In the world of finance and investments, there are countless ways to invest your money profitably. Unfortunately, there are also risks involved, especially when it comes to investment fraud. Investors can invest in stocks, funds or other investments based on false pretenses about success or return and be financially harmed.
To protect yourself from such fraudulent activity and to take the right steps in the event of a scam, it is important to be well informed.
In this guide, we take an in-depth look at investment fraud. We explain what is meant by investment fraud, the typical forms it takes and the legal basis for investor protection. In addition, we address the legal claims of investors and statutes of limitations in investment fraud.
Table of Contents
- Definition of investment fraud
- Typical forms of investment fraud
- Legal basis for investor protection
- Legal claims of investors
- Deadlines for the assertion of claims
- Role of technology in investment fraud
- Prevention and early detection of investment fraud
- What to do if you suspect investment fraud
- Current court decisions and their significance for investors
- Investment fraud: Recognizing and reacting
Definition of investment fraud
Investment fraud is a complex and multifaceted form of fraud in which investors are deceived and financially harmed by false pretenses about the success or return of stocks, funds, or other investment instruments. In order to better understand the various facets of investment fraud and to shed light on the legal aspects in this context, some important points are explained in more detail below.
Criminal classification of investment fraud
Investment fraud can constitute a criminal offense under certain circumstances. Fraud is punishable if someone, with the intention of obtaining an unlawful pecuniary advantage for himself or a third party, damages the assets of another by creating or maintaining a misapprehension by false pretenses or distortions of true facts and causes the deceived person to make a pecuniary disposition that damages that person or another’s assets.
In cases of investment fraud, this criminal offense is regularly present.
Civil law claims and liability
In addition to the consequences under criminal law, investment fraudsters can also be held liable under civil law. Damaged investors can claim damages or demand the reversal of the investment. Liability can be directed against both the investment advisor and the company that issued the investment.
Investment fraud and duty of disclosure
A central issue in connection with investment fraud is the violation of disclosure obligations. Investment advisors and issuers are legally obliged to inform potential investors comprehensively about the risks and opportunities of an investment. If they fail to do so or even intentionally mislead investors, this constitutes a case of investment fraud.
Example
An investment advisor recommends an investment in a fund to a client without pointing out that this fund invests in risky and highly speculative investments. As a result, the client loses a significant portion of his invested capital. In this case, the investment advisor can be prosecuted for investment fraud, as he failed to fulfill his duty to inform the client.
Typical forms of investment fraud
Investment fraud can take a variety of forms, some more common than others. In the following, some typical forms of investment fraud are explained in more detail and illustrated with examples and legal aspects.
Ponzi schemes (Ponzi schemes)
Ponzi schemes are a common form of investment fraud. Here, the fraudsters promise high returns, but these are not generated by actual investments. Instead, the funds of new investors are used to pay off the returns of existing investors.
These schemes are doomed to fail because they rely on a constant inflow of new money and collapse as soon as that inflow dries up.
Example
A company advertises an investment that promises high monthly returns. Investors actually receive regular payouts initially, but these come from the deposits of subsequent investors. The company does not actually invest the investors’ money and the scheme eventually collapses, with investors losing their invested capital.
False advice and kick-back payments
Misadvice occurs when an investment advisor recommends an investment to a person that does not fit that person’s investment objectives or risk tolerance. Often, such misadvice is due to kick-back payments, where the investment advisor receives a commission from the investment company or issuer to sell certain investment products.
Example
An investment advisor recommends a highly speculative investment to a conservative investor even though it does not fit the investor’s risk profile. The investment advisor receives a high commission from the investment company for brokering this investment. In this case, the investment advisor can be prosecuted for investment fraud, as he has violated his duties to inform and advise.
Insider trading
Insider trading is a form of investment fraud in which persons who have information that is not publicly available (so-called insider information) use it to conduct securities transactions or make recommendations to other persons. Insider trading is punishable under Section 14 of the German Securities Trading Act (WpHG) and can result in both civil and criminal penalties.
