Individual Investor? Here’s What You Need to Know About Securities Fraud
Securities fraud can take many forms. As an individual investor, knowing what to watch for can help mitigate your risk. However, you can never protect yourself entirely, and, as a result, it is important to know what to do if you suffer fraudulent losses as well.
We all know that investing is the key to retirement. For many people, investing is also a way to earn passive income—either as a supplement to their regular earnings or as a pathway to financial freedom. But, while there are many benefits to investing wisely, investing also involves risks—and this includes the risk of falling victim to securities fraud.
There are inherent risks to investing in securities. No one can predict the market with absolute certainty, and this means that investing is inherently speculative. But, while certain risks are considered acceptable (subject to an individual’s personal risk tolerance, financial circumstances and investment strategy), one risk that is never acceptable is the risk of securities fraud.
What is Securities Fraud?
Securities fraud can take many different forms. It is unfortunate that securities fraud exists at all, but the widespread and diverse nature of securities fraud means that individual investors face risks at virtually all stages of investing. For example, securities fraud can be committed by:
- Publicly-Traded Companies – Publicly-traded companies can commit securities fraud by withholding material information from investors, misrepresenting information, or delaying the release of unfavorable news.
- Private Companies – Private companies can commit securities fraud by making unregistered securities offerings in violation of federal law.
- Company Owners, Executives and Managers – Company owners, executives and managers can commit securities fraud by engaging in insider trading, misappropriating funds, concealing fraudulent acts, and misrepresenting information to the company’s accountants and lawyers.
- Stockbrokers and Brokerage Firms – Stockbrokers and brokerage firms can commit securities fraud by withholding or misrepresenting material information, engaging in unauthorized transactions, charging excessive fees, and making trades that do not serve their customers’ best interests.
- Investment Advisors and Advisory Firms – Investment advisors and advisory firms can commit securities fraud by withholding or misrepresenting material information, making unsuitable investment recommendations, overconcentrating investors’ portfolios, and engaging in various other forms of fraudulent conduct.
- Athletes, Celebrities, Influencers, and Community Members – Individuals not directly involved in the securities market can commit securities fraud by making misrepresentations, omitting material information, failing to disclose financial incentives, and using their influence to convince people to make risky investments or invest in fraudulent scams.
- Scam Artists – Scam artists can commit securities fraud by misrepresenting themselves as registered brokers or advisors, running “boiler rooms,” fabricating investment products, and using high-pressure tactics to misappropriate investors’ hard-earned funds.
As an individual investor, you trust professionals and securities industry regulators to help keep you safe. Unfortunately, there is only so much these individuals can do, and, in some cases (in fact, in many cases), investment professionals do not have their customers’ best interests in mind. For this reason, no matter how careful they are, individual investors should review their account statements regularly, and they should consult with an attorney if they have any concerns about suspicious activity or seemingly unexplained losses.
FBI: Investors Need to Be On the Lookout for These Forms of Securities Fraud
Several agencies enforce investor protections at the state and federal levels. One of these agencies is the Federal Bureau of Investigation (FBI). The FBI investigates allegations of securities fraud, and it works with the U.S. Department of Justice (DOJ) to prosecute individuals and companies suspected of defrauding individual investors.
The FBI has identified several priorities within the broad securities fraud arena. For example, the FBI is mainly focused on investigating cases involving:
1. High-Yield Investment Fraud
High-yield investment fraud is “[c]haracterized by promises of high rates of return with little or no risk.” Despite the inherent volatility of the securities market, some brokers, advisors and scam artists try to convince investors that they can find “can’t miss” investment opportunities—and they are often successful in doing so. Many investors fall victim to aggressive and high-pressure sales tactics, and they end up making rushed decisions that they would not have made under ordinary circumstances.
2. Ponzi Schemes and Pyramid Schemes
Ponzi schemes and pyramid schemes involve using investors’ money to pay fraudulent “returns” to previous investors. While these schemes will often appear to be legitimate investment opportunities (and scam artists are becoming increasingly sophisticated), there are still several red flags as well.
