Carntyne Riddrie · @Riddrie
21st Dec 2012 from Twitlonger
Beware of Stock Scams – The Art of Illusion
This piece generalises about the methods used in fraudulent stock sales. The actual methods used might vary from those described below as the people perpetrating these scams are extremely rich, clever and always seek to be beyond the law.
The Goods (Or how to make coal shine like a diamond
First you need a product and what better than a stock that promises to be the next Microsoft.
99% of the time the company does “exist”. In most cases it will be listed on the NASDAQ however many bandits are now selling stock in what they euphemistically call “Pre-IPO situations” which are companies not yet listed.
Generally they make sales of these ‘opportunities’ when the client has already bought a listed stock and therefore trusts his advisor. Short of knocking on the door of the Pre-IPO business address, it is impossible to assess if these businesses are what they say they are or if they even exist.
However, they all have websites and even sherpas in the Himalayas have heard of the rewards from an
oversubscribed IPO – a legacy of dot com fever – so even these scams sell.
But it is the listed companies that provide the most attractive bait for hooking unwary investors. The NASDAQ listing confers respectability, infers regulation and suggests that the stock is genuine and saleable. In reality, the NASDAQ has different boards and the likes of Intel, Microsoft, Dell and others in the limelight do not share the same air as those listed on the Bulletin Board.
Most companies listed on the BB do not have to file their financial results with NASDAQ. This means that even with the superb amount of data available on investor websites, the punter will be hard pressed to turn up more than a chart of stock price movement.
Unless the wary investor knows how to use the SEC website and contacts the ‘investor relations’ department at the company he has been recommended, the only information readily available is what he is told and the charts he can find for himself.
America is littered with companies that were once exciting start-ups that floundered after their IPO. Many of these companies can not raise cash and face collapse.
Their banks will not help, there is no prospect of raising more money from the market and their share price reflects their imminent demise. In most cases, the executives of the company have large holdings or options and therefore have a vested interest in a higher stock price.
At this stage a “Merchant Bank” approaches the company. This bank offers to inject money into the company in return for a great deal of new stock. Many companies that have no where else to turn, accept this offer.
The companies that are most sought after are the ones with good stories. “Joe’s Car Lot” in Iowa will not sell well, but “Steroidogenesis Inhibitors”, who have a promising cure for aids under development, appeal to the “What if” dreamers bored with their day job who fantasise about what it would have been like to buy Microsoft at 23 cents back in ’85.
The terms of the deal done between the company and the white knight bank are notoriously hard to uncover. It is not unusual for a company to grant twice as much stock as the cash advance would buy. In other words, if the stock price is 50 cents, the bank gets the company to issue stock for 25 cents.
The new stock is often issued directly to investors, not to the bank. This further conceals the true reason the bank gave money to the company. The company is told who to issue the stock to, and when.
The Sting (Or how to sell coals to Newcastle)
The bank uses a stock promoter to line up agents who will sell the stock. These mysterious men are responsible for ensuring that the enormous number of shares that the bank now “owns” are distributed at very favourable terms.
The first thing the promoter does is to manipulate the share price. We all know this is illegal but it happens. The industry, (and this scam is an industry which is bigger than many), is so mobile and diversified that the SEC can only scratch the surface.
More often than not, the company’s stock price has flatlined, the volume has dwindled to a few thousand and it does not take much to move it to five or ten times it’s value.
There is little danger of existing shareholders bailing out at these higher prices because most of them would still realise a loss. Indeed, the revitalised share price gives them hope of recovering their original investment.
The sales of new stock are made at this inflated price. Since the company issues the stock directly, the details are not registered on the market figures.
Furthermore, because the new stock has a year’s restriction (it can’t be sold for a year) there is no danger of the market being deluged by sell orders and spoiling the price manipulation. In fact, it is very hard to find out that the new stock even exists.
The Brokers (Diamond dealers or Coal merchants?
The SEC has very strict guidelines and enforces them, when possible, with grim determination. Hence the USA is policed and the biggest scams are largely excluded. But that leaves the international investor who is prey to the vultures.
The brokers disguise themselves in all sorts of ways, perhaps as specialist analysts with a trained eye for ‘this sort of opportunity’. They never have qualifications or licenses and are always based outside the countries in which they garner clients.
The common element is that the punter never sends his money to either their bank or address. Instead it goes to an offshore clearinghouse in the Bahamas or somewhere as lax, often via New York. The clearinghouse will instruct the company to issue the new stock when it is in receipt of funds.
What happens to all the money? Well, first of all, let’s get an idea of how much there is.
For example: The Widget Co Inc is nearly bankrupt. Nice Mr Merchant Bank offers them $2 million dollars. The stock price has fallen from $14 at IPO to just 50 cents where it has been for the last year.
The Widget Co agrees to the issue of 10,000,000 new shares in return for this cash advance. It will issue them to whoever the clearinghouse instructs them to. The stock stands the bank in at 20 cents a share.
The Merchant Bank contacts Mr Stock Promoter who has a track record in being able to shift the unshiftable. Magically the stock price rises to $5 and hey presto; the bank’s stock is now worth $50,000,000. Not bad for a $2 million investment.
The stock promoter now alerts the boiler room boys to the stock. These fellows are the ones you hear from. Credibility is their stock in trade and their plausibility combined with the recipient’s greed and gullibility ensure they live well.
Once they’ve convinced you about their outfit and offered you their free service, they’ll pause before they call you again to tell you about the hot share.
The story will be sexy. The website of The Widget Co Inc will be good. The chart will show the stock price moving towards the heavens. What could be more promising?
So the cautious investor dips his toe. He buys 1,000 shares at the prevailing (manipulated) market price of $5, little realising they are really only worth 50 cents and cost the bank only 20 cents.
He’s done his checks (or as many as he can think of) and it seems all right. He transfers $5,000. He gets regular calls to update him and he’s even introduced to a senior dealer. A nice rapport seems to be building up between him and the broker/dealer.
The share certificate duly arrives and confidence is complete. It is then that the “Loaders” extract the larger amounts. These are super-slick salesman whose real job is to squeeze the last drop of juice from the lemon. They masquerade as senior dealers, analysts, partners or anything that sounds impressive.
It is not uncommon for the “brokers” to be paid 50% of all money invested by clients. The actual salesman will receive anywhere between 5 – 25% depending on his position in the outfit. Loaders earn the most. None of the people you ever talk to, apart from the receptionist, are salaried.
None of them would ever be employed by a respectable brokerage. Most of them have no experience of financial markets (although a few may have sold mutual funds) and they simply absorb the buzzwords from their peers. Most of them are simply telesales professionals in the most lucrative job they’ve ever had… and in an exotic climate to boot!
Conclusion
If it sounds too good to be true – it probably is.
If you want to check out a broker, just ask yourself how many international calls he could afford on a normal broker’s fee. Ask yourself why he’s troubling to get business outside the country he operates from. But best of all, ask him where he’s registered – the prepared answers are always good for a laugh.
Bill Beaumont
(note: this is not his real name. He had to write under an alias after having received death threats)