Investors Have Sustained Huge Losses Investing in Small Banks
The large number of bank failures over the past two years has resulted in big financial losses for investors owning stock in those banks. In most cases, failed banks are taken over by the FDIC, which arranges for the operations to be assumed by another bank -- free of the liabilities of the failed bank. While most account holders’ deposits are safe because they are insured against loss by the FDIC, those who invested in the bank are typically left holding stock that is now worthless. In some cases, shareholders have the option of legal action to recover their losses.
If misrepresentations were made in connection with the sale of the stock—or if the investor was induced by misrepresentations to continue holding the stock when the investor was trying to sell—there may be a claim against the person or company that made the misrepresentation. Since the bank is insolvent, it will usually do little good to sue the bank or its employees, although there may be errors and omissions insurance covering officers and directors of the bank. If officers or directors committed malfeasance that caused shareholders to lose money, they can be sued individually and the insurance may cover them, although the lawsuit has to be carefully pled to avoid insurance policy exclusions for criminal fraud and the amount of available insurance coverage may be insufficient to cover all claims. On the other hand, if a registered broker-dealer or investment adviser was involved in making misrepresentations – or if they recommended purchase of bank stock that was not an appropriate investment – it may be possible for an aggrieved investor to pursue a claim against the brokerage or advisory firm.
Most of the recent spate of bank failures – including more than thirty in Georgia alone – have involved small community banks. Typically these banks are privately held, and their stock is not publicly traded. Most investors in such banks were sold stock in private offerings by financial advisers or brokers in smaller towns outside of Wall Street. Often these transactions were “handshake deals” that did not always involve the full disclosure to which investors are entitled. Such offerings have recently come under increased scrutiny. Unlike public offerings, most private placements are not registered with the SEC, and because state laws and enforcement capabilities vary widely, many of these investment offerings fly beneath the regulatory radar.
The exception to the Securities Act that allows these offerings to avoid SEC registration, commonly referred to as Regulation D, puts limits on the number of unaccredited investors who may be participate but does not limit the number of accredited investors (presently defined by SEC rules to include a individual or married couple having a net worth in excess of $1 million, or income in excess of $200,000 for two or more consecutive years in the case of an individual or $300,000 jointly for a couple). Sometimes abuses occur because investors who do not qualify as “accredited” are misclassified as such.
Other common abuses are misrepresentation of the risks, which are typically higher than for public offerings that must be registered with the SEC, or the failure to disclose material facts—that is, information, that would cause an investor not to invest were that information fully disclosed in advance. In the banking context, there may be a valid misrepresentation claim if an overzealous broker or adviser overstated the financial health of the bank whose stock was being recommended, or if the bank was having financial difficulties that were not fairly disclosed. Perhaps the most common abuse is the failure of the broker or financial adviser to make sure that the investment is suitable, both generally from the standpoint of the investing public and specifically in relation to the investment objectives of the individual customer. In the case of a failed bank, if the broker/adviser who recommended the stock was also an employee of the bank – which is increasingly common given the networking relationships that have developed between community banks and certain brokerage firms – there may also be a conflict of interest that could lead to legal liability for the brokerage firm, particularly when no money can be recovered from the bank. These and other abuses can all be grounds for the investor to file a claim against the brokerage or advisory firm to recover his or her losses.
Such claims may be brought through arbitration or lawsuits depending on the circumstances. The advantage of arbitration, which is required by most brokerage firm account agreements, is that the claim gets decided more quickly and less expensively than through litigation in court. In cases involving elderly investors, FINRA arbitration rules allow for expedited proceedings. Court cases are generally more protracted and time consuming.
Even honest advisers and brokers can be held liable for investors’ losses if they fail to investigate the offerings that they recommend. A recent FINRA Notice to Members reminds broker-dealers of their legal obligation to research the soundness of private offerings before selling them to their clients, so ignorance is not a defense if a reasonable investigation would have revealed material facts that should have been disclosed, or that the investment was not suitable for the client’s investment objectives and risk tolerance. While the FINRA notice is only applicable to broker-dealers, it is also consistent with the standard of care for investment advisers. “If you are a financial professional,” says Craig T. Jones of Page Perry LLC, “you are expected to know something about what you are selling. The law is not only designed to protect you from crooks, but also from financial professionals who are careless with your money.” Jones’ law firm, Page Perry, is based in Atlanta but handles cases for investors all over the country.
