Penny stock scams 2
Penny stock scams
By Jay Perlman (TMF Jay)
February 23, 2000
As shown in the last article, the microcap market has some characteristics that make it an effective forum for fraud. OK, but exactly what kind of scams take place in this market, and how do you recognize them?
Microcap, or penny stock fraud first became popular in the 1940s and 1950s when worthless shares of uranium mining companies were bought and sold over the counter of a Salt Lake City coffee shop. In the 1980s, precious metals mining companies and oil and gas companies promised investors a pot of gold at the end of the rainbow. Additionally, "blind pool offerings" became a popular vehicle of microcap or penny stock fraud. Blind pool companies had no assets, earnings, employees, or any sort of business plan. Promoters simply told investors "we don't have a plan or a product, but give us your money anyway, and we'll use our expertise to find the right opportunity for you. Just trust us, we'll make a lot of money for you." Blind pools were effective because investors were so hungry for a quick return that they'd rely on the representations made by the promoters.
By the 1980s microcap fraud was being promoted from boiler rooms in Denver, Salt Lake City, Spokane, and Boca Raton. They employed thousands of cold callers who read from scripts designed to prey on investors' desire to "get in on a ground floor opportunity," and the callers simply refused to take no for an answer. A typical cold calling script said:
"Stop right there! You're a businessman and you make decisions every day. You didn't get where you are by being stupid... Let's confirm the order now. OK?"
Cold callers were expected to follow the scripts to the letter and were also discouraged from doing any outside research.
As we move into the 21st century, microcap fraud has taken on a new look. The Internet has allowed the creation of a cyber-boiler room, a quicker, more efficient, and cheaper alternative to the traditional boiler room. With the Internet, a fraudster no longer has to incur rent, salary, and telephone costs. Mining and extractor programs allow pitches to be more targeted and more personalized. Finally, investors seem to lend an air of credibility to information they see on the Internet.
Whatever the medium, the scheme, known as the "pump and dump," is always the same. Microcap stocks are great targets for pump-and-dump schemes because they are low-priced and thinly traded, and it's easy to gain control of the company. For example, if a company has 1,000,000 shares outstanding and trades at $0.10 per share, anyone can gain control of the company for as little as $60,000 ($0.10 multiplied by 600,000 shares). Once a fraudster and some of his associates have control of the company, the price manipulation begins. Dissemination of bogus press releases and choreographed buying and selling give the appearance of legitimate investor interest, so the price begins to rise. Investors, not wanting to be left behind, begin buying, which leads to further price increases. When the price gets to a certain level, the fraudster and his buddies dump their holdings for a handsome profit. The "dump" causes the price to collapse, leaving innocent investors holding the bag.
As mentioned in the previous article, The Motley Fool hates penny stocks. But, if you're going to buy penny stocks, you need to know how to avoid a scam. If you do take our advice and decide to stay away from penny stocks, you should find this information helpful in avoiding other types of scams.
Beware of high-pressure sales tactics. Don't succumb to a sales pitch pressuring you to invest in a "once-in-a-lifetime opportunity" before you've had the chance to fully analyze it. Be wary of repeated solicitations for the same investment. If the investment returns sound too good to be true, they probably are. Any discussion of a product that will "revolutionize the industry" should give you pause. If a previously dormant company begins issuing press releases every day, it may be a sign that the stock price is being manipulated. Be especially wary when the press releases discuss "imminent" regulatory approval or talk about new contracts with "undisclosed" parties or "certain government agencies." Any press release that can't be easily verified should make you think twice about investing. Mergers with shell companies (public companies that have no assets or operations and are simply used as merger partners to facilitate public trading) or sudden, dramatic shifts in business are also potential warning signs.
If the investment is being promoted by an online newsletter, be suspicious if it does not specifically disclose these items: who paid them, the amount, and the type of payment. You should also be suspicious if the compensation is disclosed, but the disclosure is buried someplace in typeface that would be impossible to read without a magnifying glass. Legitimate online newsletters that have been paid to tout stocks will clearly and specifically tell investors who paid them, the amount, and the type of payment. At least with clear disclosure, you'll know that the promoter's advice may be biased. Should you invest then? Who's to say? But at least you'll have the information you need so you can make your decision.
In 1996, a company named Uniprime Capital Acceptance incorporated in Nevada and began its business of acquiring automobile dealerships. Uniprime also provided auto financing and in 1999 began branching out into auto insurance. As recently as June of 1999, Uniprime's stock was trading at about $0.50 on an average daily volume of 10,000 shares. Deciding that the car business was not the business that would make the company's stock price take off, Uniprime issued a press release stating that one of its subsidiaries, led by Dr. Alfred Flores, had made a "major breakthrough" in treating HIV. Several additional press releases touting the discovery and Dr. Flores' background were issued in the subsequent weeks. Additionally, online message boards were flooded with conversations about these disclosures. This drove Uniprime's stock price to $7.95 on volume of five million shares in a few days.
Turns out that at the time of Flores' supposed discovery, he was in jail for conspiracy to commit murder. Furthermore, the closest Mr. Flores had ever come to the medical community was the time he spent as a janitor at a nursing home. Information regarding his background, the purported cure, and its effectiveness were completely fabricated. When this was revealed, Uniprime's stock price collapsed. Mr. Flores is currently in jail and a federal investigation continues.
Sounds ridiculous, but it's true. The lack of unbiased information about Uniprime, the effective use of the Internet to promote the stock, and its low price made this a textbook example of microcap fraud. Investors got sucked in by the lure of quick riches and failed to heed the warning signs.
Back in 1994, as an April Fool's prank, The Motley Fool created Zeigletics, a penny stock that was purportedly traded on the Halifax Exchange. Even though the company, its product, and the exchange were complete fabrications, financial message boards on America Online and Prodigy were filled with lively discussions about the company. People actually tried to purchase Zeigletics stock based solely on what they read on the message boards! What it proved was that people are so eager to make a quick buck that they neglect to do their homework. Our view of microcap stocks is nicely summed up by the following posting on the Zeigletics message board:
The point Joey Roman is making is pretty clear (by the way, Joey Roman was the name given to the fictional person who was hyping Zeigletics stock): It is so easy for a fast-talking hypester to establish a position in a low-volume stock, rattle off a bunch of crap that sounds plausible enough to convince a novice, let the price pop due to uninformed amateurs flying in, and sell into the rise, laughing all the way to the bank.
Dear people, learn to evaluate and think for yourselves. There are some legit stock pickers on this board, and good ones at that, but please check their records and do your own research before buying.
The full story of Zieglitics can be found here.
Our advice: Stay away from microcap stocks.
Warning Signs
Pitches that say you can get in on the ground floor of the next big thing
Companies that make sudden shifts in their business
Mergers with companies that nave no assets, operations, or products
Press releases with information you can't verify
A sudden unexplained increase in the company's assets or stock
Promoters who bury the fact that they've been compensated for promoting the stock
Sudden increase in traffic on financial message boards
What to do if you get scammed
While the Internet is a quick, easy, and efficient way for fraudsters to target investors, the Internet is an equally effective way for aggrieved investors to seek justice. One of the most impressive characteristics about the Internet is the "vigilante" attitude toward securities fraud. For the most part, people want to keep the cyber-streets free of crime and set up their own "neighborhood watch" programs. There are websites, newsgroups, chatrooms, and bulletin boards devoted to exposing securities fraud. Visit these websites, send e-mails, post on message boards, and discuss the problem in chatrooms. Organize campaigns among defrauded investors and complain en masse. The more people that complain, the more the problem gets noticed, and that's what you want.
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Just say NO to stock fraud!
AI