3. Advanced Fee Schemes
Advanced fee schemes are similar to high-yield investment fraud and Ponzi schemes in that they often involve high-pressure sales tactics, but the difference is that investors’ funds are usually deposited directly into the scam artists’ pockets. Investors are typically pressured into making a relatively small investment with the promise of substantial returns, and then they typically never hear from the supposed “broker” again.
4. Broker Embezzlement
In addition to fraud perpetrated by individuals posing as brokers, securities fraud committed by registered brokers is a genuine concern for individual investors as well. While stockbroker fraud can take many forms, the FBI focuses primarily on cases involving the embezzlement of funds from investors’ brokerage accounts.
5. Hedge Fund Fraud
Hedge funds pool investors’ money to pursue complex (and often high-risk) investment strategies. While some hedge funds prove to be extremely profitable, the risks involved mean that investing in a hedge fund is unsuitable for most individual investors. Failing to disclose risks, charging excessive fees, and other fraudulent practices often lead to substantial losses for hedge fund investors.
SEC: Investors Need to Be Wary of These Forms of Securities Fraud as Well
The U.S. Securities and Exchange Commission (SEC) is the federal agency with primary responsibility for overseeing the securities market in the United States. It pursues enforcement actions against companies, brokerage firms, and investment advisors as well, and it works as diligently as it can to protect investors from fraud.
The SEC’s website provides a wealth of resources for individual investors. For example, its Guide to Identifying and Avoiding Securities Fraud – published in 2009 but still very relevant today – highlights the risk of forms of securities fraud, including:
1. Affinity Fraud
Affinity fraud involves individuals using positions of trust and authority to perpetrate securities fraud scams against people who are close to them. It is a particular risk for older investors, who may have long-standing relationships with individuals who choose to perpetrate fraudulent schemes and who may be more susceptible to relying on the information they are provided.
2. Internet Fraud
If Internet fraud was a concern back in 2009, you can imagine how big of a concern it is today. From email scams and fake websites to fraudulent social media endorsements, Internet fraud is among the most significant securities fraud risks for individual investors.
3. Cold Calling and ”Pump and Dump” Schemes
While most people know of cold calling and “pump and dump” schemes from Hollywood movies, these are real scams that result in real losses for real investors. Individual investors need to be extremely wary of any unsolicited investment offers, and they should do their own careful research before investing.
4. Microcap Stock Fraud
Microcap stocks (or “penny stocks”) have always presented challenges for regulators, and today many apps and websites promote these investments as having “low barriers to entry” for people who are interested in dipping their toes into the stock market. However, the microcap market presents a high risk for fraud, and many investors end up suffering substantial losses.
5. Broker and Advisor Fraud
While many brokers and advisors act in their clients’ best interests, some do not. From making unauthorized trades (to generate commissions) to only sharing the information they want their clients to know, brokers and advisors can commit securities fraud in many different ways. Brokers and advisors at local, national and global firms routinely face scrutiny for securities fraud, and each year numerous investors are forced to file claims to recover fraudulent investment losses.
What Should You Do if You Fall Victim to Securities Fraud?
If you believe that you may be a victim of securities fraud, what should you do? While you can report the fraud to the FBI or the SEC, it will also be important for you to consult with a securities fraud attorney. While federal authorities can put a stop to the fraudulent conduct and pursue charges to punish bad actors, to recover your losses, you will need to file a claim of your own.
In many cases, recovering fraudulent investment losses involves pursuing a claim in FINRA arbitration. The Financial Industry Regulatory Authority (FINRA) is the SEC’s partner in policing the U.S. securities market, and its arbitration forum provides a venue for individual investors to recover fraudulent losses without going to court. Acting quickly can help to improve your chances of recovering your losses.
In order to help you decide if you are ready to pursue a securities fraud claim, the infographic below outlines the securities arbitration process: