Stock investing is becoming increasingly popular among people. As online trading develops, a growing number of retail traders and investors emerge in the markets, bringing even more money. This creates a huge space for different kinds of stock fraud schemes.
Given active cash inflow into stocks, which is annually estimated at dozens of billions of dollars, the fraudsters have a wide field for scamming, developing schemes for millions and even billions of dollars. Let’s take a closer look at how stock fraud works, analyze the examples of the types of fraud schemes and discover how to protect yourself and avoid falling victim to fraudsters.
Before going into discussion of stock fraud, let’s first find out what stocks or shares are. Shares are a type of securities that certify the ownership right to a share in the company’s capital. When a trader or investor buys shares, they acquire a certain share (stake) in the company. This type of securities is one of the key investment and passive income instruments.
Ordinary shares or Common stock.
This type of shares gives the stakeholders a voting right at the shareholder meetings and an opportunity in profit distribution. Retail traders use such shares as an instrument for short-term trading or “buy and hold” investing. A trader acquires the shares, waits until the price grows, and then sells them.
Preference shares or Preferred stock.
This type of shares, as a rule, does not allow stakeholders to vote at the shareholder meetings, but they do have the right to guaranteed or increased dividends or other preferences.
Stock fraud is an action involving stocks that contradicts the law or the rules of the exchange with the purpose of fraudulent benefit. The fraudsters perform deceitful actions with shares, thus benefiting from it. The profit from fraud can differ, as there are many types of schemes.
There are hundreds of types of stock market fraud with new ones emerging on a regular basis. Everything depends entirely on the resourcefulness of the fraudsters. Nonetheless, the old schemes continue to work and are being actively used by the criminals. Let’s review the most popular types of stock fraud schemes.
Pump and Dump is one of the most popular fraud schemes with securities. It involves artificial inflation of the quotations on stocks against the background of false news and rumors.
The fraud is structured as follows:
The fraudsters register a company and offer shares at the exchange. The quotations are low, as the company is unknown;
An active promo campaign is carried out, using false information, publication of positive news, and expert opinions. The quotations begin to rise;
Against the background of promo campaigns and initial growth of quotations, the investors start acquiring shares. The price increases further, attracting new players;
At that time, the organizers of the fraud sell shares at a strongly inflated price;
At some point, it becomes clear that the promo campaign was based on fake news and the number of buyers falls. The price of the stock plunges.
Profit from this type of fraud depends on the scale of the promo campaign and speculative moods in the markets. If the campaign is local, it is most likely that the fraudsters will snatch a comparatively small amount. If the information is distributed to the largest markets, the gains could reach dozens of millions of dollars.
Penny stocks are shares with a stock price of less than $5 per share. Penny stock fraud, just like Pump and Dump, is designed to play on people’s emotions. The only difference is that there is no promo campaign. Instead, the fraudsters acquire a share package in a big lot. After the stocks are acquired, their price starts to increase. Traders and bots react, buying the securities based on the trend, thus pushing the price up even more. At a certain moment, the fraudsters ‘dump’ the shares and their price plunges, while the users, who believed in the success of the securities, suffer losses.
Pyramid scheme is one of the most popular types of scams involving securities and shares in particular. It involves earning profit from referring new clients to the project and using their funds to finance the profits of those who already invested into the platform.
The scheme looks as follows:
A project is registered, promising the clients high profits from investment into stocks and beneficial partnership program;
The first clients invest in the platform and start to promote it among their friends, colleagues and relatives. This forms the first level;
The clients referred by them invite new users, forming new levels. Part of the funds invested by them is used to pay the clients of a higher level and part – to the fraudsters;
The payouts continue as long as there is an inflow of new clients. As soon as it stops, the pyramid collapses and the investors lose money.
A Ponzi Scheme is a type of a pyramid scheme. The difference is that it is not the investors who attract new clients, but the project administration – promoters. The promoters are the ones who invite new clients and convince them to invest or reinvest in the platform.
Insider trading means trading based on the information from internal sources aka insiders. These people provide information about major events that could have an impact on the quotations of securities, for instance sale of the company, merger/acquisitions, business expansion, negative internal reports, etc. Insider trading is prohibited in the majority of countries. US SEC regularly uncovers such schemes and punishes the guilty parties.
