When Is Over-Concentration Considered Fraud?

The market is in a constant state of flux, and it's difficult to determine which holdings in your investment portfolio will do well. Market experts advise that diversification is a sound investment strategy to minimize financial losses. Investment advice typically warns against concentration risks. A diversified portfolio seeks to hedge against investment losses in particular securities.

Investment professionals must avoid recommending unsuitable investments for clients. They must recommend investments that align with the client's risk tolerance profile. If your broker or advisor fails to diversify your investments, you may be a victim of over-concentration. Read on to learn about over-concentration and when it might be considered investment fraud.

What Is Over-Concentration?

In securities law, over-concentration refers to having too many holdings in one particular investment, asset class, or market segment relative to your whole portfolio.

For example, you might invest too much in one company or industry, such as technology. An entire portfolio may consist of a single company stock. You could be invested in only one type of security, such as common stocks. Investment recommendations for most investment profiles usually include a mix of stocks and bonds.

Over-concentration is a high-risk investment strategy. If something happens to that one investment or class of assets, you risk losing a large portion of your portfolio. Experts recommend having a diversified portfolio of investments. This spreads your risks more across the market. While some investments might lose value, others could increase, leaving your overall portfolio fairly balanced.

FINRA Defines Over-Concentration

FINRA, the Financial Industry Regulatory Authority, is a non-governmental organization governing individual brokers and brokerage firms. It describes the factors that can lead to a concentration risk. They include the following:

• Intentional concentration: An investor can make a conscious decision to invest heavily in a specific asset class or asset
• Concentration due to asset performance: If a particular asset does well, your portfolio could become over-concentrated over time
• Company stock concentration: Employees should avoid concentrating all retirement savings in their company's stock
• Concentration due to correlated assets: Investments sharing characteristics such as industry or security type tend to be highly correlated. This means that if when one of the investments loses value, it is likely to happen to the others.
• Concentration in illiquid investments: Some investments, such as private placements and non-traded real estate investment trusts (REITs), can be difficult to sell quickly

Understanding the factors that lead to over-concentration can help you manage the concentration risk.

When Is Over-Concentration Considered Fraud?

Over-concentration can occur in several ways. When over-concentration occurs, it's not always a sign of stockbroker fraud. For example, you may have chosen to invest in one type of asset as a personal preference. In other cases, one of your investments may have performed so well over time that it now represents a more significant percentage of your portfolio than before. It's not always securities fraud when your portfolio exhibits over-concentration.

However, your broker or financial advisor may be at fault for your over-concentration. These investment professionals must ensure that their clients' investments are well diversified. The recommendations for individual securities and mutual funds must be based on the following:

• Individual circumstances
• A client's specific instructions
• A client's financial goals

This assessment evaluates factors such as the client's:

• Age
• Net worth
• Investment experience

Over-concentration is rarely a prudent strategy. For example, suppose a broker fails to diversify the portfolio of someone in their 60s and only invests the client's funds in oil. This could constitute fraud. Heavy investing in a single asset class is risky for someone close to retirement age. Losing a life savings with no time to ride out the market's ups and downs is devastating.

Were You a Victim of Over-Concentration? Speak With an Attorney

For many investors, a broker or financial advisor's failure to diversify the portfolio may constitute fraud. It all depends on the client's profile or instructions. Did you entrust your investments to an investment professional who lost some or all of your money through over-concentration? If so, it may be possible to recover those losses. However, fraudulent over-concentration can be challenging to prove. 

Contact an experienced securities attorney today. They can evaluate your case and explain your legal options.