What Are the Most Common SEC Violations That Lead to Securities Fraud Charges?
The Securities and Exchange Commission (SEC) is the federal agency tasked with enforcing securities laws and regulating the securities industry in the United States. The SEC brings both civil and criminal charges against individuals and companies accused of securities fraud and other violations of securities laws. Some of the most common SEC violations that lead to securities fraud charges include:
Insider Trading
Insider trading refers to the buying or selling of a security by someone who has access to material, non-public information about the security. This can include corporate officers, directors, employees, as well as other professionals like lawyers, accountants, consultants, and bankers. Trading on inside information allows an investor to profit from information that is not available to the general public, which gives them an unfair advantage.The SEC aggressively pursues insider trading cases under antifraud provisions in the Securities Exchange Act of 1934, including Rule 10b-5. Penalties for insider trading can include civil fines up to three times the profit gained or loss avoided, criminal fines up to $5 million, and up to 20 years in prison. High profile examples of insider trading cases brought by the SEC include cases against Martha Stewart, Mark Cuban, and Raj Rajaratnam.
Accounting Fraud
Accounting fraud refers to the deliberate falsification of a company’s financial statements and accounting records in order to make a company’s finances appear better than they really are. This can involve techniques like exaggerating revenue, understating expenses, manipulating inventory counts, hiding liabilities off the balance sheet, and altering important metrics like earnings per share.When a company releases fraudulent financial statements, it misleads investors into believing the company is more profitable and successful than reality. The SEC often charges the executives of companies involved in accounting fraud under antifraud provisions for making false statements and filings. Recent major accounting fraud cases include Enron, WorldCom, Tyco, and HealthSouth.
Misrepresentations and Omissions
Under federal securities laws, companies are prohibited from making misleading statements or omissions of material fact in connection with the purchase or sale of securities. This applies to public statements, SEC filings, advertising, press releases, and other communications. Misleading investors by misrepresenting or omitting important information about a security is considered securities fraud.For example, a biotech company exaggerating the results of a drug trial or a company failing to disclose a massive data breach could both face charges of making misrepresentations or omissions from the SEC. Knowingly making false statements can result in criminal charges, while reckless false statements may lead to civil charges.
Unregistered Securities Offerings
Under the Securities Act of 1933, any offer and sale of securities must be registered with the SEC or qualify for an exemption. Selling securities without properly registering with the SEC or meeting the requirements for an exemption is an illegal unregistered securities offering.Unregistered offerings deprive investors of important disclosures and regulatory oversight designed to protect against fraud. The SEC often charges individuals and companies criminally for the unregistered sale of securities under Section 5 of the Securities Act.
Ponzi Schemes
A Ponzi scheme is a fraudulent investing scam that generates returns for early investors by misappropriating funds from newer investors. The scam leads victims to believe they are earning profits from their investments when in reality their money is being stolen and used to pay earlier participants.When the flow of new money dries up, the scheme falls apart leaving many victims with massive losses. Ponzi schemes require a constant stream of new investors to keep the scam going. The SEC prosecutes the organizers behind Ponzi schemes for securities fraud and misappropriation of investor funds. Infamous Ponzi schemes include those run by Bernie Madoff, Scott Rothstein, and Allen Stanford.
Market Manipulation
Market manipulation involves artificially affecting the supply or demand for a security in order to profit by deceiving investors. This can be done through tactics like spreading false information, rigging prices, wash trading, spoofing, layering, and other deceptive activities. For example, a stock promoter might orchestrate a “pump and dump” scheme by hyping a stock on social media using false claims then selling their shares when the price goes up.The SEC often brings market manipulation charges under Section 9(a)(2) and Rule 10b-5 of the Exchange Act. Recent market manipulation cases targeted “meme stocks” like GameStop and AMC Theatres.
Churning
Churning occurs when a broker engages in excessive trading in a client’s account in order to generate higher commissions. Frequent buying and selling that serves no reasonable purpose other than to generate fees for the broker is considered churning and a type of securities fraud. The SEC can bring civil charges against brokers for churning and self-dealing at the expense of their clients.
Boiler Room Operations
A boiler room operation refers to a call center that uses high-pressure sales tactics to peddle speculative, risky, or fraudulent securities. Boiler room operators often target vulnerable investors like senior citizens and use deception to sell worthless or fake stocks. The SEC cracks down on boiler rooms for deceiving investors, illegally operating as unregistered brokers, and selling unregistered securities.
Violations of Broker-Dealer and Exchange Rules
The SEC enforces compliance with rules that securities broker-dealers, exchanges, and other market participants must follow. Violating rules around recordkeeping, safeguarding customer accounts, net capital requirements, short selling, and more can lead to SEC charges of securities fraud and misconduct. Minor violations may lead to fines while major violations can result in criminal charges.The SEC has broad authority to investigate and prosecute a wide range of securities violations. While securities fraud charges often involve complex financial schemes, the root of most violations is deceiving investors and compromising market integrity. Companies and individuals who deal in securities must follow strict rules or else face steep fines, disgorgement of profits, and even imprisonment for the most egregious violations that constitute criminal securities fraud.
Information Corner
Additional Resources:
- Overview of SEC Enforcement and Common Violations: https://www.sec.gov/Article/whatwedo.html
- List of Major SEC Enforcement Actions: https://www.sec.gov/spotlight/enf-actions-fc.shtml
- SEC Press Releases on Securities Fraud Cases: https://www.sec.gov/news/pressreleases
Videos Explaining Securities Fraud and SEC Violations:
- Securities Fraud Explained: https://youtu.be/U1gi8wJ2gPo
- What is Insider Trading?: https://youtu.be/ONP9jS14toE
- Understanding Accounting Fraud and SEC Violations: https://youtu.be/QlzkbK74ocM