Example
An employee of a company learns of an impending takeover and, based on this information, buys shares in the company before the takeover is publicly announced. After the takeover is announced, the share price rises and the employee sells his shares at a profit. In this case, it is insider trading, which can have both criminal and civil consequences.
Market manipulation
Market manipulation is a form of investment fraud in which the market is influenced by improper methods such as false or misleading information or price manipulation. Market manipulation is punishable under Section 20a of the German Securities Trading Act (WpHG) and can lead to civil and criminal consequences.
Example
A company spreads false rumors about an imminent takeover in order to drive up its share price. Investors who buy shares in the company based on this false information may suffer financial losses when the truth comes out and the share price falls again. In this case, the company can be prosecuted for market manipulation.
Investment fraud through unauthorized transactions
Investment fraud can also occur through unauthorized transactions, where companies or individuals offer investment products without proper regulatory approval or registration. This constitutes a violation of the German Banking Act (Kreditwesengesetz – KWG) or the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) and can lead to civil and criminal penalties.
Example
A company offers investors the purchase of shares even though it does not have the required license from the German Federal Financial Supervisory Authority (BaFin). Investors who are harmed as a result of the company’s unauthorized activity can claim damages and the company can be criminally prosecuted.
In practice, the various forms of investment fraud may be interrelated and overlap. It is therefore important that investors are vigilant and inform themselves about the legal framework in the area of investment advice in order to protect themselves from attempted fraud.
If investment fraud is suspected, legal assistance should be sought immediately in order to take the best possible legal steps and increase the chances of obtaining compensation or reversing the investment.
Legal basis for investor protection
Investor protection in Germany is guaranteed by various laws and regulations. These serve to protect investors from fraudulent and misleading practices in connection with financial products and services. The most important legal foundations for investor protection are detailed below.
Securities Trading Act (WpHG)
The Securities Trading Act regulates the conditions for trading in securities and financial instruments in Germany. It contains various obligations for securities services companies to ensure proper and transparent trading. These include:
- The duty to inform customers: providers of financial products must inform investors about the risks and costs of the products offered.
- The duty to assess suitability: Providers must check whether a financial product is suitable for the respective investor.
- The duty of best execution: Providers must ensure that investor orders are executed at the best possible price.
German Investment Code (KAGB)
The German Investment Code regulates the legal framework for investment funds and their management in Germany. Among other things, it contains requirements for the organization and supervision of capital management companies as well as regulations on investor protection. These include:
- The obligation to publish sales prospectuses and key investor information documents (KIID).
- The obligation to disclose the risks and costs of the investment funds offered.
- The obligation to report regularly on the performance of the funds.
German Civil Code (BGB)
The German Civil Code contains various regulations that are relevant for the protection of investors. In particular, the provisions on contract law and the law on damages may apply in the event of investment fraud. Examples are:
- § SECTION 311 BGB: Duties to protect during contract negotiations
- § 280 BGB: Damages for breach of duty
- § 823 BGB: Damages due to intentional or negligent damage
Criminal Code (StGB)
The Criminal Code contains various criminal offenses which may be relevant in connection with investment fraud, such as:
- § 263 StGB: Fraud
- § 264a StGB: Subsidy fraud
- § 266a StGB: Withholding and embezzlement of pay
- § 283 StGB: Prolongation of insolvency
Stock Corporation Act (AktG) and Limited Liability Company Act (GmbHG)
The German Stock Corporation Act (AktG) and the German Limited Liability Companies Act (GmbHG) contain regulations governing the formation, organization and liability of stock corporations and limited liability companies. These laws are particularly relevant for investors in connection with capital increases, corporate financing and corporate acquisitions.
Among other things, they contain regulations on prospectus liability (Section 21 of the German Stock Corporation Act, Section 13 of the German Limited Liability Companies Act) and liability for false information in connection with the formation or capital increase (Section 46 of the German Stock Corporation Act, Section 9a of the German Limited Liability Companies Act).
Legal claims of investors
Investors who have been victims of investment fraud may have various legal claims to recover their lost money. The most important bases for claims are presented and explained below.
