Can Your Firm Be Required To Cover An Employee’s Mistaken Trades?

January 12, 2016

by Anne Wallace, Esq.

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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives. This article originally appeared here.

An employee of a financial services firm, whose compensation consists of fees and commissions, asks whether it is legal for his employer to require him to reimburse a client directly for any losses the client suffers because of a trading error.

Turning the question around, would the employee have a right to recover from the employer if the client suffers losses because of a security breach or cyberattack? What if the employee’s relationship with the client or the employee’s professional reputation is damaged because of the security breach?

Teased into pieces, this is what the question looks like:

  • When may an employer require an employee to pay for mistakes?
  • When may an employer require an employee to reimburse a client directly for mistakes?
  • May an employee require an employer to reimburse the employee for harm to the employee/client relationship or future earnings?
  • Does the law apply differently to the financial services industry?

This is an interesting collection of problems because beyond a financial services firm’s obligation to make the customer whole, it is about the employer/employee relationship that exists between the firm and the employee. That relationship is governed by federal law, state law and contract, and any or all of these might be implicated in this scenario.

The financial advisor’s duty to the client

The term “financial advisor,” can cover a lot of ground. It can mean a registered investment advisor or a financial planner who is not a registered investment advisor but has a Series 65 license, which qualifies the investment professional to function as an investment adviser representative in certain states.

A financial advisor can provide a wide range of services other than advice about trades, including investment management, income tax preparation and estate planning. Some are compensated on a fee basis; others, who effectively function as salespersons, earn commissions. Most earn a combination of both.

An investment advisor who is registered under the Investment Advisors Act of 1940 has a fiduciary duty to act in the client’s best interest. Broker-dealers, who are regulated by the Financial Industry Regulatory Authority (FINRA), have only a “suitability” obligation, to make recommendations that are consistent with the best interests of the underlying customer.

If an investment advisor mishandles a trading error, it can lead to a violation of the Investment Advisors Act. In any event, all financial advisors, whether or not RIAs, have a very strong business incentive to make the client whole for any loss caused by a trading error, even if the firm takes a loss. That is why many carry Errors & Omissions insurance.

But it is worth keeping in mind that the overall purpose of financial regulation is to protect customers from the misdeeds of financial professionals, not financial professionals from the misdeeds of each other.

Most also have policies and procedures in place about how to handle trading mistakes, and that is likely the source of the practice described of having the employee reimburse the client directly.

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Can Your Firm Be Required To Cover An Employee's Mistaken Trades?