Abuses of Regulatory Codes to Sell Fraudulent Investments
Misuse of Microcap Market
Microcap companies are typically thinly capitalized and are often not required to file periodic reports with the SEC.
Securities of microcap companies may be quoted on the Over-The-Counter (OTC) Bulletin Board operated by the National Association of Securities Dealers, in the Pink Sheets operated by the National Quotation Bureau, and on the NASDAQ Small Cap Market.
In any of these trading mediums, public information is limited and a small number of brokers control the market.
The majority of these stocks never trade on an exchange where the general public has access to create even the semblance of a market.
Even when they do appear on a larger exchange, more than 80% of penny stock companies fail and their shares become worthless within 3-5 years.
Broker-dealers normally put up money, at a huge premium, to finance new ventures such as mines, then sell the newly-issued shares over the phone to hopeful and gullible investors.
Usually the broker-dealer owns most of the shares, which are unlisted, and unless the mine or venture turns a profit, the shares have no value other than what they tell you on the phone.
The increasing value and demand, all imaginary and manipulated, continues until all the shares are unloaded.
Some overcharge their customers by adding an undisclosed markup to the price the firm paid for the stock.
Although it's illegal for brokers to charge excessive markups, some dishonest brokers mark up the prices of the stocks they sell for promoters and start-ups by as much as 100% or more.
Unscrupulous brokers often employ a variety of fraudulent sales practices including "bait and switch" tactics, unauthorized trading, "touting", "no net sales" policies, "pump and dump" and "churning".
Registered Securities Salespersons
Registered agents (also called "stock brokers" or "securities salespersons") are individuals who work for broker-dealer firms buying and selling investments like stocks, bonds, and mutual funds.
They are salespeople who must be licensed by the securities regulator and must pass tests demonstrating an understanding of the products they sell and the laws of investing.
Registered stock brokers can only sell investments which are properly registered and approved for sale. Even then they can earn excellent commission income, regardless of the performance of what they sell you.
Evasion of Broker-Dealer Registration Requirements
Stockbrokers, and the firms that employ them, are required to register in the state or province in which they do business. When a broker-dealer or its representative is not properly registered, that is a sure sign that something is wrong.
Failure to Report Investor Complaints
Many offices fail to have centralized procedures for handling and reporting customer complaints.
At several firms, complaints were found stuffed in files.
One firm's branch office had reported no complaints on file with the NASD, but state officials found over 300 letters scattered throughout the office.
Excessive Trading
If a broker is constantly buying and selling in your account, this may be evidence of "churning" which means engaging in excessive trading solely in order to generate commissions for the broker.
I Misheard Your Objectives
One broker was responsible for the account of a retired woman on a fixed, limited income whose investment objectives were 50% income and 50% long-term growth.
In the first year, 65% of the securities purchased for her account were sold within 90 days of having been purchased. The next year, 72% of the securities were sold within 90 days.
This level of trading was excessive and unsuitable for the client in view of her stated long-term growth objective. During this two-year period he took commissions of $32,113.
The opening portfolio value of the account was $108,825 and, by the time the account was closed, the losses totaled $42,783.
In another account of a 61-year-old whose objectives were 30% income and 70% long-term growth, 84% of the securities were held for less than 180 days.
The broker's recommendations were also unsuitable in that they resulted in excessive concentrations in the account of the securities of two issuers.
Over a two-year period his commissions were $20,825 while the portfolio value went from $96,248 to a loss of $89,211.
The disciplinary penalties assessed against him were: a fine in the amount of $13,000, disgorgement of net commissions in the sum of $53,000; a condition of re-approval by the Association in any registered capacity such that he must rewrite and pass the examination based on the Conduct and Practices Handbook for Securities Industry Professionals and submit to being closely supervised for a period of 12 months.
In addition, he was required to pay $8,500 toward the Association's investigation costs.
"Pump and Dump" Schemes
If only one firm, or a small group of firms, makes a market in the stock, the price can be manipulated and may not reflect the true value of the company.