Claims for damages
Investors can assert claims for damages against the investment fraudster or other responsible parties. In particular, the following bases for claims can be considered:
- § Section 823 (2) BGB (German Civil Code) in conjunction with a protective law: here, the investor must prove that the investment fraudster violated a protective law, such as the German Securities Trading Act (WpHG) or the German Banking Act (KWG), and that this caused damage.
- § Section 826 of the German Civil Code (immoral damage): A claim for damages arises if the investment fraudster has intentionally and immorally harmed the investor.
- § Section 31 BGB in connection with a breach of organizational or supervisory duties: Here, the investor must prove that a company or person responsible for the investment breached its organizational or supervisory duties, causing damage.
Claims arising from prospectus liability
Investors can assert claims based on prospectus liability if the investment product was offered with the help of an incorrect or incomplete prospectus. Pursuant to Section 21 of the German Securities Prospectus Act (Wertpapierprospektgesetz, WpPG), the issuer or another responsible party is liable for incorrect or incomplete information in the prospectus.
This may involve, for example, false or misleading information about the investment, the company or the associated risks.
Claims arising from investment advisory agreements
If an investment advisor has breached its advisory duties, investors may assert claims arising from the investment advisory agreement. These include in particular:
Duty to inform: Investment advisors must provide investors with comprehensive information about the risks and opportunities of the investment product. This includes, for example, information about the company, the investment product, the associated risks and the costs of the investment.
Information requirements: Investment advisors must inform investors about all relevant information that is important for the investment decision. This may include, for example, information about the issuer, the performance or the tax treatment of the investment.
Documentation requirements: Investment advisors must document the advisory meeting and the recommendations in writing and hand them over to the investor.
Claims arising from investment brokerage agreements
Investors can also assert claims arising from investment brokerage contracts if the broker has breached its duties. These include, in particular, the duties to provide information about the investment, to check the investment for plausibility and to document the brokerage meeting.
Deadlines for the assertion of claims
The assertion of claims in connection with investment fraud is subject to certain deadlines. These deadlines are of great importance for investors as well as for investment advisors and intermediaries, as they set the time limits for asserting claims for damages. The various deadlines, as well as the legal basis and current court rulings on them, are listed below.
Knowledge-based statute of limitations pursuant to Section 199 (1) of the German Civil Code (BGB)
The regular limitation period for claims for damages is three years. However, this period does not begin until the end of the year in which the claim arose and the investor became aware of the circumstances giving rise to the claim and the person causing the damage or should have become aware of them without gross negligence (Section 199 (1) BGB). Therefore, knowledge of the circumstances giving rise to the claim is decisive for the start of the limitation period.
Example: An investor invests in a fraudulent investment in January 2018. However, he does not learn of the fraud and the persons responsible until October 2021. Therefore, the limitation period does not begin until December 31, 2021, and ends on December 31, 2024.
Start of the statute of limitations in the case of faulty investment advice
In the case of claims based on faulty investment advice, the statute of limitations also begins at the end of the year in which the investor became aware of the circumstances giving rise to the claim or should have become aware without gross negligence (section 199(1) BGB).
Example: An investor receives incorrect advice in March 2018 and invests in an unsuitable investment on the basis of this advice. However, he does not recognize the incorrectness of the advice until December 2021. The limitation period therefore begins on December 31, 2021 and ends on December 31, 2024.
Absolute statute of limitations pursuant to Section 199 (3) of the German Civil Code (BGB)
Irrespective of the investor’s knowledge of the circumstances giving rise to the claim, claims for damages become time-barred under section 199(3) of the German Civil Code no later than ten years after they arise. This absolute limitation period also applies if the investor did not yet know or should have known of the damaging circumstances.
Example: An investor invests in a fraudulent investment in May 2010, but does not learn of the fraud until January 2021. Despite the knowledge in 2021, the claim for damages is already time-barred in May 2020 due to the absolute limitation period of ten years.