Providing insider information on the necessary asset with the objective of increasing its quotations. For example, an insider may report unexpected results of financial reporting, company plans on acquisition of competitors or other potentially valuable information, which will impact the stock price;
Sale of insider information, which is just what it is.
Earning a profit from alleged insider information allows the fraudsters to get money for information, which cannot be verified a priori. Due to this fact, this type of stock fraud enjoys great popularity among fraudsters.
History knows many cases of stock fraud. Some of them were rather high-profile. Let’s review several stock fraud cases that caused huge scandals in the world.
Enron Scandal is a story that happened with Houston-based Enron Corp., USA. It involved manipulations with the company accounting and reporting. Enron thoroughly hid its financial issues – debts, failed transactions and projects. Positive financial statements led to an increase of the price of the company stocks, which by 2000 reached USD 90.75 per share.
However, in 2001 Enron stocks collapsed to less than USD, as the manipulations were revealed. As a result, Arthur Andersen, Enron’s accounting firm, was forced to shut down, Enron investors filed USD 40 billion worth of claims against the company and the company was forced to file for bankruptcy.
The scandal involving acquisition of The Gillette Company by Procter & Gamble is one of the most well-known examples of insider trading in the U.S. Merrill Lynch Bank was in charge of the transaction. The bank’s analyst Stanislav Shpigelman knew about it and shared the information with his friends from Goldman Sachs – Eugene Plotkin and David Pajcin. The trio made over USD 100,000 using the information, and they shared it with friends and colleagues.
Shpigelman, Plotkin and Pajcin wanted to do the same with the information on Adidas and Reebok merger. That’s where their scheme was uncovered. Pajcin shared the information with his aunt, a 63-year old tailor. When she made a profit of $2 million on her investment based on the tip, the investigation began.
In 2018, Elon Musk got himself into a scandal involving manipulations with Tesla shares via Twitter. Musk tweeted that he was considering taking Tesla private at $420. “Funding secured,” wrote Musk.
The quotations reacted instantly. The stock price increased by 8% to $371 per share. However, soon after that Reuters reported that “it was not clear if Musk was serious as he has a history of erratic tweets…” Then, the share price quickly returned to its previous level and Musk was charged with fraud.
California resident Zirk de Maison managed to defraud investors for a period of five years, using manipulated companies. He registered companies, which had no assets and did not conduct real business, true shells, and offered their public shares. The fraudster distributed information that his companies were involved in diamond, gold and copper mining and also in development of the latest IT technology.
The team of fraudsters led by de Maison actively disseminated information about the successes of the companies and convinced the clients to invest. Overall, they managed to attract $38 million. In 2013, the scheme was uncovered and in 2015 de Maison pled guilty and was sentenced to federal prison for committing securities fraud.
Bernard Madoff managed to defraud not only private investors, but also such large banks as HSBC, Bank Santander, and BNP Paribas. His financial pyramid operated for over 40 years. In the 1970s, Madoff, a successful investor, founded an investment company Madoff Investment Securities, offering its clients up to 46% annual profit for their investments into shares.
Madoff was one of the NASDAQ founders. He had built a good reputation and people believed him. And he did meet his obligations to the clients. Only he paid them using the money that the new clients invested in the platform.
The financial pyramid was uncovered only in 2008. Financial crisis was Madoff’s undoing, as the clients asked him to return investment early. The investigation found that Madoff’s company had not been involved in investment since 1995, operating solely at the expense of the funds invested by clients. The pyramid’s debt amounted to over $50 billion dollars, while Madoff was sentenced to 150 years in prison.
The character of Jordan Belfort, which became famous thanks to the Wolf from Wall Street movie, was based on a real person. The real Belfort was known for Penny Stock Fraud. In 1990 he established Stratton Oakmont, an investment company that worked with shares. He sold penny stocks to the clients.
Belford’s company selected rich people for its potential investors and the managers, using cold calling, convinced them to invest in cheap shares. Belfort also used pump and dump, inflating the price of securities and then dumping them.
After the schemes were uncovered Belfort was sentenced to 22 months in prison and $110 million restitution to 1,513 defrauded clients.
Unfortunately, there haven’t been many cases, when the stock fraud schemes were uncovered. In order to avoid fraud, you need to be very cautious and vigilant. Here are the 5 tips to help you avoid fraud.
Before deciding to work with any investment company or broker, check the information about the organization.
Registration certificate;
Legal address;
License.
