Breaking Down Breach of Fiduciary Duty & Fraud in a Securities Context

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Breach of Fiduciary Duty

State and federal statutes alike mandate that investment advisers conduct their business in such a way that serves their clients’ best interests. A fiduciary duty exists when an individual places their trust and confidence in another—such as a financial adviser or broker who has superior knowledge in the industry. Typically, these individuals are classified by the Financial Industry Regulatory Authority (FINRA) as broker-dealers, which are individuals or corporate entities that transact securities on behalf of its customers. These financial professionals fall under the purview of the Investment Advisers Act of 1940, a statute that has been interpreted by the Securities and Exchange Commission (SEC) to impose a fiduciary obligation on broker-dealers.

Federal law mandates that brokers owe a suitability duty to their clients—meaning that they merely must provide financial advice that is suitable regarding the customer’s goals, financial status, age, and several other pertinent factors. Put simply, the broker-dealer’s recommendations should remain consistent with a client’s best interests.

California law also imposes fiduciary obligations between a broker-dealer and their clientele. Because brokers function as their client’s agents and agents are generally a fiduciary to their principal, brokers are deemed fiduciaries in California. Accordingly, brokers’ fiduciary duties include: (1) Fully and fairly disclosing all material facts regarding transactions to their clients; (2) Ensuring their clients fully comprehend the transaction’s inherent risks with regards to their financial assets; and (3) Keeping the client informed of each transaction conducted.

The specific scope of these duties will vary depending on the level of sophistication of the client as well as any other relevant facts and circumstances relating to the nature of the relationship between the broker and his or her client, such as if the account is discretionary or nondiscretionary and the client’s ability to weigh the broker’s advice.

Common Law Fraud

California law allows individuals to recover damages for instances of common law fraud. Fraud is the act of using deceit or dishonest means for the purpose of depriving another of money, property, or a legal right. In California, a claim of deceit or intentional fraud requires that each and every one of the following elements be established by the plaintiff:

  1. A misrepresentation that can be either written, verbal or implied through conduct (false representation, concealment, or nondisclosure);
  2. Defendant’s knowledge of falsity or a false representation made recklessly and without regard for their truth in order to induce action by another (i.e. ‘scienter’);
  3. Defendant’s intent to defraud or induce reliance of plaintiff;
  4. Plaintiff’s justifiable reliance on the misrepresentation; and
  5. Resulting damage caused by plaintiff’s reasonable reliance on the misrepresentation

Securities Fraud

In the most basic terms, securities fraud involves providing misleading or patently false information regarding finances or investments with the intent to encourage another individual to either sell or purchase investments for one’s personal benefit. Fraud in the context of securities refers to deceptive practices in the stock or commodities markets that induces investors to make certain transactions premised on false information, typically resulting in losses.

This offense can also include embezzlement, stock manipulation, misstatements on a publicly traded company’s financial worksheets, and providing false information to auditors. The term can also encompass a broad range of related misconduct including insider trading, front running, and similar illegal actions on the trading floor of stock or commodity exchanges such as selling unqualified securities or selling securities that have non-compliant conditions. Unqualified securities refer to funds that are not correctly disclosed to the California Department of Corporations or that are non-compliant with the requisite qualification documentation process.

There is a possibility that some forms of security fraud can be committed unintentionally and therefore may not lead to criminal penalties when securities are transacted in good faith; however, when there is a verified instance of misleading or false information provided to an investor, there is no such good faith safe harbor as the intent of the initial misrepresentation was to manipulate either the individual investor or market in order to realize a personal profit.

Wobbler Offense

Per California law, securities fraud is classified as a ‘wobbler.’ A wobbler offense means that the crime is punishable either as a felony or misdemeanor. The government is afforded discretion in deciding whether the offender is charged with a felony or misdemeanor. The potential punishment for either individuals or corporate entities convicted of securities fraud could include substantial financial penalties or even imprisonment.

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