Suspension of the statute of limitations
The statute of limitations can be suspended pursuant to section 203 of the German Civil Code (BGB) if negotiations are held between the investor and the wrongdoer regarding the claim or the circumstances giving rise to the claim. The suspension ends if one party refuses to continue the negotiations or if no agreement is reached within two weeks (Section 203 p. 2 BGB).
Example: An investor files a claim for damages against his investment advisor in June 2021 and negotiates the amount of damages with him. The statute of limitations is suspended during these negotiations and does not start again until the negotiations end unsuccessfully.
Role of technology in investment fraud
The rapid development of technology has brought both opportunities and risks for investors. Technological innovations such as cryptocurrencies, social media, and automated trading platforms have made financial markets more accessible to retail investors. At the same time, fraudsters have used these technologies to conduct investment fraud and have developed new forms of investment fraud.
Cryptocurrencies and Initial Coin Offerings (ICOs).
Cryptocurrencies such as Bitcoin and Ethereum provide an attractive environment for fraudsters due to their decentralized, pseudonymous, and unregulated nature. Investment fraud related to cryptocurrencies can take several forms, such as:
- Ponzi and Ponzi schemes, where high returns are promised based on deposits from new participants.
- Phishing attacks, in which fraudsters try to grab credentials to crypto wallets or trading platforms.
- Fake ICOs, in which scammers collect money for purported cryptocurrency projects without ever delivering a product or service.
Investors should be aware of the risks associated with cryptocurrencies and carefully consider which cryptocurrency projects they invest in. In many countries, including Germany, cryptocurrencies and ICOs are now subject to regulation by financial regulators such as the German Federal Financial Supervisory Authority (BaFin) to improve investor protection.
Social media and online platforms
Social media and online platforms have greatly facilitated the dissemination of information about investment products and strategies. However, fraudsters also use these channels to specifically deceive investors with false information and fraudulent offers. Examples of such activities include:
- Pump-and-dump schemes, in which fraudsters artificially inflate the price of a stock or cryptocurrency by disseminating false or misleading information in order to subsequently sell their own holdings for a profit.
- False investment advice or recommendations designed to lure investors into fraudulent investment products.
Investors should always critique information from social media and online platforms and rely on trusted sources. It is advisable to use the opinions and recommendations of other investors only as a suggestion and always conduct your own research before making an investment decision.
Automated trading platforms and algorithms
Automated trading platforms and algorithms can help investors implement their trading strategies more efficiently and save time. However, there are also fraudsters who offer fake or manipulated trading algorithms and platforms to mislead investors. Examples of such fraudulent activities include:
- Trading platforms that display false trading results to deceive investors.
- Bots or automated trading algorithms that are based on fraudulent principles and promise high returns without actually being able to achieve them.
To protect themselves from fraudulent trading platforms and algorithms, investors should conduct thorough research and consider reviews and testimonials from other users. It is also important to understand how an algorithm or trading platform works before using it to ensure that it is based on sound principles.
Legal framework and safeguards
To protect investors from the dangers of investment fraud related to technology, governments and financial regulators in many countries have increased their regulatory efforts. Examples of such measures include:
- Introducing registration and licensing requirements for cryptocurrency exchanges, ICOs, and trading platforms.
- Monitoring social media channels and online platforms to detect and stop fraudulent activity.
- Prosecuting fraudsters who use technology to commit investment fraud.
Investors should be aware of the legal framework and safeguards in their country and be careful to invest only in regulated investment products and services. If investment fraud is suspected, investors should immediately inform the relevant authorities and seek legal assistance if necessary.
Prevention and early detection of investment fraud
Prevention and early detection of investment fraud are of great importance to avoid financial losses and disappointed expectations. Investors should be aware of the risks and be able to identify fraudulent offers early. This section presents several measures and strategies that can help investors prevent and detect investment fraud early.
