The complexity of investing leads many investors to engage stockbrokers to manage their investment portfolios. Most investors trust their stockbrokers to make recommendations that benefit their investment portfolio, not damage it. However, stockbroker fraud occurs with alarming frequency.
The Financial Industry Regulatory Authority (FINRA) monitors U.S. broker-dealers and their employees. In 2020 alone, FINRA received 5,472 complaints from investors, a significant increase from the 2,954 complaints received in 2019. If you think your stockbroker committed fraud, contact a broker fraud attorney with the Kurta Law Firm today.
Common Types of Stockbroker Fraud
All too often, fraudulent stockbroker schemes can continue for years without raising the investor’s suspicions. Broker fraud typically results in significant losses for investors. If investors had to go through traditional litigation to recover their losses, each case could take a long time to resolve because traditional litigation can be a lengthy process. To help investors, FINRA arbitration provides a quicker means to recover investment losses. Some of the most common types of investment fraud are described below.
1. Insider Trading
Insider trading involves buying or selling stock by someone who has material information about the stock not publicly available at the time of the transaction. Material information includes any information that may substantially impact an investor’s decision to buy or sell the stock. Insider trading also includes divulging material nonpublic information to another person, even if you do not make the trades yourself.
The SEC charged Martha Stewart with insider trading in 2003 for allegedly selling 4,000 shares of ImClone Systems after receiving a tip from her Merrill Lynch broker that ImClone’s CEO had sold all his shares. This information was material, nonpublic, and resulted in insider trading charges for Stewart and her broker.
2. Ponzi-Like Schemes
Ponzi schemes are fraudulent investment operations that use funds from new investors to pay fake returns to earlier investors. A Ponzi scheme can only operate as long as there are new investors. Once the company runs out of new investors, the scheme falls apart.
When you hear about Ponzi schemes, you might think of Bernie Madoff. Madoff operated one of the biggest Ponzi scheme securities frauds of all time and defrauded thousands of investors out of billions of dollars.
3. Pump-and-Dump Schemes
A “pump-and-dump” is a form of securities fraud using false, misleading, or exaggerated claims to boost the price of a stock.
Typically, originators of the scheme have already purchased the stock targeted in the scheme. The con artists will post misleading social media statements about the targeted stock, claiming the company is planning to release a development causing the stock price to jump drastically. In response, other individuals take the bait and purchase the stock, causing the price to increase.
After the new investors have bought into the company and caused the stock price to rise, the originators of the pump-and-dump scheme will sell, or “dump,” all their shares. This causes the stock price to drop dramatically, leaving new investors with substantial losses.
If you invest in a stock based on similar fabricated claims, you may be the victim of a pump-and-dump scheme. An experienced broker fraud attorney can work to recover your investment losses.
4. Misappropriation of Client Funds
One of the most blatant forms of broker fraud involves the outright theft of client funds. This occurs when a stockbroker deposits client funds into their own account rather than into the client’s investment account. Here’s a typical example: A broker makes an investment recommendation to a client that requires issuing a check to the broker. But the broker does not use the check to fund the purported investment. Rather, the broker deposits the check into their personal bank account. Unfortunately, many elderly investors fall victim to this kind of stockbroker fraud.
FINRA Rule 2150 addresses the conversion of client funds for personal use directly. If you suspect your stockbroker is stealing your money, reach out to a broker fraud lawyer to determine what options you have.
5. Misrepresentation or Omission of Material Facts
Almost every fraud allegation involves a claim of misrepresentations. With respect to an investment advisor fraud claim, misrepresentation means your financial advisor purposely presented you with misleading or untruthful information about an investment product. Omission refers to situations where brokers leave out specific information. This information must be relevant to your decision of whether to invest in a product.
Such omissions can hinder your ability to make an informed decision, potentially causing you losses. If your broker misrepresented an investment opportunity or omitted material facts, you should contact a stockbroker fraud attorney right away.
6. Unauthorized Trading
Generally, financial advisors must have a client’s permission or authorization to make trades in their investment account. How the broker obtains the client’s permission depends on whether the client uses a non-discretionary investment account or a discretionary investment account.
Non-discretionary accounts give investors more control over the investment account. If you have a non-discretionary account, your broker must get your verbal or written authorization prior to making any trades in your account.
Discretionary accounts give more authority to the broker managing your portfolio. Brokers managing discretionary accounts do not have to obtain authorization before making trades. Instead, the investor places certain limits on the types of securities they wish to invest in or how to balance their portfolio, and the broker is free to trade within those limits without obtaining authorization. However, brokers must still only place suitable trades in discretionary accounts, and brokerage firms must regularly review such accounts to ensure regulations are met.
If you suspect your broker of making unauthorized trades in your account, you must report the misconduct immediately. Otherwise, their firm may argue you ratified the transaction by failing to object to it. Not sure how to report the unauthorized transactions? Contact our office, and we will help walk you through the process.
7. Excessive Trading (Churning)
Excessive trading, also known as churning, occurs when a broker makes multiple trades in a customer’s investment account for the primary purpose of generating high commissions. In some cases, diligent investors can catch excessive trading by their broker before suffering significant losses. One sign of churning can be a high volume of trading activity in a short period, especially for investors pursuing a conservative investment strategy. Also, pay close attention to repeated transactions involving the purchase and sale of the same securities.
Another sign of excessive trading activity involves unusually high commission fees on your account statement. If the commission fees jump significantly from one month to the next, or if one segment of your investment portfolio consistently generates higher commissions than any other segment, there is a chance your broker is churning your account.
8. Offering Unregistered Securities
Federal securities law prohibits companies from selling securities unregistered with the SEC unless the securities qualify for an exemption. Generally, unregistered securities receive less regulation. And since regulations are intended to protect investors, less regulation can mean less protection for you. While some unregistered securities offerings are legitimate, others are used by fraudsters to conduct elaborate investment scams. Common signs of fraudulent unregistered securities include:
- Claims of high returns with little or no risk;
- Aggressive sales tactics;
- Inability to locate company information;
- Unregistered or unlicensed investment professionals;
- Lack of net worth and income requirements;
- Unsolicited offers through phone calls or email; and
- Issues with sales documentation.
Remember, if an investment opportunity seems too good to be true, it probably is.
Tips for Avoiding Broker Fraud
Despite the frequency of investment advisor fraud, you can take certain precautions to help protect you and your investments from losses. Things you can do to avoid fraud include:
- Ask your broker questions if you don’t understand something;
- Check your stockbroker’s background;
- Research a company before you invest;
- Regularly review your account statements; and
- Understand the red flags signaling a potentially fraudulent scheme.
Knowing what red flags to look for can allow you to recognize the signs of a fraudulent investment scheme from the outset. If you catch the fraud early, it could save you from suffering significant investment losses.
Were You a Victim of Broker Fraud? Contact a Broker Fraud Attorney Today
If a stockbroker’s fraud contributed to your investment losses, you could recover those losses through FINRA arbitration. At the Kurta Law Firm, we represent investors seeking to recover their investment losses occurring as a result of broker fraud. Contact our office today so we can get started on your case.