Share Marketing
Securities & Service fraud
Securities
fraud, also known as stock fraud and investment
fraud, is a deceptive practice in the stock or commodities markets that
induces investors to make purchase or sale decisions on the basis of false
information, frequently resulting in losses, in violation of securities laws.
Securities
fraud can also include outright theft from investors, stock
manipulation, misstatements on a public company's financial reports, and
lying to corporate auditors. The term encompasses a wide range of other
actions, including insider trading, front running and
other illegal acts on the trading floor of a stock or commodity exchange.
Types of
securities fraud :-
Corporate fraud
Corporate misconduct
Fraud
by high level corporate officials became a subject of wide national attention
during the early 2000s, as exemplified by corporate officer misconduct at Enron. It became a problem
of such scope that the Bush Administration announced what it described as an
"aggressive agenda" against corporate fraud. Less widely
publicized manifestations continue, such as the securities fraud conviction of
Charles E. Johnson Jr., founder of PurchasePro in
May 2008. Then-FBI Director Robert Mueller predicted
in April 2008 that corporate fraud cases will increase because of the subprime mortgage crisis.
Dummy corporations
Dummy corporations may be created by fraudsters to create
the illusion of being an existing corporation with a similar name. Fraudsters then sell
securities in the dummy corporation by misleading the investor into thinking
that they are buying shares in the real corporation.
Internet fraud
According
to enforcement officials of the Securities and Exchange Commission,
criminals engage in pump-and-dump schemes, in which false
and/or fraudulent information is disseminated in chat rooms, forums, internet
boards and via email (spamming), with the purpose of causing a dramatic price
increase in thinly traded stocks or stocks of shell companies (the
"pump"). In other instances, fraudsters disseminate materially false
information about a company in hopes of urging investors to sell their shares
so that the stock price plummets.
When
the price reaches a certain level, criminals immediately sell off their
holdings of those stocks (the "dump"), realizing substantial profits
before the stock price falls back to its usual low level. Any buyers of the
stock who are unaware of the fraud become victims once the price falls.
The
SEC says that Internet fraud resides in several forms:
·
Online
investment newsletters that offer seemingly unbiased information free of charge
about featured companies or recommending "stock picks of the month".
These newsletter writers then sell shares, previously acquired at lower prices,
when hype-generated buying drives the stock price up. This practice is known
as scalping. Conflict of interest disclosures
incorporated into a newsletter article may not be sufficient. Accused of
scalping, Thom Calandra, formerly of MarketWatch,
was the subject of an SEC enforcement
action in 2004.
·
Bulletin
boards that often contain fraudulent messages by hucksters.
·
E-Mail
spams from perpetrators of fraud.
·
Phishing
Insider trading
There
are two types of "insider trading". The first is the trading of a
corporation's stock or other security by corporate insiders such as officers,
key employees, directors, or holders of more than ten percent of the firm's
shares. This is generally legal, but there are certain reporting requirements.
The
other type of insider trading is the purchase or sale of a security based on
material non-public information. This type of trading is illegal in most
instances. In illegal insider trading, an insider or a related party trades
based on material non-public information obtained during the performance of the
insider's duties at the corporation, or otherwise misappropriated.
Microcap fraud
In microcap fraud,
stocks of small companies of under $250 million market capitalization are
deceptively promoted, then sold to an unwary public. This type of fraud has
been estimated to cost investors $1–3 billion annually. Microcap fraud
includes pump and dump schemes involving boiler rooms and scams on the Internet.
Many, but not all, microcap stocks involved in frauds are penny stocks,
which trade for less than $5 a share.
Many
penny stocks, particularly those that sell for fractions of a cent, are thinly
traded. They can become the target of stock promoters and manipulators. These manipulators first
purchase large quantities of stock, then artificially inflate the share price
through false and misleading positive statements. This is referred to as a pump
and dump scheme. The pump and dump is a form of microcap stock fraud. In more sophisticated
versions of the fraud, individuals or organizations buy millions of shares,
then use newsletter websites, chat rooms, stock message boards, press releases,
or e-mail blasts to drive up interest in the stock. Very often, the perpetrator
will claim to have "inside" information about impending news to
persuade the unwitting investor to quickly buy the shares. When buying pressure
pushes the share price up, the rise in price entices more people to believe the
hype and to buy shares as well. Eventually the manipulators doing the
"pumping" end up "dumping" when they sell their holdings. The
expanding use of the Internet and personal communication devices has made penny
stock scams easier to perpetrate. But it has also drawn high-profile
public personalities into the sphere of regulatory oversight. Though not a scam
per se, one notable example is rapper 50 Cent's use
of Twitter to
cause the price of a penny stock (HNHI) to increase dramatically. 50 Cent had
previously invested in 30 million shares of the company, and as a result made
$8.7 million in profit. Another example of an activity that skirts the
borderline between legitimate promotion and hype is the case of LEXG. Described
(but perhaps overstated) as "the biggest stock promotion of all
time", Lithium Exploration Group's market capitalization soared to over
$350 million, after an extensive direct mail campaign. The promotion drew upon
the legitimate growth in production and use of lithium, while touting Lithium
Exploration Groups position within that sector. According to the company's
December 31, 2010, form 10-Q (filed within months of the direct mail
promotion), LEXG was a lithium company without assets. Its revenues and assets
at that time were zero. Subsequently, the company did acquire lithium
production/exploration properties, and addressed concerns raised in the press.
Penny
stock companies often have low liquidity. Investors may encounter difficulty
selling their positions after the buying pressure has abated, and the
manipulators have fled.
Accountant fraud
In
2002, a wave of separate but often related accounting scandals became known to
the public in the U.S. All of the leading public accounting firms—Arthur
Andersen, Deloitte & Touche, Ernst & Young, KPMG,
PricewaterhouseCoopers— and others have admitted to or have been charged with
negligence to identify and prevent the publication of falsified financial
reports by their corporate clients which had the effect of giving a misleading
impression of their client companies' financial status. In several cases, the
monetary amounts of the fraud involved are in the billions of USD.
Boiler rooms
Boiler
rooms or boiler houses are stock brokerages that put undue pressure on clients
to trade using telesales, usually in pursuit of microcap fraud
schemes. Some boiler rooms offer clients transactions fraudulently, such as
those with an undisclosed profitable relationship to the brokerage. Some
'boiler rooms' are not licensed but may be 'tied agents' of a brokerage house
which itself is licensed or not. Securities sold in boiler rooms include
commodities and private placements as well as microcap stocks,
non-existent, or distressed stock and stock supplied by an intermediary at an
undisclosed markup.
Mutual Fund fraud
A
number of major brokerages and mutual fund firms were accused of various
deceptive acts that disadvantaged customers. Among them were late trading and
market timing. Various SEC rules were enacted to curtail this practice. Bank
of America Capital Management was accused by the SEC of having undisclosed
arrangements with customers to allow short term trading.
Short selling abuses
Abusive short selling,
including certain types of naked short selling, are also considered
securities fraud because they can drive down stock prices. In abusive naked
short selling, stock is sold without being borrowed and without any intent to
borrow. The practice of spreading false information about stocks, to drive
down their prices, is called "short and distort". During the takeover
of Bear Stearns by J.P. Morgan Chase in
March 2008, reports swirled that shorts were spreading rumors to drive down
Bear Stearns' share price. Sen. Christopher Dodd, D-Conn., said this was more
than rumors and said, "This is about collusion.
Ponzi scheme.
A
Ponzi scheme is an investment fund where withdrawals are
financed by subsequent investors, rather than profit obtained through
investment activities. The largest instance of securities fraud committed by an
individual ever is a Ponzi scheme operated by former NASDAQ chairman Bernard Madoff,
which caused up to an estimated $64.8 billion in losses depending on which
method is used to calculate the losses prior to its collapse.
Pervasiveness
of securities fraud
The Securities Investor Protection
Corporation (SIPC) reports that the Federal Trade Commission, FBI, and state securities
regulators estimate that investment fraud in the United States ranges from
$10–$40 billion annually. Of that number, SIPC estimates that $1–3 Billion is
directly attributable to microcap stock fraud. Fraudulent schemes
perpetrated in the securities and commodities markets can ultimately have a
devastating impact on the viability and operation of these markets.
Class
action securities fraud lawsuits rose 43 percent between 2006 and 2007,
according to the Stanford Law School Securities Class Action Clearinghouse.
During 2006 and 2007, securities fraud class actions were driven by market wide
events, such as the 2006 backdating scandal and the 2007 subprime crisis.
Securities fraud lawsuits remained below historical averages.
Some
manifestations of this white collar crime have become more
frequent as the Internet gives criminals greater access to
prey. The trading volume in the United States securities and commodities markets, having
grown dramatically in the 1990s, has led to an increase in fraud and misconduct
by investors, executives, shareholders,
and other market participants.
