Unauthorized trading or unauthorized transactions occur when a broker sells, buys, or exchanges, securities without the prior consent or authority from the investor-client. The Financial Industry Regulatory Authority (FINRA) prohibits unauthorized trading. FINRA Rule 2010 sets the standard for commercial honor and principles of trade. Unless an investor has given the broker discretion to make trades in the account, the broker must first discuss all trades with the investor before executing them.
FINRA Rules 2510(b) and 2020 explicitly prohibit brokers from making discretionary trades in a customers' non-discretionary accounts. The SEC has also found that unauthorized trading violates just and equitable principles of trade and constitutes violations of Rule 10b and 10b-5 due to its fraudulent nature. As one court summed up, no omission could be more material than the failure to inform the investor of his purchases and sales. However, it is important to note that the laws vary from state to state regarding unauthorized trading.
There are two principal exceptions to whether a broker may place a trade for a customer without the broker getting prior approval from the investor for the transaction at issue. The first exception is when a customer’s account is a discretionary account. A discretionary account is an investment account that permits an authorized broker to buy, sell or exchange securities without the investor’s consent for each trade. It is important to note that the customer/investor must sign a discretionary disclosure agreement with the broker and the broker’s brokerage firm to document the investor’s consent.
The second exception to the unauthorized trading rule is when a client has a margin account and the value of the margin account falls below the brokerage firm’s balance requirements. Generally, an investor will sign a margin agreement before trading that will authorize the brokerage firm to sell securities to cover the margin balance. Note, a margin account is an account offered by a brokerage firm that allows investors to borrow money from the brokerage firm to buy securities.
Unauthorized trading can occur in many different cases. For example, many investment advisors mark unauthorized trades as unsolicited, meaning that the broker makes it seem as if investor requested the trade and that the idea for the trade came from the client and not the broker. Sometimes, brokers will enter trades and then try to obtain the client’s consent after the trade. In other cases, a broker may agree to an investment strategy and then not feel as if the broker needs to contact the client again after every trade. These are all examples of unauthorized trading strategies.
Unauthorized trading can resemble identity theft or a stolen credit card. Yet, a victim of an unauthorized credit card transaction is likely to get reimbursed for any unauthorized or fraudulent purchases. In contrast, when a broker makes an unauthorized trade, many brokerage firms attempt to hold the investor responsible. The brokerage firms often claim that if the investor does not object to the trade immediately, the investor ratified the trade when the investor received confirmations and/or monthly statements reflecting the transaction. Ratification under the law is where a person, or in this case an investor, approves an act of his or her agent that lacked the authority to bind the investor legally when the actions was taken.
The remedies available to investors vary greatly. Depending on the case, brokers and brokerage firms that engage in unauthorized trading can pursue claims through FINRA arbitration. The measure of damages varies from out-of-pocket losses, interest, and attorneys’ fees and it some cases market adjusted damages. Market adjusted damages, otherwise known as properly-managed account damages, or lost profit damages, calculate the amount of money an investor would have made with a properly invested portfolio less the amount of loss the investor suffered. In the case of unauthorized trading, an investor would take the amount received from the unauthorized transaction less the amount the investor would have earned had the unauthorized transaction had not happened.
If you believe that you were the victim of unauthorized trading, the attorneys at Gana Weinstein LLP can help you determine the type of account you own, whether the trade was authorized, and how to proceed against the brokerage firm.