Since the dawn of investing, opportunists have sought to defraud investors for illicit gains. Investors, blinded by the promise of greater returns, are easily defrauded. For individual investors, justice is cost prohibitive, time consuming, and relatively unsuccessful.
In August 2014, the SEC charged four stock promoters with stock manipulation after they created false trading activity and news for marijuana companies, resulting in $2.5 million in ill-gotten gains. The promoters predicted gains as high as 2900%, blinding investors with the illusion of easy money, and encouraging investment without further research by creating a sense of urgency.
Section 10(b) of the Securities and Exchange Act of 1934 provides shareholders with a cause of action to recover damages as a result of fraud. Due in part to frivolous lawsuits, the Private Securities Litigation Reform Act of 1995 (PSLRA) increased pleading requirements. Plaintiffs must plead the misleading statement or omission with particularity, prove that the respondent intentionally defrauded the investors, and prove that the losses incurred were directly caused by the fraud perpetrated by the respondents. These heightened pleading standards result in many dismissed cases.
If pleading requirements are met, and the plaintiff prevails, enforcing a judgment can be time consuming and difficult, if not impossible. Often restitution is never received or is deeply discounted due to settlement.
Investors can also report fraud to the Securities and Exchange Commission (SEC). The SEC is not held to the heightened pleading requirements of the PSLRA. The commission can work in conjunction with the DOJ to bring criminal charges, increasing the pressure on respondents to pay restitution. However, the SEC workload and budget are such that only the most egregious incidents of fraud can be investigated and prosecuted by the commission.
Fraud prevention is key. Investor awareness can reduce victimization. Investors are often wooed by the volatility and buzz surrounding microcap stocks. Resources are available to inform investors of the risks inherent in microcap investing, but few investors know they exist. The SEC released an investor alert in May 2014 outlining the risks in purchasing marijuana stocks, and a similar bulletin outlining the general risks inherent in investing in microcap stocks. FINRA, a brokerage industry regulating body, publishes similar bulletins for the public.
Retail brokerage firms are perfectly positioned to disclose investment risks at the point of sale. These firms enable investors to purchase stock. Each purchase results in a commission, and ultimately, profit. FINRA can require disclosure and client acknowledgement before orders are accepted. Mandatory disclaimers should illustrate inherent risks in microcap investing, resulting in reduced losses. Investors wishing to purchase the stock despite the warnings can acknowledge the disclosure, and complete their purchase. Informing the public before each and every microcap purchase should eliminate some of the opportunity that allows victimization to occur in the first place.
Robert Strongarone