Investment frauds, scams and abuse – various examples of naughtiness
It has been stated that Britons were scammed out of £200m last year. The average loss per person was around £29,000. However, that figure could well have been very much larger because those that have fallen victim will generally stay quiet about their misfortune.
There are a host of ways that scamsters use to cheat unwary investors. Nothing is new, just the methods may have seen slight change.
Those perpetuators of schemes play upon greed and dreams, but sometimes they are the ones who are being greedy for themselves.
I have gone back through loads of records and reports of investment frauds, scams and abuse and then selected various brief examples of naughtiness.
The Great Stock Exchange Fraud of 1814
In the early hours of the morning of 21st February 1814 a military officer, wearing a red uniform worn under a grey greatcoat, was making a commotion at The Ship Inn in Dover.
Demanding of the innkeeper that a message was passed straight through to the Admiralty.
Colonel du Bourg, aide-de-camp to Lord Cathcart, had just arrived from France and was carrying news that Napoleon had been killed. This news had to get through, perhaps by semaphore telegraph or by express horse and rider. He also demanded a post-chaise and four to take him directly to London.
As the officer was transported to the City, he excitedly told the good news to all and sundry at the various inn stops on the way.
By the time he arrived the message was certainly going the rounds and the price of Omnium, the leading Government stock, was rising from its opening of 26.5 to a morning peak of 30.25. By lunchtime there was no official confirmation of the story and the price fell back to its early level.
The sight of three French officers circulating the City, throwing paper billets declaring ‘Vive le Roi’ from their carriage, seemed to perk up the stock to 32.5 as Napoleons downfall was seemingly confirmed.
It was all an elaborate scam, perpetuated by a small group including the famous English seaman Lord Cochrane and three colleagues.
A Stock Exchange investigating committee identified that a mega purchase of Omnium stock had been made one week before the charade took place. That stock was sold off to new buyers as the news drove the price higher. They were all subsequently arrested.
Pump and Dump
This scheme involves fraudsters buying a very large line of stock in a cheap illiquid ‘penny share’ and then pushing the market price upwards by a multitude of means – newsletter ramping, newspaper market column mentions, internet based rumours and even ‘layering’ (by which a multitude of small buy orders are placed across the market through different brokers).
When the price has risen high enough for fresh demand to be satisfied, they then push the stock out to the eager buyers.
Literally pump them up and then dump them. Chop Stock scams worked in similar fashion.
Dump and Dilute
These schemes involve quoted companies energising their share prices higher and then using brokers to place newly issued stock on their behalf.
Higher prices created bigger issues and bigger cash raises, which mostly were then used for non-corporate disposal.
Boiler Rooms
A long time ago I had a 15% stake in Reliant Motors, the three-wheeler company. I had bought my holding at around 21p a share. It had risen to 45p within three months, at which time I was approached by a broker to part with my stock at 60p a share.
That was certainly very tempting, but I needed to know who the buyer was before I dealt. Quickly I identified that it was a securities operation on the Continent.
It was, in fact, a boiler room. A team of ace equity salesmen had been flown into Amsterdam from the States. They had been put in to a newly leased (short term) office that was fully equipped with scores of phone lines and European telephone directories.
The team just hunkered down, almost day and night picking up their phones and selling stock to unsuspecting investors. To the team it didn’t matter what the business was, it was just more stock to shift to punters. With very big commissions to be earned upon the sales.
And my line of Reliant Motors was, no doubt, going to be the next featured stock to be shunted out at probably at a price of 125p or higher. Understandably I refused the broker’s offer and later placed my holding at 48p a share. A big profit missed, perhaps, but my conscience was clear.
If you saw the film ‘Boiler Room’, starring Vin Diesel, concerning one Jordan Belfort, then you will know all about how they operate and scam the investors.
Licenced Dealers
In the early 1980’s a load of securities dealers achieved registration to deal with the investing public – leading to a very fast growth of the UK Over-The-Counter Market.
At that time I was publishing investment magazines on both the USM and the OTC markets, so I did get to know a number of the companies involved.
Such dealer names included Chartwell Securities, Prior Harwin, Ravendale Securities and Harvard Securities amongst many others. They were all very similar to the Boiler Room operations.
