Broker Fraud: Legal Definition of Stock Broker Fraud

Updated January 23, 2024
9 min read
Broker Fraud: Legal Definition of Stock Broker Fraud

Introduction

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”.

What Is Stock Broker Fraud?

Have you ever heard that high risk results in high reward? Those not new to investing in the stock market know that’s not always the case. The market moves every minute of every day. As a result, you win some and lose some. Losing money on your investments is a normal part of investing in the stock market, and it doesn’t have to count as stockbroker fraud. So, what is broker embezzlement, also usually called fraud?

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

Types of Stock Broker Fraud

Stockbroker fraud ranges from simple violations like a broker giving you misinformation or omitting specific facts to trading your investments without your knowledge and theft. Knowing about the different types of stockbroker fraud may help you identify any stockbroker misconduct.

  1. Brokers providing misleading or false information: Brokers are legally prohibited from furnishing misleading or false data. It usually happens to boost their investments or firm profits and is viewed as malpractice.

  2. Misrepresentation or omission: If brokers provide inaccurate data or omit details that could influence your buying or selling decision, that's a form of stockbroker fraud. Brokers are obligated to furnish all facts to enable informed decision-making.

  3. Trading without consent: Unauthorized trading by your broker is deemed securities fraud. The law mandates brokers to obtain your consent before making any purchase on your behalf.

  4. Breach of promise: Brokers failing to honor their agreed promises amounts to a breach of contract, akin to stockbroker fraud. This type of violation is easier to prove compared to other frauds due to the presence of a formal agreement.

  5. Unsuitable investments: Making investments intentionally misaligned with your financial goals and risk tolerances is considered stockbroker fraud.

  6. Lack of diversification: Your broker must ensure adherence to diversification requirements. Putting all your investments in a single area and jeopardizing them is broker fraud.

  7. Abuse of margin accounts: Overcharging or setting fees based on your margin account amount instead of the actual investment amount is a common type of stockbroker fraud.

  8. Improper licenses or registration: Every broker or firm handling your investments should be appropriately licensed and registered. Working with an unlicensed broker or firm heightens the risk of stockbroker fraud.

Can a Stock Broker Steal Your Money?

Though it is illegal for a broker to steal your money, and it is considered stockbroker fraud, it certainly is possible. Stockbrokers may move the money from your account to their account through the so-called conversion of funds. In this situation, they take advantage of their position as a stockbroker with access to people’s money and investments. 

This practice is not very common in prominent and respected brokerage firms. You can protect yourself from this type of broker fraud by learning how to read and understand your investment statements. Once you've mastered this, you will quickly notice when something isn’t right.

Famous Stock Broker Scams

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

  1. Centennial Technologies (1996): According to the SEC (U.S. Securities and Exchange Commission), in this broker embezzlement example, Emanual Pinez and his company, Centennial Technologies, falsely recorded $2 million in revenue from selling PC memory cards when they actually traded in fruit baskets. The company forged documents as proof of sales, causing its stock to soar by 451% and overstating earnings over two years by $40 million. When this instance of broker fraud was exposed, over 20,000 investors lost all their investments.

  2. Enron (2001): In one of the biggest stockbroker frauds of the century, Enron used shell accounts to hide millions in debt and inflated their revenue, painting a false image of success. The company made significant profits by selling shares under these pretenses, constituting broker fraud. When the fraud was exposed, Enron filed for bankruptcy, marking a stark example of broker embezzlement.

  3. Bernie Madoff (2008): Financial advisor and stockbroker Bernie Madoff executed the biggest Ponzi scheme of the century. He concealed his company's liabilities by using new investors' money to pay existing investors. This instance of broker fraud lasted about 15 years, with Madoff stealing a total of $50 billion. He was convicted and sentenced to 150 years in prison.

How To Deal with Stockbroker Fraud

If you suspect stockbroker misconduct, 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 financial professionals broke any laws. Anything of relevance can prove helpful in protecting the customer and the market against unrealistic inflation or stockbroker fraud.

How Can You Protect Yourself From Broker Fraud?

Though being a victim of broker fraud is rarely the fault of the individual, there are a few things you can do to avoid it:

  1. Check your broker. It’s good to work with someone whom friends recommended. However, that doesn’t offer enough protection. Do your research and check your broker through this BrokerCheck website. At the very least, it will tell you what licenses your broker has.

  2. Know your scam. Carefully researching different types of scams may protect you from broker fraud. Take your time to read over the different types of broker fraud in this article. You will know what to look out for.

  3. Ask questions. A broker planning on scamming you will expect you to be quiet and submissive. Don’t let them win! Research each investment offered, read through all the documents before signing, and ask as many questions as you need to ensure you’re not being scammed.

Conclusion

Stock frauds do not have to go unpunished. You can demand compensation for any damages you’ve suffered, especially if they did not result from your mistake. An experienced securities fraud attorney can be beneficial to you. You and the attorney can put your broker fraud case together and find a way to get as much compensation as possible. Investment is a risky business, and losing some money is to be expected. However, securities fraud is illegal and can be punished.

Article by
Yevheniia Savchenko
Lawrina

Yevheniia Savchenko is a Product Content Manager at Lawrina. Yevheniia creates user interface copies for Lawrina products, writes release notes, and helps customers get the best user experience from all Lawrina products. Also, Yevheniia is in charge of creating helpful content on legal template pages (Lawrina Templates) and up-to-date information on US law (Lawrina Guides). In her spare time, Yevheniia takes up swimming, travels, and goes for a walk in her home city.

If you have any questions or suggestions regarding the product or UX content for Lawrina, feel free to contact Yevheniia directly at y.savchenko@lawrina.org or connect with her on LinkedIn.

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