Scam 101

This information was taken from the now sadly defunct IC Forum. I don't know who wrote the piece, but I thank them none the less.

This section refers only to schemes used by unlicensed brokers whose cases of securities fraud have been reported to SIRS:

The brokers are using an inherit flaw in the US Securities Exchange System (as well as other exchange systems) which allows market makers to quote a price based on free trading shares which is only guaranteed for a small amount of shares, not all the free trading shares. To make matters worse, the exchange system does not require companies to list what percentage of shares the stock price represents of all shares (restricted and free trading). This is one of the major factors contributing to the problem of stock price not reflecting ownership and worth of the company. The fact that the offshore share market is not regulated does not help the situation at all.

To pull off such schemes requires the coordination and willingness to engage in unethical behaviour for unjustified sums of money by professionals in the United States, Canada, and other market nations. These professionals plead ignorance of their client’s intent. Even if they are truly ignorant, they should have done some investigation and due diligence, which would have uncovered the scheme. The professionals are at least guilty of gross negligence, if not more, depending on their degree of involvement.

The professionals provide the services necessary to create the illusion of legitimate shares. Without their cooperation, none of these schemes would have worked so well, if at all. Below is a list of the professionals typically used and legislation / procedures that need to be added to prevent abuse by these professionals in the United States (and in other countries exchanges to varying degrees).

Company Frontman – Entrepreneur whose business plan and credentials make or give the illusion of making the investment appealing.

Needed: Civil, criminal, and credit background checks should be required of all directors, key management, and investors (regardless of amount) once a company is issuing shares (public or private). Such checks should also be made on directors, key managers, and significant investors (exceeding $100,000) that come on board at any time after shares are outstanding.

Company Shell Provider – A broker who buys and sells old public company shells once they are no longer active.

Needed: The US Securities Laws need to be changed to require public companies to maintain a minimum level of revenue activity to maintain public status and sale of such public shells needs to be monitored and possibly regulated. This would eliminate the misuse of reverse mergers to bypass the necessary investigations to make sure that companies trading are viable and legitimate.

Certified Professional Accountant – Who provides the audited financials that are used by the securities lawyer in the public SEC filings.

Needed: Changes to the SEC filing procedures are required so that clear warning labels are put on public filings for companies that in the past 12 months have conducted reverse stock splits, issued more than 10% of existing stock, increased their total debt by 10%, and / or had decrease of 10% in equity. The fact that a company has warning labels then would need to be indicated with all securities listings in any form of media.

Securities Lawyer – Lawyers who register the company with the SEC to be traded on the market.

Needed: The US laws need to make lawyers criminally accountable for aiding clients who run such schemes. Ignorance is not a defense for the common person, there should be no exception for the legal profession.

Market Maker – Industry experts who “appraise” the company and its potential with respect to its given market to guarantee a value on a limited amount of stock.

Needed: Market Makers should be monitored and given a rating based on their prior “appraisal” accuracy. For every time they are correct, or at least very close to the mark, they should receive points. The more points, the more accurate and experienced the market maker. Their rating should be published alongside the price they quote.

Press Release Agency – The organizations the companies and promoters use to “hype” up the company.

Needed: The warning labeling mentioned above should be mandatory and accompany every press release. Any press release without the labeling should be open for both the company and press release agency to be legally liable.

Securities Transfer Agency – The Transfer Agency is responsible for the issuing of certificates, annual reports, and share holder meeting information.

Needed: The Transfer Agency should be held liable if it does not report a public company to the SEC for not providing required information in a timely manner to redistribute to the share holders.

Bank Manager – The bank managers who provide the accounts for the promoters and companies.

Needed: The banks are required to report any transfer of funds over USD 10000 to the government. The problem lies in the lack of content and background checking submitted in such information. In order to catch money laundering, additional information should be required from the bank manager to submit when reporting such transfers.

Once all the professionals are setup and in place, the brokerage firms can begin to cold call their victims. The lists are purchased from a variety of source such as telemarketing firms, other unlicensed brokerage firms, and even government databases from civil servants who feel violating a citizens right to privacy is worth up to $20 per name. The target victim market consists primarily of business owners. They are the ideal victims in that they usually have little time to investigate, have plenty of funds available to make such investments, listen for opportunity and willing to take calculated risks.

The unlicensed brokerage firms tend to operate in countries where police corruption and political bribery provide an ideal business environment for these organizations. They typically will rent out either a mailbox or even go as far as a serviced office-front in reputable countries such as the United Kingdom, Switzerland, Japan, and the United States. However, the main selling is done in countries such as the Philippines, Thailand, Indonesia, Spain, and Hong Kong. These are the locations where the victims usually need to send their funds, paperwork, etc… Even those brokerage firms who have victims send their funds to the United States are themselves not operating out of the United States for otherwise they would fall within jurisdiction of the US law authorities who could close down the operations and seize the assets as was portrayed in the Hollywood film, Boiler Room.

The roles of the personnel in unlicensed brokerage firms are as follows:

Receptionist – These are usually locals that are paid very well for their country, but the pay can be as little as $20 per day. These are the front door people to the unlicensed brokerage firm, there are no direct numbers to get a hold of the broker, and they are always either in a meeting, on the john, or on the market floor.