Their duty seemed to be the placing of large lines of shares in newly floated OTC companies, at several times their real value. With the unlucky investors rarely able to achieve profits in their OTC dealings.
Some of the licensed dealers had extremely questionable connections both in the States and on the Continent.
I can clearly remember being flown over to New York with a number of fund managers to meet some stock market players from a couple of Wall Street firms. One firm in particular was Marsan Securities, which had a big hook-up with Ravendale.
We enjoyed lavish hospitality over there, staying at the Hemsley Palace Hotel. We also endured a superb dinner at a wonderful steak restaurant called Smith & Wollensky, with a table of notables including Richard Nixon’s Watergate lawyer and a very smart suited individual by the name of Thomas Quinn.
Marsan was looking to export some US pink sheet companies on to London’s OTC through Ravendale. Later I was to find out that Marsan was steeped in Mafia capital and that Tommy Quinn was subsequently jailed as a Mafia front man in several stock frauds.
Another very close shave.
Exempt Securities
Otherwise known as Offshore Scams, this involves the selling by brokers of stock that can only be sold to investors outside of the US to foreign or offshore buyers – generally ‘Regulation S’ equity.
Investors are convinced by dealers that there are massive profits to be made by switching registration details. It doesn’t happen and investors get scammed, yet again.
Frontrunning
This scam concerns brokers receiving large market moving orders from their institutional and fund manager clients. Not all of them by any means, but the unscrupulous brokers use such knowledge to feather their own nests.
Using other broking firms and acting as private clients they place orders in the same stocks beforehand.
Then, when they have handled their own large clients price increasing business, they place sell orders with those other brokers and take full advantage of the risk-free gains.
I remember a couple of brokers doing just that some time ago, in cahoots with a certain fund manager at Piccadilly Unit Trusts.
Although it is now illegal and there is very careful computer monitoring of such business today, brokers can still buy ‘burner’ telephones for placing orders with friendly dealers, thereby enabling frontrunning of their client’s business.
Churning
Many investors give their brokers the ability to deal on their behalf without the need to refer. This is a form of discretionary dealing. You may give a fixed sum upon which they can play/gamble with for the credit of your account.
However, more often or not, this authority leads to ‘churning’ by the broker, who lives off the commissions that are generated and not upon the profit that should be made for the client.
Excessive trading ensues in the pursuit of such profits you may be told but look at the number of trades that have been made and the commission that has been charged.
Very quickly the fast dealing losses and the expenses of such dealing dissolves your initial discretionary capital sum.
I would never recommend setting up a discretionary account, nor would I suggest leaving a broker with a chunk of your capital with which he can trade. Don’t leave it to someone else – you can make your own losses thank you very much!
And if you don’t understand how to research your stocks then either take investment lessons or buy a spread of investment/unit trusts as your portfolio.
Unauthorised Trading
Always check your trading accounts and never allow your broker to buy stock for you without asking your permission – it only leads to investment fraud and you don’t need that.
Short Selling Abuse
This is becoming a very fashionable scamming method.
A large company is selected by the person/s behind this scheme. They thoroughly research that company, its people, its workforce, its operations, its products and identify a number of bearish facts and figures to grossly embellish by way of publishing an investment newsletter and making it available via the internet.
The publisher is an unknown name, and its address is hidden through several ‘offshore’ companies. The researcher never speaks to the company management, in fear that identities become known.
Large option positions are taken out calling the stock lower over a short period of time.
Then the full force of a ‘rumour machine’ is swung into action, helping to drive the corporate victim’s stock down. Newspaper market column mentions, anonymous chat room conversations exacerbate the situation, together with a number of mishandled short-selling orders – and down the price goes.
The lower it falls the more the rumours and the responsive column inches reporting the price falls. It can become self-feeding. Effectively this is a ‘short and distort’ operation and they can be brutal to share prices.
Despite any denials of such rumours by the ‘victim’ company the price carries on easing away.
When the price is still in freefall then the scheme’s operators exercise their options and buy back their shorts.
Many commentators do not consider that this type of operation is an abuse, however it is still market manipulation.
Advance Fee Scheme
This scam works upon investors who know that they have been wronged, or they think that their losses are down to a ‘pump and dump’ type dealer.
