Friday, October 5, 2007

Fraud-Pump And Dump Schemes Are Still Around

Pump and dump schemes have cost investors hundreds of millions of dollars in the past few years. The World English Dictionary defines them as, involving unscrupulous stock market manipulation: describes a fraudulent scheme in which unscrupulous stockbrokers, analysts, or stockholders highly recommend their own stocks in order to drive up the price before selling for a quick profit (slang). Although the definition describes a textbook scheme, it does not describe how this fraud is operating in the investment market today.

An advanced communication system has made these schemes much easier to perpetrate. A fraudster can take a position in a stock, promote (hype) the stock and sell after the price has increased; then sell the stock short on the way down. Since he must know how the price of the stock will operate to be effective, he has to control the reasons investors will buy and sell the stock.

The fraudster will use a microcap stock. Most of these stocks trade on the Over The Counter-Bulletin Board market (OTC-BB). These thinly traded stocks help in taking an initial position at a low price, controlling the information about the stock, and attaining large increases in the stocks price on small demand. The textbook approach was for the fraudster, often the broker, to tell other investors about the stock to create demand and increase the price. The fraudster will then sell (dump) his stock at a profit.

This scheme evolved by using boiler-room marketers, when the technology of telephone systems began to have automated dialing systems and inexpensive calling costs. This further evolved to the fax machine, which became popular and less expensive than the labor-intensive boiler-rooms. Once the internet became popular, it became the tool of choice for the fraudster. It is the most effective way to get information out to investors and often not disclose the fraudsters true identity.

One actual case went as follows. Fraudster one identified a small high-tech company, which needed capital to get its products to market. He had fraudster two, an investment banker he knew, approach the owner of the company about raising capital. The owner agreed and the investment banker suggested taking the company public by merging the company into a clean publicly-owned shell company, which was trading on the OTC-BB. Fraudster two arranged a $10 million investment from a third party into the now public company. An initial deposit of $800,000 was made into the company with the balance due upon closing. Fraudster one, two and several others, who knew about the fraud, took positions in the companys stock at very low prices.

Then the hype or pump started in earnest. The owner began reporting news of the new investment on the companys web site. The group of fraudsters, who had done this many times before, began posting information about the company in chat rooms and on web sites. They also purchased stock at increasing prices to encourage the run-up in price. The stock started at $ .10, but increased to over $10 within a few weeks.

It was now time for the dump or sale of the stock by the fraudsters. They not only began selling off their positions, but also sold the stock short, knowing it would continue to decline. After they sold their positions at a nice profit, fraudster two told the owner that the new investment had fallen through and this news hit the companys web site and chat rooms. The stock went into a free fall and bottomed below its original $ .10. Of course the fraudsters covered their short positions, making another tidy profit.

Did the owner know about the fraud? No, but he was encouraged to take part in the hype. He lost his investment and the company was bankrupt, having counted on the new investment. Of course the $10 million new investment was part of the fraud. How much did the group of fraudsters make on this fraud? No one knows for sure, but based on the volume and the price fluctuation, their profit is estimated in the millions.

The Securities and Exchange Commission has released these tips for avoiding stock scams on the internet: consider the source, find out where the stock trades, independently verify claims, research the opportunity, watch out for high-pressure pitches, and always be skeptical.

Mr. Cuthill's practice is limited to court-appointed positions in large fraud cases. His work has produced the return of millions of dollars of investors' funds. For more information about him go to