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Failure To Diversify / Overconcentration

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When to File a Failure to Diversify Lawsuit Nationwide

Financial advisors, brokers and trustees are expected to act as prudent investors. They should administer your investments carefully and avoid the unreasonable risk of “putting all your eggs in one basket”. If they over-concentrate investment on only one market sector or business, they may be liable to a failure to diversify lawsuit. The rule is that administrators of an account should try to mitigate risk. They should help make investors’ holdings safer and increase return on investments. Through investment types such as bonds, stocks, and treasury bills, they should diversify.

But if your financial advisor or trustee has over-concentrated your investment in only one business, causing you loss, you may be able to sue. The law protects your right to be compensated for that loss. This may be through a failure to diversify lawsuit or FINRA arbitration. Weltz Law has a strong track record of handling securities cases that allege over-concentration. We have helped countless clients successfully in FINRA arbitration and in state and federal court.

If you believe that your investment portfolio has been harmed due to a failure to diversify, you should seek help immediately. Speak with our experienced New York attorneys by calling (877) 905-7671.

The Duty to Diversify

It is generally accepted that investment is risky business. After all, no one can always tell with absolute certainty how the market will behave. Investors are expected to understand this risk before their foray into the securities and exchange market. This is why it is a fundamental tenet of investment strategy that investment portfolios should always be diversified. Granted, investment is risky. But investing in a broad range of businesses through a variety of investment types helps to reduce the risk of investors.

This fundamental tenet of diversification is recognized under laws applicable in New York. The Uniform Prudent Investor Act imposes a duty to diversify on investment professionals. This duty arises because financial advisors owe a fiduciary duty to investor clients. Under the Securities Exchange Commission Act, financial advisors must act in the best interests of their clients. Even under some specific state law’s, brokers owe their investors an ongoing fiduciary duty of good faith and fair dealing.

Based on this duty, they are expected to act prudently. They should never expose your portfolio or assets within your portfolio to unreasonable risk. Investment decision should be taken carefully. This should be in accordance with the need to increase returns and also protect the value of the investments. A good broker should review all relevant facts and recommend a diversified portfolio. This should be one that best suits the investor’s goals and risk tolerance.

If your financial advisor has failed to live up to this duty, causing you loss, you may be entitled to pursue compensation. The law allows you to do this through a FINRA arbitration or a lawsuit if the other party refuses to settle.

Over Concentration

Over concentration is the direct opposite of diversification. It is when you have a majority of your holdings in a particular market segment, class of investments, or one particular investment in relation to your entire portfolio. One of the biggest risks of over concentration is that if anything happens to the class of investments or the particular investment you have put all your holdings in, you might lose a significant amount of money. Experts recommend that investors embrace a diversified portfolio of their investments so that their risks are spread out across the market. With diversification, some investments increase in value while others lose, and this creates a balance in your portfolio.

Common types of over concentration are:

  • Owning lots of mutual funds in the same category.
  • Owning many mutual funds in the same class.
  • Owning too much of a single stock.
  • Owning many mutual funds with similar stocks holdings.
  • Owning many mutual funds with a particular objective.

Even though over concentration is, in some cases, intentional and beneficial for investors, it can be a result of fraud. Stockbrokers and brokerage firms must ensure their clients’ investments are diversified on their investment profiles. Failure to do this could result in devastating financial losses.

A broker’s failure to recommend diversification of securities is considered negligent and unsuitable investment advice as well as a violation of FINRA sales practices. Stockbrokers and brokerage firms are required to abide by financial industry standards of care and best practices when giving investment recommendations. They have a fundamental duty to act in the best interest of their clients when making these recommendations, and if they don’t, they can be sued for a breach of fiduciary duty.

When Can a Financial Advisor be Liable for a Failure to Diversify?

While the law imposes a clear duty on investment professionals to diversify investor portfolios. Although, there is no standard formula for diversification. There is no automatic rule for determining what the appropriate level of diversification should be. Neither is there any rule to determine whether over-concentration has occurred.

Due to this, the question of whether over-concentration has occurred is usually treated as a fact that must be proved. It would depend on the unique circumstances of your case. As well as how your financial advisor has behaved. Despite this, over-concentration can generally be said to have occurred in any of these three instances:

  1. Sole investment in just one company: The stocks of a single company can be quite volatile. This means that an investor is more likely to register huge losses on their portfolio when all or a large part of their investments are in one company.
  2. Industry over-concentration: Just as individual company stocks can be volatile; industries can also have their ups and downs. Many things can cause the sector to suffer. These include typical market fluctuations, foreign competition and even fears about the economy.
  3. Investment in only one product types: A good portfolio should also consider investment in diverse product types. These should include investment in equities, bonds, and cash. This will reduce volatility and allow for better returns over time.

Overall, financial advisors should carefully review what investments are best for their clients. They must also take into consideration the duty to diversify. A diversified portfolio should meet the expectation of the client. It should also consider the risks and rewards that different investment types and industry sectors can offer.

Determining when over-concentration has occurred is not always easy though. If you are uncertain about whether you have a claim for over-concentration, it is best to contact a competent securities law attorney. They would be able to explain to you if the loss you have suffered was due to a failure to diversify. They will also be able to explain what options are available to you.

Special Circumstances That Allow Non-Diversification

You should note that it is not in all cases that a financial advisor or trustee would have a duty to diversify. The law provides some special circumstances where they may fail to diversify an investment portfolio. One of these is where the portfolio was created by a trust. In this situation, the trustee may be able to avoid the duty to diversify if the trust limits this duty. For instance, the trust instrument may state that the trustee should keep the portfolio in a particular type of business. In this instance, the trustee may have limited liability for failure to diversify.

Even for portfolios not created by trust, a financial advisor or broker may have limited liability for failure to diversify. For instance, your broker may conclude that the benefits of diversifying your portfolio are outweighed by the tax implications that will follow.

This is subject to proof though. Regardless of what circumstances your trustee or financial advisor claims to limit their liability. There may be facts that point to inappropriate behavior. They must be able to show that they acted prudently in all circumstances, with the object of securing your best interest.

If you’re ready to speak to a member of our legal team, then please give us a call today at (877) 905-7671 to set up a free case consultation.


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