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Stock Investment Fraud

Did You Know?

Bank Fraud has been added to the list of crimes that comprise prohibited activities under the Racketeer Influenced and Corrupt Organizations Act

Stock fraud takes advantage of the trust a consumer places in a broker or brokerage firm. Stock fraud occurs when a broker manipulates customers into trading stocks without regard for the customer's interests. Stock fraud can be orchestrated at the company level, or can be committed by a single employee; stock fraud can also range in size financially from multi-million dollar deals to penny stocks, but stock fraud consistently involves intentional disregard for the financial situation of customers and obsession with personal gain.

An attorney experienced in defending the rights of stock fraud victims and recovering funds stolen from them may be able to help guide you through your legal rights and advise you on the most appropriate course of legal action.

The Following Activities are Considered Stock Fraud When Done Intentionally:

  • Giving biased investment advice
  • Giving unfounded advice
  • Offering separate clients contradicting advice
  • Advising clients to continue an imprudent risk
  • Advising out of a conflict of interest

Protecting Yourself Against Stock Investment Fraud

There are many ways in which you can protect yourself from fraud before it occurs. One way is to make sure you are closely monitoring transactions and commissions in your account. Another way to help safeguard your account is to keep it from becoming too concentrated in any one stock position. As a general rule, no one stock position should represent more than 2% of your total portfolio. You don't want another Enron on your hands!

Securities Exchange Act of 1934 (partial)

Federal securities fraud under Section 10(b) of the Securities Exchange Act of 1934 is defined as "(1) material misstatements or omissions, (2) indicating an intent to deceive or defraud, (3) in connection with the purchase or sale of a security." Brown v. E.F. Hutton Group, Inc. , 991 F.2d 1020 (2nd Cir. 1993). An unsuitability claim is a subset of 10(b) securities fraud with the following elements to be proved:

"(1) that the securities purchased were unsuited to the buyer's needs; (2) that the defendant knew or reasonably believed the securities were unsuited to the buyer's needs; (3) that the defendant recommended or purchased the unsuitable securities for the buyer anyway; (4) that, with scienter, the defendant made material misrepresentations (or, owing a duty to the buyer, failed to disclose material information) relating to the suitability of the securities; and (5) that the buyer justifiably relied to its detriment on the defendant's fraudulent conduct."

Banca Cremi, S.A. v. Alex. Brown & Sons, Inc. 132 F.3d 1017, 1032 (4th Cir. 1997).

"For Rule 10(b)(5) purposes, scienter includes recklessness." Breard v. Sachnoff & Weaver, Ltd. , 941 F.2d 142, 144 (2nd Cir. 1991).

NASD Conduct Rule 2310 requires that NASD members "shall make reasonable efforts to obtain information concerning: (1) the customer's financial status; (2) the customer's tax status; (3) the customer's investment objectives; and (4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer." This information is then to be used in making a suitability determination under Rule 2310:

"(a) In recommending to a customer the purchase, sale or exchange of any security, member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs."

A "recommendation" has been further defined by the NASD in NASD Notice to Members 96-60 as follows:

". a broad range of circumstances may cause a transaction to be considered recommended, and this determination does not depend on the classification of the transaction by a particular member as "solicited" or "unsolicited." In particular a transaction will be considered to be recommended when the member or its associated person brings a specific security to the attention of the customer through any means, including, but not limited to, direct telephone communication, the delivery of promotional material through the mail, or the transmission of electronic messages."

B. Breach of Fiduciary Duty.

As set out by the 11th Circuit Court of Appeals: "[t]he law is clear that a broker owes a fiduciary duty of care and loyalty to a securities investor." Gochnauer v. A.G. Edwards & Sons, Inc. , 810 F.2d 1042, 1049 (11th Cir. 1987).

A stockbroker is "an agent who owes his principal a duty to act only as authorized." Merrill Lynch v. Cheng , 901 F.2d 1124, 1128 (D.C. Cir. 1990). "As an agent, he has a duty to deal in the principal's interest. Moreover, he has a duty to give his principal information which is relevant to affairs entrusted to him of which he has notice." Id. The fiduciary responsibilities of a broker to his customer are more specifically set out as follows:

"(1) the duty to recommend a stock only after studying it sufficiently to become informed as to its nature, price, and financial prognosis; (2) the duty to carry out the customer's orders promptly in a manner best suited to serve the customer's interests; (3) the duty to inform the customer of the risks involved in purchasing or selling a particular security; (4) the duty to refrain from self-dealing or refusing to disclose any personal interest the broker may have in a particular recommended security; (5) the duty not to misrepresent any material fact to the transaction; and (6) the duty to transact business only after receiving prior authorization from the customer."

Lieb v. Merrill Lynch, Pierce, Fenner and Smith, 461 F.Supp. 951, 953 (E.D.Mich. 1978) (citations omitted).

C. Negligence.

As set out in Merrill Lynch, Pierce, Fenner & Smith v. Cheng , 697 F.Supp. 1224, 1227 (D.D.C. 1988): "It is clear from the case law that a stockbroker can be held liable to his client for negligence." The Cheng court went on to state that although it did not find a private right of action based upon NASD rules, a violation of the NASD rules would be a "factor for consideration by the jury as to whether [the broker] acted as a 'reasonable' person in his conduct..." Id.


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