Playing with Fire: The High Risks of Overconcentration

Today, I’d like to examine the very real dangers of “overconcentration” in a particular investment or industry sector. Overconcentration is best defined as an investment portfolio marked by a significant holding in a single stock, bond, note or other investment vehicle, when measured against the value of the portfolio as a whole. This phenomenon most frequently results from an inherited stock position, a broker who falls in love with a certain company or sector—say energy, bio-tech or social media—or an investor who decides to swing for the fences. No matter what the origin, an overconcentrated position can create a dangerously volatile investment portfolio, one subject to extreme swings and nasty collateral consequences.

FINRA (the Financial Industry Regulatory Authority) has routinely warned brokerage firms and customers of the risks associated with overconcentration. Somehow, though, the risk that amplified losses will result from having a large portion of your holdings in a particular investment, asset class or market segment are often overlooked.

FINRA Rule 2111 requires brokers to “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person to ascertain the customer’s investment profile.” In general, a customer’s investment profile would include the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance.

In addition to a customer’s investment profile, a broker must consider whether a recommended purchase or sale will cause an overconcentration in a particular investment or investment class.

Despite the clear guidance of FINRA, some brokers ignore concentration risk and recommend transactions without carefully considering the customer’s investment profile, and without clearly disclosing—in plain language—what can go wrong if the investor follows the recommendation and puts too many of their “eggs in one basket.”

We recently filed a FINRA arbitration on behalf of a group of unsophisticated investors whose 401(k) accounts were grossly mishandled by their broker. The broker, employed by a well-known firm, recommended—and in many instances bought without even discussing—an extremely risky set of investments in a single sector: energy. In fact, this firm invested the majority of our clients’ hard-earned retirement savings into a single stock. Due to the inexcusable conduct of their broker, our clients suffered massive losses from which they have been unable to recover. Now, only by bringing a FINRA arbitration do they stand a real chance of rebuilding their retirement savings.

As the case moves forward, we will gather and present evidence in an effort to force the firm to repay the losses, plus all the management fees that were charged, as well as our legal fees, so that they can be made whole and get their retirement plans back on track.

If you have suffered substantial losses as a result of unsuitable recommendations by your brokerage firm, or are concerned that someone you know may fit that profile, please contact a securities attorney at The Galbraith Law Firm. Call 212.203.8134 or email kevin@galbraithlawfirm.com for a free confidential consultation regarding your legal rights.