Why Your Broker Asking You to Sign A Comfort Letter is A Big Misconduct Red Flag

shutterstock_50736130Your brokerage firm reviews customer accounts for misconduct and what does it find; bizarre and unreasonable trading activity. Maybe dozens of trades are being made every month or an account previously invested in plain vanilla mutual funds is now loaded up with speculative penny stocks and private placements. Whatever the cause, the firm has a system to monitor for unusual trading activity and sends the customer a letter. These letters go by many names including “happiness”, “comfort”, and more appropriately “Cover You’re A@!” (CYA).

A recent article by the Wall Street Journal explored how the purpose of these letters is to elicit an acknowledgment from the customer that they are satisfied with how the account is being handled in order to minimize future liability from a suit concerning the wrongful activity. To clarify, when a brokerage firm finds indications of possible misconduct their first action isn’t to stop the misconduct and help their client but to get the client to release the firm from liability.

Having reviewed dozens of these letters myself they are designed to be unreadable to the average investor and use industry jargon and legal lingo that is indecipherable to anyone but a securities attorney. These letters begin warmly enough by thanking you for your business and hoping that everything is well with you. Then the conversation becomes impersonal and maybe mentions that your investment choices have become more risky or aggressive recently. These sentences are code words for your investment objectives have completely changed from generating retirement income to you are now interested in potentially losing all your money with casino level risk. Maybe some information related to a “cost-to-equity ratio” or “turnover” is given. There is no explanation as to what these terms mean or why you should be concerned because they are just being provided for legal reasons that the customer should be unconcerned with.

Finally, these letters end by either telling you that if you are unhappy to discuss the matter with your broker or to actually sign the letter and mail it back to the firm. Taking any other action than contacting the firm’s compliance department and complaining is a huge mistake. If signed or ignored brokerage firms will later claim in arbitration that the happiness letter response shows that the customer was pleased with the account’s performance and waived any possible liability for the firm.

The point of a happiness letter is to shift supervisory oversight from the brokerage firm to the client. The letters are not designed to seriously help monitor client accounts for misconduct for a number of reasons. First, if a firm suspects potential misconduct in your account it should not send you a letter telling you to contact the same broker who engaged in the misconduct to determine what steps you should take next.  The broker will tell you to either ignore the letter or sign it and mail it back every time. Second, if the firm is really concerned then it should pick up the phone and interview the client rather than send junk mail that is likely to be thrown aware or ignored by the client.

Determining misconduct is not difficult. If the client can’t tell you what investments have been made in an interview or cannot describe the trading strategy then clearly the client is not in control of the account. In sum, supervisory oversight cannot be achieved through sending a robo letter to be signed at the behest of the same defrauding broker.

Investors who have suffered losses through excessive trading and churning may be able recover their losses through arbitration. The attorneys at Gana LLP are experienced in representing investors in cases where brokerage firms fail to supervise their representatives trading in client accounts. Our consultations are free of charge and the firm is only compensated if you recover