Conflict of interest of Stockbrokers

A business based on commissions would always have conflicts that need to be managed? The stockbroker’s incentive is to sell you the product on which he gets the largest commission not necessarily the one that is the best investment for you, leading to conflicts of interest. However, it becomes a fraud when the conflict of interest leads to a gain from taking actions that are detrimental to a party in the transaction, through misrepresentation of facts.

One of the notorious methods used by stockbrokers in collusion with an investor for personal gain is “pump and dump”. This is when a stockbroker who owns a security (of an investor) artificially inflates the price by upgrading it or spreading rumors, and then sells the security. This rise in prices can entice more people to believe the hype and then buy shares as well. The stockbrokers will then sell their shares and stop promoting, the price will drop, and other investors are left holding stock that is worth nothing compared to what they paid for it. It is a conflict of interest because the stockbrokers are concealing and manipulating information for his gain and to make it misleading for the buyers.

Another fraud which is difficult to prove is when the stockbroker conspires with its investment advisory arm to over price IPO stocks and dump them on unsuspecting clients. They make the front loaded fees and the commissions in addition to other undisclosed benefits. The buyers of the stock lose when the price starts stumbling towards its fair value. Facebook’s IPO under investigation was compared to pump and dump schemes, bringing the underwriters and bankers to the issue under criticism. Locally, few companies did a similar exercise to dump over priced IPOs on investors, in 2012, with no worries of consequences!

Follow up to the post on: https://surenrajdotcom.wordpress.com/2013/09/20/governance-in-the-capital-markets-and-stock-broker-frauds/

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About surenraj

“Views expressed are my own”
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