What Is Securities Fraud?

Securities fraud, also referred to as stock or investment fraud, is a type of serious white-collar crime that can be committed in a variety of forms but primarily involves misrepresenting information investors use to make decisions.

The perpetrator of the fraud can be an individual, such as a stockbroker. Or, it can be an organization, such as a brokerage firm, corporation, or investment bank. Independent individuals might also commit this type of fraud through schemes such as insider trading.

Key Takeaways

  • Securities fraud is illegal or unethical activity carried out involving securities or asset markets in order to profit at the expense of others.
  • This type of fraud a serious crime usually involving the investment world.
  • Examples of securities fraud include Ponzi schemes, pyramid schemes, and late-day trading.
  • Securities fraud can also include false information, pump-and-dump schemes, or trading on insider information.

Understanding Securities Fraud

The Federal Bureau of Investigation (FBI) describes securities fraud as criminal activity that can include high yield investment fraud, Ponzi schemes, pyramid schemes, advanced fee schemes, foreign currency fraud, broker embezzlement, hedge fund related fraud, and late-day trading. In many cases, the fraudster seeks to dupe investors through misrepresentation and to manipulate financial markets in some way.

This crime includes providing false information, withholding key information, offering bad advice, and offering or acting on inside information.

Types of Securities Fraud

Securities fraud takes on many forms. In fact, there is no shortage of methods used to trick investors with false information. High-yield investment fraud, for example, may come with guarantees of high rates of return while claiming there is little to no risk. The investments themselves may be in commodities, securities, real estate, and other categories. Advance fee schemes can follow a more subtle strategy, where the fraudster convinces their targets to advance them small amounts of money that are promised to result in greater returns.

Sometimes the money is requested to cover processing fees and taxes for the funds that allegedly await to be disbursed. Ponzi and pyramid schemes typically draw upon the funds furnished by new investors to pay the returns that were promised to prior investors caught up in the arrangement. Such schemes require the fraudsters to continuously recruit more and more victims to maintain the sham for as long as possible.

One of the newer types of securities fraud is Internet fraud. This type of scheme is also referred to as a "pump-and-dump" scheme, in which people use chat rooms and forums to spread false or fraudulent information concerning stocks. The intention is to force a price increase in those stocks—the pump, and then once the price reaches a certain level, they sell them off—the dump.

The FBI warns that security fraud is often noted by unsolicited offers and high-pressure sales tactics on the part of the fraudster, along with demands for personal information such as credit card information and Social Security numbers. The Securities and Exchange Commission (SEC) and National Association of Securities Dealers (NASD) investigate allegations of securities fraud. The crime can carry both criminal and civil penalties, resulting in imprisonment and fines.

Example of Securities Fraud

Some common types of securities fraud include manipulating stock prices, lying on SEC filings, and committing accounting fraud. Some famous examples of securities fraud are the Enron, Tyco, Adelphia, and WorldCom scandals.

Another common example is the pump-and-dump scheme. Here, bad actors try to manipulate the price of a stock for their own gain by spreading false information, often via internet or newsletter, and then getting out of their position after that false information has been acted upon by unsuspecting investors. For instance, during the summer months of the stock below, a pump and dump scheme was initiated by using a "wrong number" scam. A message was left on victims answering machines that talked of a hot stock tip and was constructed so that the victim would think that the message was an accident.

Pump and Dump
Pump and Dump.

As seen in the above chart, the price rose from around $0.30 to nearly $1.00, a more than 200% increase in a one-week period. This drastic increase was seen along with an equally large increase in volume. The stock had seen an average daily trading volume before the price increase of less than 250,000, but during the scam the stock traded up to nearly one million shares on a number of trading days. The unsuspecting investors would have bought into the stock at around $1.00. As seen above, it fell to around $0.20, an 80% decline in value for those unfortunate investors.