What is securities Fraud and types of securities fraud – Part 1 of 3
Fraud is defined as an act or course of deception, an intentional concealment, omission, or perversion of truth, to (1) gain unlawful or unfair advantage, (2) induce another to part with some valuable item or surrender a legal right, or (3) inflict injury in some manner. Fraud is an offense which is criminal in nature and calls for severe penalties.
Securities fraud can be understood by which a person or a stockbroker or listed company or its directors or an investment bank, misrepresents critical information which help investors make decisions to buy or sell the share. There are many types of misrepresentation like providing false information, withholding key information, offering bad advice, offering insider information, etc.
Why does securities Fraud Happen?
Thera are mainly three reasons why securities fraud happen. One is Human greed. “Greed” means “intense and selfish desire for something, especially wealth, power, or food”. Greed can be categorised as greed to make more money and greed to keep it. Because of this human greed people try to gain wealth by an intentional and unfair conduct which is prohibited by law. This greed to earn more money or to become rich overnight is what drives people to commit the fraud.
The other reason is the quality of being too clever and finding loop holes in the system to exploit and make profits. We as humans, try to be too clever sometimes and in search for more profits try to bend the rules. We start looking at the rules designed by the regulators not from the spirit of having a fair, transparent and true securities market but from a critical angle of exploitation. To understand better, if you read some orders of SAT (Securities Appellate Tribunal) you will find that the company has not clearly violated any rules but their conduct does not show that they followed the rules in a true spirit with which it was intended by the regulators.
One more reason we can attribute is the low values. Values can be understood as the criteria people use in understanding lives like arranging their priorities, measuring them, various pleasures and pains, and also choosing between alternatives. Moral values can be understood as principles that a person follows to distinguish the right from the wrong. These principals are considered while understanding the character of an individual. Moral Value generally refer to good virtues such as honesty, integrity, truthfulness, love, respectfulness, hard-work, etc. Social values form a vital part of the culture of a society. Social values and norms explain the way in which social processes operates in a society. Social values are the sources of patterned interaction.
What is securities Fraud and types of securities fraud – Part 2 of 3 and Part 3 of 3
The securities market is a wide open ocean and still developing with new products and services coming in. As we know there are many more people applying their brains to by-pass the law rather than to strengthen and adhere to the law. That is the precise reason why we have more very intelligent unethical hackers rather than the ethical hackers. Since, the market is large, complex and has so many participants with different mind sets, it paves the way for more and more types of fraud. Following are the types of fraud and the list is only inclusive and not restrictive.
Types of Securities Fraud
|Micro cap fraud||Dabba Trading|
|Dummy Corporations||Boiler rooms|
|Synchronized trades||IPO related manipulation|
|Microcap Fraud||Order book manipulation|
|Circular trading||False corporate announcement|
|Insider Trading||Misleading Stock Recommendations|
|Accountant Fraud||Front Running|
- Synchronized trades and Circular trading – When a buyer and seller place identical orders in the trading system at the same time, it is called Synchronized trades. A circular trade happens when a set of brokers’ trade in the same script for the simple purpose of artificially increasing volumes and pushing prices up or down the price of the script. This is an illegal method and should be avoided. Here the brokers do not have genuine intentions to trade. So if a person just trades based on rumors or on scripts that are in the news or due to increase in prices, he can become a victim of this fraud.
- Insider Trading – Insider trading means trading done by some person who is considered as an insider when he is in possession of information that can influence the price of the stock and that information is yet to go public. This is considered illegal because information must flow equally to the public at large and no one should take advantage of having unpublished information just by the virtue of the post they hold in the company. An insider is someone who is connected with the company or is deemed to be connected with the company. The person is assumed to have access to information by virtue of such connection. A person can also be an insider by virtue of a post he holds and can be assumed to have received the unpublished information and has profited from it.
- Front running – Front running is where the trader of the broker takes a position in the market just before a large buy or sell order that the trader knows will be placed in the market and will influence the price.
- Dabba Trading – In Dabba trading, the trades on the investors are not placed on recognized stock exchanges but are placed illegally only in the Dabba operators trading books. The prices of securities that are used as benchmarks are the same prices that reflect on the recognized stock exchanges. The Dabba operator is the counter party to all the trades placed in his book. This system is illegal and also has no guarantee of funds.
- IPO related manipulation: – Some clients or brokers try to create demand and procure more shares illegally by through trading & demat accounts held in fictitious names. This is generally done when the client or the broker believes that the shares will be listed at a premium to the allotment price and then the can sell the shares on the first day of trading and book profits. This in turn will put selling pressure on the stock and drive the price of the stock downward.
- Another IPO related manipulation – In the book building process, the broker placed orders repeatedly with very large quantities that can influence the price and later delete those orders.
- False announcement – In this type of manipulation, the company or management or an appointed person spreads some false information about the company and influences the price. They give out misleading or false information through advertisement or press release or announcement to stock exchanges etc.
- Recommendations- Here investment advisors are paid to price wring investment advice and profit from it.
- Dummy corporations – Dummy corporations with looks similar to a famous company are created by some people illegally to make people believe that it is an existing corporation. Later they sell fake shares to those investors and pocket the money.
- Microcap fraud – In this type of fraud, the stocks of very small companies are promoted by brokers and sold to people who do not have much knowledge of the securities market. But remember that not all microcap stocks are fraud. But since they have less volumes, less price movement and are lesser known companies, it is subject to fraud very easily.
- Accountant fraud – The biggest case we have seen is the Satyam computers where FD worth 9000 crore was shown in the records of the company but it did not actually exist. Accounting firms have been negligence to identify and prevent falsified financial reports by their clients which gives a misleading impression about the finances of the company to the investing public.
- Boiler rooms – Here the stock brokers put pressure on clients to buy some shares using telesales in microcap Some brokers offer clients transactions fraudulently which are profitable to the broker. Boiler rooms are not necessarily licensed but may agents of the broker doing this job which is illegal in itself. Securities sold in boiler rooms include Microcao shares, commodities, non-existent shares, shares of distressed companies etc.
- Short selling abuses – Short selling abuses means that a person starts to sell the stock or the futures or the option repeatedly with an intention to drive down the prices artificially. This is considered fraud because in some types of naked short selling, stock is sold without being borrowed and without any intention to borrow but with the sole purpose to drive down the prices
Now that we have learnt what is fraud, we have also understood what is securities fraud, why do people do fraud, the reason behind fraud and the types of fraud that people do in the securities market, we are better prepared to keep ourselves and our money safe from the fraudsters with low or no moral and social values.