Movies like Wolf of Wall Street, Wall Street, and Boiler Room highlight the extremes of unscrupulous, if not outright illegal, sales tactics used by shady brokers. But in reality, many brokers – both inside boiler rooms and out – still employ these kinds of tactics to sell dubious or inappropriate securities to unwitting buyers.
The legality of such sales swindling is a matter of interpretation and may vary between states based on their securities laws. In many cases, these tactics may violate the Securities and Exchange Commission's Rule 10b5-1 and 10b5-2, which covers the employment of manipulative and deceptive practices to sell securities. The rules prohibit employing any device, scheme or artifice to defraud; making any untrue statement of a material fact or omitting a material fact, or engaging in deceitful behavior.
Here is a handful of bad sales tactics used by brokers that may be illegal under federal or state laws, or at least prompt Financial Industry Regulatory Authority (FINRA) violations.
- Being an aggressive broker can help win business, but you should be careful about when certain sales tactics cross the line and become unlawful.
- FINRA regulates brokers and financial advisors, ensuring that customers are not mis-informed or defrauded.
- Omitting material facts about an investment, inflating performance numbers, lying to clients, or making unreasonable promises are all violations.
Pushing to Buy Blindly
Many classic boiler room operations focus on long-distance cold-calling to make sales, with the brokers pushing hard to sell in a single phone call. When doing so, brokers often neglect to provide the would-be client with sufficient information to properly make an investment decision. These omissions are especially deceitful when selling stocks of obscure companies with limited or no operating history without disclosing their lack of revenue or operations.
The omission of material facts when selling securities is a clear violation of Rule 10b-5.
Inflating Past Performance
Brokers may make misleading claims about their past track record to gain a would-be client’s confidence in their investing abilities. For instance, a broker may say that he or she had recently sold stocks for triple-digit gains in just weeks when, in reality, they haven’t sold the shares in question. These track records can be difficult to verify objectively, which makes the lies especially insidious when trying to close customers over the phone.
The untrue statement of a material fact when selling securities also violates Rule 10b-5.
Ignoring Client Sustainability
FINRA Rule 2111 requires that brokers have a “reasonable basis to believe that a recommended transaction or investment strategy is suitable for a customer.” Of course, brokers who are cold-calling new potential clients and pitching one-size-fits-all security haven’t conducted due diligence on the customer or considered the suitability of the investment for the customer. For instance, a micro-cap stock being sold in a cold-call lacks a reasonable basis.
The ignorance of suitability may not violate a specific part of Rule 10b-5, but it does violate FINRA’s rules and could lead to penalties for the broker.
Using Manipulative Talk
Brokers may use a variety of different manipulative sales techniques designed to talk someone into buying security. For example, the Wolf of Wall Street highlights an instance where a sales script addressed a would-be client’s desire to ask his spouse before purchasing by saying, “I’m sure you didn’t get to where you are today by consulting with your wife on everyday decisions.” That manipulates a customer by playing to his or her ego.
These manipulative sales techniques may violate Rule 10b-5’s manipulative practices clause.
Making Outrageous Promises
Brokers may pitch an investment as a guarantee or certainty, when in reality there is no such thing, particularly with risky securities. For example, a broker may portray a merger rumor as a certainty that’s confirmed with “insider information,” which could lead to “multi-bagger" returns for the would-be client over the coming weeks. Of course, the stock would already be trading much higher if a merger had been made public or even strongly suspected.
These promises may violate Rule 10b-5’s guidelines covering deceitful behaviors.
The Bottom Line
The movies highlight extreme cases, but smooth-talking boiler room operators are out there. By being aware of their manipulative tactics and high-pressure tricks, individual investors can avoid losing money to these unscrupulous types – or any investment professional who has only his own best interests at heart.