What is generally associated with
the hope of high returns in investment, in this fast-paced world of the stock
market, is massive risk. The two most well-known hazards are known risks-market
volatility and economic factors. However, one of the guileful threats to your
investments within the stock market is fraudulent schemes. Scammers are always
coming up with other ways to dupe financial specialists; hence it is imperative
that anybody included in stock trading has to be mindful of these schemes
and avoid them.
The stock market has been
characterized by pump-and-dump scams, Ponzi schemes, among other tricks run by
fraudsters as they look for to require as much money as possible from
unconscious investors. It is not only the money that goes, but the level of confidence
in the financial system gets eroded and also rather long-drawn-out legal
battles, plus psychological distress on the investors. Due to new technology as
well as trading platforms online, scams have become sophisticated where novices
meet experienced fraudsters.
Now, even for Indian investors,
this risk of fraud in stock markets has become even more pronounced as they go
on with increasing participation levels in the markets. That fertile ground is
there, with fast growth in digital investment platforms and increased
proliferation of small-cap and penny stocks to take advantage of poorly
informed or overeager investors. Already, the infamous Saradha Group Ponzi
scandal had sucked billions of rupees from Indian investors. Therefore,
vigilance will be the best investment one can do in keeping one's stock
portfolio safe.
The prevalence of scams
notwithstanding, there is ways to protect your investments. This blog
will explore the most common stock market frauds, explain how these schemes
work, and provide actionable tips for protecting your stock portfolio. Right
from fact-checking and research to knowing how a regulatory body like SEBI
(Securities and Exchange Board of India) would treat investors; we will discuss
all the important steps every investor has to undertake in order to reduce the
associated risk.
Knowledge regarding fraud
detection and avoidance, with or without experience, may better serve to
protect financial resources. The better one is prepared to learn from the
experience and become aware of fraudulent practices; the better a person can
work on ridding frauds lurking behind his investment portfolio and building a
more formidable and profit-generating investment system. Today, nothing can
better protect the shield of knowledge than staying ahead of all potential
scams that might have your wealth.
Common Types of Stock Market Frauds
Pump-and-Dump Schemes
In this scheme, they manipulate
the price of a share either through false or misleading information. As long as
the price is up due to the "interest" other investors have caused,
they "dump" their shares at the inflated price and the rest of the
investors get worthless stock when the price crashes.
Global Illustration: Stratton Oakmont
Perhaps the most infamous
pump-and-dump scheme of them all was that by brokerage house Stratton Oakmont
which functioned during the 1990s. The firm was highly aggressive and misguided
in its attempts to promote a host of penny stocks where the firm itself sold
its shares once the price had peaked crashing even further the stock leaving
most of the common investors with huge losses. That scam eventually motivated
the making of the movie, The Wolf of Wall Street.
For instance,
pump-and-dump involving several small-cap companies was cleared by the
Securities and Exchange Board of India, or SEBI, in 2018; fraudsters spread
deceitful news and then dumped shares, leaving ordinary investors with huge
losses.
Insider Trading
This insider trading practice
gives the insider an advantage over others in trading shares of the same
company that uses material, non-public information. Other unsuspecting
investors who trade based on information from the insider receive charges of
being legal infractions.
Example: Kodak Insider Trading Scandal (USA)
In 2020, Eastman Kodak becomes
embroiled in an ugly insider trading scandal after the company discloses it had
accepted an around $765 million loan from the U.S. government in order to allow
the firm to continue to manufacture pharmaceutical ingredients during the
COVID-19 pandemic and that several top executives bought stock shares before
the official announcement. With the announcement of the loan, the company's
stock price went rocketing by a huge margin, and the executives who had
purchased shares earlier found a huge money bag. The sale at the right time did
raise allegations of insider trading since the executives may have known about
the government loan in advance.
For instance: In
2020, SEBI levied and penalized a former managing director of ICICI Securities
for insider trading. The managing director traded in shares of a company before
the inside information-lit when he came to know that the company is being taken
over by another company.
