Activity letters: An ironclad defense against a claim by an investor against a broker or brokerage house?
By Christopher A. Zampogna
Principal, Zampogna, P.C.
Brokers and brokerage houses commonly claims that any action by their investors are barred by the doctrines of waiver and estoppel (See in that regard, Karlen v. Ray E. Friedman & Co., 688 F. 2d 1193 (1982)) or, at a minimum, their liability limited due to the mailing of activity letters to their investor concerning the use of risky investments, churning, or other fraudulent behavior. Such letters require the investor’s acknowledgement of their understanding of the manner in which their account was being handled by the brokerage house and the broker. These activity letters are also known customarily as “suicide notes,” since the letters, once executed by the customer and received by the brokerage firm, can become important evidence against the customer when she attempts to claim that the accounts were churned or they were otherwise defrauded. Hobbs v. Bateman Eichler, Hill Richards, 164 Cal. App. 3d 174, 210 Cal. Rptr. 387 (1985); Churned or Traded? Mark J. Astarita, www.seclaw.com; Churning by Securities Dealers, 80 Harv. L.R. 869 (1967). For the purposes of this article, we will focus on excessive trading or churning.
Brokerage houses attempt to avail themselves of this form of communication as part of its compliance policy to inquire about performance by the broker. Most importantly, brokerage houses need to obtain periodic confirmations of the strategy being utilized during the life of the investor account to establish that the customer was directing the level of activity and, therefore, controlling the account. Under this policy, if the customer of an account that has been actively traded does not return an executed activity letter, the customer should be contacted by the compliance department and trading ceased until the brokerage firm and the broker are assured of the customer’s full understanding of the letter. Ronald J. Wildermuth and Diane C. Wildermuth v. Irving Becker and Phillips, Appel and Walden, Inc., Civil Action No. 87-5368 U.S. Dist. Ct. Pa. E.D., 1989 U.S. Dist. LEXIS 4817 (1989).
The following is an example. During two years of excessive trading by a broker for two investors, a husband and wife, the broker’s manager sent only three activity letters to the investors without acknowledgement. The investors were highly leveraged in an account and trading was occurring at a frenetic pace by their broker. Further, the manager recorded no details of any follow up calls to these letters. And, these calls occurred during the early months of opening the investors’ accounts.
The investors do not recall receiving any of these warning letters or phone calls.
Neither investor had any experience with securities trading or with the risks involved with certain investment strategies, including margin trading.
In addition to this disparity in expertise, the brokerage house failed to follow standard compliance policies because it did not record the investor’s acknowledgement of receipt of such letters. Under customary practice, the lack of such receipt should have led the brokerage house to discontinue all trading in the account until it was convinced of the investors understanding of the investment strategy being directly pursued by the brokerage house and broker.
Also, since the manager made no detailed follow up communication the brokerage house could not have adequately supervised its broker without obtaining the investor’s confirmation of his broker’s activities. A brokerage house’s failure to obtain such confirmation again confirms its failure to supervise its broker.
This lack of confirmation by the investors does not demonstrate a waiver of rights and does it prevent them from asserting claims against the brokerage house.
In conclusion, an activity letter alone does not prevent or even limit a claim of fraud or other violations by an investor. An investor need not believe her claim is lost or pursuing it is “suicidal.”