Had you walked into a certain Manhattan office recently, you would have met a group of seemingly typical New York stockbrokers.
But officials of a number of small companies liked these brokers for a sinister reason: The stockbrokers were not averse to accepting payoffs to push stock sales to unwary customers.
Surprise! The "brokers" were actually undercover FBI agents working an elaborate sting. On Oct. 10, federal regulators, including the FBI and the US Securities and Exchange Commission, charged 45 individuals here with conspiracy, securities fraud, and criminal contempt. Among those indicted were stock promoters, officers of publicly traded companies, and current and former brokers. In some cases, the perpetrators had allegedly made kickbacks equal to 40 percent of the value of stock being sold to investors.
When it comes to buying securities, experts say remember the old adage, "Caveat emptor" - buyer beware.
Fraud cases this year, for example, range from alleged fraudulent transactions by brokers and investment-house trading desks to allegations that journalists and financial newsletter writers might have accepted kickbacks for stock recommendations.
On the flip side, officers at several prominent high-tech firms in California have taken vows of silence. They're worried about a ballot initiative in the state that, if approved, would make it easier for investors to bring lawsuits against company executives for misleading investors in their public statements.
How to avoid being taken
What should an individual do to ensure that a report he or she has read or heard about a stock is not influenced by fraud or manipulation?
Here are some tips experts offer:
1. "Be skeptical about stock recommendations," says Alan Bromberg, a professor of law at Southern Methodist University, Dallas.
2. Read widely. Most libraries carry Value Line stock reports, for example.
3. In brokerage reports, look for fine print indicating the company may have a position in the stock.
4. If a "broker" you have never met calls you out of the blue to peddle an unknown stock, be suspicious. Perhaps even contact your local state securities regulatory office.
5. If an investment offer sounds too good to be true, it probably is.
At least two major laws apply to securities fraud cases: Section 17-B of the Securities Act of 1933 bars manipulation and other fraudulent acts by stockbrokers; and section 10-B-5 of Title 240 applies to all parties, including journalists and newsletter writers. In the late 1980s, a reporter for The Wall Street Journal was convicted after profiting from stories written for the paper's "Heard in the Street" column. The Journal was vigorous in helping to ferret out the wrongdoing.
Fraud or manipulation must be considered a possibility whenever a journalist, newsletter writer, or other person "fails to disclose material information" relating to a financial security, says Professor Bromberg.
Examples of potential manipulation, he says, might include the reporter being given stock at a reduced price prior to his reporting about the stock, or where the journalist or newsletter writer knows that a favorable report might drive up the share price and benefit his personal financial stake in that company.
Thus, if the writer is merely objectively commenting on a stock or a financial transaction, or presenting the objective views of others regarding a financial matter, without having received any quid pro quo (remuneration) for his comments, there is no apparent fraud or manipulation. "A reader should want to know if the writer is presenting an objective review of that stock, or a biased account" designed to profit the writer, Bromberg says.
In the case of a mutual fund, of course, it would be very difficult for a writer to influence the share price of the fund, because the portfolio is under the control of a fund manager, who buys and sells specific stocks within the portfolio.
Some columnists in financial publications, who regularly tout specific stocks, are "licensed brokers or financial planners to begin with," notes an SEC spokeswoman. "They are merely doing in print what they are licensed to do in private - make recommendations." These columnists must abide by the regulations that govern their professions.
Precisely because of concerns about stock-price manipulation, some brokerage houses are reluctant to let securities analysts talk to the press. Most houses will allow only experienced professionals to talk with reporters.
Hot debate in California
Meanwhile, California's Proposition 211 represents what many businesspeople see as a worrisome extension of fraud law. If approved, it would make it easier for state-resident shareholders to sue company officers, including board members, for alleged misleading statements, even if the company is not based in California. Some companies have tightened their discussion of earnings projections until they see how the November vote goes. Intel Corp. canceled an Oct. 31 press conference because of concerns about the measure. If passed, it could discourage people from serving on corporate boards, some analysts say.
While the California measure is controversial, combatting fraud is clearly an important matter.
Members of the Old Westbury Golf & Country Club on Long Island, N.Y., were cheated out of more than $7 million in investments and loans made to a prominent father-and-son accounting team. The two, who were given federal jail sentences earlier this year, had promised returns of up to 16 percent a year. Most of the victims, along with the perpetrators, were members of the same Jewish temple. An account of the scam can be found in November's "Smart Money" magazine.
Blind trust, as members of the Old Westbury Golf & Country Club learned, can be costly.
WHO YA GONNA CALL?
Who should you contact if you think you've been defrauded? The regional office of the Securities and Exchange Commission, the National Association of Securities Dealers (NASD's phone number is 800-289-9999), and your state attorney general's office are all possible places to start. You can also check with the NASD before you buy a security, to see if any formal complaints have been filed against the broker.
For a fee, Weiss Research (800-289-9222) will provide a report on the financial soundness of insurance companies, banks, thrifts, and, in "a few weeks," brokerage companies.