Ponzi Schemes
Ponzi schemes promise unusually
high returns with little risk by paying returns to old investors using money
taken in from new investors. When new investment runs out, the scheme
collapses, and most financial specialists lose an incredible deal of money.
For illustration,
West Bengal's Saradha Group financial scam is one of the very high profile
cases in which lakhs of investors were cheated. Saradha claimed it would return
huge amounts through some investment schemes but was a pure Ponzi setup.
Thousands of investors lost their savings when the company went belly up.
Chop Stocks
This fraud usually takes the route
where the buying of small or micro-cap stocks, sometimes by dubious brokers,
passes on false claims to investors leading to loss when reality sets in and
the stock prices plummet.
Example Satyam Infoway India
The Satyam scam is basically a
corporate fraud scam but it resembled chop stock tactics in its tools of stock
manipulation. When the promoters of Satyam Infoway purchased colossal amounts
of shares at low valuations, false statements relating to the financial
performance of the company were made to the market. When such financial
statements are used to inflate the price of the stock, the insiders sell their
shares at a huge profit. When the facts about the inflated earnings of the
company leaked to the limelight, the stock price crashed, inflicting enormous
financial damage on common shareholders.
Boilers Room Scams
Boiler room scams are
high-pressure sales frauds, wherein the fraudsters are brokers or agents
selling doubtful stocks to investors. This often consists of low-quality and,
at times, fraudulent stocks, causing heavy losses to people buying such stocks
as part of the scam.
In 2015, SEBI targeted those
companies accused of operating boiler rooms-thus, involving brokers that allure
investors into purchasing penny stocks on promises of huge returns.
How to Detect Scam Schemes
Before describing how to protect
your equity portfolio, first let's observe some warning signals of fraudulent
business activities:
Unsolicited Offers: If you
receive a hot stock tip or investment opportunity by cold call, email or social
networking sites, be very careful. Legitimate financial professionals never
make unsolicited offers of advice.
Guaranteed High Returns: By
definition, there is no risk-free investment, and any promise of a high
guarantee of returns is almost certainly fraudulent.
Time to Act: Scammers will
always put false pressure on you to invest as fast as possible, not giving you
any time to research. And always take your time to make the right decision.
Lack of Transparency: The
inability to identify or understand financial information about the company may
indicate that something is being hidden. All legitimate companies promote
transparency in their statements and operations.
Complex Jargon: Swindlers
use very technical language or confusing jargon to hide the real nature of
fraud. If something sounds too technical, get a financial expert before
investing.
How a Stock Portfolio is Protected
With all the common scams and red
flags placed above, here are some actionable steps to avoid getting victimized
by fraudulent schemes in your stock portfolio:
Conduct Your Own Research
Never accept tips or any such
information that just falls into your lap, especially when unsolicited. Take
time to study the basics of the company before investing in a particular stock.
Read and understand financial statements, earnings reports as well as market
performance. Ensure that the company is listed on a reputable stock exchange
and has good business operation.
Tip: Always
cross-check information from multiple sources. SEBI’s or nation wise government
stock market website provides access to company filings and other essential
data that investors can use to verify the authenticity of the companies they
are interested in.
Choose Licensed Broker and Advisor
Only work with registered,
respectable brokers or financial advisors who are registered with regulatory
bodies such as SEBI or FINRA. Find information on your broker or financial
advisor's credentials and history of disciplinary action through public records
or the websites of such regulatory bodies.
Tip: You may
crosscheck the registration of the brokers at the website of SEBI. In 2019,
SEBI barred and penalised many unregistered brokers that were proven to cheat
investors through fraudulent trades undertaken without authorisation.
Diversify Your Portfolio
Diversification can limit
potential losses in case of stock frauds in diversified portfolios. If you
spread investments into different sectors, industries, even asset classes, you
will necessarily reduce how hard those possible losses hit your overall
financial health, at the time that the fraudulent stocks or scams happen. It
cushions a portfolio from huge losses in any given investment.
