Proving Securities Fraud

As an investor, it is often difficult to determine whether you have been the victim of investment or securities fraud. Many instances of securities fraud go undetected. The market fluctuates, so not every loss means you have been the victim of fraud. Significant losses should prompt further investigation, though.

Sometimes, it's difficult or almost impossible to detect fraud without professional help. This is even more true for proving fraud. When it comes to consumer protection, you'll need assistance.

This article discusses securities fraud and provides a high-level overview of how to prove fraud under securities laws. An experienced securities attorney is your best resource if you believe you are a victim of securities fraud. They can assess your case and determine if you have a valid claim.

Securities Law

The United States Securities and Exchange Commission (SEC) enforces federal securities laws and regulations. The states also regulate securities. Several state and federal laws govern the securities industry in the United States. For example, the Securities Act of 1933 (15 U.S.C. 77 et. seq.) regulates the sale and offer of sale for securities in the United States. The Securities Exchange Act of 1934 (15 U.S.C. 78 et. seq.) governs the trading, purchase, and sale of securities.

Common Violations of Securities Laws

Violations investigated under federal securities law include the following:

• Insider trading
• Accounting fraud
• False statements about financial information regarding the company in registration statements
• Fiduciaries stealing customer funds
• Fraudulent schemes, such as Ponzi or pyramid schemes
• Illegal churning
• Market manipulation regarding an investment price
• False or misleading statements about a company in auditing or financial statements
• Selling unregistered securities
• Violating broker-dealers' responsibility to treat customers with fairness

The SEC brings hundreds of civil and administrative enforcement actions against individuals and companies for federal securities violations.

SEC Investigations

The Division of Enforcement conducts investigations. This division also works with the U.S. Department of Justice (DOJ) and other law enforcement agencies when necessary.

If the SEC Commissioner authorizes a case to proceed following an investigation, the case may be brought in federal court. The federal government may bring an administrative action or refer the case to the DOJ for criminal prosecution. Many securities fraud cases are resolved by settlement involving sanctions without going through the full securities litigation process.

Common Signs of Securities Fraud

Listed below are a few of the warning signs for securities or investment fraud:

• Your broker does not return your phone calls
• The transactions on your statements don't make sense to you
• Your account statements include transactions you did not authorize
• You find unidentifiable debits or credits on monthly account statements
• You see a dramatic drop in the stock's value in a short time
• It's an "up" market, but you're losing money
• The majority of investments recommended by the broker are declining in value
• Your broker tells you to view market news as entertainment
• Your broker fails to disclose important information regarding an investment purchase
• Your broker begins trading in high-risk and speculative investments
• You are paying capital gains taxes, even though your account value is decreasing
• Financial results are different from publicly announced expectations
• You begin to think your broker may have lied about certain derivatives

These warning signs don't always mean you are a victim of fraud or have an actionable securities fraud claim. If you experience any of these, it is in your best interest to seek the advice of an attorney with experience handling investment and securities fraud matters.

Proving Fraud

Proving fraud in a securities case depends on the particular statute or common law theory the plaintiff uses to bring the case. For example, Section 10(b) of the Securities and Exchange Act establishes civil liability for securities fraud. The Supreme Court has emphasized that Section 10(b) should be interpreted to effectuate its remedial purposes.

To state a claim under Section 10(b), a plaintiff must allege that a defendant: (1) made a misstatement or omission of material fact, (2) with scienter, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff relief, and (5) that the plaintiff's reliance was the proximate cause of the injury. A misstatement or omission is material if a reasonable investor would have considered the information relevant to the total mix of information available.

Scienter

When proving a claim for securities fraud, many consider the scienter element the most difficult to plead and prove. Concerning securities fraud, scienter refers to the mental state embracing the intent to deceive, manipulate, or defraud.

Requirements To Prove Fraud

To prove fraud, a customer must show that the broker or someone else in the industry misrepresented or omitted material facts in an intentional or reckless manner. The customer must have relied upon the fact and then suffered damages.

You must prove that you lost money because you relied on factual information from your broker or another securities industry member. The financial professional must have either known or should have known the information was false.

For particular fraud claims, an investor must show some reliance or action related to the misrepresentation. An investor can establish reliance by direct or indirect evidence. Direct evidence can be a statement in a prospectus claiming the existence of a lucrative contract that the issuer does not have. When investors can show they based their investment decision on that statement, they have provided direct evidence of reliance.

Fraud-on-the-Market Theory

Investors can use indirect evidence to prove reliance using a theory called fraud-on-the-market. Courts use the fraud-on-the-market theory when a misrepresentation creates an artificial inflation of the stock's price.

Investors argue that the misrepresentation affected the stock price. They assert they bought the stock based on the inflated price. In such cases, it's assumed that the investor relied on the misrepresentation that misled the market.

Plaintiffs can file a class action "fraud-on-the-market" claim. The private right of action under Rule 10b-5 is broadened to allow a class of securities purchasers to sue an issuer for making a public misrepresentation.

In such cases, the defendant may try to show that the misrepresentation was not important or did not affect stock prices. The defendant may claim that the individual investor knew the statement was false or would have bought the stock even if they knew the statement's falsity.

Fraud by Omission

When an investor claims fraud by omission, the investor does not have to prove reliance. For example, suppose a prospectus fails to disclose that the issuer's patent on its primary product is being contested in court. In such a case, it would be difficult for the investor to prove that they relied on the missing information.

The courts have decided that if the omitted information constitutes material facts that created reasonable expectations to influence an investor's purchase decision, positive proof of reliance is not required. Rather, reliance is presumed to exist.

The defendant can overcome this presumption by showing that the investor's purchase decision would not have been affected even if the defendant had disclosed the omitted fact. For example, if the defendant proves that the plaintiff did not read the prospectus, it succeeded in overcoming the presumption.

Getting Legal Help

Companies dealing with securities must protect their clients. Among other misconduct, they must avoid self-dealing, misrepresentations, and negligent handing of clients' funds.

Determining whether you are a victim of securities fraud can be challenging in some cases. A securities law attorney can help you in this situation in several ways. They can do the following:

• Determine whether you have a valid claim to bring to an attorney general
• Gather the necessary information
• Conduct an investigation
• File a complaint with the SEC
• Navigate the FINRA dispute procedures
• Calculate damages
• Represent your best interests

You have rights as an investor. You may be entitled to recover the investment money lost by broker or company misconduct. If you note any suspicious activity and feel you have been wronged, contact an attorney with experience in securities and investment fraud.