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Securities Fraud

Fraud, or “misrepresentation,” is one of the most common claims in securities litigation. Fraud includes three types of false statements: (1) the outright falsehood; (2) the half-truth; (3) the omission of a material fact which the speaker (in this case, the registered representative, or “stockbroker”) has a duty to convey to the customer.

Fraud claims have their roots in the common law. After the excesses (and fraudulent schemes) of the 1920s led to the 1929 stock market crash, the federal government enacted the federal securities statutes in the 1930s, which incorporate misrepresentation sections (i.e., section 10-b of the Securities Exchange Act). Most states have also passed their own state securities fraud statutes.

Aside from the obvious credibility and swearing-contest scenarios (the broker denies making the statement or swears he did inform the customer of the risk, while the customer testifies that he the broker lied or kept silent when he had a duty to speak), misrepresentation claims in some instances may fail because the securities were sold by prospectus. If a security is sold through an offering (whether an “initial public offering” or a “secondary offering”), a prospectus will usually be delivered to the customer. Mutual funds, because they are sold through a “continuous offering,” are always sold by prospectus. Some insurance products such as variable annuities are also sold by prospectus. The customer who claims the broker made a face-to-face misrepresentation or failed to disclose important facts will be met with the defense that the true and the important (“material” is the legal term) facts were included in the prospectus.

What is more, most state courts have held that a customer not under a disability is deemed to have read and understood a document when the document is part of a sale. If the case is in court, the trial judge has no choice but to apply the law. The customer will usually testify that he or she did not read the prospectus. Arbitration panels, cynical and sophisticated as they often are, are not required to apply the letter of the law as rigorously as courts, and arbitrators realize that most customers toss the prospectus into the recycling bin without a glance. Arbitrators are thus left with the need to determine whether, under all the circumstances including the age and perceived sophistication of the customer, they believe the broker or the customer. These cases often turn on such small details as marginal notes on brokerage statements or the investing history of the customer.

If you think you may have a misrepresentation claim against a brokerage firm, or if you are a broker accused of committing fraud, seek competent, experienced securities counsel.

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