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What is securities fraud?

Securities fraud

Securities fraud is a white-collar crime which covers a wide range of illegal activities mainly involving the misrepresentation of information, deception of investors or manipulation of markets. Securities fraud is also known as investment fraud or stock fraud.

Infamous scams like Ponzi schemes and pyramid schemes fall under securities fraud. According to the FBI, high yield investment fraud, foreign currency fraud, broker embezzlement, hedge fund related fraud, advance fee schemes and late day trading are different types of securities fraud. 

Types of securities fraud

Ponzi and Pyramid schemes

Ponzi and pyramid schemes are characterised by the promise of high and quick returns to investors. In reality, these schemes pay off old investors with money funded by new investors.

In 2016, Los Angeles-based nutrition company Herbalife Nutrition was ordered to restructure its business and pay a $200m fine after the US Federal Trade Commission alleged the company made “misleading money making claims”. The US Federal Trade Commission had opened an investigation into Herbalife Nutrition in 2014 on allegations from billionaire activist investor Bill Ackman that the company was running a pyramid scheme.

According to the FBI: “Ponzi schemes promise high financial returns or dividends not available through traditional investments. Instead of investing the funds of victims, however, the con artist pays ‘dividends’ to initial investors using the funds of subsequent investors. The scheme generally falls apart when the operator flees with all of the proceeds or when a sufficient number of new investors cannot be found to allow the continued payment of ‘dividends’.” 

Ponzi scheme in cryptocurrency 

Market watchdog US Securities and Exchanges Commission (SEC) has voiced concern about potential scams using cryptocurrencies.

The SEC highlighted a recent case, SEC vs. Shavers, where the organiser of an alleged Ponzi scheme advertised an investment opportunity in bitcoin.

“Investors were allegedly promised up to 7% interest per week and that the invested funds would be used for Bitcoin arbitrage activities in order to generate the returns. Instead, invested Bitcoins were allegedly used to pay existing investors and exchanged into US dollars to pay the organiser’s personal expenses,” said the US SEC.

In December 2021, Brazilian computer scientist Jorge Stolfi risked the ire of crypto enthusiasts by arguing that investing in bitcoin checks all the features of a Ponzi scheme. 

“It follows that bitcoins have no more intrinsic value than coins of any other cryptocurrency, or than the shares of Madoff's ponzi fund. These too were only an entry in a ledger, and where [sic] worthless by themselves. Unlike stocks or dollars in a checking account, none of those ledger entries gave their holders legal property rights on anything else; their value being only the right, conceded by the operators, to play the game – that particular game – while it lasted,” wrote Stolfi in a blog post.

Bitcoin strategist Kraken Pierre Rochard expressed the opposite view. In a video debate with Jorge Stolfi, Rochard said: “The Ponzi promoter is promising returns, is promising a profit. I think that with bitcoin, there isn’t such a promise. In fact, what we see is that Bitcoin's promoters repeatedly emphasise that there is a risk of loss.

“Let's keep in mind, bitcoin is a peer to peer electronic cash system that doesn't really hold up as an argument for it being a Ponzi scheme… I think that, first of all, bitcoin is not a Ponzi scheme. It's a currency and it's a decentralised currency.”

Other examples of securities fraud

According to the FBI, high yield investment frauds are typically “too good to be true” investment opportunities. Advance fee schemes happen when a victim advances a small sum of money on expectation of a higher return.

Other common types of stock fraud involve manipulating stock prices by disclosing incorrect information and accounting scams. 

In 2020, Chinese coffee house Luckin Coffee was forced to delist from the Nasdaq after failing to file its annual report following allegations of accounting fraud. A short-seller report claimed that Luckin Coffee was inflating its revenue and key accounting figures.

Pump-and-dump is a common stock exchange fraud where investors manipulate the stock by spreading false information to unsuspecting investors. After the price of the security jumps on investor euphoria, manipulators dump all their assets for hefty profits, leaving new investors with losses.

Promoters of cryptocurrency token SQUID, named after the hit Netflix series Squid Game, pulled off a classic pump-and-dump in November 2021, when the SQUID token crashed from over $2,800 to $0.0007926 within five minutes.

Stock broking fraud is a common type of securities fraud which could involve stock brokers making unauthorised trades, excessive trading, failure to disclose personal conflict of interest and outright theft, among others.

“Sometimes investment losses occur because advisors, stockbrokers, and even brokerage firms, commit fraud,” said Florida-based Sonn Law Group.

How to prevent securities fraud? One can report securities frauds to the US SEC, Financial Industry Regulatory Authority (FINRA) and state securities regulator, according to the US SEC.

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