Opener – These are usually fresh recruits, some using their real names, but most told to use fake names. Very few openers are truly in the dark as to the operations. The fact that they are paid salary and commissions well above the industry average should be a red flag. Those that are in the dark, when they discover the truth are either scared into submission or are brought into the action and promoted to the position of loader. The opener is there to entice the victim, get their trust, and confirm their ability and likelihood to part with their hard-earned money.

Loader – The loader is to make the hard sell. These are people that have worked their way up from being an opener or have had previous securities sales experience in their own country but have either had their license revoked or are purely interested in the 10% commissions (5-10 times the industry average). The loaders are knee deep in the scam. They use fake names and clearly know what is going on in the operation.

Closer – The closer is there to make sure the victim sends the money. The victim almost never deals with the same closer twice. The unlicensed brokerage firms do not want the victim and the closer to build a close relationship which might arouse suspicion in the mind of the closer or the victim. The degree to which closers are aware of the scam varies.

Associate – Associates are the sergeants of the scam army. These individuals are waist deep in the scam and are called in to help the loaders with victims on the fence and large account victims. They typically have Vice President in their titles. They get a percentage of the commissions as well are part of the profit sharing.

General Manager – These individuals are the officers of the scam army. The General Manager usually operates anywhere from 1-3 brokerage firms for the principal benefactor. They usually have the title of President and are paid handsomely for their ability to run such professional appearing operations. General Managers are generally promoted from within the ranks of successful associates but occasionally ex-freelance con artists with previous scam experience are brought in.

Director – These individuals are lawyers, securities experts, accountants, and other professionals who are trusted confidants of the principal benefactor. They are either directors of the unlicensed brokerage firms and entrusted with the securities scam aspect or are directors of the companies being sold by the unlicensed brokers. Many of these individuals are willing to be directors because they are confident that no matter what, there is no way to hold them personally and legally accountable for their actions. If the scam is uncovered, they claim they are shareholder victims as well and seek a tax write-off for the “loss”.

Principal Benefactor – These are the generals of the scam army. These are the masterminds of the scam operations. Their names are never directly associated with any of the companies or brokerage firms involved. Instead, they have multiple companies own each other which coincidentally are all owned by the principal benefactor or by a relative. All the principal benefactors used to be general managers who have either struck out on their own or have “inherited” their operations from former principal benefactors who have gone into retirement. The principal benefactor can afford legions of lawyers using a large war chest of ill-gotten gains from tens of thousands of victims worldwide.

Promoter – These special individuals either “recruit” companies by posing as investors or just plain fabricate the companies. They coordinate and organize the professionals used in the United States, Canada, UK, and Australia to get the shares on the market and the illusion of market performance. An expert promoter can earn upwards of a million dollars for setting up companies which are able to bilk tens of millions of dollars out of thousands of “investors”.

The following is a list of schemes that are currently being offered to cold-called victims.

Pump ‘n Dump – This is the most prevalent scam currently on the market. However, with recent media exposure, this scheme is on the decline. The victims are offered to invest in a small amount of shares (usually worth USD 5000) to “test the waters.” The promoter tells the market maker to pump up the price and the broker calls again after the price has gone up to get the victim to buy more shares. This time they try to get them to buy at least ten times the previous amount (usually USD 50000). This cycle sometime repeats a couple of times and then comes the downturn. The downturn serves two purposes. The first is to create pressure on the victims to be willing to switch into other shares (and pay a bit more). The second is to lower the price far enough that the shares can be issued and not violate the dollar limit the restricted shares were allowed to be issued for when the securities lawyer submitted the filing on behalf of their less than ethical clients. With the price spiraling down from dollars per share down to cents per share, the broker calls up and apologizes for the poor performance and has “talked their manager” into allowing the victim to switch over to another stock that may or may not be trading. The victim will usually be swapped into the other shares at no loss to their original purchase price of the old shares but need to buy some additional shares in the new stock (usually worth USD 5000). The victim is usually willing to put in another USD 5000 rather than loose the whole investment. This results in more money from the victim and now the broker has an excuse and reason for the delay in issuing share certificates.

Switch and Bait – This is exactly the same operation as the Pump ‘n Dump scheme except that the shares being offered are in a company with an almost identical name to an actual viable and operating company. The victim is sent to the website of a legitimate private company which is attempting to go public for information. The principal benefactor of the unlicensed brokerage firm sometimes is an actual investor of the legitimate firm and takes the company information they receive, modify it slightly and use the altered information to sell shares in the company with the similar sounding name. The victim has bought worthless shares in bogus company.

Smoke and Mirrors – This is another variant of the Pump ‘n Dump scheme in that the company exists, the shares exist, everything seems on the up and up, however, the securities price is inflated well beyond its realizable value by a factor as much as fifty times the actual value. The unlicensed broker then usually resorts to issuing only shares to those who complain or are willing to wait until the share price is lowered far enough as to not violate the restricted securities covenants.

