Tuesday, January 12, 2010

Custodial Firm Not Liable for RIA's Alleged MisManagement

Clearing firms, those entities which perform back office, bookkeeping, accounting, custodian and record-keeping functions for other broker-dealers, hedge funds and investment advisers, are not liable for the investment losses of their client's customers. That has been clear for quite some time, and really isn't in dispute.

The outcome makes sense. Firms like Fidelity and Schwab are not in direct contact with the customers of the firms and RIAs that they carry accounts for, they do not make decisions in the account, and are not the party providing investment advice. They are not compensated for selling securities, or for giving advice, and have no responsibility for the investments, or the advice that the broker or investment adviser provides.

Certainly, if the firm makes a mistake or is negligent in carrying out its obligations, it might be liable to the customer damaged by the negligence, but that is not the same as bearing responsibility for investment losses.

Securities attorneys are well aware of this legal concept, and you don't see many cases brought against clearing firms alleging violations of sales practice violations or inappropriate investment recommendations or choices. But every once in a while you see one, and the decision is typically in line with the concept.

A FINRA arbitration panel rendered such an award, and  gave a zero award to an investor who tried to claim that Fidelity was responsible for the losses in their RIA managed accounts. The panel denied the claim as against Fidelity. The RIA was not a party to the arbitration, presumably because there was no arbitration agreement with the RIA firm.

Another interesting point. The customers claimed that they stopped opening their statements when the investments went bad. That was a huge mistake, as the panel found, since customers are charged with the knowledge of the information contained in those statements. Further, by not opening the statements, customers have denied themselves of the ability to monitor and control their own investments, putting a damper on any claim that they were unaware of ignorant of the investments, or the losses.

Read your statements. Take action when you think something is wrong, or run the risk of a zero award.


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