Securities fraud includes a wide range of illegal activities, all of which involve the deception of investors or the manipulation of financial markets. Under federal law, a person commits the criminal offense of securities and commodities fraud by using any scheme or artifice to defraud another person in connection with any security or commodity. 18 U.S.C. §1348. This statute applies to any securities (financial instruments such as stocks, bonds, options, certificates of deposit, etc.) whose issuer is required to register or file reports under the Securities Exchange Act of 1934—which are generally publicly traded companies.
A violation of one of these federal statutes may constitute securities fraud: (1) The Securities Act of 1933 (15 U.S.C. §77a); (2) The Securities Exchange Act of 1934 (15 U.S.C. §78a); (3) The Trust Indenture Act of 1939 (15 U.S.C. §77aaa to 15 U.S.C. §77bbbb); (4) The Investment Company Act of 1940 (15 U.S.C. §80a-1); or (5) The Investment Advisors Act of 1940 (15 U.S.C. §80b-1).
And one of the most important rules regarding securities fraud was created by the Securities and Exchange Commission (SEC) and is located in the Code of Federal Regulations at 17 CFR §240.10b-5. Rule 10b-5 makes it unlawful for any person to directly or indirectly use the U.S. mail or any means of interstate commerce or any national securities exchange to (1) employ any device, scheme, or artifice to defraud; (2) make any untrue statement of a material fact, or to omit to state a material fact necessary in order to make the statements made not misleading, in light of the circumstances under which they were made; or (3) engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security.
Some common forms of federal securities fraud include:
Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security. Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.
Examples of insider trading cases that have been brought by the SEC are cases against:
• Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments;
• Friends, business associates, family members, and other "tippees" of such officers, directors, and employees, who traded the securities after receiving such information;
• Employees of law, banking, brokerage and printing firms who traded based on information they obtained in connection with providing services to the corporation whose securities they traded;
• Government employees who traded based on confidential information they learned because of their employment with the government;
• Political intelligence consultants who may tip or trade based on material, nonpublic information they obtain from government employees; and
• Other persons who misappropriated, and took advantage of, confidential information from their employers, family, friends, and others.
Because insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.
Accounting fraud generally involves the manipulation or falsification of a publicly traded company’s financial records with the intent to misrepresent the company’s assets or liabilities.
Pump and Dump
In a pump and dump scheme, fraudsters typically spread false or misleading information to create a buying frenzy that will “pump” up the price of a stock and then “dump” shares of the stock by selling their own shares at the inflated price. Once the fraudsters dump their shares and stop hyping the stock, the stock price typically falls and investors lose money.
False or misleading information about a company’s stock price may be spread through sources including social media, investment research websites, investment newsletters, investment clubs, online advertisements, e-mail, internet chat rooms, direct mail, newspapers, magazines, and radio. Microcap companies are particularly vulnerable to pump and dump schemes because there is often limited publicly-available information about microcap companies.
Offering frauds (offering securities for sale) come in many different forms. Generally, an offering fraud involves a security of some sort that is offered to the public, where the terms of the offer are materially misrepresented. The offerings, which can be made online, may make misrepresentations about the likelihood of a return. For example, the fraudsters may use a website to offer investors a “guaranteed return” of 1.5% per day, for example.
Other online offerings may not be fraudulent per se (on their face) but may still fail to comply with the applicable registration provisions of the federal securities laws. Although the federal securities laws require the registration of solicitations or offerings, some offerings are exempt.
A broker typically earns a portion of the commissions or other fees on each purchase or sale of securities that the brokerage firm makes for an investor. When a broker engages in excessive buying and selling (i.e., trading) of securities in a customer’s account without considering the customer’s investment goals and primarily to generate commissions that benefit the broker, the broker may be engaged in an illegal practice known as churning.
Red flags of excessive trading may include:
• Unauthorized Trading—be alarmed if you become aware of trades in your account that you did not authorize your broker to make.
• Frequent Trading—be wary of frequent in-and-out purchases and sales of securities that don’t seem consistent with your investment goals and risk tolerance.
• Excessive Fees—be suspicious if the total amount of fees seems high or if one segment of your portfolio consistently generates high fees.
Outsider trading is the sale or purchase of publicly traded securities on the basis of material, nonpublic information by individuals who do not qualify as insiders. Outsider trading is increasingly done by criminals who access the material, nonpublic information by illegally accessing or breaching corporate, government, or personal computers, systems, and networks (hacking).
Other common forms of securities fraud include:
High Yield Investment Frauds
High yield investment frauds are characterized by promises of high rates of return with little or no risk.
• May involve various forms of investments (e.g. securities, commodities, real estate, precious metals, etc.)
• "Too good to be true” investment opportunities
• Perpetrators may contact victims by telephone, e-mail, or in person
• The offers are generally unsolicited
Ponzi & Pyramid Schemes
• Use money collected from new victims to pay the high rates of return promised to earlier investors
• Payouts give the impression of a legitimate, money-making enterprise behind the fraudster's story
• In reality, investors are the only source of funding
Advance Fee Schemes
• Victims advance relatively small sums of money in the hope of realizing much larger gains
• Gains never materialize because there is no legitimate underlying investment
• To participate a particular investment opportunity, victims must first send funds to cover “taxes” or “processing fees”
• After victims send the “fees,” the perpetrators appropriate the funds and never deliver on the investment.
Foreign Exchange Currency Fraud
Foreign exchange (Forex) currency fraud scams attract customers with sophisticated-sounding offers placed in newspaper advertisements, radio promotions, or on internet sites. Promoters often lure investors with the concept of leverage—the right to control a large amount of foreign currency with an initial payment representing only a fraction of the total cost.
These promotions often include predictions of inevitable increases in currency prices, offering huge returns over a short period of time, with little risk. In a typical case, investors may be assured of reaping tens of thousands of dollars in just a few weeks or months, with an initial investment of only $5,000, for example. Typically, the investor’s money is never actually placed in the market or through a legitimate dealer—it is simply diverted or stolen for the personal benefit of the criminals.
Broker embezzlement fraud schemes involve illegal and unauthorized actions by brokers to steal directly from their clients. Such schemes may be facilitated by the forging of client documents, doctoring of account statements, unauthorized trading/funds transfer activities, or other conduct in breach of the broker’s fiduciary responsibilities to the client.
Hedge Fund Fraud
Hedge funds pool money from investors and invest in securities or other types of investments with the goal of getting positive returns. Hedge funds are not regulated as heavily as mutual funds and generally have more leeway than mutual funds to pursue investments and strategies that may increase the risk of investment losses. Hedge funds are limited to wealthier investors (accredited investors) who can afford the higher fees and risks of hedge fund investing, and institutional investors, including pension funds.
Hedge fund fraud can take many forms, including a person pretending to be a successful hedge fund manager while raising large amounts of money and promising consistently high returns. It is common in such frauds for the hedge fund manager to make few if any real investments, and to withdraw and spend the cash to support a lavish lifestyle.
Late trading refers to the practice of placing orders to buy or redeem mutual fund shares after the time as of which a mutual fund has calculated its net asset value (NAV)—usually as of the close of trading at 4:00 p.m. Eastern Time—but receiving the price based on the prior NAV already determined as of that day. Late trading violates the federal securities laws concerning the price at which mutual fund shares must be bought or redeemed and defrauds innocent investors in those mutual funds by giving the late trader an advantage not available to other investors. The late trader obtains an especially significant advantage—at the expense of the other shareholders of the mutual fund—when he learns of market-moving information and is able to purchase or redeem mutual fund shares at prices set before the market-moving information was released.