As an individual investor, the ability to make informed decisions is critical to managing your portfolio effectively and minimizing your risk of loss. If you work with a stockbroker or investment advisor, you rely on your broker or advisor to provide trustworthy information that you can use to guide your decision-making. If your broker or advisor provides misleading information, you can unknowingly make unsound decisions, and you can find yourself facing losses that you could have avoided had you received complete and accurate disclosures.
One form of fraudulent disclosure that can lead to losses for investors is what is known as a “misleading illustration.” If you have received a misleading illustration from your stockbroker or investment advisor, you may have a claim for investment fraud.
What Constitutes a Misleading Illustration?
In the world of investing, a misleading illustration is a false or unrealistic hypothetical example of an investment’s potential performance. When recommending long-term investments or long-term investment strategies, it is common for stockbrokers and investment advisors to provide their clients with a forecast of how the investment or strategy may perform over a certain period of time (i.e. 5, 10 or 20 years). Like all investment disclosures, this hypothetical illustration must have a sound basis, and it must not omit or misrepresent any material information.
If an illustration lacks a sound basis or omits or misrepresents material information, it is referred to as a misleading illustration. Some specific examples of issues that can make an illustration misleading include:
- Inflating the Maximum Potential Return – Under FINRA Rules, the maximum potential return a broker or advisor can state in an illustration is 12 percent. If 12 percent is not realistic (as it often isn’t), then the maximum potential return stated in an investment’s or strategy’s illustration must be lower.
- Only Disclosing the Maximum Potential Return – When projecting an investment’s or strategy’s performance in an illustration, the projection cannot focus solely on the maximum potential return. The illustration must also state that a zero-percent return is a possibility, and it must include a projection with this rate of return as well.
- Using Misleading Statistics – In many cases, investment illustrations will include an average annual return. This average will almost always be a positive number. However, even if an investment’s or strategy’s average annual return is positive, it is still possible that investors could lose money. For example, consider a scenario where an investor earns 60 percent on a $50,000 investment one year (leading to a portfolio value of $80,000) and then loses 50 percent the next year (leading to a portfolio value of $40,000). After two years, the investor has an average annual return of five percent, but the investor has lost $10,000.
- Ignoring Risk Factors – Oftentimes, brokers and advisors will prepare illustrations that rely on a best-case scenario. In doing so, they will ignore very real risks (i.e. pandemics, natural disasters, and shortages) that have the potential to significantly impact investors’ returns.
- Ignoring Costs or Fees – Even if an investment strategy returns six percent per year, this does not mean that the investor’s portfolio will increase in value by six percent. Fees and commissions will reduce the investor’s take-home returns, and this can significantly reduce the value of the strategy over the long term. In fact, in some cases, investors can break even (or even lose money) because their costs and fees consume their returns.
In short, an investment illustration must take into account all potential scenarios, and it must acknowledge its own shortcomings. If it paints an investment or strategy in a false light, it can serve as the basis for a fraud claim in the event that investors who rely on the illustration suffer investment losses.
Filings a Fraud Claim for a Misleading Illustration in FINRA Arbitration
Generally speaking, pursuing a fraud claim for a misleading illustration involves taking your broker or advisor to FINRA arbitration. The Financial Industry Regulatory Authority (FINRA) is a quasi-governmental authority that works alongside the U.S. Securities and Exchange Commission (SEC) to protect retail investors. Filing for FINRA arbitration provides investors an opportunity to recover their fraudulent losses without going to court, and brokers and advisors can face significant consequences—including loss of registration—if they do not participate in the arbitration process.
Do You Have a Claim for a Misleading Illustration?
If you believe that you received a misleading illustration from your broker or advisor, we encourage you to contact us for more information. To speak with an attorney at Zamansky LLC in confidence, call 212-742-1414 or request a free consultation today.