Bonds May Be the Next Wave of FINRA Claims

By Denis C. Dice, Esq.*


Key Points:

  • Bond suitability and misrepresentation claims are on the horizon.
  • Proper client counseling and disclosure documentation will be critical to defend these claims.


Interest rates have been at an all time low for approximately the last nine years. The Federal Reserve has artificially reduced interest rates in an effort to stimulate the economy and provide additional liquidity. In addition, the stock market has been in a bull market since March of 2009. This six-year bull market has resulted in significant appreciation in the value of stocks, and these favorable market conditions have resulted in the reduction of customer disputes filed at arbitration before FINRA. Currently, it is projected that FINRA arbitration claims will be about half the number of claims filed in 2009. Claims filed at FINRA for 2015 will be somewhere in the range of 3,000 to 3,500.

However, the zero interest rate environment we are currently experiencing will change within the next six months to a year. The Federal Reserve indicated that it intended to raise interest rates as early as September of 2015. The Federal Reserve plans to raise interest rates although the inflation rate is below a level that the Fed formerly believed would not necessitate a rise in interest rates. However, the rise in interest rates by the Federal Reserve will likewise cause the rise in interest rates in bonds. Not only corporate, but also municipal bond interest rates for new issue bonds, will increase relative to bonds that were issued in a lower interest rate environment.

Once the interest rate on new issue bonds increases, the value of bonds that have a lower interest rate decreases. The lower value of bonds paying a lower interest rate is caused by market forces where investors will pay less for a bond with a lower interest rate then could be otherwise obtained by purchasing a new issue bond. Therefore, the yield on a bond purchased in the secondary market at a discount to its par value will rise while the market value of the bond will decrease.

The decreasing value of bonds sold on the secondary market creates risk to investors who own those bonds. Unless the bond defaults, however, it will continue to pay the interest rate through its maturity date, and the bond holder would continue to receive that interest. Upon the maturity date, the bond holder can sell the bond at the price for which it was purchased and suffer no losses. Unfortunately, investors often times decide to sell a bond when they see that its market value has declined. Investors may panic in the face of this bond value decline and lock in their losses, although they would not have incurred such losses if they continued to own it through maturity. Other investors may have a need for liquidity and decide that the bond needs to be sold in order to satisfy other income and/or expense needs. However, and for whatever reason, an investor may decide to sell bonds in a rising interest rate environment, and they will suffer losses in the event that the bond they own pays an interest rate less than what is available on new issue bonds.

Investors who incur these losses may decide that those losses are, in fact, the responsibility of the broker-dealer who recommended such bonds for their portfolio. For example, when the Fed announced that it would be raising interest rates in 2013, this created what was referred to as a “taper tantrum.” The taper referred to the tapering of quantitative easing of the infusion of government funds and stimulus into the economy. Markets overreacted, causing yields to rise and the market value of bonds to dramatically decline. Upon seeing a decline in value of bonds which investors thought were conservative, many panicked, sold the bonds, locked in their losses and some decided to blame their broker-dealer for such losses.

Investors complained the bonds were overly risky and were “guaranteed” against losses. Investors claimed they were unaware of market risk associated with the ownership of these bonds and that they would never have purchased the bonds if they were aware of such risk.

Based upon these events that unfolded in 2013, it is very likely that the market value for bonds will dramatically decrease when the Fed, in fact, raises interest rates. Some customers will undoubtedly claim they were unaware of any such market risk associated with their bonds and may seek to lay blame for such loss at the feet of the broker-dealers.

In an effort to combat these inevitable claims, broker-dealers should warn their clients about the effect of rising interest rates on their bond portfolios. Broker-dealers should also review their clients’ accounts for overconcentration of bonds and for suitability purposes. Broker-dealers need to be prepared to discuss strategies for the purchase of bonds when interest rates are on the rise. For example, clients can be counseled to purchase bonds with shorter maturities and also not to sell their bonds as the market value declines. Clients should be counseled that the bond will continue to pay the stated interest rate and that losses will only be incurred upon the sale of such bonds. Broker-dealers should also strive to document all such warnings and retain copies of all correspondence to clients outlining the risks associated with the ownership of bonds and strategies for dealing with declining market value for bonds.

Bond suitability and misrepresentation claims are on the horizon. Proper client counseling and disclosure documentation will be critical in the defense of these claims.

*Denis, a shareholder in our Philadelphia, Pennsylvania office, can be reached at 215.575.2779 or

Defense Digest, Vol 21, No. 4, December 2015

Defense Digest is prepared by Marshall Dennehey Warner Coleman & Goggin to provide information on recent legal developments of interest to our readers. This publication is not intended to provide legal advice for a specific situation or to create an attorney-client relationship. ATTORNEY ADVERTISING pursuant to New York RPC 7.1. © 2015 Marshall Dennehey Warner Coleman & Goggin. All Rights Reserved. This article may not be reprinted without the express written permission of our firm. For reprints, contact