White Knight Swap – This is a follow up from one of the above mentioned scheme. A new brokerage firm has supposedly bought the victim’s account from the former unlicensed brokerage firm and will “save the day” by selling your existing shares non-performing shares for more then they are currently worth and put the funds into a trading account of their from which the victim can use the “credit” as a partial payment for other shares that they are now offering that are just about to go big on the market….deja vu?

Black Knight Swap – Similar to the White Knight Swap, except that the cold caller supposedly works for either a legal or tax accounting firm that has a client that needs a tax write-off and is willing to buy the worthless shares (sometimes for more money than originally paid) and sell blue-chip shares. There are two variants. With the first variant, the value of the blue-chip shares is more than the new value of the worthless shares. The victim must send the difference and will then receive the blue-chip shares. The second variant is that the values are identical, but that a 20% “security deposit” needs to be sent by the victim in order to ensure that the deal will be done. With either variant, the victim sends the money and receives nothing in return but a disconnected line.

Collection for Fee – This last scheme is starting to gain some momentum as the securities fraud problem gets more media exposure. There are lawyers and debt collectors stating that they can recover funds from the unlicensed brokerage firms but need the victim to send funds in advance or be willing to sign a legal contract for payment of daily consulting fees. Short of taking the law into their own hands, the odds of recovering funds directly from the unlicensed brokerage firm are probably less than winning the lottery. Getting groups together to go after the professionals that helped make these schemes possible is more likely to get money back from the insurance companies that cover the professionals for malpractice.

A Sample of the Smoke and Mirrors scheme:

The principal benefactor indirectly owns and controls the majority of the free trading shares and sells all of its Reg 144 or Reg S shares through the unlicensed brokerage to "its clients" at prices anywhere from 15 to 40 times the purchase price and then manipulate the share price on the market by getting market makers to boost (and lower) the price of the free trading shares as they see fit. Since the NASDAQ does not keep track of offshore sales transactions of Reg 144 and Reg S shares, the price of the securities listed on the exchange market only reflects the buying and selling of free trading shares, the restricted shares are not mentioned anywhere. So the only way for a novice investor to know that something is wrong is if they checked the trading share volume and notice that the price is irrelevant of their purchase of restricted shares and therefore would need to be able to calculate the following formula (and the company or NASDAQ would need to provide the information regarding the variables):

Real Share Worth = (NASDAQ listed share price) x (Number of Free trading shares covered by market maker) / (Total Number of Free trading shares + Total Number of Restricted shares)

For example (using Smoke & Mirrors Company, Inc)

Real Share Worth = ($4.25 x 5,000) / 15,000,000 = 1.4/10 of a cent

Now the price goes up to $8

Real Share Worth = ($8.00 x 5,000) / 15,000,000 = 2.7/10 of a cent

The unlicensed brokerage sells the restricted shares for $3.50 to John Doe. He buys 20,000 shares for $75,750 (1% for commission fees). He believes he has already made $9,250 from the purchase which he is told is made possible since the unlicensed brokerage was able to offer these discounted shares. The unlicensed brokerage bought the shares at $0.25 per share from Smoke & Mirrors Company. The unlicensed brokerage has made a Net Revenue from the transaction of $70,750. All the while, the real value of John Doe's investment is $280.

The price is moved up to $8.00 per share by the market maker two months later, and John Doe is again contacted by his friends at the unlicensed brokerage. He believes his shares are now worth $160,000 and his net worth has increased by $84,250 in just two months!!! That is a Return on Investment (ROI) of almost 800%. With that kind of return, he is very amiable to the suggestion to invest in another 10,000 shares at $7.50 and sends another $75,750 to the accounts of Non- Jurisdiction Bank that the unlicensed brokerage has instructed the funds be transferred to. John Doe believes he has just made another $4,250 instantaneously.

In total here are the figures to demonstrate the severity of the problem.

Perceived value of shares owned by John Doe: $240,000

Actual value of shares owned by John Doe: $ 550

Money Transferred by John Doe to Non-Jurisdiction Bank: $151,500

Net Revenue for The Unlicensed brokerage from deal: $144,000

Perceived amount invested in Smoke & Mirrors Company: $150,000

Actual amount invested in Smoke & Mirrors Company: $ 7,500

None of this manipulation of figures would be possible if the securities exchange market accepted reforms proposed back in 1991 when the problem was first brought to light. A complete overhaul of the securities exchange system needs to occur immediately before the lack of consumer confidence in the securities exchange system reach critical levels and bring the exchanges to a grinding halt. The impact on the global economy would make the Great Depression seem like a dress rehearsal. The current system of raising public funds is so cumbersome, inefficient, that the very nature of the current system attracts criminal elements. The current financial indicators have little bearing on actual company performance. The indicators were developed centuries ago when demand outstripped supply and the financial reports on tangible assets reflected 90% of the company’s value. Today, most companies have less than 5% tangible assets and accountants have developed so many creative accounting practices that indicators, financials, and market value bear almost no resemblance to actual company performance or future potential earnings. It is quite ironic, the company that was going to show the real value of companies to replace today’s flawed and archaic system was itself a victim of this securities fraud scam. The Emperor has no clothes, but everyone better say that he is wearing the most beautiful outfit in the world or else everyone will see the naked truth.