Broker Fraud Overview
Broker Fraud Resources
To buy or sell stocks, bonds or mutual funds, an investor often relies on an investment broker to process the transaction. And, depending on the relationship, the investment broker may also provide investment advice or investment management services. When investment professionals deal with an investor, they must act in good faith and provide full and fair disclosure of all material facts. If they fail to act honestly and in the client's best interest, they may be charged with investment fraud.
Stock Market Losses
Not all investment losses are caused by broker fraud. Usually, if a company's projected growth does not materialize, this will drive down its stock price. Other events that commonly drive down stock prices are higher interest rates and defective products that cause severe injuries and trigger costly recalls.
However, investment losses are sometimes caused by broker misconduct. In such instances, victims of broker fraud should immediately file a complaint with the Securities and Exchange Commission (SEC) and seek legal representation to recover their losses.
Types of Broker Fraud
Broker fraud may take a number of different forms. The most common types of broker fraud include unsuitability, churning, misrepresentation/omission, overconcentration and unauthorized trading.
- Unsuitability. An investment broker must recommend investments based on a client's individual financial needs. However, brokers may be pressured by their firms to push a certain stock, or may have a personal interest in a corporation or other investment opportunity. A broker is guilty of unsuitability if they advise their client to invest in stocks that they know are outside the client's risk tolerance or are not suited to meet the client's financial goals.
- Churning. A broker typically receives a commission from a client every time they complete a buy or sell transaction. Churning refers to the excessive buying and selling of stock in order to generate commissions. A broker may be guilty of churning if the same stock is bought or sold two or more times in one month, or if the amount of trading is excessive compared to the amount of money invested.
- Misrepresentation/Omission. A broker may commit fraud by misrepresenting material facts about a stock, or by failing to offer material information regarding an investment opportunity. A fact is material if it would be important to a reasonable investor in making an investment decision. "Pump and dump schemes" are examples of broker misrepresentation. "Pump and dump" refers to the practice of making false or misleading statements regarding a stock in order to quickly generate a large number of investors. Once the stock has been sufficiently "pumped," brokers "dump" their shares into the market and make a significant profit. Investors are then left with worthless stock.
- Overconcentration. An investment professional protects a client's assets from sudden market fluctuations by investing in a broad range of stocks. This ensures that the entire investment will not be lost if a certain stock decreases in value. Overconcentration is an intentional or negligent failure to diversify a client's investment portfolio.
- Unauthorized Trading. An investment broker must obtain a client's permission before engaging in a stock transaction. If a broker fails to obtain permission before buying or selling stock, or acts against a client's express instructions, a broker will be guilty of unauthorized trading.
SEC Guidelines
The SEC has enacted guidelines to protect investors against broker fraud. The guidelines were developed to ensure that clients receive accurate and complete investment information from their brokers, while protecting the broker's ability to fully serve the client. Key regulations require that brokers:
- Buy and sell stocks within the client's appropriate risk level.
- Receive the client's permission before making an investment.
- Follow client orders regarding when to buy or sell stocks.
- Disclose all material information to clients.
- Charge reasonable prices.
- Fully disclose all conflicts of interest.