Deceptive or fraudulent activities involving stock or commodities markets are generally known as securities fraud. The term “securities” includes the vast range of financial instruments representing the rights of investors to income, voting rights, and other benefits. Stocks, treasury stocks, bonds, and notes are a tiny sample of the vast array of securities. Unlike cash or tangible property, securities have no intrinsic value. Their value is based on market conditions, representations made by the issuer, and other extrinsic factors.
Like other fraud offenses, securities fraud is typically perpetrated through one or more schemes to induce others to put forth money or something else of value willingly. Some types of securities fraud, however, may involve embezzlement, which is a theft offense. Statutes at the federal and state level prohibit securities fraud, although federal agencies like the Securities and Exchange Commission (SEC) play a substantial role in investigating and prosecuting alleged offenses. Relatively new developments like online trading have led to an increase in cybercrime schemes and increased use of the wire fraud statute to prosecute alleged offenders
Federal and State Law
The United States Code has a complex set of laws regulating the securities industry. A securities fraud offense, as defined by federal law, includes violations of the following statutes:
- The Securities Act of 1933;
- The Securities Exchange Act of 1934;
- The Trust Indenture Act of 1939;
- The Investment Company Act of 1940; or
- The Investment Advisers Act of 1940.
The federal offense of securities and commodities fraud prohibits any “scheme or artifice” to defraud a person, or fraudulently obtain money, in connection with commodities, commodity options, or securities. The statute applies to any security whose issuer is required to register or file reports under the Securities Exchange Act of 1934, generally known as publicly traded companies.
Corporate Securities Fraud
In some instances, entire corporations are engaged in securities fraud. Examples include the Enron scandal of the early 2000s and the subprime mortgage crisis of 2007-08. High-level corporate officers may use the structures of the corporation to carry out fraudulent schemes, or they may misrepresent or withhold information about the corporation in public filings in order to manipulate its stock price. Corporations may also defraud investors through actions like Ponzi schemes.
Individual Securities Fraud
Stockbrokers, investment bankers, analysts, and traders, to name a few of the professions in the securities industry, may commit securities fraud with the access and resources obtained through their jobs. Disseminating false or misleading information on the Internet in an effort to influence stock prices is a common form of securities fraud. Another well-known form of securities fraud is insider trading, which involves trading in the stock market with the benefit of information that is not available to the public.
The SEC defines microcap stocks as low-priced stocks of smaller companies, usually those with less than $300 million in market capitalization. “Penny stocks” are even smaller, often trading for fractions of a cent. These stocks do not trade in the big exchanges like NASDAQ, and therefore they are not subject to the disclosure requirements of the larger exchanges. A microcap fraud scheme might involve misrepresentation of the size of the company and the value of its stock, which induces an investor to make a large purchase at an inflated price.
Ponzi schemes, pyramid schemes, and similar types of investment fraud involve soliciting money from investors for an investment fund and then using their contributions to pay earlier investors, who believe they are receiving revenue from the investment. The principals of the scheme skim money from all of the investors’ contributions. These schemes inevitably collapse, but they still cost investors billions of dollars every year.