Stock Fraud

Early Frauds

Historically, documented stock frauds in the United States date back to the 1800s. These frauds included the gold and silver mines of the American west, in particular the Colorado gold rush in the 1880s. Prospectors had little capital and turned to selling shares to finance their ventures. Those unable to lure more substantial investments sold shares for as little as a penny. Of course, many “prospectors” were nothing of the sort, and frauds were commonplace.

On the heels of the 19th century miners came the oil and gas promoters. By 1918, towns like Fort Worth, Texas, were home to motley armies of “lease sharks, grafters and grabbers, operators, speculators, and gamblers,” according to authors Roger[Page 769] M. Olien and Diana Davids Olien. In Los Angeles, California, the Department of Justice estimated that stock swindlers hawking oil securities, many for little more than $1, were making about $100,000 a week in 1923. The activities leading up to, and including, the stock market crash of 1929 resulted in the Securities Act of 1933, which requires companies going public to register their securities offerings and to supply financial and other material information enabling investors to make informed decisions. The Securities Exchange Act of 1934 followed, creating the Securities and Exchange Commission (SEC) as the primary agency responsible for administering federal securities laws. These measures were intended to restore confidence in securities trading, and have remained the hallmark of regulation and enforcement.

The topic of stock fraud lay dormant, with minor exceptions, until the infamous insider trading cases of the 1980s. These scandals were serious enough to result in the U.S. Senate Committee on Banking, Housing, and Urban Affairs inquiry, “Improper Activities in the Securities Industry.” Following the insider trading cases of the 1980s and before the high-profile Enron, Tyco et al. cases the early 2000s, the most commonly discussed frauds were concentrated in the “micro-cap” market, more commonly referred to as the penny-stock industry.

Penny Stocks

The U.S. penny-stock market was designed as a “conduit through which money from small investors travels to legitimate young companies in need of venture financing,” according to Robert L. Frick and Mary Lynne Vellinga. There is no commonly held definition for penny stocks. In general, penny stocks are considered those securities not listed on a recognized exchange, hence they are traded over-the-counter (OTC), and information about them is only available on the “pink sheets.” Some argue, however, penny stocks are those that trade for less than $5.00 per share, and thus can be found on NASDAQ exchange. While there are several types of securities violations (for example, failure to disclose, unauthorized trading, refusal to execute orders, etc.), market manipulation dominates penny-stock fraud.

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