Information gathering
Thorough information gathering is the first step in preventing investment fraud. Investors should obtain comprehensive information about the investment products offered, the companies involved and the respective business models. Various sources of information can be used for this purpose, such as:
- Annual reports and financial reports of the companies
- Ratings and testimonials from other investors
- News articles and financial news
- Information from financial regulators and consumer protection organizations
Critical examination of promised returns
Investors should be particularly cautious when they are promised exceptionally high returns. In many cases, such promises are unrealistic and an indicator of possible investment fraud. It is important to critically examine the promises of returns and compare them with other investment products on the market.
Checking the providers
A thorough review of providers can also help avoid investment fraud. Investors should check the seriousness of the providers, for example, by looking for licenses or registrations with financial supervisory authorities, such as BaFin in Germany. In addition, investors can research information about the providers’ management and past to uncover possible links to fraudulent activities.
Beware of unsolicited offers
Investors should be particularly cautious if they receive unsolicited investment offers, for example by e-mail, telephone or via social media. Such offers may be an indicator of fraudulent intent. Investors should not allow themselves to be pressured and should always conduct an independent review of the offer before deciding to invest.
Independent advice
Seeking independent investment advice can also help prevent investment fraud. Independent investment advisors can help objectively evaluate the risks and rewards of various investment products, providing investors with an informed basis for decision-making.
Current court rulings and their importance
Knowledge of current court rulings can help investors better understand case law and identify potential risks early. By analyzing rulings, investors can gain a better understanding of the legal framework and the associated obligations of providers. This can help uncover deceptive practices and avoid making appropriate investment decisions.
Example
A recent ruling by the German Federal Court of Justice (BGH) dated January 25, 2022 (Case No. VI ZR 512/20) deals with the liability of investment advisors in the event of incorrect investment advice and a lack of information about risks. This ruling can serve as a guide for investors to better assess the requirements for proper investment advice and, if necessary, to take appropriate criteria into account when selecting an investment advisor.
Control of investment performance
Regular monitoring and control of investment performance is another important step in early detection of investment fraud. Investors should regularly review their investment, looking for anomalies that could indicate fraudulent activity, such as unexplained losses or sudden changes in performance.
If investment fraud is suspected, investors should seek legal assistance immediately and, if necessary, file a report with the appropriate law enforcement agency.
What to do if you suspect investment fraud
As soon as investment fraud is suspected, it is important to act quickly and take the right steps to enforce one’s claims and recover lost assets. The most important options for action and legal aspects in the event of suspected investment fraud are explained in more detail below.
Preservation of evidence
The first step to take in cases of suspected investment fraud is to secure evidence that can prove the fraud. This includes contracts, account statements, emails, correspondence with the investment advisor or issuer, and witness statements. This evidence is critical to enforcing claims for damages or unwinding the investment.
Legal assistance
If investment fraud is suspected, an experienced lawyer should be consulted immediately. This person can examine the facts of the case, determine possible bases for claims and initiate the legal steps to enforce the claims.
Criminal complaint
In cases of investment fraud, it may make sense to file a criminal complaint with the responsible public prosecutor’s office. This can help ensure that the perpetrators are prosecuted and further injured parties are protected. A criminal complaint can also support the civil enforcement of claims for damages by providing additional evidence or enabling asset recovery from the perpetrators.
Civil law claims
Injured investors usually have various civil law claims against the fraudsters, such as claims for damages, reversal of the investment or surrender of kick-back payments. These claims can be asserted against both the investment advisor and the company that issued the investment. In some cases, there may also be claims against third parties, such as auditors or banks.
Example
A court ruling by the German Federal Court of Justice (BGH) on December 19, 2017 (Case No. XI ZR 152/17) affirmed that banks distributing investment products may be liable to pay damages if the issuer intentionally causes immoral damage to the investor.
Class actions and communities of interest
In some cases, it may make sense to join forces with other affected parties and take joint action against investment fraud. This can increase the chances of success and reduce the costs of litigation.
In Germany, class actions in the classic sense are not possible, but there are alternative approaches, such as the bundling of lawsuits by litigation financiers or the formation of communities of interest. These can commission joint legal representation and thus proceed more effectively and at lower cost.