Let’s talk more about the license. A financial license certifies that the organization operates fully legally, guarantees security of funds and timely withdrawal. However, only the companies licensed by reliable state regulators can be trusted.
USA – SEC;
Great Britain – FCA;
Cyprus – CySec;
United Arab Emirates – DFSA (Dubai) or FRSA (Abu Dabi);
Australia – ASIC;
Japan – JFSA and KLFB;
Germany – BaFin, etc.
If a company does not have a license, it operates illegally and does not meet the financial requirements of the regulators. Accordingly, it is highly probable that it is a fraud. Therefore, check company information before starting to work with it; check all data about the legal entity thoroughly.
Reviews about the company is an important choice factor. A company must gain a good reputation among users. If there are positive reviews about an organization, it is a good sign. It means that the clients are happy with the investment platform or the broker, that they indeed pay money, etc. If the reviews about the company are negative, it is best not to work with it. If there are no reviews about an organization, it may mean that it is a rather new company. It needs to be additionally checked.
It is best to read the reviews about investment companies and brokers on independent platforms. There, you have the best chance to find unbiased opinions about the broker or investment platform. On Traders Union, you will find honest and fair reviews about companies.
Promises of huge profits are one of the main methods of attracting clients. The fraudsters manipulate the desires of the users to make as much as possible and offer fantastic profitability, which can exceed 100% per month. These promises must be treated with a grain of salt. Before deciding to work with a broker or investment platform, first you need to make sure there is substance to such promises.
Remember that overstated profitability is most likely just a ‘bait’. It is possible to earn hundreds percent annual profits only in one case – by investing in high-risk assets. Fraudsters, as a rule, promise guaranteed returns. None of the portfolio managers will promise you high profitability without warning about the risks. Check to see that the mechanism of earning a return is transparent and clear and that there is a warning about possible risks.
Emotional trading is one of the biggest issues traders face. It makes Pump and Dump possible. Therefore, if you see some urgent message with positive news about some company, try to verify this information first. It could be financial statements or audit results on the website; check information in third-party sources.
Be extremely cautious when dealing with little-known companies. If you have never heard about an organization, check it first. Make sure the organization does exist and that it is successful in its industry, and that there is substance behind positive news.
Reaction to rapidly growing quotations of stocks is another issue linked to emotional trading. Often, traders buy them reacting to the trend, but not checking whether there are any grounds for that and not thinking when the price growth may stop. This makes not only Pump and dump, but also Penny stock fraud possible. If one person buys a large number of cheap shares, their price will increase. Before making any sort of transaction, you need to conduct thorough analysis first. Learn whether there are objective reasons for the price hike. Check information about the companies and news about it. In addition, it is very important to stick to your chosen strategy. Conduct a technical analysis and make sure that the price movement is substantiated and there are prospects of this trend continuing.
Before starting to invest in stocks, you need to choose the right broker first. The company must be reliable and with a license of a trusted regulator. We offer you a list of the best brokers you can safely invest in stocks with, without the risk of fraud.
| Broker | Stock Fees | Regulation |
|---|---|---|
Free |
USA |
|
Free (except for OTC) |
USA |
|
Low |
USA, UK, Australia, Canada, Japan, Hong Kong, Singapore, India |
Webull is an American company founded in 2017. The broker provides financial services based on the SEC license No. 8-69978. The company is a member of FINRA and SIPC. Stocks are the main area of business of Webull.
NYSE
NASDAQ
CBOE EDGX
Commissions for trading shares for Webull clients are 0% per contract. No commissions are also charged for trading options and ETFs, which are also available. The broker offers its proprietary platform for working with investment assets. The clients can use analytics and trading ideas of Webull experts.
TD Ameritrade is one of the oldest American brokers. The company was founded in 1975. The broker operated on the U.S. license – SEC No. 1-35509 and is a member of SIPC, providing deposit guarantee for the amount of up to USD 500,000.
NYSE
NASDAQ
AMEX
OTCBB
The broker also provides access to over-the-counter (OTC) transactions with shares.
TD Ameritrade offers beneficial conditions for trading and investment. Transactions with U.S. stocks are not charged with a commission. The only exception are the OTC transactions with shares of non-US companies. In this case, the commission is USD 6.95 per contract.
Interactive Brokers is an international broker providing services for clients from over 170 countries.