This occurs when stock promoters buy or create little-known and generally worthless stocks and promote them with lies and misrepresentations.
The firm may have been involved in the company's initial public offering or the firm may "make a market" in the stock, which means it buys and sells the stock, sometimes called a "house stock", for its own account.
Scammy brokers often drive up the purported market prices of their house stocks until they get rid of their own holdings at a profit.
Knowing they control the stock price, they can easily predict stock movement in time increments, end of week, three weeks, two months.
If you haven't come on board right away, you soon will after the predictions become reflected in the prices they quote you.
These predictions are first taken as assumptions, then as facts, as they unveil new and exciting news, a bit at a time, without any verification.
They will say they have an inside track, but no one takes responsibility, or will put in writing, this whispered information about secret facts on key issues.
Then, when they stop promoting the stock, the price falls, and investors lose their money.
Once unsuspecting victims buy these "pumped up" stocks, they find they've had the worthless stocks "dumped" on them.
A Prime Example
In one case where individuals agreed to purchase a privately-owned company by a "reverse merger", whereby the new or "merged" company, named Prime, would be able to trade its stock on the Over-The-Counter (OTC) Bulletin Board.
In anticipation of the proposed reverse merger, they issued 18 million shares of Prime stock to their nominees, who they designated to act as nominal corporate officers, directors and stockholders of Prime, in order to conceal this control from both the SEC and investors.
Then, after fraudulently acquiring control of Prime's stock and making misrepresentations, they sold it on the OTC Bulletin Board to unsuspecting investors at prices substantially higher than it was worth.
They realized more than $5.3 million in profits, which they hid in various places including about $580,000 in an account at Caesar's Casino.
An Offer You Can't Refuse
Sovereign Equity Management manipulated the prices of at least four stocks traded on the NASDAQ.
Notwithstanding the fact that only one name appeared on the corporate records, other individuals, one who was barred for life from the Securities Industry by the National Association of Securities Dealers, as well as a "captain" or "capo" in the Cosa Nostra also had a hidden interest and exercised control over the operations.
They approached corporations who were having financial difficulties with offers to help them obtain financing through the sale of stock.
In exchange for providing interim financing they were provided with discounted stock in these corporations which they then sold to the public
They then manipulated the market through brokers who "pumped" up the price of the shares in order to make the most money while they "dumped" the stock upon the public.
They would issue fake press releases regarding the financial condition and prospective business of the corporations as well as provide brokers with "juice" payments, or payments over and above the lawful commission, in order to sell the stock.
After "dumping" or selling their discounted shares at artificially inflated prices, they would "short" the stock, then have the brokers stop supporting its price.
The investing public lost all or the majority of their money in these securities as the price plummeted.
"The mob never saw a market it didn't want to control," said Lewis Schiliro, head of the FBI's New York office.
In one $10 million scam, led by two associates of the Colombo crime family and one from the Bor Russian crime group, the reputed mobsters infiltrated the now-closed New York branches of Global Strategies Inc., Amerivet Dymally Securities and First National Equity Corp.
They paid kickbacks to brokers as an incentive to call investors and pitch dubious startup companies, including one that claimed to be developing golf courses in the South.
Dot Gone
In a major 100 defendant bust occurring in June of 2000 the USDOJ found that members of the country's five largest organized-crime families conspired to manipulate publicly traded securities in nineteen companies, bilking investors out of $50 million over five years.
The stocks of Wamex Holdings and EPawn.com were involved in the alleged scheme.
Aiming to exploit the Internet boom by touting the companies as dot-com plays they promoted Wamex as an alternative online-trading system that would soon be available but the SEC said it wasn't lawfully authorized to operate such a system.
Prosecutors said that brokers who didn't play ball in the pump and dump scheme were subjected to beatings, intimidation and threats.
Many of the charges stemmed from a successful one-year undercover operation, code-named "Uptick" by the Federal Bureau of Investigation's New York office, with assistance from the SEC and the regulatory arm of the National Association of Securities Dealers.
