Stock Frauds: Definition and 5 Examples of Scams

Stock Cheats: Definition and 5 Examples of Scams

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.

Given the active inflow of money into stocks, estimated annually at tens of billions of dollars, scammers have a wide scope for fraud, developing schemes for millions and even billions of dollars. Let's take a closer look at how stock fraud works, look at examples of types of fraud schemes, and find out how to protect yourself and avoid falling victim to fraudsters.

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.

Before getting into the stock fraud discussion, let's first find out what stocks are.

The share is the smallest portion of the capital stock of companies or corporations. It is, therefore, an equity title and, as such, grants its holders, shareholders, all the rights and duties of a partner, within the limits of the shares held. When a trader or investor buys shares, they acquire a certain share (share) in the company. This type of bonds is one of the main investment instruments and passive income.

Stock fraud: There are two main types of stock fraud:

Ordinary actions

This type of shares gives shareholders a right to vote at shareholders' meetings and an opportunity to distribute profits. Retail traders use such stocks as an instrument for short-term trading or to “buy and hold” investments. A trader buys the shares, waits for the price to rise, and then sells them.

Preferencial acts

This type of shares, as a rule, does not allow interested parties to vote at shareholders' meetings, but has preference when it comes to receiving distributions of profits, such as payment of dividends, and compensation, in the event of bankruptcy, for example.

Stock fraud is an action involving stock that goes against the law or stock exchange rules for the purpose of fraudulent benefit. Fraudsters carry out deceitful actions with shares, benefiting themselves. Fraud profit may differ as there are many types of schemes.

Top stock market fraud schemes

There are hundreds of types of fraud in the stock market, with new scams popping up regularly.

It all depends entirely on the resourcefulness of the fraudsters. However, the old schemes continue to work and are being actively used by criminals. Let's review the most popular types of stock fraud schemes.

Pump and Dump

Pump and Dump is one of the most popular securities fraud schemes. It involves artificially inflating stock prices in the context of fake news and rumours.

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.

The fraud is structured as follows:

 

1 — Fraudsters register a company and offer shares on the stock exchange. Quotes are low as the company is unknown;

2 — An active promotional campaign is carried out, using false information, posting positive news and expert opinions. Quotes start to rise;

3In the context of promotional campaigns and initial growth in quotations, investors begin to acquire shares. The price increases even more, attracting new players;

4At that time, the organizers of the fraud sell shares at a heavily inflated price;

5 — At some point, it becomes clear that the promotional campaign was based on fake news and the number of shoppers drops. The share price plummets.

Penny stock scams

Penny stocks are the shares of companies that trade at very low values. This type of stock fraud, like Pump and Dump, is designed to play with people's emotions.

The only difference is that there is no promotional campaign. Instead, fraudsters buy a bundle of shares in bulk.

After the shares are acquired, their price starts to rise. Traders and bots react by buying the securities based on the trend, pushing the price even higher.

At one point, fraudsters 'dump' the shares and their prices plummet, while users, who believed in the success of bonds, suffer losses.

Stock fraud in a pyramid scheme

Pyramid scheme is one of the most popular types of frauds involving bonds and stocks in particular. It is about making a profit by referring new clients to the project and using their funds to finance the profits of those who have already invested in the platform.

The schema looks like this:

1 — A project is registered, promising clients high returns from equity investment and beneficial partnership program;

2The first clients invest in the platform and start to spread it among friends, colleagues and relatives. This forms the first level;

3 — The first clients invest in the platform and start to spread it among friends, colleagues and relatives. This forms the first level;

4 - Payments continue as long as new customers arrive. As soon as new entrants stop, the pyramid collapses and investors lose money.

Um Ponzi scheme It is a type of pyramid scheme. The difference is that it is not the investors who attract new clients, but the management of the project — the promoters. Promoters are the ones who invite new customers and convince them to invest or reinvest in the platform.

Insider trading

Insider trading means trading based on information from inside sources, also known as insiders.

These people provide information about important events that may impact securities quotations, e.g. company sale, merger/acquisitions, business expansion, negative internal reports, etc.

Insider trading is prohibited in most countries.

Insider trading is a very widespread phenomenon. As a rule, fraudsters use two methods:

  • Provide privileged information about the asset with the aim of increasing its quotations. For example, an insider may report unexpected results from financial reports, the company's plans to acquire competitors, or other potentially valuable information that will affect the stock price;
  • Insider trading, that's exactly what it is.

Making a profit from alleged insider information allows fraudsters to obtain money for information, which cannot be verified a priori. Due to this fact, this type of stock fraud enjoys great popularity among fraudsters.

