When investors put their money in the hands of Wall Street, they should be able to do so with the understanding that they’re doing so in a transparent, trustworthy manner.

Unfortunately, that doesn’t always happen. Broker-dealers sometimes misuse cash or fail to disclose complete and important information, putting customer securities at risk.

It’s important to know what fraud on Wall Street looks like so we can work together to keep investment firms accountable. Let’s take a look at some of the regulations that exist to protect investors and some instances where they were not followed.

What are some regulations that protect investors?

The SEC put a number of measures in place to help prevent fraud and protect investors. Two important ones to call out are:

The Consumer Protection Rule Initiative – The Consumer Protection Rule aims to “avoid, in the event of a broker-dealer failure, a delay in returning customer securities or worse, a shortfall in which customers are not made whole, by requiring broker-dealers to safeguard both the cash and securities of their customers.” This protects investors by requiring that a broker-dealer keeps a reserve of funds at least equal to the amount of net cash owed to customers. You can read more about the Consumer Protection Rule Initiative here.

Regulation SHO – Regulation SHO outlines a code of conduct regarding short sales. It requires broker-dealers to “identify a source of borrowable stock before executing a short sale in any equity security with the goal of reducing the number of situations where stock is unavailable for settlement.” It has been amended several times in order to provide clarification and exceptions; but for the most part, Regulation SHO has made a significant impact on keeping the market even. You can read more about Regulation SHO here.

Examples of misusing cash and putting customer securities at risk

Unfortunately, these and other rules and regulations sometimes get broken. In that case, investors usually suffer a financial loss while investment firms reap profits. Here are three examples of fraud on Wall Street that violated regulations:

In September 2020, Morgan Stanley agreed to pay $5 million for violating Regulation SHO. According to the SEC, Morgan Stanley was using the same management structures, locations, strategies, and objectives for their long sales as their short sales. Even though hedges were separated into different aggregation units (long and short), the “long” sales were operating as short sales and did not meet Regulation SHO’s exception permitting broker-dealers to establish aggregation units because they were not independent and did not have a separate trade strategy.

In 2016, Merrill Lynch was ordered to pay $415 million to settle charges of misusing customer cash to generate profits. To summarize, Merrill Lynch violated the Customer Protection Rule by using customer cash that should have been kept in the reserve account to engage in complex trades. While that resulted in billions of dollars in revenue from 2009 to 2012 for Merrill Lynch, it would have also resulted in a shortfall for customers if those trades failed. Merrill Lynch also failed to hold fully-paid customer securities in a lien-free account to protect them in the event of the firm collapsing.

A little further back in 2010, Goldman Sachs paid a record $550 million to settle SEC charges regarding a synthetic collateralized debt obligation (CDO). The settlement stated that Goldman Sachs misstated and omitted key facts about the CDO to investors; for example, no information was disclosed about the ABACUS 20017-AC1 that discussed the role the hedge fund Paulson & Co. Inc. played in the portfolio selection process and the short position they had taken against the CDO. Failure to provide accurate, transparent information misleads investors.

As you can see, there are serious ramifications for going against Wall Street regulations and guidance. This type of behavior is illegal, immoral, and needs to be addressed as soon as possible in order to protect investors. If you work in the financial sector and are aware of similar fraud taking place, contact the team at the DJO Whistleblower Law Group. We will work with you every step of the way to ensure your company is held accountable and you are protected, and possibly even rewarded.

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