The operation involved surveillance devices at the office of DMN Capital Investments Inc, a small securities firm that prosecutors say was at the heart of the alleged manipulation.
The brokerage firms involved included First Liberty Investment Group Inc, William Scott & Co and Bryn Mawr Investment Group Inc. Other firms allegedly controlled or infiltrated by the mob group included Monitor Investment Group Inc; Meyers Pollack & Robbins, First Liberty Investment Group Inc and Atlantic General Financial Group.
Prosecutors have also alleged that Sterling Foster & Co and A R Baron & Co, two small securities firms, each bilked investors out of $75 million over six months. (Both firms now are out of business)
Bait and Switch
Crooked brokers entice new clients by getting them to purchase widely-traded "blue chip" stocks.
After taking the bait, they pressure you to spend increasing amounts of money on small, often self-controlled, non-existent companies with little or no earnings, whose stocks are risky, thinly traded and often worthless.
At one firm, a review of a thousand customer accounts showed that all of the clients had bought only one or two stocks —solely in unknown microcap company stocks that only that particular firm was selling to the public.
General Infractions
Brokers from one boiler room "sweep" were shown to have defrauded investors by:
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lying about the firm's reputation and expertise, claiming it had a "research department" that analyzed stocks when it didn't, |
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refusing to say anything negative about the stocks they pushed, including the risk factors discussed in the prospectus, |
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making baseless price predictions, promising that certain stocks would double in price within a short time period, |
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impersonating other salespeople at the firm, and |
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discouraging customers from selling the stocks they recommended, without regard to the customers' best interests. |
Unethical or dishonest practices in the securities business include, but are not limited to, the following:
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entering into a transaction with a customer in any security at an unreasonable price, or at a price not reasonably related to the current market price of the security, or receiving an unreasonable commission, markup or profit; | ||||||||
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effecting a transaction in the account of a customer without authority to do so; | ||||||||
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switching or churning of securities or inducing unwarranted trading in a customer's account; | ||||||||
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engaging or aiding in boiler room operations or high pressure tactics in connection with the solicitation of a sale or purchase of a security by means of an intensive telephone campaign whereby the prospective purchaser is encouraged to make a hasty decision to buy, irrespective of his or her investment needs and objectives; | ||||||||
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failing to furnish to a customer purchasing securities either a final prospectus or a preliminary prospectus, or making oral or written statements contrary to, or inconsistent with, the disclosures contained in the prospectus; | ||||||||
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making a false, misleading, deceptive or exaggerated representation or prediction in connection with solicitation of a sale such as:
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failing to disclose that the broker-dealer or sales representative is controlled by, controlling, affiliated with or under common control with the issuer of any security; |
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using, commingling or hypothecation of the customers' money or securities; |
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failure or refusal to furnish a customer, upon reasonable request, information to which he or she is entitled, or to respond to a formal written demand or complaint; |
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borrowing money or securities from, or lending money or securities to a customer by a sales representative, or for a sales representative to act as a custodian for money or securities; |
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after soliciting a purchase by a customer, failing or refusing, in connection with a principal transaction, to promptly execute sell orders on behalf of the customer; |
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leading a customer to believe that the broker-dealer or sales representative is in possession of material, nonpublic information that would affect the value of the security; |
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engaging in a pattern or practice of making contradictory recommendations to different investors of similar investment objectives, such as for some to sell and others to purchase, the same security, at or about the same time. |
Touting a Stock
Most commercial electronic bulletin board services allow individuals to post messages under multiple aliases.
Since it may be impossible for another subscriber to ascertain the true identity of the individual behind the message (or even if a series of messages are being entered by just one individual under various aliases), there is enormous potential for manipulation of little-known companies that have a small capitalization.
Acting alone or with accomplices, one company insider, broker, public relations executive or even just a large shareholder can leave numerous messages calculated to spark interest in an obscure stock.
