Broker-Dealer Fraud and Misconduct: The Customer Takes the Risk, the Firm Takes the Fee

Broker-dealer fraud and misconduct can turn customer accounts into a source of excessive commissions, put unsuitable investments into retirement savings, or use customer cash to finance the firm’s business. The evidence crosses desks: a representative makes the recommendation, a supervisor approves it, and operations records the trade and its cost. If you work inside that business, you may know why the customer-facing explanation leaves out the decision that mattered.

This page follows recommendations, execution, compensation, customer assets and supervision through the records each produces. Our page on Regulation Best Interest examines retail recommendations in greater depth, including the product review and the customer’s circumstances.

The Recommendation, the Trade and the Money

A broker-dealer’s work includes recommending securities, executing trades and supervising the people doing that work. A firm that carries customer accounts also holds cash and securities subject to customer-protection requirements. Each function leaves a different comparison for an insider to make.

For recommendations, the customer profile belongs beside the product’s risks, costs and compensation. For custody, the statement belongs beside reserve calculations, clearing agreements and the records showing who can claim the assets.

Regulation Best Interest requires brokerage firms making retail recommendations to disclose material information, understand what they recommend, address conflicts and enforce their procedures. The standard connects what the firm sells to what it understands about the customer and how it controls its own incentives. The cases below show those decisions in actual transactions, from a trading strategy that consumed account value to a reserve calculation that freed customer cash for the firm’s use.

SEC Alleged Excessive Trading Made Profit Practically Unreachable

Churning and excessive trading put the frequency and cost of recommendations at the center of the inquiry. A trade can generate a commission each time it happens, while the customer’s account has to earn enough to cover the accumulated charges.

In its September 2023 order concerning Salomon Whitney, known as SW Financial, the Securities and Exchange Commission alleged that representatives recommended and executed more than 2,000 trades for at least sixteen customers. The SEC described purchases, sales and repurchases of the same stock within the same week, sometimes on the same or consecutive days. It alleged that the firm and representatives knowingly or recklessly disregarded a strategy’s virtually nonexistent chance of producing a profit.

The SEC alleged customer losses above $1 million while the firm and representatives received more than $660,000 in commissions and fees. Its order described cost-to-equity ratios above 100% in many affected accounts, meaning customers needed returns above that level just to cover commissions and fees. We see who the strategy was serving.

The order addressed alleged securities-fraud violations and failures under Regulation Best Interest. Customer acknowledgments of active trading did not relieve the firm of its duty of care. An insider who saw the trading reports and the compensation records could connect the account’s diminishing prospects to the firm’s continuing revenue.

Western International and the Customer Behind the Form

Unsuitable recommendations become concrete when the product’s risk meets the customer’s actual finances. The SEC alleged that Western International Securities representatives sold approximately $13.3 million in GWG L Bonds from July 2020 through April 2021 without adequately understanding the bonds’ risks or establishing why particular customers should buy them.

The SEC’s complaint described a retired truck driver with moderate risk tolerance and limited investment knowledge who purchased $100,000 of L Bonds. That purchase represented 10% of his total net worth and 33% of his liquid net worth. The customer profile and the denominator told the story: an investment could look much smaller against all his wealth than against the money readily available to him.

According to the complaint, the representative’s explanation focused on obtaining more interest and supplemental monthly income. It did not explain why these bonds served this customer better than other investments offering more interest than his savings account. The SEC alleged that neither supervision nor compliance raised questions about the purchase.

The complaint also described the firm’s procedures:

The SEC’s July 2024 announcement described proposed settlements with Western and the representatives. We examine the product review and the customer’s finances with someone who saw how the recommendation reached approval.

Best Execution Reaches Beyond the Commission

Trade execution can cost a customer money through the price received, even when the trade carries no commission. That puts the actual execution price beside the advertised cost when we examine what the customer paid.

In its December 2020 Robinhood Financial announcement, the SEC alleged that inferior trade prices deprived customers of $34.1 million after allowing for the savings from commission-free trading. Robinhood agreed to pay $65 million to settle the charges. The commission line told only part of the price story.

Merrill Lynch Used Customer Reserves to Finance Its Business

Customer protection reaches the cash and securities behind the account statement. The customer-reserve requirement and the requirement to keep customer securities protected from creditors’ claims address how a carrying broker-dealer holds those assets. Treasury and clearing staff can see decisions that never appear as a recommendation to an investor.

