Failure to diversify a client's portfolio can be a form of
stock fraud. In order to protect a client's assets, the
broker should vary the types of stock purchased. Stock
fraud through over concentration strips the client of the
protection diversification affords.
Diversification of investment holdings is the most
important shield against risk. Since some investments rise
in value while others fall, diversification smoothes out
some of the volatility of the overall return from a
portfolio. Diversification may sacrifice some of the upside
potential, but should be more than offset by the benefits
of lower levels of risk.
Diversification is a strategy for managing a customer
portfolio to limit risk. Instead of all the investments
being concentrated in one market sector, investments are
diversified among a variety of industry sectors and types
of security.
Therefore, as it is less likely that all of the major
sectors or specific types will be hit with a significant
downturn at once the portfolio contains less risk.
It is a broker's responsibility to advise clients to
diversify their portfolio to reduce risk. Proper
diversification is the foremost issue in all-efficient
investments, especially when individual stocks are
purchased.
When an investment portfolio or account is over
concentrated in a particular security, type of security, or
industry sector, the risk of loss in the account is
increased. The broker has a duty to explain the increased
risk and to recommend actions to correct the problem. Over
concentration in an account that contains only one
individual investment is easy to recognize. Accounts may
also be over concentrated if they:
* Contain only common stocks (including mutual funds that
invest in common stocks) rather than a mix of common
stocks, preferred stocks, and debt instruments (bonds).
* Contain investments that are limited to one particular
industry (such as telecommunications) or industry sector
(such as health care or finance).
Brokers are obligated to carefully evaluate each client's
investment goals to provide for adequate portfolio
diversification and not give up potential returns. If a
broker places the vast majority of a client's total
investment holdings in one sector, and this sector declines
significantly, the broker may be liable.
All investors are unique, and careful strategies must be
employed to properly diversify a client portfolio. Failure
to do so can result in negligence and malpractice liability
when that portfolio sustains significant losses.
The cause of action for negligence or malpractice is based
upon the duty owed by the broker to the customer and the
breach of that duty, including the duty to exercise due
care in connection with the account. Even if the broker did
not have actual knowledge as to the falsity of statements
that they made, the activity may constitute negligent
misrepresentations.
Failing to properly diversify the customer's account may
also be considered negligent management of an account.
In general, reports have shown that:
* Smaller companies typically have higher risk of failure.
* Smaller-company stocks generally experience a greater
degree of market volatility.
* Foreign securities have additional risks.
* Emerging markets typically have higher risk because they
are underdeveloped markets.
The right level of diversification for a client depends
upon a variety of factors, including the individual's
financial position and long and short term financial goals,
and how the market is performing. Many portfolios are not
properly diversified and therefore an extended risk is
being taken.
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LegalView offers more information on failure to diversify
at http://diversify.legalview.com , or use the LegalView
homepage at http://www.LegalView.com to find the latest on
the controversial prescription drugs such as the Digitek
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