CORPORATE SHAREHOLDER
FRAUD
Investment
and brokerage houses commit fraud when they offer false or
deceptive information to their investors in an effort to
manipulate the market. The SEC has set business standards for
broker-dealers to follow in order to advise investors well, and
handle the flow of inside information fairly.
Investment
advisors and stockbrokers are responsible for providing
information that is accurate and complete to investors.
Investment fraud (AKA brokerage fraud) occurs when an advisor,
stockbroker, or brokerage firm offers inaccurate, incomplete, or
biased information in an effort to control the market or draw
business. The SEC has established guidelines for stockbrokers
and advisors to follow to ensure that investment advice is being
given fairly and consistently.
TYPES OF INVESTMENT
FRAUD
Biased Investment Advice
An advisor may have a
preference towards or against a specific company and advise
his or her clients according to that bias instead of
research results.
Unfounded
Advice
An advisor may persuade or
discourage an investor toward, or against a company, without
the support of appropriate research.
Contradictory Investment
Advice
An advisor may give
contradicting advice to different clients.
Continuing a Risk
-
An advisor may advise his or her client to 'stay in' when
the risk is apparent and the potential gain is unlikely.
Conflict of Interest
-
An advisor or firm that has outside ties to a business may
sell that business's stock, even if the investment
opportunity is not the most lucrative for the client.
Churning
-
In order to create additional broker’s fees, a form of
stock fraud called “churning” is used. Churning requires
a large numbers of transactions; often this form of stock
fraud consists of selling stocks with small gains in order
to show a profit.
Over-Concentration -
Failure to diversify a client’s portfolio can be a form of
stock fraud. In order to protect a client’s assets, the
broker should vary the types of stock purchased, stock fraud
through over concentration strips the client of the
protection diversification can afford.
Unsuitability
-
Stock frauds involving unsuitability occur when the broker
recommends stocks that are outside the client’s risk
tolerance. Stock frauds committed through unsuitable matches
allow the broker to push undesirable stocks; this stock
fraud frequently results in losses much higher than the
client can bear.
Misrepresentation/Omission
-
This form of stock fraud occurs when the broker
intentionally misleads the customer about material facts
regarding the stock. Stock fraud involving misrepresentation
or omission often disguises risk factors associated with
that particular stock.
SEC GUIDELINES FOR STOCKBROKERS
Because the investor-advisor relationship balances the trust of
the investor with the knowledge of the advisor, guidelines are
necessary to protect both parties. The investor must receive
accurate information, but also must understand the risks
involved in investment. In October of 1998, the SEC set
standards for how stockbrokers, dealers, and advisors would
distribute information (section IV of the "Compliance Guide
to the Registration and Regulation of Brokers and
Dealers"). The intent of the compliance guide was to create
an investment environment where the investor knew his advisor
was seeking to find him or her the best possible gains, and the
advisor could perform his or her duties reasonably within a risk
market with normal fluctuations.
Fair Dealing
By establishing oneself as a stockbroker, an individual
becomes accountable to the standard rules and laws of the
profession. Among these standards are requirements to:
"execute orders promptly, disclose material [relevant]
information…charge prices reasonably related to the
prevailing market, and fully disclose any conflict of
interest."
Best Execution
The stockbroker must find the best deal for the client. As
an advisor, he or she is responsible to the client for the
money being invested. An advisor must assess what the
appropriate risk level for the investor is, and which market
will provide that investor with the greatest gains. The
stockbroker is responsible to buy and sell within this
market.
Customer Confirmation Rule
The stockbroker must receive the investor's permission
before purchasing stocks, bonds, or mutual funds. The
investor must be informed as to:
~ The date and time the
investment will be made
~ Which companies will be
invested in
~ How many shares will be
purchased
~ What the purchase price of each
share is
~ How much stockbroker commission
will be charged, and how it will be charged
~ If the stockbroker or dealer is
an SIPC (Securities Investor Protection Corporation)
member
~ Expected yield
Disclosure of Credit Terms
If the client desires to purchase securities on credit,
the dealer must explain the credit terms upfront. In
addition, the status of the client's account must be
provided when he or she initially purchases shares, and
again on each of the client's quarterly account statements.
Short Sales
In a short sale a stockbroker sells securities that are
'on loan.' If an investor realizes that the value of his or
her shares is going down, he or she may lend them to a
stockbroker, who will sell them at the market price. When
prices go down, the stockbroker will repurchase the shares
at their low point, and make a profit between the difference
of what they were sold at (high market price), and what they
were bought back at (new, low market price). Regardless of
whether share prices go up or down, the stockbroker must
return the original number of shares to the lender. He or
she is, in a sense, borrowing them against a drop in the
market. These sales are highly restricted.
Trading During an Offering
A public offering occurs when new securities are made
available to the public. When a company first 'goes public,'
it will hold an initial public offering. Individuals
participating in an offering may not manipulate the price of
the security. For example, a brokerage firm that is
underwriting an IPO may not purposefully undervalue its IPO
client's shares to make profits when the shares hit a more
accurate market price.
Inside Trading
Stockbrokers, dealers, and advisors often have access to
private material. Dealers may not make trades based on this
information. Preventative measures must be taken to maintain
an equal distribution of information among investors (that
is to say, certain investor should not be privileged with
inside information). Some ways through which information
leaks can be prevented:
Trading restrictions for
employees of brokerage houses
Information control between
departments of brokerage firms
Employee training
