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White-Collar Crime - Securities Fraud

stock investors company stocks

Securities are stocks and bonds an investor may purchase. Stocks give the investors an ownership share in the company.

Securities Regulation

Between 1929 and 1941 the people of the United States suffered through the Great Depression, the deepest and most prolonged economic crisis in American history. Although many factors contributed to the economic depression, the crash of the stock market in October 1929 marked its beginning. Investors in securities, stocks, and bonds lost everything in the unregulated market.

Following the leadership of President Franklin D. Roosevelt (1882–1945; served 1933–45), Congress passed new legislation known as the New Deal, designed to protect citizens from economic fluctuations. Two of these legislative remedies were the Securities Act of 1933 and the Securities Exchange Act of 1934. Both laws restored investor confidence in the market by providing more structure and government regulation.

The 1933 Securities Act required both businesses who desired to sell their stock and stockbrokers who sold stock to provide full information about stocks to potential investors. The Securities Exchange Act of 1934 prohibited certain activities in stock market trading and set penalties for violations. It also established the Securities and Exchange Commission (SEC) to oversee stock market trading.

These laws were based on two ideas. First, companies offering stock on the market had to tell the public the truth about their businesses and the risks involved in investing in them. Second, stockbrokers were to put the interests of investors above any other consideration and deal with them fairly and honestly.

The two 1930s acts remain the foundation of securities regulation. The SEC continued to be the top regulatory agency at the beginning of the twenty-first century. The SEC oversees all key participants in the securities market including the stock exchanges, stock brokerage firms, the actions of individual stockbrokers, investment advisors, and mutual funds (groups of stocks in which people may invest). They are the overseer to protect investors against deceptive or illegal activities such as security fraud.

Stock ownership entitles investors to a dividend or payment per share of stock if the company earns a profit (money left over after all expenses are paid). Stock increases in value if the company is growing and profitable. Investment in bonds pays the investor a set amount over a period of time like a bank pays interest in a savings account. Bonds do not grant the investor any ownership in the company. Commodities are economic goods being sold and purchased in large quantities. Securities fraud is committed by an individual or firm intending to influence the price of a stock or commodity by providing misleading information to investors.

As more people invest in securities and business practices become more complex, securities fraud involving company officials, investment bankers, and others operating in the industry also increases. Dealing with millions of dollars everyday, some individuals cannot resist fraudulent schemes to pad their own pockets. A stable securities industry is essential for the nation's economic health and financial growth. By the early twenty-first century, approximately 80 percent of the American population owned some kind of stock, bond, or commodity. Only 20 percent of these citizens bought and sold stocks themselves; the majority were invested in retirement plans or company stock option plans.

The FBI is responsible for uncovering securities and commodities fraud schemes. They work in close cooperation with the Securities and Exchange Commission (SEC), the National Association of Securities Dealers (NASD), the Commodities and Futures Trading Commission (CFTC), the North American Securities Administrators Association (NASAA), and state and local agencies.

The usual types of securities fraud are embezzlement and insider trading. Embezzlement is the unlawful use of money belonging to a company or its investors. Types of embezzlement include brokers (those who buy and sell securities) writing forged checks from investor accounts, illegally transferring funds, or purposely misleading investors with falsified documents.

Insider trading involves the sale or buying of stock by people who have knowledge about a company that is not available to the public. For example, executives from a drug manufacturer learn a new drug their company is marketing will not be approved by the FDA (Federal Drug Administration) for general use. They learn this before any public announcement is made and warn a few investors to sell their stock in the drug company before the news breaks and the stock's value falls sharply, leaving the stocks worthless and making them nearly impossible to sell.

Kickbacks, or money payouts, are often paid to persons who have advance knowledge about a product or company and are willing to tell others. If the insider uses the information for his or her own gain, it is insider trading; if the person tells someone else and receives money in return after the information has been verified, it is called a kickback.

The New York Stock Exchange is the center of stock trading. (AP/Wide World Photos)

A well-known case of insider trading that gained national attention in 2003 and 2004 involved celebrity homemaker Martha Stewart (1941–). Stewart was allegedly told privately that stock in ImClone Systems Inc., a biotechnology company, would plunge in the next few days. Stewart sold her stock to avoid a loss. While Stewart was only prosecuted for lying to the FBI about the incident, her actions were a high-profile example of insider trading.

Another type of securities fraud concerns illegal trading referred to as Micro-Cap. Micro means very small and Cap refers to capital, or the money invested in a company. Micro-Cap stocks are low priced shares of new companies with little or no business track record. Securities fraud rings included organized crime, which often used highly persuasive calls to pressure people into investing money in a Micro-Cap. Any money received is generally hidden in foreign bank accounts, and investors rarely see their money again.

Other twenty-first century securities fraud schemes make use of the Internet. Investors often check the Internet daily for information on stocks. Many fake get-rich-quick stocks are offered over the Internet, tricking unsuspecting or inexperienced investors (see chapter 11 on Cyber Crime).

Another example of securities fraud played out between 2000 and 2002 at Merrill Lynch, one of the nation's top securities firms. In 2000 a number of relatively new Internet companies did their banking with Merrill Lynch, whose securities expert, Henry Blodget, gave these companies a high or "buy" rating (meaning it was a good time to buy these stocks), even when he knew they were in trouble and might fail. Trusting Blodget, many investors continued to follow his advice and buy stock in the companies.

As a high-profile example of insider trading, celebrity homemaker Martha Stewart was sentenced to five months in prison for her convictions on charges of conspiracy, obstruction of justice, and making false statements to federal investigators about a December 2001 stock sale. (AP/Wide World Photos)


By 2001 several of the companies had failed and investors lost millions. New York attorney general Eliot Spitzer investigated and found emails written between other Merrill Lynch analysts describing Blodget's recommended stocks as "junk," and called them "disasters waiting to happen." Spitzer even found company emails from Blodget himself calling the very stocks he continued to rate high to investors as junk.

Merrill Lynch paid a settlement of $100 million to the State of New York on May 21, 2002. The SEC and other regulators added another $100 million. Henry Blodget was banned from the securities industry and fined $4 million dollars.



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