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Over Concentration simply relates to a customer having too many assets invested in one particular security or asset class. The proverbial "too many eggs in one basket" can carry many risks. When an investor fails to diversify, or allocate investment assets into different companies or market sectors, there is a risk of greater loss when a particular sector takes a downturn. For instance, by investing a percentage of assets into the bond market, the investor is hedging against a stock market downturn as bond prices generally rally when the stock market loses value. When an investor is under-diversified in one company, the risks of company loss and the potential for the company to go defunct, can cause massive market losses. The Enron Collapse in 2000 is a profound example of the risks of concentration in one stock. The company lost 98.8% of its market value in a very short amount of time, wiping out the retirement savings and investments of thousands almost overnight.
Concentration loss doesn't necessarily have to be a concentration in stock or bond XYZ, but could be over allocation into a risky market sector, such as commodities or biotech equities. An allegation of overconcentration against a broker connects to Suitability and FINRA Rule 2111, and is considered a violation of the rule, as well as a breach of a broker's fiduciary duty. Whether a broker actually engaged in overconcentration and failed to properly diversify a client's assets is a very fact sensitive inquiry and consideration must be taken of numerous factors. First, before a customer can simply allege overconcentration or stock fraud against the broker, a consideration of the customer's investment strategy, profile, and objectives must be considered. For instance, a customer may have stated that his or her investment objectives permit speculation and that their risk tolerance is aggressive. The total amount of assets the customer has invested vs. how much was allocated into the specific sector must be considered. The customer may have a non-discretionary account which makes it impossible for a broker to enter into trades without the customer's account.
Concentration risk may also increase due to a bull market in one particular market sector. Occasionally, concentration may also be intentional. As stated on the FINRA Investors Protection Site, an investor might believe that a sector or stock will climb and may directly order purchases to this effect, making a claim for unsuitability on the basis of overconcentration very difficult
An investor may have overconcentration due to stock purchase plans from a company 401k. According to the Employee Benefits Research Institute and the Investment Company Institute, 53% of employees invest in company stock if presented with the opportunity, with 7% allocating more than 80% of company stock into their 401k. Overconcentration in 401k's and retirement investment plans is a concern that has been raised by FINRA. There are currently no rules in place that limit the amount of assets that can be invested in a company 401(k). The Employment Retirement Income Security Act (ERISA 74 Act) does place traditional pension plans under tight restrictions, capping the allocation into company stock at 10%. There may be a claim for investment fraud against 401(k) plans depending on a number of factors such as whether the stock was vested or limitations the company placed on selling the stock. The percentage of stock allocated in the investment account will clearly be a key determination on whether there can be a claim for unsuitability on the basis of concentration risk.
According to FINRA, most financial advisors and brokers agree that a properly diversified portfolio should have no more than 10 to 20 percent of total investment assets in a particular stock.
If you believe your account was mismanaged and too many assets were concentrated into one stock or market sector, please contact the attorneys of Lubiner, Schmidt and Palumbo for a consultation.