“The point is, ladies and gentlemen, that greed – for lack of a better term – is good.”
So says the character Gordon Gecko in the movie “Wall Street.” In the movie, Gecko, played by actor Michael Douglas, is a wealthy investment executive eventually tried and convicted for illegal insider trading. Insider trading is one form of securities fraud – an umbrella term that includes a number of deceptive practices by individuals and companies during the sale of stocks and bonds.
While the story of Gordon Gecko is fictional, securities fraud is all too real – involving thousands of victims and billions of dollars each year.
Securities Exchange Commission
The Securities Exchange Commission (SEC) is the federal government’s regulatory body that has wide authority over the securities industry. The SEC was created with the Securities Exchange Act of 1934 and oversees brokerage firms and the nation’s various stock exchanges, such as the New York Stock Exchange. The SEC also requires publicly held companies to report specific financial information.
The SEC has the power to investigate and dole out punishment for cases of securities fraud.
Types of Securities Fraud
The most common types of securities fraud are:
- Insider trading
- Stock options fraud
The misrepresentation category of securities fraud is the most broad. It is “misrepresentation” to make false or misleading statements or to omit key information relating to the buying or selling of securities. This applies to stock brokers and financial advisors, and public companies that distort their financial situations. The misrepresentations must be made with the intent to deceive in order to be classified as fraudulent behavior.
Illegal insider trading typically involves company employees buying or selling shares based on private company information – material facts that haven’t been disclosed to the general public. Non-employees can be charged with insider trading if they use insider information provided to them by a company employee to buy or sell securities.
The third most common type of securities fraud, stock options fraud, occurs when stock options granted to company executives and employees are changed to ensure a profit for the individuals. Stock options allow an employee to purchase the company’s stock at a specified future date. But the purchase price is based on the date the option is granted. The employee makes a profit if the stock goes up. If the stock price falls, then the option is worthless. So, individuals and companies in this situation may illegally backdate the option to a date when the stocks were priced lower than on the date when the stock option was originally granted.
Securities Fraud Class Action Lawsuits
Like the iconic Gordon Gecko, individuals convicted of securities fraud may be incarcerated. However, companies and individuals committing securities fraud are also subject to private class action lawsuits brought by shareholders. In 2010, 86 securities class action lawsuits were settled, bringing $3.1 billion in total recovery for the plaintiffs.
Finance and accounting professors from Rutgers University and Emory University conducted a 2011 study into the effects of securities fraud class action lawsuits. They concluded that class action lawsuits tend to deter companies from committing financial fraud and, in many cases, they prevent more fraud than SEC actions.