Broker Fraud: Legal Definition Of Stock Broker Fraud


If you have investments, you know that each investment comes with a risk, and sometimes you don’t always win. But what happens when you lose too much, for the wrong reasons? This is called stockbroker fraud. 

Do you need legal assistance?Find the right lawyer in your area.

What is Stock Broker Fraud?

With any form of investment, there is a chance for normal investment losses. When investments lose money, this is likely a regular part of market fluctuations. It does not mean that fraud is involved. Stockbrokers do not offer insurance or protection against market risk. Similarly, there are situations where a broker makes a mistake, a clerical error. These too can result in serious monetary losses but do not count as broker fraud. 

So what does?

Stockbroker fraud refers to unscrupulous and illegal actions on behalf of stockbrokers. While there is risk involved in any investment, including securities, stockbrokers have to abide by certain laws and regulations. Failure to do so is considered fraud. 

Types of Stock Broker Fraud

There are many types of broker fraud, ranging from direct violations of your investment agreement with the brokerage firm to outright theft of your money. Understanding them can help you remain vigilant and protect against them happening to you. 

Brokers Providing Misleading or False Information 

Stockbrokers are not legally allowed to provide you with misleading or false information. If they do, it is usually to support their individual investments or their company profits. This is considered malpractice. 

Misrepresentation or Omission

Similarly, brokers cannot try to influence your investments by misrepresentation facts or omitting certain information. If they omit information that might dissuade you from an investment decision, that is illegal. They must legally provide you with all the facts and information you need to make an informed decision. Anything else constitutes investment fraud. 

Trading Without Consent

If your stockbroker trades without your knowledge that constitutes securities fraud. The law dictates that brokers have to obtain your consent before they make any purchase on your behalf. They need to inform you of the terms for any purchase before you agree and confirm the details again after they make the trade you consent to. If they do not, they can be punished. 

Breach of Promise

As a breach of contract, a breach of promise is the stockbroker equivalent. This refers to any situation where your broker makes an agreement with you and fails to honor it. When you sign up with a brokerage firm, you will sign an investment contract and these types of violations are much easier to prove than other forms of broker fraud because you have a clear-cut agreement and can more easily show that parts of that agreement were not honored. Similarly, they might be subject to negative portfolio management claims if the broker did not manage your account in the way it was supposed to. 

Unsuitable Investments

When you work with your broker, you will work out a requested level of risk with which you are comfortable, and what types of potential losses you can handle. By law, your broker is required to work within the guidelines of your level of risk and potential gain. If they do not act in your best interest and intentionally make unsuitable investments outside of these agreed-upon parameters, they can be penalized. 

Lack of Diversification

The government does not want investors to lose everything, all the time, because they put all their monetary eggs into one basket, so to speak. This is why diversification requirements exist. Diversification requirements require your broker to ensure you have investments across a range of investment types. They have to work hard to prevent you from investing in one thing only. This is also called over-concentration. By overly concentrating your investment in one area, big bursts can harm your portfolio and the market in general. This is not only irresponsible financial behavior but illegal financial behavior.  

Abuse of Margin Accounts

When you invest money with a brokerage firm, they will often take that money and pool it into a big cash account, like a bank. Margin accounts use your personal investment as collateral which serves to potentially double your investment. The brokerage fees for the management of margin accounts are supposed to be based on the amount that is invested but some fraudulent companies will charge their fees based on the balance in the margin account. Seeing as the purpose of this account is to effectively double what you are working with for investments, that means they are charging fees based on double the amount you have invested. 

Improper Licenses or Registration

The brokers who handle your money must be legally allowed to do so. This means the brokers and their brokerage firm must register and receive licenses through the government, such as the Securities and Exchange Commission. If they trade your money without going through the proper legal channels, or they do not have current licenses or registration for their brokerage firm, this is considered securities fraud. Not only can it lose your investments but it leaves them at risk for penalties.    

Can a Stock Broker Steal Your Money?

A broker cannot legally steal your money, just the same as your neighbor or your bank cannot legally steal your money. However, it is possible for a stockbroker to steal your money and the money from other investors. This is called Conversion of Funds. Conversion of Funds is a violation of FINRA Rule 2150. This is when stockbrokers use their position to intentionally steal money from your trading account. The legal term is “misappropriation” whereby they use different tactics to move your money from your account into their account. People who are unable to read their investment statements and understand them well are at a higher risk of this type of broker fraud. 