"I heard that Mighscam is about to make a major announcement. E-mail me or call this toll-free number to get an information package."
As well, these microcap stocks also are being touted on the Internet by unregistered promoters. The information conveyed to investors often is at best exaggerated and at worst completely fabricated.
"I spoke to Mighscam's CEO who confirmed details of next month's big news. I've bought 10,000 shares. Look for the share price to double next month! Get in now!"
The promoters of these companies, and often company insiders, typically hold large amounts of stock and make substantial profits when the stock price rises following intense promotional efforts.
Once the price rises, the promoters, insider and brokers sell, realizing their profits.
Through the use of puffery, speculation, and unfounded, but conspiratorial, claims of inside information regarding pending announcements, product innovations, and new contracts, the schemers seek to run up the price of the stock, which starts rising as unwary investors read of the "great opportunity" and buy shares.
In response, the insiders take their shares (bought at the low, "pre-hype" prices) and sell them into the rising market. As interest builds, dozens of messages may be posted about the stock.
"Big news is just around the corner. We hear from a friend who has visited Mighscam that it is going to be even bigger than we thought. There's still time to get in."
When the hype-fueled stock price falters, the promoters may blame unnamed short-sellers.
"Short-sellers are in the market! Keep the faith… This will bounce back. The smart money will use the lower price as an opportunity to buy more and dollar average."
Talk of the stock then disappears from the board and investors are left holding the bag.
Just because these tips appear in cyberspace does not mean that they are exempt from federal insider trading laws and rules.
It is, however, extremely unlikely that genuine "insider information" is going to be publicly broadcast on a investment bulletin board. No one is that altruistic. They have another agenda.
The opposite of this technique, often perpetrated by short sellers, is the "cybersmear" or "trash and cash" fraud which is intended to driven down a stock price on the basis of spreading false negative information.
New on the scene is the "hack attack" whereby infiltrators get past a company's firewall and alter the website to reflect exceptionally good or bad news, then direct bulletin board participants to view the site after taking a favourable position in that stock.
Insider Trading Bounty:
Get a reward for identifying insider trading.
I Heard It On The Grapevine
Using made-up screen names to post false messages on electronic bulletin boards, two individuals caused the price of the stock of NEI Webworld, Inc. to soar from 13 cents a share to more than $15 a share when they stated that NEI was going to be taken over by a large wireless telecommunications concern.
The touters realized more than $350,000 in profits after they made large low-price purchases of NEI stock and then, using the Internet, encouraged others to buy the stock at the high price.
The buyers were left with significant losses on their "investment" when the stock price collapsed.
The messages —which appeared to come from many different people —failed to state that NEI was bankrupt, that its assets were liquidated, and that no one had any intention of merging with them.
Investment Newsletters and Independent Opinions
Some individuals claim to be giving "independent" stock recommendations in on-line or printed newsletters, spams (Internet junk e-mail), message board postings, and web sites, when, in fact, their opinions have been bought and paid for.
They will make all sorts of claims about visiting companies, inspecting mining operations, and having personal conversations with company officials.
Keep in mind that you may not be able to determine bias in these claims, much less whether any of the information is true or the supposed research ever took place.
One group of promoters received over $6.3 million and nearly two million shares of cheap insider stock and options from the companies whose stocks they touted.
In some instances, they sold their stocks immediately after recommending that investors purchase them —a deceptive practice referred to as "scalping".
Independent Sales Offices
A new trend in investment fraud involves the use of Independent Sales Offices (ISOs) located throughout the country to market worthless investment opportunities.
Promoters go to great lengths to disguise their affiliation with the fraudulent operations.
Often, it is difficult to identify the head promoter of investment schemes due to the fact that each ISO operates as an independent entity, under a separate company name.
Finding It Hard to Sell
Many investors find that once they buy a "house stock", they can't get what they paid for it, even if they decide to sell right away since their once persistent broker now refuses to take calls from customers who want to sell.
The person who sold you the investment, for example, may suddenly become inaccessible or continuously tied up on the telephone, unwilling to return your calls, busy with clients, or out-of-town on important business matters.