Securities
fraud is becoming more complex as the industry develops more complicated investment vehicles. In addition, white collar
criminals are expanding the scope of their fraud and are looking outside the
United States for new markets, new investors, and banking secrecy
havens to hide unjust enrichment.
A
study conducted by the New York Stock Exchange in the mid-1990s
reveals approximately 51.4 million individuals owned some type of traded stock, while 200 million
individuals owned securities indirectly. These same financial markets provide
the opportunity for wealth to be obtained and the opportunity for white collar
criminals to take advantage of unwary investors.
Recovery
of assets from
the proceeds of securities fraud is a resource intensive and expensive
undertaking because of the cleverness of fraudsters in concealment of assets
and money laundering, as well as the tendency of
many criminals to be profligate spenders. A victim of securities
fraud is usually fortunate to recover any money from the defrauder.
Sometimes
the losses caused by securities fraud are difficult to quantify. For example,
insider trading is believed to raise the cost of capital for securities
issuers, thus decreasing overall economic growth.
Characteristics
of victims and perpetrators
Any
investor can become a victim, but persons aged fifty years or older are most
often victimized, whether as direct purchasers in securities or indirect
purchasers through pension funds. Not only do investors lose
but so can creditors, taxing authorities, and employees.
Potential
perpetrators of securities fraud within a publicly traded firm include any
dishonest official within the company who has access to the payroll or
financial reports that can be manipulated to:
1.
overstate
assets
2.
overstate
revenues
3.
understate
costs
4.
understate
liabilities
5.
understate
penny stock
Enron Corporation exemplifies
all five tendencies, and its failure demonstrates the extreme dangers of a
culture of corruption within a publicly traded corporation. The rarity of such
spectacular failures of a corporation from securities fraud attests to the
general reliability of most executives and boards of large corporations. Most
spectacular failures of publicly traded companies result from such innocent
causes as marketing blunders (Schlitz), an obsolete
model of business (Penn Central, Woolworth's), inadequate market share (Studebaker), non-criminal
incompetence .
Other
effects of securities fraud
Even
if the effect of securities fraud is not enough to cause bankruptcy, a lesser
level can wipe out holders of common stock because of the leverage of value of
shares upon the difference between assets and liabilities. Such fraud has been
known as watered stock, analogous to the
practice of force-feeding livestock great amounts of water to inflate their
weight before sale to dealers.
Penny
stock regulation
The
regulation and prosecution of securities fraud violations is undertaken on a
broad front, involving numerous government agencies and self-regulatory organizations. One method
of regulating and restricting a specific type of fraud perpetrated by pump and
dump manipulators, is to target the category of
stocks most often associated with this scheme. To that end, penny stocks have
been the target of heightened enforcement efforts. In the United States,
regulators have defined a penny stock as
a security that must meet a number of specific standards. The criteria include
price, market capitalization, and minimum shareholder
equity. Securities traded on a national stock
exchange, regardless of price, are exempt from regulatory
designation as a penny stock, since it is thought that exchange traded
securities are less vulnerable to manipulation. Therefore, CitiGroup (NYSE:C)
and other NYSE listed
securities which traded below $1.00 during the market downturn of 2008–2009,
while properly regarded as "low priced" securities, were not
technically "penny stocks". Although penny stock trading in the
United States is now primarily controlled through rules and
regulations enforced by the United States
Securities and Exchange Commission (SEC) and the Financial Industry Regulatory
Authority (FINRA), the genesis of this control is found in
State securities law. The State of
Georgia was the first state to codify a comprehensive penny stock
securities law. Secretary of State Max Cleland,
whose office enforced State securities laws was a principal proponent of
the legislation. Representative Chesley V.
Morton, the only stockbroker in
the Georgia General Assembly at the time,
was principal sponsor of the bill in the House of Representatives. Georgia's
penny stock law was subsequently challenged in court. However, the law was
eventually upheld in U.S. District Court, and the statute became
the template for laws enacted in other states. Shortly thereafter, both FINRA
and the SEC enacted comprehensive revisions of their penny stock regulations.
These regulations proved effective in either closing or greatly
restricting broker/dealers, such as Blinder, Robinson &
Company, which specialized in the penny stocks sector. Meyer Blinder was jailed
for securities fraud in 1992, after the collapse of his firm. However,
sanctions under these specific regulations lack an effective means to
address pump and dump schemes perpetrated by
unregistered groups and individuals.
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