Famous Stock Broker Scams

There have been dozens of famous cases where brokers steal money from customers or investors. While these are just a few of the nationally recognized cases, hundreds of cases happen regularly that do not make the news which is why knowing about broker fraud is so important for anyone who uses a brokerage firm or stockbroker to manage their assets. 

Centennial Technologies (1996)

According to the SEC, in this example of brokerage fraud Emanual Pinez and his company, Centennial Technologies, recorded $2 million in revenued, which was generated from the PC memory cards they sold. However, the company never sold such cards. Instead, they sold fruit baskets. They made forged documents as their evidence of sales. Their stock increased in value b 451%. The company overstated their earnings over the span of two years by $40 million. When the stockbroker frauds were revealed, over 20,000 investors lost their entire investment.

Enron (2001)

Enron represents a particularly popular example of stockbroker cheating. The SEC investigated this Houston-based energy company. At the time the company was the seventh biggest in America. They used shell companies to hide hundreds of millions of dollars in debt from their accounting ledgers or books. By hiding their debt, they could trick investors into thinking they were a very stable company, with a lot of profit and very little liability. The shell companies were also fraudulent in that they recorded fraudulent revenue, recording the same single dollar multiple times to make it appear that the company was worth triple or quadruple what it was. Once their stockbroker fraud was uncovered, their share prices dropped and the auditor ordered their financial statements and accounts be shredded to prevent them from being prosecuted by the federal government. They faced criminal charges nonetheless.

Bernie Madoff (2008)

The SEC charged Bernie Madoff and his company with securities fraud. In 2008, the former Nasdaq chair and founder of his private investment securities company was arrested after being turned in by his sons. He was famous for running what is called a Ponzi Scheme where his company would hide their losses by paying dividends to one investor from the money invested by another investor. The company reported 11% gains every year for 15 years in a row pretending they used a special type of option that minimized investment risk. In total, the company stole over $50 billion dollars from its investors. 

How To Deal With Stockbroker Fraud

If you suspect stockbroker fraud you can help yourself and other investors by filing a complaint with the SEC. Any information of interest can help the SEC investigate the facts, the investments, and whether any laws were broken by financial professionals. Anything of relevance can prove useful in protecting the customer and the market against unrealistic inflation or fraud. 

Consider Hiring a Securities Fraud Attorney

With any investment, there is a risk, and your financial decisions need to consider your personal risk tolerance but there are many cases where professionals in the stockbroker field exploit hardworking people like yourself through stockbroker fraud. If you have been the victim of securities fraud, consider reaching out to an attorney with experience in investor cases like these. You have the legal right to pursue compensation for broker fraud. An attorney can review your relevant financial statements and complaints who have with your brokers. 

Article by Yevheniia Savchenko

Yevheniia Savchenko is a Legal Writer at Lawrina. Yevheniia browses through the most interesting and relevant news in the legal and legaltech world and collects them on Lawrina’s blog. Also, Yevheniia composes various how-to guides on legaltech, plus writes product articles and release notes for Loio, AI-powered contract review and drafting software.

Thank You! Welcome on board
We use cookies to improve our website's work and deliver better services.
Our use of cookies
Upgrade the manual re-reading of agreements with Loio's AI-driven Highlights. Be in full control over every editing decision, but have the power of machine learning analysis by your hand. Turn on the Highlights tool whenever you need an extra check of your document's most essential details.
These cookies collect information that is used to help Us understand how Our Site are being used or how effective Our marketing campaigns are, or to help Us customize Our Site for You. We use Google Analytics to recognize You and link the devices You use when You visit Our Site or Service on Your browser or mobile device, login to Your User Account on Our Site, or otherwise engage with Us.
Communication services
These cookies collect information that is used to help Us to facilitate the interaction with You on Our Site. We also use those cookies to improve customer service by maintaining contact with visitors of Our Site through Intercom chat.
Ad Services
We and Our third-party partners may also use cookies and tracking technologies for advertising purposes. These third-party services collect information about Your use of Our Site over time so that they may play or display ads on devices You may use, and on other websites, apps, or services.