Stock Broker Fraud – What You Must Know

By Todd Tresidder

Advertising Disclosure

Financial Mentor has commercial relationships with certain companies we reference on this website. Opinions are ours alone, and we take a good faith approach to maintaining objectivity. If we wouldn’t use a product ourselves, we won’t recommend it. We strive to keep information accurate and up-to-date, however, all products are presented without warranty.

Financial Mentor has partnered with CardRatings for our coverage of credit card products. Financial Mentor and CardRatings may receive a commission from card issuers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities.

Reveals The 11 Tell-Tale Signs Of Stock Broker Fraud And What You Can Do To Protect Your Investments

You assume a stock broker is a fiduciary that represents your best interests at all times.

His job should be to make your money earn more money, and he should earn a fair fee for that service.

Unfortunately, there are time when stock brokers put their financial interests before yours, violating that sacred trust and creating an opportunity for investment fraud.

We're not alarmist here at Financial Mentor. Most stock brokers and financial advisors are honest, hard working people. They do their level best to offer you a legitimate service with the limited knowledge and resources they possess.

However, there’s also a small, but ever-present contingent of fraudulent stock brokers that are drawn to the investment business because of the large dollars involved.

Related: How Your Financial Advisor is Taking 75% of Your Retirement Income (or More!) Video, PDF download, or Audio.

The unfortunate reality is investors are defrauded every day by their stock brokers. Don't become the next victim. Here’s what you need to watch out for.

Normal Investment Losses vs. Stock Broker Fraud

Before getting into the details of detecting stock broker fraud, it’s important to distinguish between normal investment losses and stock broker fraud.

Just because your investments lose money doesn’t necessarily mean you’re a victim of stock broker fraud. The markets fluctuate, and some losses are a natural and normal part of the investment process. Stock brokers don't insure you against market risk.

Additionally, there may be costly mistakes in your stock brokerage account that aren't fraud, but simply clerical errors. These can easily be corrected when pointed out. This isn't an example of investment fraud or stock broker fraud – just a business boo-boo.

“Where there is a sea, there are pirates.”– Proverb

Beyond the realm of normal investment losses and business mistakes lay situations that cross ethical standards – where brokers place their interests in front of yours. That’s the key distinction.

When a stock broker puts his financial interests before yours, you’ve entered the world of stock broker fraud. Below are the most common types of stock broker fraud you need to know.

See My Related Book…

Amazon Kobo B&N iBooks

11 Types of Stock Broker Fraud

1. Unsuitable Investments: Are you a widow or an orphan who was sold a portfolio of high risk stocks? Were you pressured to invest in securities you didn't understand, or did you trade on margin without knowing the added risks? If so, you may be the victim of a stock broker recommending unsuitable investments, which can be fraud.
   A stock broker is required to learn about your risk tolerance, income, investment experience, other assets, financial needs, and investment goals, before ever recommending an investment. Based upon that information, your stock broker is obligated to only recommend investments suitable to your specific situation. Anything less runs the risk of fraud.
2. Misrepresenting or Omitting Facts: Stock broker misrepresentation occurs when misleading information is provided, or material facts are withheld, that impact the investment decision. This can include not adequately disclosing sales-related compensation, risks, liquidity, or any other material facts. All investment recommendations must have a reasonable basis in fact, and all relevant information to the investment decision must be disclosed.
   If a stock broker gives an honest investment recommendation that turns out lousy, you aren't necessarily a victim of fraud. It's more likely just incompetence. However, if your broker suggests he has “inside information” or misleads you regarding the potential risks or rewards of an investment, then you may be a victim of fraud.
3. Over-concentration: Did excessive losses in your portfolio result from most or all of your money being invested in one type of security or market sector, such as technology? If so, you may be a victim of your stock broker concentrating your investment portfolio, rather than diversifying.
   A proven method for risk reduction is to diversify your stock portfolio across various types of stock and industry sectors, while also balancing equities with other investment classes such as bonds, real estate, commodities, etc. If a stock broker puts too much of your money in one or two different stocks, or buys too many stocks in the same industry, it can be a form of investment fraud.