Merrill Lynch and Merrill Lynch Professional Clearing admitted facts about their reserve practices in the SEC’s June 2016 order. The firms used complex trades and associated margin loans to reduce the cash required in their customer reserve account. The trades eventually became instantaneous round trips arranged to finance the firms’ activities.

The order described removing up to $5 billion of customer cash from the reserve week after week and using it to finance the business. Separately, Merrill Lynch admitted holding customer securities in clearing accounts subject to banks’ general liens, giving those banks claims over assets belonging to customers. The SEC ordered $415 million in total monetary relief.

For an insider, the relevant comparison connects reserve workpapers, the trades entered into the calculation and the clearing agreements governing the securities. Customer statements show the holdings. The agreements and calculations show what the firm did with them.

Supervision Has to Reach the Conduct

Written supervisory procedures matter through the decisions they require and the response they produce. In SW Financial’s case, the SEC alleged that the procedures repeated Regulation Best Interest’s care language but relied on active-account reviews and letters that alerted customers after excessive trading had occurred. According to the order, the firm sent more than 260 active-account letters, yet representatives continued recommending the same high-volume strategy.

That puts the reports, letters and subsequent recommendations into the same story. A person reviewing accounts may know when the firm saw the pattern and what it chose to do next. In the SEC’s account, the firm kept notifying customers about trading it kept recommending.

The audit record can carry a similar gap between an approval and work actually performed. In its May 2024 BF Borgers order, the SEC alleged that audit staff copied earlier workpapers, changed dates and carried forward check marks and approval names for work that had not occurred. It alleged that the missing quality reviews reached 45 broker-dealer annual filings.

The SEC also alleged that a staff member used different usernames to enter purportedly separate audit signoffs within seconds of one another. Someone who performed the work, administered the audit system or received the supposed review can explain the difference between an authentic approval and a name entered on a form.

What Evidence Shows Broker-Dealer Fraud?

Useful evidence of broker-dealer fraud connects the customer transaction to the firm’s decisions, compensation and controls. We work with your firsthand knowledge and the records behind the transaction to establish what happened, who understood it and which comparison makes the conduct visible.

Different parts of the business can supply different pieces:

• Recommendations and customer profiles: the investment objective, liquidity needs, product-risk material and explanation for choosing the investment.
• Trading and compensation: the sequence of purchases and sales, transaction costs, commissions and the account value supporting the strategy.
• Supervision: written procedures, active-account reports, customer letters, approvals and the response to concerns.
• Customer assets: reserve calculations, clearing agreements, confirmations and records of authority over the cash or securities.

A study of occupational fraud helps explain why that inside view matters. The Significance of Whistleblowing as an Anti-Fraud Measure, published in the Journal of Forensic & Investigative Accounting in 2018, found that whistleblowing detected 35.9% of the frauds in its analyzed sample, compared with 21.4% detected through internal controls. Its discussion gives the human expectation behind those reports:

That is the work we undertake with you. A person who knows why a review was bypassed or why a trade entered the reserve calculation can give the documents meaning that their titles and totals leave out.

Who Investigates Broker-Dealer Fraud and Misconduct?

The Securities and Exchange Commission investigates broker-dealer securities violations and brings civil and administrative enforcement actions. FINRA supervises and disciplines its member firms and associated people, while the Justice Department handles federal criminal enforcement and state authorities act under state law. We assess the authorities relevant to your information with you.

An enforcement action, an investor’s recovery claim and a whistleblower award serve different purposes. Our page on investor recoveries and whistleblower awards follows those different money paths.

Eligible SEC whistleblowers can share 10% to 30% of qualifying sanctions collected, where the qualifying action exceeds $1 million in monetary sanctions. Separately, a whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. The securities matters discussed here concern SEC enforcement, and we assess the applicable whistleblower program as part of building your case. We work through reporting securities fraud with you, including questions about your role and the information you hold.

You Know What the Approval Left Out

If you saw the sales incentive, trading pattern or reserve decision behind the customer’s account, speak with our whistleblower experts about what happened inside the firm. We connect that knowledge to the financial records and bring in securities fraud whistleblower lawyers who understand brokerage recommendations, trading and customer-asset controls. We stay beside you as partners in building and pursuing your strongest broker-dealer whistleblower case.