deceive you, you have no case, though some courts have allowed a showing of recklessness, which is even “more negligent” than gross negligence, to be enough.
State Your Claim
States have their own securities laws, called “blue sky” laws, that vary from state to state. Most state laws typically require companies to register their offerings before they can be sold in that state. The laws also license brokerage firms, brokers and investment advisers in the state.
Sometimes, as with New York, the state law helps the government regulate brokers and mutual funds but doesn’t provide a “private right of action” – i.e., you can’t use the law to sue.
Other times, they do establish additional legal grounds for the victims of unscrupulous or negligent brokers and fund managers to seek redress. You should be sure to check your own state law to see what rights they provide.
Other Common (Law) Grounds for Legal Action
Common law is law based in court cases and judicial decisions, rather than statute or legislation. It’s a key feature of English and American law, and it’s law that has grown up organically over time, as judges apply principles and decide cases, rather than being laid down by a state legislature or Congress, or by some administrative or rule-making body.
Many important areas of law such as torts – which is the law of “somebody done somebody wrong,” such as suing your neighbor because his dog bit you – are defined mostly by common law, not by statute.
Your state of residency matters. Remember, courts make common law. A court in New York doesn’t have to listen to a Delaware court or Pennsylvania, or California. The different court systems interpret the common law in different ways. What might be a winning legal proposition in one state is not necessarily one in another state.
You have to check your own state’s laws to know where you stand on common law causes of action.
There are four common law grounds for suing your broker, investment adviser or fund manager: fraud, breach of fiduciary duty, breach of contract and negligence. Since three of those are also specific claims or causes of action against your broker, they’re reviewed in the Types of Claims section.
What Constitutes Fraud?
However, since fraud cuts across several claims – including important ones, such as misrepresentation, churning and unsuitability – let’s go over those elements of fraud important to any fraud-based claim.
Fraud is “theft by deception.” It’s stealing by trickery. Fraud is the chief common law basis for a claim against a broker, financial adviser or fund manager who lied to you, misrepresented risks, or misused control over your account to steal.
Ultimately, many different claims are based on fraud: churning is a type of fraud, as is making misrepresentations. It’s broad; it’s intuitively easy to grasp; it’s powerful.
Fraud is a great basis for claims against brokers who have acted improperly, except for the fact that fraud requires intent to defraud or steal.
Sometimes that’s just not there – your broker was an idiot or careless to the point of idiocy, but not a crook.
And even when the intent to steal was there, it may be hard to prove.
Look to your state law to see exactly what you need to prove and how hard it is to prove it, and make sure to check out the potential claims in detail.
About the Author
Attorney Steven Peck has been practicing law since 1981. A former successful business owner, Mr. Peck initially focused his legal career on business law. Within the first three years, after some colleagues and friend’s parents endured nursing home neglect and elder abuse, he continued his education to begin practicing elder law and nursing home abuse law.