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Description / Definition:
What Are Securities?
People commonly think of securities as stocks. The type of stocks that are bought and sold on the securities exchanges like the New York Stock Exchange. In addition, people usually have the understanding that the main purpose behind the purchase and sale of securities is to see some sort of financial gain; big or small depending upon the investor’s personal investment goals. But given today’s financial markets and the proliferation of many types of “full-service” brokerage houses competing for investment business, there are many more types of securities out there besides stocks. For example, bonds, mutual funds, options contracts, futures contracts and even telephone service contracts have been determined to be securities by the Securities and Exchange Commission and the Federal courts of our nation.
Technically speaking, as defined by the United States Code (the relevant Federal law), the term "security" means any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "security," or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
What does all this mean to investors, young and old? The markets are tricky and, unless you are an accredited financial advisor and invest for a living, generally, you should not invest on your own. It is recommended to consult with an accredited financial advisor especially when presented with complex or risky investment instruments.
As an example, the power of the market is demonstrated by the fact that the United States and the international financial markets have provided capital to finance the development of the modern world. Technological advances which raise the quality of life for the world can in some way be traced to the financial markets. The markets make dreams come true. On the other hand, the financial markets are fraught with problems. Money can be lost and futures and lives destroyed by investment losses. Not too long ago, and cases continue on today, a significant majority of major Wall Street Investment Banking and Financial Services Firms were forced to pay some of the biggest fines in history for their involvement in conflict of interest situations where the firm’s interest in securing buyers of stock offerings conflicted with the interests of the unwitting investors who were told to buy the stocks. Stated differently, the Firms told investors to buy stocks to create a demand and thus a higher price, so they could generate more investment banking fees, while internally, these same Firm’s joked that the stocks “were junk” and they would not buy them under any circumstances. The opportunity for financial gain attracts many snake oil peddlers and in the analyst conflict cases many thousands of investors lost billions in necessary retirement money. In many cases, these retired folks lost everything.
What Obligations Do Brokerage Firms Owe Their Clients?
It is well-established in California that a broker acts as a fiduciary on behalf of the client. A fiduciary relationship is a special type of relationship which imposes an affirmative obligation on the broker of having to act in the highest good faith toward the client. California cases state that with respect to stockbrokers, it is recognized that the duties of the broker, being fiduciary in character, must be exercised with the utmost good faith and integrity. The rationale behind holding the trusted financial advisor to such a high standard is because the markets are treacherous and unwary investors need an experienced guide. In fact, before a broker can transact securities transactions on behalf of a customer, the broker must be duly licensed. This usually requires comprehensive study, tests taken with minimum scoring requirements met, background checks, references and other such inquiry into the brokers fitness to act in such an important capacity.
If you are investing, you should know that many brokerage firms these days deny that they owe their clients a fiduciary duty. They often take the position that they are mere order takers doing what the client asked. They even go so far as to say that they never provide financial advice. Wouldn’t this make you wonder if the person you were dealing with had “Mr. XXX, Financial Advisor” on their business cards and letterhead and then later denied that they ever provided you with financial advice? This denial phenomena is particularly interesting because these same brokerage houses publish advertisements and create commercials which are designed to make the customer or potential customer feel that the broker, the firm and its whole private army of resources are committed to protecting the client’s interests 24 hours a day seven days a week.
So what is a broker supposed to do for you? The key function is to make sure that the recommended investments are “suitable” for you. A step in satisfying the suitability requirement is that the broker must have "reasonable grounds" for believing that a recommendation is suitable based on facts disclosed by customers as to their other security holdings and financial situation and needs. The NASD (National Association of Securities Dealers-probably the biggest private sector provider of financial regulatory services) has created rules and regulations to assist brokers in making sure you are presented with the right investments. NASD Rule 2310, entitled “Recommendations to Customers (Suitability)” provides in part that:
- (a)In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his/her other security holdings and as to his/her financial situation and needs.
- (b)Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:
- (1)the customer’s financial status;
- (2) the customer’s tax status;
- (3)the customer’s investment objectives; and
- (4)such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer. …
A "suitability" violation occurs when an investment made for an investor by a broker is inconsistent with the investor's investment objectives and risk tolerance, and the broker knows, or at least should have known, that the investment is inappropriate. If for example, your broker never meets or speaks with you and you have no recollection of ever discussing your investment goals, your income, your earning potential, your risk tolerance (how much of your hard earned money you are willing to lose), or the investments that have been made, then you may have a problem. A problem may exist even if you did not lose money. This is so because the market could be doing well overall, but if economic conditions change, and the tide goes out, your account value could go out with it. Suitable investments carry the ability to withstand risk and/or a risk management strategy so you do not suffer catastrophic losses if your account is fully invested. It is very important that you discuss risk management with your financial advisor and that you are prepared for a market downturn. Do not be afraid to ask your broker these questions.
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