Unauthorized trading involves the purchase or sale of securities in a customer’s account without the customer’s prior knowledge and authorization. This can occur with any security. For example, a broker may believe a transaction is in an investor’s best interest and, without contacting the investor, makes the trade. Or the broker attempts to convince the investor of a transaction’s benefit in the hope the investor ratifies the trade after the fact.
Unauthorized trading can take several forms, including:
- “rogue” or other unauthorized trading or trade execution in customer, client, or proprietary accounts
- exceeding firm limits on position exposures, risk tolerances, and losses
- intentionally mismarking positions
- creating records of nonexistent (or sham) transactions
Traders, assistants on trading desks, portfolio managers, brokers, risk managers, and other personnel (including those in administrative positions in a firm’s back office) can all engage in unauthorized trading.
Investors may discover unauthorized trading by scrutinizing confirmations and regular account statements. Investors should vigilantly watch for unauthorized transactions, as they may be masked by the fact that they do not require payment. For example, a transaction may only involve existing assets, such as the liquidation of an existing account asset to fund the purchase of a new security.
Unauthorized trading may run afoul of federal law. SEC Rule 10b-5, codified at 17 C.F.R. § 240.10b-5, prohibits engaging in fraudulent schemes, misrepresentations or omissions, and deceitful practices in connection with the sale or purchase of a security.
Additionally, unauthorized trading may violate Financial Industry Regulatory Authority (FINRA) rules. FINRA is a self-regulating body that promulgates and adopts rules its members must follow. For example, NASD Rule 2510, incorporated into the FINRA Manual, specifically prohibits brokers or investment advisers from executing discretionary trades without the client’s express, written permission. Further, FINRA Rule 4512 imposes on brokers several record-keeping requirements, one of which is to keep a list of people with authority to make discretionary trades for the account.
Unauthorized trading has also been interpreted to violate FINRA Rule 2020, which prohibits the use of manipulative, fraudulent, or deceptive practices, and Rule 2010, which requires its member to observe “high standards of commercial honor” and fair-trade principles.
To find out more about whether a particular type of fraud is covered by the whistleblower provisions of Dodd-Frank, contact us today.