Examples of stock fraud you should know about

History knows many cases of stock fraud. Some of them were quite well known.

Let's review several stock fraud cases that caused major scandals in the world.

Stock Fraud: The Enron Scandal

Enron ScandalThe Enron scandal is a story that happened to Enron Corp., based in Houston, USA. It involved manipulations with the company's accounting and reports. Enron completely hid its financial problems—debts, transactions, and failed projects.

Positive financial statements led to an increase in the company's share price, which in 2000 reached USD 90,75 per share.

However, in 2001, Enron shares dropped below 1 US dollar when the manipulations were revealed.

As a result, Arthur Andersen, Enron's accounting firm, was forced to close, Enron investors filed lawsuits worth $40 billion against the company, and the company was forced to file for bankruptcy.

Stanislav Shpigelman case

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.The scandal involving the acquisition of The Gillette Company by Procter & Gamble is one of the best-known examples of insider trading in the US. Merrill Lynch Bank was responsible for the transaction.

Bank analyst Stanislav Shpigelman knew this and shared the information with his friends at Goldman Sachs — Eugene Plotkin and David Pajcin. The trio made over $100.000 from the information and shared it with friends and colleagues.

Shpigelman, Plotkin and Pajcin wanted to do the same with information about the Adidas and Reebok merger. That's when their scheme was discovered.

Pajcin shared the information with his aunt, a 63-year-old tailor. When she made a $2 million profit on her investment based on the tip, the investigation began.

Elon Musk Scandal

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.In 2018, Elon Musk was involved in a scandal involving manipulations with Tesla shares via Twitter. Musk tweeted that he was considering taking Tesla private for $420. “Funding guaranteed,” Musk wrote.

Quotes reacted instantly. The stock price rose 8% to $371 a share. However, shortly after that, Reuters reported that "it was unclear if Musk was serious as he has a history of erratic tweets..." Then the stock price quickly returned to its previous level and Musk was accused of fraud.

Pump and Dump by Zirk de Maison

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.Californian Zirk de Maison managed to defraud investors for a period of five years, using rigged companies. He registered companies, which had no assets and did not conduct real business, real shells, and offered their shares public.

The fraudster distributed information that his companies were involved in mining diamonds, gold and copper and also in the development of the latest IT technology.

The team of fraudsters led by de Maison actively disseminated information about the companies' successes and convinced clients to invest. Overall, they managed to attract $38 million. In 2013, the scheme was discovered and in 2015 de Maison pleaded guilty and was sentenced to federal prison for committing securities fraud.

Madoff Investment Securities — the oldest pyramid in the US

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.Bernard Madoff managed to defraud not only private investors, but also large banks such as HSBC, Banco Santander and BNP Paribas. His financial pyramid has worked for over 40 years. In the 1970s, Madoff, a successful investor, founded an investment firm Madoff Investment Securities, offering his clients up to 46% annual profit for their equity investments.

Madoff was one of the founders of NASDAQ. He had built a good reputation and people believed him. And he fulfilled his obligations to customers. He only paid them with the money that new customers invested in the platform.

The financial pyramid was only discovered in 2008. The financial crisis was Madoff's undoing, as clients asked him to return their investment early.

The investigation found that Madoff's company had not been involved in investments since 1995, operating solely at the expense of the funds invested by clients.

The pyramid's debt was over $50 billion, while Madoff was sentenced to 150 years in prison.

Jordan Belfort — “Wolf of Wall Street”

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.The character Jordan Belfort, made famous by the movie The Wolf of Wall Street, was based on a real person. The real Belfort was known as the Penny Stock Fraud. In 1990 he founded Stratton Oakmont, an investment company that dealt in stocks. He sold stocks cheaply to customers.

Belford's company selected wealthy people for its potential investors and the managers, using cold calling, convinced them to invest in cheap stocks. Belfort also used pump and dump, inflating the price of bonds and then dumping them.

After the schemes were discovered, Belfort was sentenced to 22 months in prison and restitution of $110 million to 1.513 defrauded customers.

How to Avoid Stock Market Scams: Top 5 Tips

Unfortunately, there haven't been many cases when stock fraud schemes were discovered. To avoid scams, you need to be very cautious and vigilant. Here are 5 tips to help you avoid scams.

  • Always check company information
  • Before deciding to work with any investment firm or broker, check the information about the organization.

The company must provide the following information:

  • Registration certificate;
  • Legal address;
  • License.

Let's talk more about the license. A financial license certifies that the organization operates fully legally, guarantees the security of funds and timely withdrawal. However, only companies licensed by trusted state regulators can be trusted.