The operator either entices the investor with the promise of getting in on a really low price into a stock that is going to fly and that will ‘right’ the losses made on other stocks.
By paying a small fee to get in advance for the service the investor again loses his money.
Alternatively, an investor may well be tempted to seek redress from the firm that sold the shares upon which money was lost, for that redress service the new company (often associated with the original company) will charge a fee to help the investor recover the lost funds.
But it never materialises and yet again the punter has lost money.
Corporate Misconduct
Bre-X Minerals – this was a case of falsified sample findings from this wonderful, biggest ever, gold prospect in Indonesia. In 1996 Michael de Guzman cost investors around $3bn when no actual gold was found. The shares, which had gone from 30 cents in initial offerings to over $286, crashed upon realisation that it was all a scam. Several investors chased the company’s shares up in price and made themselves fortunes in the process, whilst others, like a certain Scottish fund manager, bankers Lehman Brothers and major mining companies all ended up with egg on their face. Ahead of a Due Diligence meeting de Guzman fell out of his helicopter and his decayed body was later found in the jungle.
Enron – yet another case of corporate misconduct. At one time it was the 7th largest company in the States. To exaggerate the health of his company founder Kenneth Lay falsified its financial results, it went from strength to strength before the true facts were revealed and in 2001 it filed for bankruptcy. Whilst on holiday before getting his sentence for security fraud he dropped dead – the investor loss was $74bn.
WorldCom – in 2005 Bernard Ebbers helped to lose investors some $100bn when his WorldCom, the second largest US telecoms company, sought Chapter 11 bankruptcy. He had overstated his company’s cashflows, and covered up its acquisition fuelled debt, thereby bloating its assets by about $11bn. His stock fell from $64 at its peak to less than $1 upon discovery of his false accounting and that he was crooked.
Questionable accounting practices in 2014 brought about the collapse of insurance firm Quindell.
The UK AIM quoted Langbar International was another scam. In 2011 it was discovered that £370m of bank deposits by the company, and loudly declared in the accounts, did not exist.
Another AIM company was the software developer Globo. The mobile technology company founded by a champion windsurfer, provided software designed to create a secure space for an employer's data on employees' personal phones. It was later revealed that it had masses of fake clients and suppliers, all based in discrete jurisdictions like Panama and Cyprus – you have to ask the question – just what were its accountants doing in not having checked them all out?
Insider Trading
Certain ‘insider trading’ can be considered legal. Directors, key employees and officers of a company can deal in their company’s equity, as long as they adhere to fairly strict dealing requirements and report all of their dealings to the market.
But the profitable ‘insider trading’ is totally illegal. Buying or selling of stock in any company in the knowledge that certain events or items of news are imminent, which could push the share price higher or lower – that really is a no-no.
However, it happens every day. Non-public information can move markets quite dramatically and greed can so often replace caution in the pursuit of sizeable profits.
Way back in 1929, Albert Wiggin, the chairman of Chase National Bank shorted his own bank’s stock. He had been leading the company for 12 years but took the view that the banks shares were headed lower, as Wall Street crashed he made the equivalent of $50m by doing so. In those days it was totally legal but it caused ructions and he later resigned his post.
Jumping forward over 50 years Michael Milken, the US ‘Junk Bond King’, was helping to build up investment bankers Drexel Burnham Lambert. Together with his colleague Dennis Levine they helped the funding of the DBL client Ivan Boesky, known as the ‘Arbitrage King’. Boesky became one of the biggest ever market players and seemed to always get it right – scoring big time in deals by Getty Oil, Nabisco, Texaco, Gulf Oil and Chevron – all clients of DBL. In 1986 Boesky settled insider dealing charges with a mega payment to the SEC and taking just a 3.5 year jail term.
Here in the UK perhaps the most famous insider dealing surrounded the shares of Guinness ahead of its bid for the Distillers drinks company. Stockbroker Anthony Parnes, property developers Jack Lyons and Gerald Ronson, together with Guinness boss Ernest Saunders took part in a share price ramping to help Guinness win through. All four were convicted with theft and false accounting. However, Saunders saw his sentence halved because he claimed to have Alzheimer’s, from which he miraculously recovered some years later.
