The Securities And Exchange Commission (SEC) is continuing to litigate against fraud and other violations of the US securities laws. During the first nine months of 2006 they announced in Litigation Releases the opening of one hundred thirty-one new cases. Almost half of the cases were of the three following types: accounting fraud, insider trading and PONZI schemes.

Accounting fraud, sometimes called “cooking the books”, is one in which the reporting company alters its books and reports materially different results from its actual results. In the past few years, the media has headlined cases of this type of fraud, the largest being Enron. Since all reporting companies send various reports to the SEC for review, the financial reporting of the company is well documented. When the reporting company gets into financial trouble, the SEC has the documentation to investigate what went wrong. Cooking the books is hard to uncover unless looking in the rear view mirror.

Insider trading is simply trading a stock with information not known to the public. Martha Stewart is the best-known recent example of this. She was sentenced to five months in Federal Prison for obstructing justice, making false statements, and conspiracy during her investigation of trading ImClone Systems stock using insider information. She had been told through her broker that ImClone’s chairman was selling his stock before a Food and Drug Administration’s rejection of the firm’s new cancer drug. She sold her stock also on this information not known to the public.

PONZI schemes are investment schemes where new investors’ money is used to pay old investors, so they will think they are receiving a profit. Charles Ponzi defrauded over forty thousand investors of more than fifteen million dollars in Boston in the 1920’s selling them investments in postal reply coupons. His pitch was the offer of a high return in a safe investment. These frauds are hard to identify until they implode due to a never-ending need for new investors. The media has called Evergreen Security, Ltd. “the largest PONZI scheme in Florida’s history.” It took investors down for over $213 million during the nineties.

The next seven most numerous types of cases opened by the SEC this year were, in order of number: unregistered securities offerings, misappropriation of funds, hedge funds, illegal touting of securities, false statements, fraud transactions, and stock manipulation. There were fifty cases opened during this period for these seven types of cases. There were seventeen other cases opened, which don’t fall into the ten largest types.

So what can an investor gain from this information? Fraud in the world of securities is a continuing problem. Although the SEC is the primary regulatory body for US security markets, it is mainly a reactionary regulator. In other words, most of its cases come from complaints investors make after they have been defrauded, or tips received through hotlines set up by the SEC or companies. The perpetrators are usually prosecuted in the larger cases, such as Enron, Martha Stewart and Evergreen, and third parties are appointed to recover the lost investor funds. The sad fact is the sentences are usually short and the recovery is usually in the pennies per dollar lost, if any at all.

Investors need to guard against these types of frauds and not rely on the regulators to protect them. Some of the warning signs, which have been evident in previous frauds, are the following: 1. securities which are not registered, 2. investment funds (including hedge funds) which are not registered, 3. investments with high returns with little risk, 4. secret trading schemes, 5. offshore investment funds, 6. small-cap stocks touted on the Internet or by faxes, 7. investment advisors who want trading control of your portfolio without the proper oversight 8. investment advisors who advise you to put all of your portfolio in their can’t-lose investment, and 9. returns which are just too good to be true.

Although many investments with some of these warning signs are fine, some are not. It is avoiding the ones which aren’t, that is your job. Old investment wisdom tells us that the hope of a great return is never worth losing your principal.

Mr. Cuthill's practice is limited to court-appointed positions in large fraud cases. His work has produced the return of millions of dollars of investors' funds. For more information about him go to http://trusteeandexaminerCuthill.com.