The objective of investment professionals is to meet client financial goals by increasing the value of their investment in a matter consistent with the client’s ability and willingness to take risk. That requires some investment professionals to put the interest of their clients before their own personal interest and that of their employers. However, in practice, investment professionals sometimes neglect the duties to their clients in exchange for career advancement and financial gains or simply because of negligence and lack of proper training and education. When investment professionals such as brokers, financial advisors or investment managers neglect their duties to clients and that neglect results in financial losses, clients can seek relief and compensation either through the court system or through voluntary arbitration. In either case, clients’ attorneys would have to show the court or to the FINRA arbitrators the value of financial damages the client has suffered. To that end the plaintiff has to show investor damages.

It is best practice that attorneys retain financial experts on behalf of their clients with the necessary experience, credentials, and knowledge to prepare a report and calculate the investor damages. As practice shows good financial experts can point to negligence on behalf of the investment professional(s) and damages that the client and their attorney have not been previously aware of.

Before we start discussing the different methods for calculating investor damages, it is worth mentioning some of the common mistakes that investment professionals do. The most common roles of investment professionals are that of broker-dealer, financial advisor, and investment manager.

Broker-dealers recommend and sell securities to their clients. Those securities can be stocks, corporate, treasury or municipal bonds, exchange traded funds, cryptocurrencies, REITS and others. A common mistake brokers would do is to sell investments that are not suitable for their clients either because they did not inquire about the client’s personal situation or outright ignored it. Unsuitable investments can lead to an investor purchasing securities with a lot higher risk profile that she or he can absorb, sometimes leading to substantial financial losses that are near impossible to recoup. Broker-dealers can also input the wrong trade orders, fail to execute, or record an order as instructed, which could also lead to substantial losses.

Financial advisors work with their clients on asset allocation, investment selection, estate and tax planning. Just like broker-dealers they can recommend unsuitable investments to their clients that do not fit their risk profile. Another common mistake that a financial advisor can do is to recommend an asset allocation that is inconsistent with a client’s risk tolerance. Improper asset allocation is harder to detect by non-investment professionals because it is not each investment taken individually that makes an investment portfolio unsuitable for a given client, rather it is the way investments are allocated that can be unsuitable for a client.

Investment managers typically manage pooled investment vehicles such as mutual funds, exchange traded funds and hedge funds but can also manage an institution or an individual’s portfolio as a separately managed account. Investment managers have to follow the investment strategy, investment constraints and risk parameters as outlined in the offering documents for the investment vehicle they manage. Most common mistakes by investment managers include not following the outlined investment strategy and ignoring investment constraints that are meant to control risk. Investment managers can also misprice illiquid investments in order to show better performance and misrepresent the liquidity of securities held in the funds they manage.

The three most common methods for calculating investor damages are Net of Pocket, Market Adjusted Damages and Trading Losses. Judges and arbitration panels can choose to determine the appropriate method given the circumstances of each case.

Net Out of Pocket – damages are determined by calculating the total loss of the original investment in an individual security or an investment portfolio. That involves subtracting the value of the original investment from the value of the investment when sold while adding back any dividend or interest income against the resulting loss. For example, if an investor purchases a corporate bond for $1000, the company that issued the bond goes bankrupt and the investor receives back only $350 for a principal loss of $650 but receives $100 of coupon payments (interest). That makes a net out-of-pocket loss of $550 ($1000-$350-$100). This methods for calculating damages is considered to be the most favorable method for the defendants.

Trading Losses – reflect the actual principal loss realized by the investor. It is the same as net out of pocket, but it does not involve adding back interest or dividend income. This method is favorable to the investor seeking the damages and is often objected to by brokers and financial advisors.

Market Adjusted Damages – is based on the theory that investors are entitled to receive a return on their investment that is commensurate with a well-allocated and diversified investment portfolio. This is often applicable when investment advisors misallocate investor portfolios to be overly risky in a matter not suitable to the client. In this case, the financial professional would construct an investable portfolio that is suitable to the client who seeks the damages and then calculate the hypothetical return for that portfolio. The investor’s loss is not only the loss of principal the she or he sustained but also the return that she or he would have received from a properly managed portfolio.

Calculating investor damages often requires the retention of a qualified financial expert. When an investor or/and their attorney are able to identify losses caused by the misdoing of an investment professional it is a sign that there could be other undetected mistakes, and that investor is entitled to additional damages.

If you need a trusted and qualified financial professional to calculate the losses your client has suffered, contact us, your investor damages expert.