Broker / Securities Fraud
A significant portion of the U.S. economy is dedicated to the buying, selling, and trading of financial instruments, known as securities, in various marketplaces. Almost anyone who has a retirement or investment account is involved, at least indirectly, in the securities markets. The 2008 financial crisis was the first time that many people became aware of how complicated these markets, and the securities they trade, have become. Few, if any, people in the finance industry even really understood some of the securities involved in the crisis. This environment of complexity and uncertainty can be fertile ground for scams that target consumers. Some of these schemes rise to the level of criminal securities fraud, while others could result in civil liability under federal or state law.
What Are Securities?
The Securities Act of 1933 defines a “security” as any of a wide range of financial instruments other than cash, checks, or other instruments with a clear and unchanging face value. Securities can typically appreciate or depreciate over time. They include stock in publicly traded corporations, shares in closely held corporations, promissory notes, treasury bills, corporate bonds, and options for the purchase of stock. Some securities, such as corporate stock, are traded in public exchanges. Other types of securities may be offered for sale to consumers as investments. People and businesses involved in offering, selling, and trading these types of securities must comply with various reporting and disclosure requirements.
Most securities fraud cases involve Section 10b of the Securities Exchange Act of 1934, along with the associated Rule 10b-5. Section 10b prohibits “any manipulative or deceptive contrivance” in the purchase or sale of a security, whether or not it is registered for sale on a public exchange. The Securities and Exchange Commission (SEC) is the federal agency tasked with investigating securities fraud and bringing civil claims or criminal charges for alleged violations.
Acts prohibited by Section 10b and Rule 10b-5 might include false statements or omissions of information about a stock that are material to someone’s decision to buy or sell that stock and intended to influence that decision. A person might mislead others about a stock in order to manipulate its market price or improve their own financial position.
Brokers are agents who represent buyers and sellers in the marketplace. They handle requests to buy or sell securities, and they may also make recommendations regarding particular securities and offer other investment advice. Brokers must pass an examination, such as the Series 7 exam administered by the Financial Industry Regulatory Authority (FINRA), in order to obtain a professional license. FINRA is a private nonprofit organization that acts as a regulatory organization for securities brokers and the financial industry.
Because of their specialized training and their position of trust, brokers owe a duty of care to their clients, similar to the duty owed by people in other professional fields. Examples of broker fraud, which could violate Rule 10b-5 as well as FINRA rules, include trading without a client’s authorization, recommending investments that are not suited to a client’s needs, and executing unnecessary trades in order to generate additional commissions, which is known as “churning.”
Trading securities based on information that is not available to the general public is known as insider trading. While it does not necessarily harm the interests of specific people or businesses, it is usually considered illegal because it gives an advantage to those who have access to inside information, which may affect the market in ways that harm others.
Microcap and Penny Stock Fraud
A type of securities fraud that frequently targets consumers is known as microcap fraud. Microcap stocks are stocks in smaller companies, usually with less than $300 million in market capitalization. Even smaller companies may offer stocks known as “penny stocks.” These stocks are often traded in the “over-the-counter” (OTC) market, which are not subject to as many regulations, instead of the major exchanges.
A common type of microcap fraud, known as a “pump and dump” scheme, involves making false or misleading statements about a stock to encourage people to buy it, often through direct solicitation by telephone, email, or the internet. Consumers pay inflated prices for the stock, which actually has little to no value.