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I am a small buy-and-hold investor. I recently asked a question about pump and dump scams: Will I be investigated if I regularly profit from pump and dump scams? One interesting comment by user @Steve-O says (emphasis mine):

SEC: "Look at all these seemingly unconnected pump and dumps, but Flux over there is buying into all of them and regularly jumping out at just the right time. He must know something." I can definitely see how that could lead to an investigation, once the statistical odds of success move past a reasonable threshold. Even if you're proven innocent every time, they're going to be keeping an eye on you, which might lead to you getting pinned for some other violation, even a minor one they don't usually bother pursuing.

Is it actually possible to violate SEC rules within a retail brokerage account? I am struggling to think of things I could do within my brokerage account that could get me pinned for violating SEC rules. Could you give me some examples of violations of SEC rules that can be committed by small investors (accidentally or otherwise)?

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As with all crimes there is a huge difference between violating the law and being caught.

Probably the most problematic and easiest SEC rule for a small investor to break is insider trading. In most firms employees are informed of changes to the firm's financial situation or new clients that are close to signing in town halls before they are released to the market and many if not most employees of any company will have an idea of how the firm is performing from their day-to-day work. This will result in most employees having non-public information on their company. If that information contains information that is not priced into the stock price it is immediately material. Trading on your own private account on material non-public information about your own company is insider trading. It doesn't matter how big your account.

Since your broker likely doesn't know who your employer is (mine doesn't) especially if you changed jobs since your last KYC update it is very easy to do this and not get caught. Who realistically knows and cares enough to raise this with the SEC? That said many people still get caught insider trading in this way and it is common for people in a company who are likely to have such information to be closely monitored. In spite of the fact that I am closely monitored thanks to the information I have my partner isn't so she could break the regulations on insider information that I have and probably not get flagged.

Clearly it is very easy for someone to intentionally violate the rules from a retail brokerage account in this way. It is less clear whether they would be caught breaking the law.

I have worked in the industry for many years and worked on compliance monitoring until a short time ago. I can tell you that we don't just monitor for brokers' clients actually breaking the law; we also monitor for any suspicious activity that could indicate a rules breach. The closer you get to demonstrably breaking the law and the more significant or frequent you are "lucky", the more likely we are to pass your details on to regulators.

I chose insider trading because it is simple to explain how we can monitor for it; we have a trades feed, a news feed and a market data feed and when the price moves we look back for a piece of news that might have caused it. We then look at all trading in the few days before the announcement that might indicate a trader knowing the news ahead of time. The more times and the more profit (in % terms) a trader is making on these the more likely it is that it will be passed to the SEC. Note that this doesn't require us to know anything about the person trading or have any idea how or why they might have the insider information, it is enough that they are trading in advance of the news. Note that in order to profit on insider trading you normally have to buy or sell and hold for a few days until the news appears.

All of this monitoring is automatic now and once your account is flagged for a potential breach of one rule the analysts will look at all of the potential breaches for that account in the system to get an idea of the trader's pattern of trading and whether it is likely enough that they are breaking the rules to raise it with regulators.

In case you were wondering there are also some very powerful pump & dump analytics available which might well flag you.

Addendum for posterity:

The following is the SEC definition of nonpublic information as a reference to my quick example:

Nonpublic, or inside, information about the Company that is not known to the investing public may include, among other things, strategic plans; significant capital investment plans; negotiations concerning acquisitions or dispositions; major new contracts (or the loss of a major contract); other favorable or unfavorable business or financial developments, projections or prospects; a change in control or a significant change in management; impending securities splits, securities dividends or changes in dividends to be paid; a call of securities for redemption; and, most frequently, financial results.

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    Actually most large companies do not release financial information generally to employees before they do to the public, for exactly the reasons you describe. A smaller number of employees do need to know in advance, and smaller companies may let everyone know a short time in advance. – DJClayworth Oct 27 at 15:04
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    @DJClayworth it must be the firms I've worked for then - I generally get insider information in town halls and the like, particularly about things like clients that are close to signing etc. once a month! – MD-Tech Oct 27 at 15:06
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    @DJClayworth to be totally honest I was in a town hall today where my company announced clients that were about to sign which is what prompted me to put it like that. As I indicate though we are closely monitored for compliance so that might also be why they are open with us. – MD-Tech Oct 27 at 15:10
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    @Aganju wouldn't that be insider information of both companies? – user253751 Oct 28 at 11:20
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    @Aganju the SEC defines those things as nonpublic: sec.gov/Archives/edgar/data/25743/000138713113000737/… – MD-Tech Oct 28 at 14:44
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A wash trade - where a single person takes both sides of a trade - is against the rules, as they can be used to manipulate the market. I ran into this (I wasn't trying to manipulate anything).