Statute of limitations
When asserting claims in connection with investment fraud, the limitation periods must be observed. These vary depending on the type of claim and the underlying legal provisions. However, as a general rule, claims for damages are subject to a three-year statute of limitations pursuant to Section 195 of the German Civil Code (BGB).
The limitation period begins at the end of the year in which the claim arose and the injured party became aware of the circumstances giving rise to the claim and of the person who caused the damage or should have become aware without gross negligence.
Example
An investor discovers in January 2023 that he has been damaged due to investment fraud. The statute of limitations begins on December 31, 2023 and ends on December 31, 2026, so the investor should take legal action to assert his or her claims before this period expires.
It is important to emphasize that asserting claims related to investment fraud can be complex and time-consuming. Hiring a lawyer early on is therefore crucial to maximize the chances of success and protect one’s interests in the best possible way.
Current court decisions and their significance for investors
Recent court rulings have a significant impact on investors’ rights in cases of investment fraud. They can serve as precedents and expand the legal options available to injured parties. Below is a more detailed discussion of some relevant rulings and their significance for investors.
I. Federal Court of Justice (BGH) on prospectus liability
The Federal Supreme Court has strengthened the prospectus liability of investment advisors and brokers in several decisions. For example, the BGH has ruled that investment advisors and brokers can be liable for incorrect or incomplete information in the sales prospectus (BGH, judgment of May 22, 2014, Case No. III ZR 156/13). This means that investors can assert claims for damages in the event of incorrect prospectuses.
II. Obligations to provide information in the case of investment advice
In several rulings, the Federal Court of Justice (BGH) has specified and extended the duties of investment advisors to provide information. For example, the court ruled that investment advisors must inform their clients about all risks and costs of the recommended investment. This applies in particular to “gray market products” such as closed-end funds and investments, for which the duties of disclosure are particularly strict (BGH, judgment of January 20, 2015, Case No. XI ZR 316/13).
III Liability in the event of incorrect investment advice
In another judgment, the BGH ruled that investment advisors are also liable for incorrect advice given to customers who have decided in favor of a particular capital investment based on the advisor’s recommendation (BGH, judgment of May 12, 2016, ref. III ZR 108/15). This means that investors can assert claims for damages against the advisor in the event of erroneous investment advice.
IV. Statute of limitations for claims for damages
In a ruling, the Federal Court of Justice (BGH) clarified that the regular limitation period of three years for claims for damages arising from incorrect investment advice can be suspended under certain conditions (BGH, ruling of April 29, 2014, Ref. XI ZR 477/12). Accordingly, the statute of limitations can be suspended if the investor is prevented from asserting his claims in court due to negotiations with the advisor or intermediary.
V. Duties of banks in providing investment advice
A further ruling by the BGH has specified the obligations of banks in connection with investment advice. Thus, the court ruled that banks must inform their customers, without being asked, about reimbursements they receive for the sale of financial products (BGH, ruling of December 19, 2017, ref. XI ZR 152/17).
This transparency obligation is intended to prevent banks from advising their customers primarily on the basis of the commissions to which they are entitled and not acting in the best interests of the investor.
Investment fraud: Recognizing and reacting
Investment fraud is a serious problem that can harm investors financially and undermine confidence in the financial system. To protect themselves from investment fraud and act appropriately when suspicions arise, investors should always be vigilant and well informed. Affected individuals should seek legal counsel to assert their claims and increase the likelihood of getting their money back.
In summary, the following recommended actions for investors are the result:
- Inform yourself thoroughly about potential investment products and advisors before making an investment decision.
- Be skeptical of overpromising returns and observe the principle of spreading risk by diversifying your investments.
- Monitor your investments regularly and stay in touch with your investment advisor.
- If you suspect investment fraud, act promptly, preserve evidence, seek legal counsel, and file criminal charges if necessary.
- Network with others affected to take joint action against investment fraud and share experiences and information.
If you believe you have been affected by investment fraud, do not hesitate to contact us. We will provide you with comprehensive advice and discuss with you the best legal steps to protect your assets and safeguard your interests.