This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
A question that is bound to arise whenever a bond or brokerage house recommends a security which afterward turns out to be a poor purchase, concerns the extent of the obligation which the house should be willing to assume. So far as the legal obligation goes, the house is always careful to protect itself by disclaiming responsibility for the statements of fact which it transmits from the corporation to the purchaser and by clearly setting forth that prophecies as to the future represent only its opinions and not definite promises. This attitude is in itself entirely correct; yet there remains a certain moral obligation which the better houses are quite willing to recognize. As to how far this obligation extends, there is naturally considerable difference of opinion.
Clearly there is rarely a well-marked opposition of interest in this matter between a well-established banking house of high repute and its customers. The prosperity - the very existence - of the house is dependent upon its ability to retain the unquestioning confidence of a large number of investors. Every time a security which it handles goes wrong, that confidence is perceptibly diminished. The reputable banking house, therefore, takes great pains in the first place to make certain that its statements of fact are fully verified and that its recommendations are justified. As a further protection, it is customary for the banking house to obtain for itself some kind of representation, direct or indirect, on the board of directors of the corporation. It is thus in position to keep itself informed and to exercise some influence on the future policies of the enterprise. If, in spite of these precautions, the corporation's record is unsatisfactory and the market value of its securities decline, the banking house will frequently try to maintain the market price and perhaps will quietly assist its clients in disposing of their holdings. If the market decline seems to be due to extraneous factors rather than to any real falling off in the financial standing or profits of the corporation, the banking house will perhaps be satisfied with doing what it can to maintain the price and with reassuring its own clients. In case the situation becomes worse and the corporation finally goes through insolvency and reorganization, the banking house will in all probability do its best to secure favorable terms for the holders of the securities which it has itself recommended. It has even sometimes happened that the security merchant will repurchase securities which he has sold and which have afterward declined in value, at their original selling prices; but this is an exceptional case and is not to be expected as a regular policy.
On the whole, as the investing public comes to be better educated in financial affairs, and as the standards of correct practice in these matters become better established, there is evidently a strong tendency toward more complete and unquestioning recognition on the part of the security merchant of his moral obligation. The case is rare where the purchaser from a reputable house has any just cause for vigorous complaint.