Trusted regulators include:

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.
USA — SEC;
Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.
Great Britain — FCA;
Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.
Cyprus — CySec;
Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.
United Arab Emirates — DFSA (Dubai) or FRSA (Abu Dhabi);
Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.
Australia — ASIC;
Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.
Japan — JFSA and KLFB;
Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.
Germany — BaFin, etc.

If a company does not have a license, it operates illegally and does not meet the financial requirements of regulators. Thus, it is highly likely that it is a scam.

So, check the company's information before starting to work with them; thoroughly check all data about the legal entity.

Read company reviews

Reviews about the company is an important choice factor. A company must earn a good reputation among users.

If there are positive comments about an organization, it is a good sign. This means that clients are satisfied with the investment platform or broker, that they actually pay money, etc.

If the reviews about the company are negative, it is better not to work with them. If there are no comments about an organization, it could mean that it is a fairly new company. It needs to be verified additionally.

Make sure promises have foundations

Huge profit promises are one of the main methods to attract customers.

Fraudsters manipulate users' wishes to earn as much as possible and offer fantastic profitability, which can exceed 100% per month.

These promises should be treated with a grain of salt. Before deciding to work with a broker or investment platform, you first need to make sure that these promises are consistent.

Remember that exaggerated profitability is probably just a 'bait'.

It is possible to earn annual profits of hundreds of percent in just one case—investing in high-risk assets.

Fraudsters, as a rule, promise guaranteed returns. None of the portfolio managers promise high profitability without warning about the risks.

Check that the feedback mechanism is transparent and clear and that there is an alert about potential risks.

Always check the information received

A emotional negotiation is one of the biggest problems traders face. This makes Pump and Dump possible.

So, if you see an urgent message with positive news about a company, try to verify this information first.

These could be financial statements or audit results on the website; verify information from third-party sources.

Be extremely cautious when dealing with little-known companies. If you've never heard of an organization, check it out first. Make sure the organization exists and is successful in its industry, and that there are fundamentals behind positive news.

Don't be in a hurry to react to the moment

The reaction to rapidly rising stock quotes is another issue linked to emotional trading.

Often, traders buy them by reacting to the trend, but not checking if there is a reason to do so and not thinking about when price growth might stop.

This makes possible not only Pump and Dump, but also stock fraud and Penny Stock (cheap stocks).

If a person buys a large number of cheap shares, their price will increase. Before making any kind of transaction, you need to carry out a thorough analysis first.

Find out if there are objective reasons for the price increase. Check out information about the companies and news on the subject.

In addition, it is very important to stick to the chosen strategy. Do one technical analysis and make sure that price movement is proven and that there are prospects for this trend to continue.

Stock fraud is a frequent occurrence in the stock market.

Interest in the investment is growing among private investors, thus inciting interest among fraudsters.

Stock fraud schemes can be very unique, but in most cases they are all based on popular schemes. Unfortunately, fraudsters continue to make millions from the carelessness of investors.

Before investing in stocks, you need to select the right broker. Only a licensed broker can guarantee honesty and transparency.

Do not be quick to trust people who make 'very attractive offers'. Ask them questions.

Ask about the factors that will guarantee high profits, how the investment mechanism works, what kind of portfolio the managers have, etc. Ask specific questions and demand specific answers.

If you come across any information, check it out.

Haste is the biggest enemy in investing and trading. A hasty decision can cause substantial financial losses.

Any trade must be opened for specific reasons, with a specific deadline and early closing conditions.

Stock investing is becoming more and more popular among people. With the development of online trading, an increasing number of retail traders and investors emerge in the markets, bringing in even more money. This creates a huge scope for different types of stock fraud schemes.Frequently asked questions about stock fraud

 

Can I profit from stock pyramids?
Theoretically, it is possible, but the potential gains are not worth the risks. The probability of losing money is very high. Therefore, you should not work with a company that you are not 100% confident in.
A stranger is offering inside information and promises to 'return your money' if it is false. Should I accept?
It's a popular scheme that involves a money-back 'guarantee'. As a rule, such 'insiders' do not have any knowledge. They may actually return the money, but in case of failure, you will lose your money once the trade is opened. For this reason, you shouldn't work with 'insiders' you don't know.
Is fraud possible when working with licensed brokers?
Do not. The license confirms that the broker complies with the laws and financial 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 fraudsters often work without licenses or an offshore license where requirements are minimal.
Can I get my money back in court in case of fraud?
Theoretically it is possible, but you will have to prove the fact of the frauds and manipulations, find the culprits and prosecute them. It is a long process and there is no guarantee that the case will be resolved in your favor. Also, 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 may not be enough money to pay refunds at all. In that case, it will be impossible to get your money back.

 

 

 

 

 

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