Generally, securities fraud occurs when someone makes a false statement about a company or the value of its stock, and others makes financial decisions based on the false information. Although the crime itself isn’t complicated, securities fraud can be particularly difficult to grasp if you lack an understanding of securities regulation. Below, you’ll find information on common forms of securities fraud and how to protect your assets.
Securities Fraud by the Company Itself
The first type of securities fraud occurs when an officer or director of a corporation doesn’t accurately report the company's financial information to its shareholders. This can artificially raise the worth of the company’s stock and encourage investors to buy shares of an unhealthy company. If the company subsequently goes bankrupt, the people who bought shares based on false information lose their investment completely. One famous example of this type of securities fraud was the Enron scandal, in which corporate officers failed to report the company's expenses, causing profits to appear larger than they were in reality.
Insider trading is another type of securities fraud. It occurs when someone with confidential information about a company's financial state uses that information to make decisions about whether to buy or sell the stock before that information is disclosed to the public. For example, a corporate accountant could notice that the company is losing money fast and heading towards bankruptcy. If the accountant places an order to sell his stock before notifying the board, he’s arguably guilty of insider trading.
Third Party Misrepresentation
The last type of securities fraud occurs when a third party gives out false information about the stock market or a particular company or industry. “Pump and dump” schemes are a prevalent type of third party misrepresentations. In a pump and dump scheme, a person will find a small, unknown company with cheap stock and buy large amounts of its shares. The perpetrator will then send out false information about the company to encourage others to buy the stock, driving up the price. Once the price of the stock is high enough, the perpetrator sells his or her shares for a profit.
Federal and state governments do their best to combat securities fraud, but it’s still a good idea to take steps to protect yourself and your assets. With all the information about financial markets, and the huge number of players in the stock market, it’s often hard to separate truth from fiction.
There are, however, some things you can do to help. Learn some of the warning signs of securities fraud, so if you’re ever the victim, you could catch it early and minimize the damage. If you own stock, make sure you get your information directly from the company itself, rather than from third parties, and then double check that information against the SEC's database.
For more information, see FindLaw's sections on financial crime and securities.