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Stock Fraud

While you may not need to worry about stock fraud when trading for your own forex account, any investor or speculator in the financial markets would do well to at least have a basic familiarity of what is involved in a stock fraud.

Unlike foreign currencies which trade in a huge, global marketplace, stocks of small companies can lend themselves to manipulation and fraudulent practices more readily. The primary reason for this has to do with the nature of the stock market and the comparative lack of liquidity which does not usually present an issue in the currency market because of its size and depth.

As a result, stocks tend to be more carefully regulated and monitored by agencies such as the Securities and Exchange Commission which was founded in the aftermath of the huge stock market crash of 1929. A variety of different fraudulent practices involving stocks are listed in the sections below.

Corporate Fraud

Corporate stock fraud usually involves officers of the corporation disseminating false or misleading information in order to increase the value of the company’s stock. They do this in order to later sell the stock at the artificially inflated price. Enron was a classic example of a corporate stock fraud.

Other ways that corporate executives perpetrate fraud to manipulate the stock market include: making large purchases amongst several colluding investors in order to make the stock appear to be under accumulation by third parties. This might then prompt other investors to buy the stock at inflated prices.

After taking the stock price higher through these pre-arranged transactions, the stock is subsequently dumped by the perpetrators at the inflated price. This falls into the general category of a “pump and dump” stock scam.

Churn and Burn

Another type of stock fraud involves unscrupulous stock brokers that overtrade in their customer’s accounts in order to charge an excessive amount of commissions. This type of fraud is widespread and is not particular to the stock market.

Any financial market where a broker performs executions of financial instruments, especially on a discretionary basis, is subject to this type of fraud. Unfortunately, many people have no idea their broker is doing this if they have given the broker power of attorney over their account and do not monitor it closely.

Pump and Dump

This form of securities fraud has become especially widespread since it now often uses the Internet for the pump part of the scheme to artificially inflate a stock’s price. Con artists employing this scam disseminate fraudulent information via chat rooms and by spamming people’s e-mail accounts.

The false information will typically produce a rise in the stock price. At this time, the fraudsters dump their stocks and the subsequent investors lose out. This type of stock fraud works best with thinly traded and illiquid stocks that have little public information available about them.

Insider Trading

This type of securities fraud is performed by the corporation’s key personnel, directors and holders of a large percentage of the outstanding stock or other corporate insiders.

Basically, the fraud involves such insiders who trade on information which is yet to be made public. This might include such things as a pending corporate takeover or a disappointing earnings report, for example.

Other Stock Fraud Situations

Corporations can sometimes “cook the books,” which involves the corporate accounting of the firm, making it appear the company is doing much better than it actually is, making the stock price reflect the distorted information and defrauding investors. This sort of fraud came to light recently in the huge Refco case that forced the company into bankruptcy shortly after its Initial Public Offering or IPO.

Shorting stocks, which involves borrowing stock in order to initiate a short position, can also be fraudulent if done with the intent to profit by subsequently disseminating false or misleading information to make the market in the stock drop. “Short and distort” is the common term for this sort of stock fraud.

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