How does the stock market work?

Stock markets are a form of centralized exchange where investors buy and sell ownership (stocks) of various companies. Most stock markets worldwide are highly regulated and involve legal, nationally registered, and regulated brokers to facilitate the transfer of stock from a seller to a buyer.

Examples of regulated stock exchanges are the US-based NYSE (New York Stock Exchange) and the NASDAQ (National Association of Securities Dealers Automated Quotations). Our ability to access the stock market has never been more effortless, and the barriers to entry continue to fall every year.

But this ease of access is not without its dangers. We are all susceptible to different types of investment scams in the investment and stock world, so it is incumbent on us to do our due diligence and protect ourselves and our money from becoming victims of stock fraud and stock scams.

Types of Securities fraud

Ponzi Schemes

Perhaps the most well-known version of a stock fraud scheme in history is a Ponzi scheme. A Ponzi scheme involves paying investment profits to old investors with the deposits of new investors. When a new investor joins the system, it is most often at the advice of another investor unknowingly part of the Ponzi scheme. What makes Ponzi schemes so successful is the perceived legitimacy and history of returns. Ponzi schemes can exist for years or even decades.

In the case of Bernie Madoff, his Ponzi scheme and fraud empire lasted for over 20 years. He was so successful at this fraud that his firm even became one of the leading market makers of the stock market, and he was a former chairman of the NASDAQ! Ponzi schemes eventually fail because there is never enough new investor money to keep paying off old investors. Some of the keywords or phrases with a Ponzi scheme are ‘guaranteed income,’ ‘offshore investment,’ ‘small, private hedge fund,’ ‘secret invite-only fund,’ or any other form of ‘too good to be true’ sales pitch.

Pump and Dump

Pump and Dump (sometimes referred to as P&Ds) scams are perhaps one of the classic and persistent forms of stock fraud that exist. What makes pump and dump scams challenging to detect is that they can often be done in a legitimate fashion. A pump and dump is essentially an event where you are targeted to buy a stock. The stock is sometimes referred to as a ‘multi-bagger,’ indicating a massive return on investment. You may also read about how the stock is an emerging leader in its sector/industry, how it could be the next Apple or Amazon.

The stocks used in pump and dump are often publicly traded and listed on a regulated exchange like the NASDAQ and bought through a regulated stockbroker. The stock price is almost always between $1.00 to $10.00; how a pump and dump works is straightforward. The scammers purchase the cheap stock early then begins to campaign on its behalf and drum up support and enthusiasm. As new investors buy, the price starts to spike up and accelerate – it is at that point the originators of the scam sell and exit their positions at a significant profit and at the expense of yourself and everyone else who bought too late.

Penny Stock Scams

Along with pump and dump scams, penny stock scams are among the oldest and most well-known forms of stock fraud. Penny scams and pump and dumps often work hand in hand with pump and dump scams utilizing penny stocks. Penny stock scams are often touted as ways to invest in new companies via their stock at very low-priced shares with the promise of massive returns in the future – the definition of a get rich quick scheme. The phrase ‘Penny Stock’ doesn’t necessarily mean that the stock is worth pennies – today, it generally means a very low-value stock.

However, modern penny stock scams have increasingly used stocks that are not available from the major regulated exchanges like the NYSE. Instead, these penny stocks are found on the ‘Pink Sheets’ or OTC markets (Over The Counter). OTC securities are not always available from regulated stockbrokers as the securities themselves must be exchanged between the company selling their stock to you directly or through another non-centralized broker/exchange.

Stock Broker Fraud

Stock broker fraud is, thankfully, one of the forms of fraud that has decreased as stock markets have become more regulated. However, that doesn’t mean it doesn’t happen. The days of a stockbroker taking the old physical paper securities or deposited cash and running away are long gone. Stockbrokers who wish to do wrong by the clients today now have to resort to more shady methods.

One of the most prevalent (and, sometimes legal) forms of stockbroker fraud is an activity known as ‘front-running.’ Let’s say you were to call your brokerage firm and you wanted to buy 100 shares of XYZ. Your broker, knowing that this would likely move the market, instead places an order himself before executing your order. The broker essentially enters the market early, for himself, before completing your order and allows your order to drive up the value of his earlier entry.

The major problem with front-running is it is nearly impossible to detect. With the amount of high-frequency-trading (HFT) that occurs every second, front-running is a type of fraud that only diligent and active regulators can determine. There are other tactics that stockbrokers will employ that are not necessarily fraudulent but unethical. Some types of behavior are encouraging high-frequency day trading by new investors, undisclosed appropriation of dividends, and unclear rules or fees associated with shorting.

Boiler Room Scams

If you have seen the movie ‘The Wolf of Wallstreet’ then you have seen what a boiler room is. Jordan Belfort’s (Wolf of Wallstreet) company employed hundreds of ‘brokers’ who called prospective investors to buy stock in individual companies – often overvalued but cheap companies. The ‘broker’ used high energy sale tactics that made the potential investor fear they would be missing out on an opportunity of a lifetime (FOMO = Fear Of Missing Out).

While the days of call-center type boiler rooms like those in The Wolf of Wall Street no longer exist, that doesn’t mean the concept has gone away. It has evolved. Instead of boiler rooms, we now have subreddits (the website Reddit), private/public forums and message boards, emails, text alerts, fraudulent websites, fake webinars, automated social media generators on Twitter, Facebook, and StockTwits (Twitter version for stock traders). Modern boiler room operations are now more prevalent than their old counterparts, and they continue to grow and become more sophisticated.

Signal Providers

Signal providers are companies or individuals which want you to subscribe to their frequent notifications which will give you a stock to buy or short, what the stock price entry is, where to take profit and where to place a stop loss or trailing stop. While this kind of service sounds fantastic and appears like a good deal, signal providers are only after one thing: your subscription, and is another one of the potential stock scams.

Almost all signal providers are just nicer versions of scammers and fraudsters who are able to operate and peddle their service in a legal way. You may also come across signal providers who offer their services for free. Signal providers who provide a free service are almost always involved in Pump and Dump schemes. They entice new traders and investors into thinking that they’re getting a great deal by getting free information – when all you are really doing is acting as a liquidity tool to pump up a stock that the provider has every intention of dumping as soon as its price spikes higher.

Can you get your money back from after a stock scam?

If you have lost money due to a scam or fraud in the stock market, you have options. With the stock market so regulated and scrutinized, thankfully, there are ways for you to recover money. But the process is exhaustive and prohibitively challenging that many become frustrated and decide not to pursue monetary recovery.

At Investment Payback , we specialize in the recovery of funds due to fraudulent activity and stock market scams. We have experience in working with regulators and litigating against bad actors in the stock market space. Our representatives create an exhaustive and detailed analysis of what happened to you to determine the best way to get your money back. Then we assign a caseworker that focuses on your case throughout the process. We have a myriad of positive reviews and an extremely high positive expectancy rate in the field.