Stock Fraud

Investing in stocks has been the backbone of the financial market for many years. Of all investments made, buying stocks is perhaps the most common. Through the years, investors assume that the risks in purchasing stocks are well known and easy to avoid. Unfortunately, that is not the case. The following serve as examples of some of the risks that can arise.

Of course, investing in stocks involves risks and investors need to carefully balance their purchases of stocks to match their risk profiles. Stocks can range from relatively safe and conservative (e.g. utilities) to quite speculative (small cap companies).

When companies issue stock, they are legally required to provide investors with reasonable disclosures of material facts and risks associated with the stock. Such disclosures are typically made in prospectuses, private placement memoranda or similar disclosure documents. Unfortunately, at times companies fail to satisfy their disclosure obligations by either misrepresenting information or omitting to disclose important information. In those circumstances, investors have legal rights to recoup their damages.

Similarly, brokers are required to recommend only stocks that they reasonably believe are suitable for a given investor, given the investor’s investment objectives, risk tolerance, financial situation and needs, tax status, other security holdings, and other relevant information known by the broker. In addition, brokers are obligated to provide investors with balanced disclosures of all material facts – good and bad – regarding stocks (and companies) that they recommend. Likewise, brokers have a duty not to omit to disclose material facts to a customer. Breach of these duties also give rise to legal rights.

Investing in stocks also carries other risks. These include, but are not limited to:

  • Analyst Fraud This is where the brokerage firm’s analyst issues a Buy recommendation on a stock that they know, or should know, does not meet the firm’s criteria for such a recommendation. This caused significant losses for investors in the early 2000s through the likes of Smith Barney’s Jack Grubman and Merrill Lynch’s Henry Blodget.
  • Churning This occurs when a broker excessively trades stocks in an investor’s account to generate commissions.
  • Concentration Maintaining a well-diversified account is critical, particularly in turbulent times. Concentration is when brokers ignore that market wisdom and recommend that clients concentrate their holdings in a particular stock or asset class. Concentrations of 20% or more are suspect.
  • Volatility There have been large swings in the market, and it is not uncommon to see market drops of 300 or more points in a single day. This can create significant losses for investors, particularly if their broker recommended they trade on margin.
  • Broker Exuberance Some brokers pride themselves in being able to find the next big stock. Maybe they have fallen in love with a particular stock, and maybe that love has blinded them. Certain brokers may be so convinced they are right about a particular stock they sell that stock to all their investors, regardless of the individual investor’s needs and wants. In order to sell this stock, these brokers often fail to disclose the negative information that is available about the underlying company.
  • Sales Incentives On other occasions, brokerage firms may find themselves sitting on a large block of stock that they suspect (or know) is about to receive some negative news. In order to unload this stock, they offer their brokers extra sales incentives to sell this stock. In selling this stock to their customers, brokers, eager to earn the extra commission, will sometimes ignore the suitability standards and will often omit to disclose the risks or potentially bad news.

Though buying stock has become a relatively common activity, there are still many risks associated with investing in stocks.

If you have investment losses or problems involving stock fraud, call the lawyers at Page Perry for experienced representation at (770) 673-0047 or (877) 673-0047 (toll free).