The United States Securities and Exchanges Commission is the regulatory agency for the U.S. securities markets and is charged with protecting investors, preserving the markets and aiding in capital formation. To this end, the SEC enacts and enforces a number of laws governing the securities and commodities markets. Violations of these laws to dupe investors, gain an unfair or unlawful advantage, and misrepresent a company’s financial health, all to make an illegal profit through these practices of deception and misrepresentation make up the commission of SEC Fraud.
SEC fraud, securities fraud, and investment fraud are white color crimes. These crimes are perpetrated by both individuals and business entities. Some examples of the guilty parties are brokerage firms, stockbrokers, investment banks, accountants, corporate officers and directors. Legal penalties include fines and up to 20 years in prison.
A company may commit securities fraud when an officer of the company inaccurately reports the company’s financial situation to artificially raise its stock value and then encourages individuals to invest in the misrepresented company. When the unhealthy company enters bankruptcy, investors are left with nothing.
Insider trading is a possibly one of the more well-known methods of SEC fraud. In these situations, an insider uses knowledge he is privy to due to his position, when making purchasing and selling decisions in the stock market. For example, an insider at a pharmaceutical company may fail to disclose information and data acquired from clinical trials that may negatively impact the company’s stock price and then use this information to trade on the stock market.
Another large area of SEC fraud occurs through third parties. These parties spread fabricated and misleading information to artificially inflate the price of stock that the scammer intends to sell at a profit. This is referred to as a “pump and dump” scheme.
Examples of SEC Fraud
- Insider Trading;
- Broker embezzlement;
- Manipulating stock prices;
- High yield investment fraud;
- Submitting false information on SEC filings;
- Withholding key information to mislead investors;
- Hedge fund fraud;
- Accounting fraud;
- Mutual fund fraud;
- Foreign currency fraud;
- Offering unsound financial advice;
- Financial statement fraud;
- Abuse of short selling to drive down stock prices;
- Ponzi schemes and pyramid schemes;
- Advanced fee schemes; and
- Use of the internet for “pump and dump” schemes.
SEC Whistleblower Program
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 created the current SEC Whistleblower Program. This law rewards and protects whistleblowers who expose corporate and securities fraud to the SEC or the U.S. Commodity Futures Trading Commission in the following three areas:
- Federal Securities Law Violations
- Consumer Protection Law Violations
- Commodity Exchange Act Violations
Under this law, whistleblowers who assist in exposing fraud and the recovery of funds in excess of $1 million by providing original information, may be eligible for an award of between 10 and 30 percent of the recovered money and fines.
To be eligible for an award, the whistleblower must meet the following conditions:
- The whistleblower, known as the relator, provided the details of the fraudulent activity to the SEC or CFTC;
- The whistleblower must have acquired his knowledge of the fraudulent activity through his own analysis; and
- Knowledge of the fraud must not have been attainable to the government through other means or avenues.
Insiders and employees may report the fraudulent activity to both the SEC and the audit committee of the company simultaneously. The whistleblower may keep his identify secret until he receives an award. Additionally, if the whistleblower is subjected to retaliatory actions by his employer, he may file a separate law suit against the employer to recover damages.
The major difference between the perhaps better known federal Whistleblower Law, the False Claims Act, and the Dodd-Frank Act is the broadness and scope. The FCA only addresses fraud that injures the government. The Dodd-Frank Act, however, applies to all businesses that report to the CFTC or SEC, and allows a larger number and variety of individuals to file a whistleblower claim. In addition to employees, this includes customers, board members, and suppliers.
Prior to enactment of the Dodd-Frank Act, the prevailing law in this area was the Sarbanes Oxley Act of 2002. OSHA continues to administer this program under its Whistleblower Protection Program.
Well-known Securities Fraud Cases
- Bernie Madoff
- Tyco International
- Peregrine Systems
- 15 U.S. Code § 78o - Dodd-Frank Wall Street Reform and Consumer Protection Act
- 15 U.S. Code § 7201 - Sarbanes-Oxley Act
- U.S Securities and Exchange Commission Website; “Financial Reporting and Audit Task Force”, 2014; web http://www.sec.gov/spotlight/finreporting-audittaskforce.shtml
- Investopedia Website; “Whistleblowers Set to Receive First SE Payouts”, 2012; web http://www.investopedia.com/financial-edge/0612/whistleblowers-set-to-receive-first-sec-payouts.aspx