Former Cazenove partner Malcolm Calvert was a big UK insider trader. In 2010 he was found guilty of trading shares of three companies ahead of takeover news. Jailed for 21 months.
If you want some other examples check out the dealings by: former Dresdner Kleinwort banker Christopher Littlewood and his wife and close friend, for 10 years they were insider trading; Matthew and Neel Uberoi, the former worked in corporate broking on takeover and price sensitive deals, with the latter dealing on his sons insider information; and also look at former AKO Capital trader Anjam Ahmad, who dealt some 19 times on inside knowledge.
Ponzi Schemes
This is a special kind of fraud. It is based upon a fake investment that a schemer gets other people to give money to participate. By peddling the scheme to make money fast the operator persuades others to join him and put their own money in to achieve big returns.
In the early 1920s Carlo ‘Charles’ Ponzi became known in North America as a swindler for his money-making scheme. He promised clients a 50% profit within 45 days or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the States, effectively a form of arbitrage.
But in reality Ponzi was paying earlier investors their returns by using the fresh investments of later investors.
Ponzi was raking new money in every day on the back of his fat promises. That was before he was found out and some 18,000 investors lost the equivalent of $20m. It even brought down six banks in the process.
Ponzi, who was born and raised in Italy before moving to the States, was declared an ‘undesirable alien’ by the US immigration authorities in 1922.
And finally, it is very important to mention Bernard Madoff and his Madoff Investment Securities company. This was and still is the biggest scam ever.
In 1960 he formed a ‘penny stock’ brokerage, which became one of the top market making businesses on Wall Street. In the top six by 2008 and certainly the largest NASDAQ market maker.
Madoff was the former Chairman of NASDAQ and a totally reputable stockbroker. He was respected wherever he went but in reality he was a real ‘market gangster’, a scamster of the first order.
It is thought that he may well have started his fraud in the early 1970’s. Federal investigators reckoned that it really got underway in the 1980’s and it gained prominence in the 1990’s.
He ran a ‘hedge fund’ that appeared to achieve almost yearly an 11% return for its investors. What was happening at his firm was the issue of false trade notes that helped to produce investors such returns.
Everyone wanted a piece of this action run by one of Wall Street’s respected seniors.
In typical ponzi style it was the fresh wave of investment funds that were being used to pay off the investor returns.
Of some $36bn invested with Madoff only $18bn was returned to investors, the balance went missing. Madoff admitted that he never made any legitimate investments with his clients’ money. It did, however, get ‘invested’ in Madoff’s own business banking account with Chase Manhattan Bank, which he then used to pay for withdrawals when his clients asked for return of funds.
Market onlookers considered that it was both legally and mathematically impossible for Madoff to achieve the gains that he declared.
Believe it or not the SEC in the States actually investigated Madoff six times, because the returns were so good and even market beating. Each time they failed to find anything amiss.
Madoff was later reported as having stated that “I was astonished. They never even looked at my stock records. If investigators had checked with The Depository Trust Company, a central securities depository, it would've been easy for them to see. If you're looking at a Ponzi scheme, it's the first thing you do.”
Understandably the SEC, which had been receiving complaints about Madoff for over a decade, was heavily criticised for its own lack of financial expertise and its inability to identify Madoff’s corrupt scheme.
By reporting him to the authorities it was Madoff’s own sons that eventually brought his scam to its knees. Some 24,000 victims lost money.
What to look for and how to protect yourself
Hopefully in this article I have identified various investment scams, frauds and abuse of which you should be aware.
It has been said so many times before and yet the warning phrase is so often forgotten “If it seems to good to be true, it probably is” – so stay alert.
Wherever you can make sure that a 3rd party has approved any corporate statements that are made, especially in drilling samples.
Can you identify whether the balance sheets are legitimate, I know that is not an easy task.
If you get a ‘cold call’ to participate in a wonderful opportunity – just put the phone down, after all if it is so good why don’t they just keep it all for themselves.
Remember that a key element of stock fraud and any type of investment scam is that your interests are second to the broker or dealer that is operating on you.
When they see you coming into their sights, they can only see pound signs above your head.
Their financial gain comes well before yours !