Tip: A
diversification approach can be attained through large-cap, mid-cap, or
small-cap stocks. Other asset classes, such as mutual funds or bonds, will be
introduced to reduce such risk.
Verify Information by Using Multiple Sources
There are always fraud parties
that manipulate information to lure investors into poor deals. Verify any claim
you hear, especially the "next big stock." Crosscheck from reliable
news sources, company filings, and independent analysts so you will have a
comprehensive, accurate view of an investment opportunity.
For instance, with
Stratton Oakmont's pump-and-dump scheme, most investors were led to invest in
penny stocks based on claims that they never verified personally. Always
crosscheck your claims using the following trusted sources of news and sound
analysis of financial news, regulatory filings, and analyst reports.
Avoid Penny Stocks
Penny stocks privileges of stock
trading at less than penny a share are highly susceptible to manipulation and
scams. In general, there is not a lot of trading in penny stocks, and scammers
easily drive up prices by manipulating them. Unless you have been around
playing with unsafe investments, absolutely avoid penny stocks.
For example, SEBI
in India regularly cautions the public against weak financial micro-cap
companies. Recently, fraudulent promoters had gamed the stock price of such
companies and cheated the investors.
Monitor Your Portfolio Regularly
You should follow your portfolios
in stock closely for shifts in current values, trends in the market, and
company performances. Such monitoring can show anomalies such as spikes or
downtrends in prices without any palpable reason that can reveal some form of
fraud. All this information can be monitored real-time through various tools
and apps available on the internet.
Tip: Using
portfolio tracking tools or mobile apps will keep you up-to-date regarding
movements and news on a stock and companies, thus allowing for quick, fast
responses if "something smells fishy.".
Keep Up With Regulatory Changes
Financial regulations and
securities laws are always changing to protect investors from new forms of
fraud. Keep abreast of changes in any laws and regulations by staying up to
date with update notices from regulatory bodies such as SEBI or the SEC.
Defending your portfolio requires knowledge of your rights as an investor under
the law.
For example, after
the Madoff scandal, the SEC demands strengthened oversight within the agency
and, investors become more aware of their rights to gain access to more open
financial information. What is important here is keeping pace with these
changes.
Be Watchful of Unregulated Markets
Trading in unauthorized or
unregulated regulated markets increments your chances of being a victim of
false schemes. It would in this way be prudent to stay with more established
stock exchanges, such as the NSE or the BSE in India, or others countries, over
the globe. More established exchanges impose really stringent requirements and
oversight mechanisms that protect investors.
So many retail investors in India
get short changed with tips coming through WhatsApp or Telegram groups. SEBI
said that it does not approve of decisions based on unsolicited material.
Report Suspicious Activity
Suppose you suspect you have
uncovered a fraud scheme. Report this to regulatory authorities right away. In
India, SEBI is a forum where an investor can file their complaint and report
fraud. Reporting any suspicious activity is not only keeping you safe but also
will help others avoid becoming victims.
What to Do if You Are a Victim of Stock Market Fraud
If you feel swindled, do not wait
and act fast to contain your loss:
- Report the incident to your broker or advisor and ask him to freeze any other transaction from happening.
- Gather evidence, including emails, messages, and transaction records that may support your case.
- File a complaint with an appropriate regulatory authority depending on your geography, like SEBI, SEC, or FINRA.
- Get yourself an attorney or lawyer who specializes in securities fraud; he or she will help you in understanding how to approach a lawsuit that will recuperate your loss.
Final Thoughts
The interesting appeal of stock
market as a ground to be fed is that which creates vulnerability to fall prey
to a myriad of scams designed to prey on ready, unsuspecting naïve gullible
investors. Being alert, doing the proper research, and working with qualified
professionals can work in your favour to help mitigate getting duped through
stock market fraud. Protecting your portfolio is an ongoing process, continuous
vigilance, and knowledge acquisition of new threats and changes in the
regulatory system can help.
Knowledge would, hence, be the
best asset in those times guarding your money and investments amidst an
ever-changing marketplace.
