[Updated through 2021] Yesterday we posted a story about WFG Investments, a Texas based independent broker dealer that is struggling after it reported to the SEC that it faces a $650,000 penalty. We expressed our concern, then, about many indie brokerage firms and their ability to survive if faced with a large claim. Less than 24 hours, our fears were realized.
InvestmentNews reported today that Resource Horizon Group, another independent broker dealer with roughly the same amount of brokers as WFG, was hit with a $4 million arbitration award. Unfortunately, the firm reports that it only has less than $500,000 excess net capital. If it can’t immediately find the funds, it could be forced to shut down within days.
Going out of business is bad for employees, bad for other customers and bad for the victim of the stockbroker fraud loss.
Most members of the public would be shocked to know that brokerage firms need only keep $100,000 in capital on hand and are not required to carry insurance. That means the actions of a single stockbroker fraud claim could wipe out the company and leave the victim collecting just pennies on the dollar.
Business Threatened Because of a Single Bad Broker
The $4 million arbitration award stems from a former stockbroker at the firm, Robert Gist. Last year both the SEC and the Financial Industry Regulatory Authority barred Gist from the securities industry for life after the SEC found that he stole millions from dozens of his customers. He was ordered to pay $5.4 million but has not done so leaving Resource Horizons Group on the hook.
Brokerage firms are responsible for the actions of their employees. A FINRA panel found that the firm was negligent in hiring Gist and failed to supervise him. At the time of his hiring, Gist already had several black marks on his record.
How bad was Gist? BEFORE he was hired by Resource Horizons, Gist was denied a license to sell securities by Ohio because he was “not of good business repute.” He was also twice accused of stealing from a clients’ account in 1991 and 1992. His then employers paid to settle those claims.
According to InvestmentNews, Resource Horizons attorney called the award “beyond frustrating” and claimed the award of punitive damages was “inexplicable.” We disagree.
Need for Stockbroker Fraud Insurance
SIPC Does Not Cover Fraud Losses
We often hear from investors who believe that their losses are covered by SIPC, the Securities Investor Protection Corporation. SIPC is a non-profit chartered by Congress to protect investors.
SIPC protection is limited. It only protects the custody function of the broker dealer, which means that SIPC works to restore to customers their securities and cash that are in their accounts when the brokerage firm liquidation begins. They do not protect against the decline in value of your securities nor do they protect individuals who are sold worthless investments or claims against a broker for bad investment advice or inappropriate investments.
SIPC coverage is also limited to $500,000 per account ($250,000 for cash held in account).
Liability (Fraud) Insurance
What is frustrating to us is the refusal of many broker dealers to purchase insurance to protect against these risks. What is unfortunate, is the real risk that Gist’s victims will not be able to collect because Resource Horizons failed to carry liability insurance. One industry person commented on the story, “The ‘supervisors’ at RHG were statutorily required to reasonably supervise this leper and they failed miserably.”
Resource Horizons may otherwise be a clean business. But by hiring a broker with a checkered past and not properly supervising him, everyone was put at risk.
Brokerage firms should be mandated to carry insurance to protect against stockbroker fraud claims. Over half the brokerage firms that sold phony TIC investments promoted by Carlton Cabot and DBSI are now out of business. Many closed their doors after just a single claim!
The primary regulator for brokerage firms is FINRA, the Financial Industry Regulatory Authority. FINRA has the ability to require brokerage firms to carry liability insurance to cover the acts of bad brokers but hasn’t done so.
You can’t drive in most states without insurance. Yet brokerage firms aren’t required to have any.
In October 2020, I attended the annual meeting of the Public Investors Arbitration Bar Association, the plaintiff’s bar for investors wishing to sue their stockbrokers. According to the group, one out of three awards against brokerage firms are never paid. And suing your individual stockbroker? Good luck!
In a 2016 Senate hearing, Sen. Elizabeth Warren asked FINRA’s CEO Robert Robert Ketchum if FINRA should require insurance or take other steps to insure victims of stockbroker fraud get paid. His response? “Something should be done.”Five years later, nothing has been done.
We have nothing against small brokerage firms but investors take a huge leap of faith that they will get their life savings back if their broker runs off with their money. Fraud losses are not covered by SIPC.
What should you do? First, if you decide to use a small independent brokerage firm, see what insurance they have and whether it covers fraud losses. Second, use FINRA’s free BrokerCheck tool to see what type of claims history both the brokerage firm and your broker have.
Most individual brokers have no disclosable events. If there is a disclosure, download the free detailed report and see what it says. Was your broker sued 10 years ago for a car accident? Probably not a worry? Is she currently in bankruptcy and being sued for theft? Those are red flags.
As to the brokerage firm, every brokerage firm will sometimes have an unhappy client or a small technical violation. Once again, however, pull the detailed report and see how many disclosable events and if there is a pattern of serious regulatory problems.
I Lost Money in a Bad Investment, Now What? (Stockbroker Fraud)
Have you lost $100,000 or more as the result of a bad stockbroker? Even if your broker is judgment proof we can often hold his or her employer responsible. To learn more, visit our investment fraud recovery page. Ready to see if you have a case? Contact us online, by email or by phone 202-800-9791.
Cases accepted anywhere in the United States. No fee unless we win.