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Securities Fraud

What You Need To Know As an Investor


By Jeffrey B. Kaplan


The number of people investing in securities has increased significantly over the years. There also has been a proliferation of complex financial instruments available to investors. Unfortunately, this growth has led to a corresponding explosion of fraud in the financial markets.
Almost anyone can be a victim of securities fraud. But not everyone knows how to recognize or prevent it. Even the term itself can be a source of confusion. Securities fraud encompasses a wide range of illegal and improper conduct. For anyone with a stake in the financial markets, a basic understanding of securities fraud can prove invaluable.

Types of Securities Fraud and Common Schemes

Securities fraud generally involves the deception of investors, manipulation of financial markets, or the abuse of investors’ trust. Some forms of securities fraud involve intentional misconduct, whereas other forms are the result of negligence.

Intentional Misconduct

There are numerous types of intentional securities fraud, including Ponzi schemes, market manipulation, intentional misrepresentations and omissions, and excessive trading.

• Ponzi schemes involve using money collected from new investors to pay returns promised to earlier investors. While the payouts give the impression of a legitimate enterprise, defrauded investors are the only source of the “investment returns;”

• Market manipulation or “pump-and-dump” schemes involve the fraudster’s inflating or “pumping up” the price of a stock artificially through aggressive sales tactics, false information, or rumors. Once the share price increases, fraudsters sell (“dump”) their shares at a profit, to the detriment of hoodwinked investors;

• Misrepresentations and omissions can involve purposely presenting misleading, untruthful, or incomplete information to investors. This often involves the misrepresentation of the nature of an investment or the risks associated with an investment; and

• “Churning” or excessive trading involves a broker making trades for the primary purpose of generating commissions, rather than because the trades make financial sense for the investor.

Negligent Misconduct

Some securities fraud does not require a complex framework or even intentional misconduct. Rather, even negligent conduct can be deemed a form of securities fraud. Such misconduct can include:

• Unsuitability claims if your broker recommends securities that are not consistent with your investment objectives or risk tolerance;

• Improper asset allocation or lack of diversification of your account assets; and

• Misrepresentations or omissions of material information about an investment and its risks as a result of a broker’s or brokerage firm’s negligent failure to understand the investment. Such misconduct has increased with the proliferation of ever more complex and difficult to understand structured investment products.

Recognizing and Preventing Securities Fraud

Even though securities regulators seem to have increased their scrutiny of securities fraud, investors can take steps to protect themselves.  
When opening a brokerage account, make sure your new account application accurately reflects your investment objectives, risk tolerance, income, and net worth.  Brokerage firms rely on this information to determine whether account activity is improper.

After you open an account, you can help avoid stockbroker misconduct in the following ways:

Monitor Your Account

Review trade confirmations and account statements for signs of unsuitable investments, lack of diversification, and excessive trading. Do not rely on summaries prepared by your broker. If your review reveals potential misconduct, you should contact the broker.  If you are not satisfied with the broker’s response, address the issue with the broker’s supervisor.  You also should seek an independent review of your account from another securities industry professional.

Brokers frequently tell investors that investment losses are the result of “market losses,” which is not always true. In many instances, account losses are much greater than general market losses. If you receive such an explanation then you should request documentation reflecting the performance of an appropriate market index as compared to your own accounts over the same time period.  If your account performed significantly worse than the comparable index, your losses could be the result of stockbroker misconduct rather than “market losses.”

“Happiness” Letters Do Not Mean You Should Be Happy


Brokerage firms have internal reports that expose questionable account activity.  When accounts appear on these reports, a letter commonly referred to as a “happiness” letter often is sent to the investor. If you receive such a letter you should recognize it for what it is  –  a warning sign that there might be broker misconduct that is worth investigating. You should contact the branch manager and ask if there is any account activity that is inconsistent with your investor profile.  If the branch manager identifies any problems, you should request that changes be made to resolve the problem. You also should consider an independent review of your account and consider changing brokers or moving your account to another brokerage firm.

If you believe your investments losses are the result of securities fraud, we recommend that you seek the advice of counsel rather than seek relief from securities regulators. Investors typically receive little to no benefit from contacting securities regulators. While these entities are charged with policing the securities industry, they typically do not assist investors in the recovery of investment losses.

Jeffrey B. Kaplan is a shareholder of the law firm Dimond Kaplan & Rothstein, P.A.  DKR is an AV-rated litigation boutique that represents individual and institutional investors in stockbroker misconduct and securities fraud claims.  The firm represents clients throughout the United States and Latin America from its offices located in Miami, West Palm Beach, Los Angeles, and New York.



South Florida Legal Guide 2012 Financial Edition



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