“The secret of life is honesty and fair dealing. If you can fake that, you've got it made.” – Groucho Marx

4. Unauthorized Trading: Has your stock broker ever made a purchase for your account that you didn’t agree to in advance? There are only two conditions under which a broker can transact on your behalf. The first is if he's granted discretionary authority, and the second is when you give him expressed and detailed permission. Anything less is possibly investment fraud.
5. Churning: Has there been excessive trading in your account in an effort to pursue quick profits? Has the same stock been bought and sold multiple times? If your stock broker was in control of your account, then churning may have occurred. This is another form of investment fraud.
   If your stock broker is paid by commission, then he has an incentive to increase transaction frequency regardless of what’s in your best interests. The more transactions, the more money he makes. If your stock broker has discretionary authority over your investment account, then you must monitor trading activity closely to determine if you’re a fraud victim.

6. Timely Execution: Has your stock broker ever failed to execute your investment orders? He is required, by law, to promptly execute all your orders and cannot ever refuse an order. Anything less can be fraud.
7. Inappropriate Mutual Fund and Variable Annuity Sales: Just as a stock broker can fraudulently churn stocks in your account, a broker may also switch between mutual funds with excessive frequency for no valid reason except to earn commissions. Another form of mutual fund sales abuse is selling various forms of loaded funds or Class B shares to clients who might qualify for Class A shares, or be equally served by no load equivalents. Finally, variable annuity sales abuse is so widespread and complicated that an entire article is devoted to that subject on this website (see Variable Annuity Investment Fraud).

“A thing worth having is a thing worth cheating for.”– W.C. Fields

8. Illegal Accounts: Has your stock broker ever recommended using an address other than your home or businesses, or suggested lying on an investment account application? Placing client money in a stock broker's own investment account, or setting up false accounts, is another example of potential stock broker fraud.
9. Unlicensed or Unregistered: All brokerage firms, investment advisors, stock brokers, and other euphemisms for investment product salespeople must be registered to sell securities. Additionally, every security product sold must be registered according to state and federal guidelines.
10. Other Fraudulent Activity: No funds may be withdrawn from a customer's account without prior, written authorization. Additionally, any request for delivery of securities or liquid funds in an account must be completed within a reasonable time period. Other activities such as forgery, selling securities that don't exist, and misappropriation of funds are all examples of potential stock broker fraud.

“It turns out that an eerie type of chaos can lurk just behind a façade of order – and yet, deep inside the chaos lurks an even eerier type of order.”– Douglas Hostadter

11. Institutionalized Brokerage Fraud: It’s misrepresentation to tout an investment recommendation as objective when the only reason for the favorable opinion is an undisclosed back-door payment. (This was common in the late 1990's with internet stocks.) Several large brokerage houses have been prosecuted over the years for using their sales force (stock brokers) to peddle undesirable stocks in an effort to attract and retain lucrative investment banking relationships. It’s also fraudulent when a brokerage firm sells IPO stocks (i.e.: hot issues) to favored clients and business relationships before the release date.

Stock Broker Fraud Summary

All forms of stock broker fraud violate the fiduciary responsibility of the broker to the investor. The key principle is the broker placing his interests in front of the investor's best interests.

Stock brokers are governed by strict rules of conduct. If you believe you've been victimized by fraud, contact your state securities regulator and/or the Securities and Exchange Commission to report any potential wrongdoings.

See My Related Book…

Amazon Kobo B&N iBooks

Want to Learn More about Investment? Pick Up a Copy of My Book.

If you invest, then it’s a near certainty you’ll encounter investment fraud. Nobody is immune.

Knowledge is your only defense. This book will show you how to recognize investment fraud so you don’t become the next victim.

It’s knowledge that will pay you dividends for a lifetime.