1) Bond Suitability

The NASD Conduct Rules require that in recommending to a customer any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to their other security holdings and as to their financial situation and needs.  All securities, not just stocks, must be suitable for an investor.  For example, if an investor wanted rock solid, safe returns, and a stockbroker recommended lower quality bonds, (also known as junk bonds), then the stockbroker may have made an unsuitable investment recommendations.  If a broker has willfully disregarded his clients stated investment objectives by recommending low priced or speculative bonds, the firm and the broker could be found to have made an unsuitable investment recommendation.  

2) Excessive Activity or Bond Churning

Most brokers are compensated by the transaction based commissions or markups charged to the client. Sometimes financial advisors effect transactions not for the purpose of reasonably fulfilling the clients stated investment objectives, but instead in an effort to generate excessive commissions or markups for themselves and their firm.  Under no conditions are bonds to be utilized as a trading vehicle.  Bonds are intended to be long term investments.  Bond don’t have commissions but rather have markups embedded in the price of the securities.  In other words, a bond may be held in the inventory of a brokerage firm at a cost of $950 per bond.  The firm, prior to selling the bond to a client, imposes a markup on the bond.  Generally, the lower the quality of bond, the higher the markup.  Also, the longer it takes the bond to mature, the larger the markup.  So a junk quality bond maturing in 20 years may have a $80 markup.  A short term government security, on the other hand, may have a markup of only $5.      

3) Bond Purchases on Margin

Stockbrokers often may recommend to a client that he or she buys lower quality bonds on margin.  The purported logic is that if a broker can get his or her client 10%-12% on a lower quality bond purchased on margin and the client pays margin interest of 8%, then the client is in effect receiving free money.  This logic is tragically flawed and often leads to massive losses for the investor.   

Many experienced investors do not understand margin accounts. When you purchase securities on margin, your brokerage firm is lending you money to pay for these securities. Initially, you may use cash equal to half the securities purchased, or pledge certain fully paid securities. Either way, you owe the brokerage firm, or most likely its clearing agent, the debit balance, or the amount borrowed to pay for these securities. In general, unless you purchase more securities or pay down the balance, the debit or the amount borrowed does not change. Bond prices, however, change and if the market value of the securities (bonds or stocks) in your account declines in value, you will be required to meet margin calls and will be called upon to deposit additional cash, or fully-paid securities, into your account. If you fail to meet a margin call, or if your account falls below minimum maintenance levels, even in the absence of notice of a margin call, by contract, your broker is able to liquidate your investments.

However, many unscrupulous brokers use margin to increase the purchasing power in your account in order to facilitate excessive activity or churning. Aside from this practice, unless you are able to make and meet margin calls, and have the financial ability to satisfy the debit balance in your account, based on your overall financial condition, you may be unsuited for a margin account. If your broker has placed your account on margin, and you do not understand, or are unwilling to trade on margin, you should have your account evaluated by a professional. Such practices are usually the warning sign of other inappropriate activity in your account.

4) Unauthorized Trading

Unless you have signed discretionary papers giving your broker permission to trade your account without your authorization, a broker is required to obtain his clients permission before buying or selling bonds (or any other securities) in the account.  It is not uncommon for unscrupulous brokers to buy and sell bonds in a clients account without authorization.  If the client calls to complain, the broker might blame it on a "computer error" or some other excuse. 

5) False Statements or Omissions in the Purchase and Sale of Bonds

State and federal securities laws prohibit brokers from making false statements or omissions of material fact in connection with the sale of securities. False statements in the purchase and sale of fixed income products often includes guaranties, price predictions, or purported “special information” regarding merits of the company.  Fraud, however, may also take the form of omission by failing to disclose, among other things, the actual quality of the bond, the underlying risks inherent in the bond purchase or other material, relevant information that the client is entitled to before purchasing the bond.  

6) Failure To Execute

Brokers are obligated to follow their client’s instructions when selling or buying bonds.  Actions may exist based on your broker's failure to execute certain orders. Actions may also be based upon your broker's dissuading you from selling particular bonds. 

7) Failure To Supervise

Brokerage firms have a duty to supervise their brokers and the sales practices of their brokers, and to review customer statements for, among other things, evidence of bond suitability, unauthorized trading, or excessive bond trading activity. But for the performance of these duties, most cases of bond fraud may have been reasonably prevented. The failure to supervise is a violation of self-regulatory rules. Courts have recognized a cause of action for the negligent failure to supervise, and brokerage firms are liable for the acts of their registered representatives under the common law doctrine of respondeat superior, and as control persons under Section 20(a) of the Exchange Act.