USA – SEC CIK No.0000922792;
UK – FCA No.208159;
Australia – ASIC AFSL No.453554;
Canada – IIROC 08-0111;
Hong Kong – SEHK No.AEX264;
Japan – KLFB No.187
Singapore – MAS No.CMS100917
India – SEBI No.INZ000217730.
The broker’s choice of markets is huge. The company provides access to 135 markets in 33 countries. The markets of the U.S., UK and EU are particularly widely represented here.
The company charges low commissions. The broker has two methods of calculation – fixed and based on trading volume. In case of fixed commission, the client pays USD 0.0035 per share. If the commission is based on the trading volume, it can vary from USD 0.0035 (for a volume less than 300,000 shares per month) to USD0.0005 (over 1,000,000 shares per month).
Stock fraud is a frequent occurrence in the stock market. Interest towards investment is growing among private traders, thus inciting interest among fraudsters. The stock fraud schemes can be very original, but in most cases, they are all based on popular schemes. Unfortunately, the fraudsters continue to make millions on the carelessness of investors. Before you invest in shares, you need to select the right broker. Only a licensed broker can guarantee you honesty and transparency. Do not rush to trust people who make ‘very enticing offers’. Ask them questions. Ask about the factors that will ensure high profits, how the investment mechanism works, what kind of portfolio the managers have, etc. Ask specific questions and demand specific answers.
If you stumble upon some information, verify it. Rushing is the biggest enemy in investment and trading. A rash decision may cause substantial financial loss. Any trade must open on specific grounds, with a specific timeframe and conditions of early closure.
Antony Robertson,
Traders Union Financial Analyst
I once witnessed an abnormal picture. The shares of a company that was not known to me were growing in price right in front of my eyes. A couple hours ago, they valued at slightly over $4 and then soared straight to $7. I felt the desire to make some profit, but something held me back. The price continued to hike, but the quotations collapsed after several days. That was the moment when I knew I was really close to falling for this fraud.
Jekson White, 27
Trader
US
I now analyze the market much more thoroughly after I fell victim to stock fraud. I tried trading based on news and after one ‘explosive’ news, without verifying it, purchased a large lot of shares. I didn’t know anything about Pump and dump back then. After that trade, I learned not only about the fraud scheme, but also, unfortunately, experienced it.
Tiller Daniels, 34
Trader
US
At the start of my career, I made a mistake when I was choosing the broker to work with. I thought all companies provided honest quotations. The fraudsters I encountered had their own method of getting the money. They published messages about successes of specific companies on their own website under the disguise of ‘expert opinion’ and raised quotations. After a certain peak price was reached, the broker changed the direction of quotation downwards.
Miguel Addington, 47
Pharmacist
US
Theoretically, it is possible, but the potential gains are not worth the risks. The probability of losing money is too high. Therefore, you should not work with a company you are not 100% confident about.
It is a popular scheme involving a ‘guarantee’ of money return. As a rule, such ‘insiders’ do not possess any knowledge. They can indeed return you the money, but in case of failure, you will lose your money as soon as the trade opens. For this reason, you should not work with ‘insiders’ you don’t know.
No. The license confirms that the broker complies with financial laws and rules of the country, where the document was issued. The procedure for obtaining a license involves a lengthy and complicated process that requires large financial expenses. This is why, the fraudsters usually work without the licenses or an offshore license, where the requirements are minimal.
Theoretically, it is possible, but you will have to prove the fact of the fraud and manipulations, find the guilty parties and prosecute them. It is a long process and there is no guarantee that the case will be resolved in your favor. In addition, if we are talking about Pump and dump or Penny stock fraud, the company may file for bankruptcy and after its assets are sold, there just might not be enough money to pay restitutions to all. In that case, it will be impossible to get your money back.
Chinmay Soni is a financial analyst with more than 5 years of experience in working with stocks, Forex, derivatives, and other assets. As a founder of a boutique research firm and an active researcher, he covers various industries and fields, providing insights backed by statistical data. He is also an educator in the field of finance and technology.
As an author for Traders Union, he contributes his deep analytical insights on various topics, taking into account various aspects.
Bruce Powers is an expert trader and technical analyst with over 20 years of experience in Forex, commodities, ETFs, cryptocurrencies and other assets. He is an active trader, technical and fundamental analyst, media commentator, educator and a writer. As an author for Traders Union, he contributes his deep analytical skills, expertise and understanding of the global economy and financial markets to provide market analysis and insights. Powers is also a frequent guest on business TV news shows.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.
