Fraud, fraud, and more fraud. There are so many ways companies can mislead shareholders. Some are subtle and others are more egregious, but all of them are bad for shareholders, bad for the companies, and bad for business.

Whether motivated by personal financial gain, the pressure to meet performance expectations, or to bolster performance for financing, corporate fiduciaries have myriad opportunities to take advantage of unsuspecting shareholders and cause harm to the company they are bound to manage honestly and transparently. Fraudulent behavior by executives can lead to regulatory enforcement by the Financial Industry Regulatory Authority, the U.S. Securities and Exchange Commission, and the Department of Justice, can be criminally actionable, can subject the company to securities fraud class actions and shareholder derivative actions, and can damage the company's reputation and good will.   

Shareholders should consider the different types of fraudulent behavior and note that false statements and misrepresentations can present in a variety of ways. 

Financial Reporting Tricks: One category of misrepresentation is characterized as financial reporting tricks. Key to this category is accelerating revenues and delaying expenses. Aggressive revenue recognition can include booking lump-sum payments as immediate sales even though the services are rendered over multiple years, and "channel stuffing," which occurs when a manufacturer ships goods to a distributor and recognizes the shipments as sales even though the distributor retains the right to return unsold merchandise, rendering the transactions contingent. Delaying expense recognition can happen when companies hide liabilities or debt by keeping the occurrences off the balance sheet or using complex structures to obscure the risk. Companies may also report non-recurring expenses – one-time charges – in their financial statements annually and then subsequently realize overestimated reserves to manipulate the company's financial performance.

Misleading Disclosures and Communications: Another category includes misleading disclosures and communications, which are false, deceptive, or omitted statements companies make to deceive stakeholders about their financial health, product capabilities, or risks. Behavior that falls within this category of fraud includes: (i) selectively sharing positive information while withholding or hiding negative information from stakeholders; (ii) issuing overly optimistic guidance that is unlikely and then lowering expectations at a later time; (iii) utilizing testimonials that do not represent typical results; (iv) failing to disclose paid endorsements; (iv) allowing influencers to post unverified claims; and (v) intentionally manipulating financial reports, such as overstating revenue or assets.  

Operational Misrepresentations: Finally, operational misrepresentations occur when a company or fiduciary provides false, incomplete, or misleading information about its operational performance, products, or commitments. Examples include: (i) altering performance reports to attract investors; (ii) overstating product performance to entice buyers; (iii) failing to disclose product recalls or defects in a product to maintain good will; and (iv) exaggerating sustainability practices, providing inaccurate data about environmental impact, or concealing ecological harm to avoid lability.

Corporate Governance Abuses: Many forms of fraud appear as corporate governance abuses, defined as the failure of the company’s board or executives in their oversight duties, leading to ethical lapses, fraud, and stakeholder harm. Such abuses are broad and can include: (i) self-dealing, such as executives using their positions for personal gain by selling company assets to themselves at below market value or doing deals with companies they own or control; (ii) violations of the Foreign Corrupt Practices Act by bribing foreign officials to secure business; (iii) weak internal controls, including a lack of independent board members, incompetent directors, failure to protect whistleblowers, and the prevention of internal reporting of misconduct, and (iv) executive compensation abuse in which bonuses are tied to easily manipulated metrics or given despite poor performance.

Market Manipulations: A prevalent theme lately is market manipulation. Market manipulation involves artificially inflating or deflating the price of securities or creating false demand to deceive investors. Some common examples include: (i) pump and dump schemes in which a promotor buys a low-value, thinly traded stock, spreads false news online to inflate the stock price (pump) and then sells their stock for a profit (dump) leaving new investors with worthless stock; (ii) spoofing – placing large orders to buy or sell to create the false appearance of high market demand but having no intention of executing on the trade; and (iii) wash trading – the simultaneous buying and selling of the same security by the same person to create misleading, high-volume activity and artificially inflate the stock price. Market manipulation goes hand in hand with insider trading as those involved in the manipulation often sell their stock when the price is elevated from the fraud to reap the benefit of their actions.

When these fraudulent behaviors harm your investments, you want reputable, experienced legal counsel on your side. Proving fiduciaries' behavior rises to an actionable level must be supported by evidence that: (i) the information, i.e., misstatement, is material, i.e., "there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision; (ii) the information is knowingly false and misleading; and (iii) the investor relies on the information to purchase or sell a security; and (4) suffers a loss as a result. In most cases, corporate fiduciaries will hide behind the business judgment rule to argue that their decisions were made in good faith and with the honest belief that they acted in the best interests of the company. 

Investing is inherently risky, and shareholders should not be exposed to increased risk just because of the blatant fraud committed by a few self-serving fiduciaries. If you believe you have been a victim of fraud, Robbins LLP can help. We can evaluate your stock holdings for signs of corporate malfeasance and advise you on your rights.     

The information provided here is for general purposes and should not be considered as legal, financial, or investment advice.

Lauren Levi