Area of Law: Criminal Law
Answer # 1803
Securities fraudRegion: Ontario Answer # 1803
What is securities fraud?
Securities fraud takes place in the stock or commodities markets. It includes a variety of unlawful activities and strategies that primarily involve misrepresenting information that investors use to make decisions. Securities fraud is also known as stock fraud and investment fraud.
What is the law?
In Canada, the regulation of securities markets is a provincial responsibility.
The sale of securities and investments is regulated by a number of provincial and federal statutes, court decisions, and the Criminal Code. Each province has its own securities commission. The Ontario Securities Commission, commonly referred to as the OSC, administers the securities industry and capital markets in Ontario, and enforces the Securities Act, the Commodity Futures Act, as well as certain parts of the Business Corporations Act.
If an individual or company purports to be selling shares, stocks or other investment instruments, they must be registered and qualified by the OSC.
Common securities fraudsters
Securities fraud is most often committed by:
- an individual, such as an investment advisor or stockbroker;
- an organization, such as a brokerage firm, corporation, investment bank, or
- an individual or company purporting to be a legitimate investment advisor or brokerage.
Common types of securities fraud
1. Insider trading
Insider trading occurs when someone on the inside, like a senior officer of a corporation, who has access to privileged, non-public, material information, uses that information to buy or sell a security. When an insider uses that information for their own personal gain, or discloses it to someone else – such as a family member, friend or other 3rd party – this is called tipping. The person receiving this information is also then considered an insider.
Securities fraud occurs when an insider or a related party makes trades based on this insider information that is either obtained during the performance of the insider’s duties at the corporation, or otherwise misappropriated.
2. Illegal distribution
According to the Canadian Securities Administrators, an illegal distribution is characterized as, “a sale of securities to investors that does not comply with securities law trading and disclosure requirements.” A common way the illegal distribution of securities occurs is through Ponzi schemes.
In a Ponzi scheme, an investor will initially receive large payments from the first investment and encouraged, will usually invest even more money. However, withdrawals from the investment fund are financed by subsequent investors, not from real profits obtained through investment activities. The scheme is eventually uncovered because there is no underlying asset or business and the fraudster is ultimately unable to make payments to investors.
3. Registrant misconduct
As previously mentioned, in Canada any person or company in the business of advising or trading in securities must be registered under the securities laws of the province in which they conduct this activity (unless an exemption is provided in legislation or by order from the securities regulators). This includes brokers and investment advisors. Misconduct occurs when a registered person or company:
- violates securities laws,
- fails to register when required to do so, or
- fails to adhere to the conditions of a registration exemption.
Registrants who conduct business while committing misconduct can be guilty of securities fraud.
4. Market manipulation
Simply stated, “market manipulation is the effort to artificially increase or decrease a company’s share price”. A common way market manipulation is committed is through pump and dump scams.
In a pump and dump, false information is spread online in chat rooms, forums, internet boards and through email, with the purpose of causing a dramatic price increase in an infrequently traded stock, or stocks of companies that do not actually exist. This is known as the pump.
The fraudster promotes the stock as an incredible once in a lifetime opportunity. What the victim doesn’t know is that the person or company touting the stock owns a large percentage of it. As more and more investors buy shares, the value increases. Once the price hits a peak, the fraudster sells their shares – this is the dump, the value of the stock falls dramatically, and the victim is left with worthless shares.
5. Dummy corporations
Securities fraud occurs when fraudsters invent dummy corporations that create the illusion of it being an existing corporation with a similar name. Fraudsters are then able to sell securities in the dummy corporation to investors who are misled into believing they are buying shares in the real corporation.
Refer to topic #1802 Investment fraud for more information on other types of investment scams, including:
- boiler room scams
- off shore investment scams
- foreign exchange scams (Forex)
- affinity fraud
Tips for avoiding investment and securities fraud
While there is nothing someone can do to protect themselves 100% from investment fraud, there are many simple rules that can go a long away in helping prevent fraud:
1. Only deal with registered advisors
To minimize the risk of fraud when investing in the markets, you should deal only with registered advisors and firms. In Canada, investment firms and advisors must be licensed to sell investments. It is also advisable to check the advisor’s disciplinary history before investing.
2. Be aware of warning signs or red flags, such as:
- The promise of unrealistic returns on your investment. Investments that offer a higher-than-market rate of return and little, to no risk are almost always fraudulent,
- Guaranteed high returns,
- Pressure to borrow money to invest,
- High-pressure sales tactics, such as ones that state “limited time offer”, “act now” or “don’t miss this opportunity”.
3. Make cheques payable to registered firms, not individuals or other unrelated companies.
4. Ask to see the prospectus or other disclosure documents for the investment.
A legitimate investment will have a prospectus and other disclosure documents filed with the securities regulator, unless they are prospectus-exempt.
5. Ask questions and verify information
Further warning signs of fraud include:
- If you do not understand something about the investment and it cannot be explained to your satisfaction,
- If you are asked to lie about your personal financial situation, such as your income, or
- If the investment paperwork involves blank documents.
If you discover you are a victim of fraud, it is a good idea to contact a fraud recovery expert for advice.
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