Some firms follow "no net sales" policies where brokers can't execute orders to sell "house stocks" unless and until they find the next victim to buy an equal number of shares, even though you were led to believe that demand for the stock was widespread.
"When I told my broker to sell my portfolio, he said "I can't do it . . . I can't explain why, but what I'll do is send you the stock and you sell it through another broker.""
Other firms discourage brokers from selling by offering low, or no commissions on house stock "sales".
These brokers will use high-pressure tactics to persuade you to keep the stock. Or they will simply refuse to sell it.
A high commission, linked to the purchase and forfeited on redemption, motivates sales staff to keep clients until the scam is completed and inflated prices are just a memory.
They never intended to permit clients to make a profit as the stock returns to negligible worth.
Whether you bought in at a low or high price, without the opportunity to sell, you are left holding the bag, and it doesn't contain gold.
A Goldmen Opportunity
One Florida securities firm committed massive stock fraud against thousands of elderly investors which cheated them out of almost $100 million.
A.S. Goldmen was created in 1988 to steal money from investors and at its peak in 1994-95 had more than 300 brokers and 50,000 customer accounts.
The firm's chief financial officer was a former official of the National Association of Securities Dealers and therefore knew many ways to help Goldmen hide its wrongdoing.
They bilked investors by lying to them, performing unauthorized trades, ignoring sell orders, forgery and outright theft.
Some investors were persuaded to get as much cash as possible from their credit cards, or withdraw money from retirement accounts, to invest.
Virtually all which was lost. One 73-year-old retiree lost his life savings and had to return to work as a bus driver.
Don't Turn Your Back On This Guy
Robert C. Ingardia, 25, who worked for Joseph Stevens & Co., took advantage of his access to clients' personal information, from Social Security numbers to the names of their beneficiaries.
He called the firms that held his clients' money, including Fidelity and Charles Schwab & Co., and, without permission, sold off hundreds of thousands of dollars worth of stocks and mutual funds, the SEC alleges.
He then tried to buy large amounts of thinly traded penny stocks in an apparent attempt to drive up their prices.
In one case, after a client told him he was going on vacation he called Fidelity and ordered the sale of the man's $450,000 of securities then tried to buy 600,000 shares of a stock that was trading for less than 20 cents.
Fidelity did complete the $450,000 sell order but did not buy the penny stock. They instead called to check the order a second time and reached the client, who said he never placed the order.
In all, Ingardia made $1.1 million in unauthorized trades, the SEC alleges. Fortunately Fidelity, Schwab, and Brown & Co. returned any clients' money that had been lost because of the fraud.
Why Do You Think We're Called Broker?
My Dad was a proud and private man, typical for his age, and entrusted all of his financial matters to one person, his broker.
In early 2000, this broker exerted his undue influence over Dad by running him around (at a period of time when Dad was especially vulnerable), cashing in CDs and re-investing the funds for him at the national brokerage he worked for.
He then started stealing from him by forging checks from both the brokerage account and personal checking account at the bank.
He also stole Dad's social security checks and was depositing all of this into his own personal banking account.
All of this has pretty much been confirmed by the criminal investigation by the police department.
Dad was first informed about this last December and, unfortunately, he became despondent and reclusive, refusing to eat, and passed away June 18 at the age of 83.
He was in pretty good health prior to this, but his last 6 months was pure Hell.
I have done the forensic investigation and met with the attorney for the Estate and the Executrix last week.
We placed the loss at around $1/4 million, with $100,000 being outright theft of forged and stolen checks deposited in the broker's personal bank account.
The national broker and the perpetrator are now being uncooperative and have ceased dealing in good faith with the Estate at this very sensitive time for the surviving children (and heirs).
The criminal investigation seems to have stalled also (the Probate judge at the first hearing expressed concern that the local prosecutor does not like to prosecute white-collar crime).
What can we do?
Jim Beasley 08/25/02
