What Is Stock Market Fraud?
Stock market fraud occurs through unlawful and deceitful manipulation of stock trading. This can involve individual brokers, brokerage firms and investment or financial planners. The level of fraud can vary from misrepresentation of a stock to the stock advisor's intentional disregard for his customer's interests in order to serve his own financial gain. In order to avoid stock market fraud scams, the U.S. Security and Exchange Commission advises investors to be skeptical of stock "tips," consider the source, verify claims independently, beware of high-pressure pitches and research the company thoroughly.
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Insider Trading
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Insider trading occurs when an employee of a company buys or sells shares in her company. It is legal for employees to do this under very specific conditions, providing they file the proper forms with the SEC. It is illegal for an employee to do this if they have information that will affect the value of its stock that is not known to the public, or to pass along this information to a third party so that they can profit from this information. Illegal insider trading is considered commonplace, however, occasionally high-profile cases have come to light and been prosecuted. One such case in the late 1990s involved a man named Anthony Elgindy who conspired with a corrupt FBI agent to gain information on ongoing criminal investigations of company executives and used that information to manipulate the company's stock value.
Pump and Dump
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Stock brokers "pump" a stock by waging a campaign to convince investors that a stock is about to dramatically increase in value due to some new product, industry breakthrough or some other news that hasn't yet become widely known. They send messages over the Internet, post on investment blogs and even go on television to promote this "once-in-a-lifetime opportunity." Fueled by speculation, the stock price climbs. Insiders, knowing that the hype isn't true, wait until speculation reaches its peak and then "dump" their shares at a huge profit. When the truth comes out, the stock price crashes as everyone tries to sell their shares before it hits the bottom. Those who hang on the longest lose the most.
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Churning
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Some investors give a great deal of control of their accounts to their broker through either a formal written agreement that sets up a discretionary account, or in a de facto sense, wherein the broker recommends most or all of his client's trades. Churning is a term that refers to a broker excessively buying and selling stocks in his client's portfolio for the purpose of generating commissions or fees.
Private Broker-Dealer Self-Offerings
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Private brokerage firms (those not publicly traded on the stock exchange) sometimes raise capital to finance their operations by selling stock in their own (or their affiliate's) company. Private broker-dealer self-offerings can present substantial risk. Besides the inherent conflict of interest, state and federal laws often prohibit the investor from selling broker-dealer self-offerings within a year of purchase, and there is no guarantee that the investor will be able to sell his shares later. Investors are often taken in by high-pressure sales tactics and claims that they will be able to "cash-in" by getting in on the "ground floor."
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References
- Qwoter.com: Stock Market Scams: Pump and Dump
- CNN Money.com; Ex-FBI Agent, Trader Guilty of Fraud; January 2005
- Stock Fraud Newswire: Stock Fraud Information
- U.S. Securities and Exchange Commission; Investor Alert; March 2001
- FINRA: Brokerage Firm Private Securities Offerings: Buying Your Brokerage
- U.S. Securities and Exchange Commission; Churning; April 2009