I wanted to transfer some stock from one account to another. Same broker. They only allow one account to have margin, and I wanted to be able to sell covered calls on this stock.

A transfer of assets was possible, but the rep said I'd have to not touch the stock for several days.

I didn't want to be unable to sell the stock if it suddenly started to drop.

So I decided to buy the stock in one account and sell it in the other account. Same price, as it turned out. Same trade, as it turned out. I received a stern letter from the broker saying not to do it again.

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  • Meaning, you bought it from yourself? – UuDdLrLrSs Oct 29 at 13:59
  • @UuDdLrLrSs Yes. – Lou Oct 29 at 14:41
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The most straightforward way I can think of to violate SEC rules with a retail brokerage account would be insider trading: trade a stock based on non-public information in breach of a fiduciary duty.

For instance, if you worked for a company that you knew was about to get acquired, but that information wasn't public yet, you could buy a bunch of your employer's stock with your brokerage account. That would be textbook insider trading (and also extremely obvious if any auditors took a close look at it).

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If you're a small buy-and-hold investor, you're not going to show up on the SEC's radar. What gets you on the SEC's radar is very large profitable positions. For example, you've never bought more than 5 options on a stock and suddenly you buy several hundred of them just before a news release and the stock then makes a large move in your favor after news.

An example of out of character size: 20 years or so ago there was a chap on a stock related chat web site promoting himself in order to sell advisory subscriptions. The dream of big money got to him and he bought a wad of puts and then tampered with OTC drug store medicine. Yep, he got caught and went to jail.

As for pump-and-dump, it's the illegal practice of owning a position in a stock prior to attempting to boost share price with or exaggerated statements. If you're clever enough to regularly profit from other people's pump and dump scams with no connection to the perps then you have done nothing illegal. The SEC might look closely at you but without proof, there's nothing that they can do to you since you did no wrong.

Yes, it is possible to violate SEC rules within a retail brokerage account. But they are violations not criminal misconduct. Some examples would include cash liquidations, good faith violations, free riding, pattern day trading violations. The penalty for these might be an initial warning and in some cases, account restriction.

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    Could you add a link to the drug tampering case? I found the 1986 case of Edward Arlen Marks who added rat posion to drug capsules on store shelves to profit from put options on SmithKline Beckman Corp stock. The World Wide Web did not exist at the time, so it would not have been possible for him to use a "stock related chat web site". – Flux Oct 27 at 15:58
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    Online services existed before 1986 (Compuserve was founded in 1969, Prodigy in 1984, etc.). The early variations were dial up and they included access to bulletin boards where people chatted. I was on Prodigy in the late 80's but I can't remember the details of the drug tampering case. The guy's first name was Justin but that's about all I recall. – Bob Baerker Oct 27 at 16:36
  • "Some examples would include..." -- strictly speaking, aren't some of those rules the domain of the Federal Reserve rather than the SEC? – nanoman Oct 27 at 20:41
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    There's a lot of overlap with FINRA, the FRB and the SEC. The Pattern Day Trader rule (2520) was enacted by FINRA and the SEC. While freeriding violations are covered under the FRB's Reg T rules, it's the SEC that prosecutes egregious violations. You can read about all of these violations at the SEC's web site. – Bob Baerker Oct 27 at 22:31
  • Bob, I think you should use @username when replying. nanoman probably did not receive your reply. See: How do comment @replies work? – Flux Oct 28 at 20:49
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Yes, it's possible.

The SEC (and Federal Reserve) lay out several rules that you might violate from a personal account only from trading. In special:

  • Good Faith Violations
  • Liquidation Violations
  • Free Riding Violations

A Good Faith Violation is something that does not exist in all jurisdictions, so a new investor from another country may be especially susceptible to have their account restricted.

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