A microcap is a publicly traded company whose stock might be worth only pennies, which causes its price to be volatile and thus easier for fraudsters to manipulate. Although CFEs like our Central Virginia Chapter members might not regularly come across microcap stock manipulation, it’s important for all of us to be aware of the methods and motivations behind this significant criminal activity. In this scheme, promoters and insiders, after cheaply purchasing a stock, typically pump up its value through embellished or entirely false news. However, as reported recently in the trade press, other fraudsters have successfully employed much more creative strategies in exploiting microcaps. Several articles and books have told of the involvement of organized crime, especially throughout the ’00s and ’10s, in this highly profitable illegal business.
Basic pump and dump schemes, also known as hype and dump manipulation, involve the touting of a company’s stock (typically micro-cap companies) through false or misleading statements to the marketplace. After pumping up the stock, scam artists make huge profits by selling or dumping their cheap stock onto the market. Today, pump and dump schemes have been updated and most frequently occur over the Internet, where it is common to see e-mail and other messages posted that urge consumers to buy a stock quickly or to sell their stocks before the price goes down. In some cases, a spam-call telemarketer contacts potential investors using the same sort of pitch. Often the promoters claim to have inside information about an impending development, or to have employed an infallible combination of economic and stock market data to pick stocks. In reality, they may be company insiders or paid promoters who stand to gain by selling their shares after the stock price is pumped up by the buying frenzy they create. Once these fraudulent promoters dump their shares and stop hyping the stock, the price typically falls and investors lose their money.
In another recent but simple form of the micro-cap scheme, a caller leaves a message on a potential victim’s voice mail under the guise of someone who dialed the wrong number. Sounding as if they didn’t realize they had misdialed, the message contains a hot investment tip for a friend. However, the caller is actually a spammer, someone being paid to tout this stock on hundreds of cell phones. Those behind the scheme generally own some of the stock and hope to profit by pumping up the share price and selling off their investments.
Pump-and-dump schemes can be as relatively simple as the one above, or such as an individual or small group releasing false information in a chat room or insiders publishing inflated company information. Sometimes the business owners themselves are complicit, especially with shell corporations that have little actual operations or value. Occasionally, scammers dupe business owners into participating in schemes through promises of investment support and/or related marketing help. Or fraudsters, unbeknownst to the victim company, hijack their target company’s stock and falsely hype it, which often causes irreparable damage to the owners’ and to their business’ reputations. CFEs whose clients include small or new venture businesses should be especially cautious of unsolicited offers made to their clients to receive loans or to raise capital through microcap stock offerings. Criminals commonly target businesses in the pharmaceutical, energy or technology sectors, attempting to use their names and initial offerings to manipulate stock for profit.
More complex microcap stock manipulation schemes involving organized crime typically employ a number of persons who are instructed to buy in at various points that coincide with a series of false press releases and concurrent investor forum-controlled chat and spam emails. This orchestrated activity provides the illusion of stock movement resulting from large investor interest thus drawing in the required funds of outsider victims. The actual manipulation often resembles a series of smaller pumps and dumps instead of one large event. So the fraudsters can use the same stock over and over with less chance of detection by regulatory authorities. More refined players also employ foreign or off-shore brokerage accounts as a further veil over their illegal activities.
When the organized manipulation plan succeeds, the ringleaders will permit the accomplices to sell and obtain their related profit depending on their hierarchy in the organization. However, the end process is often far from perfect. Occasionally, accomplices don’t follow instructions, at their significant personal risk, and sell too early or late. Even if the manipulation isn’t always successful, organized crime members who have invested in the process expect and demand a certain profit, which places additional pressure on participants who might find they have debt on their hands because of their failures.
Occasionally, outsiders also take large positions either profiting from or destroying the momentum of the criminal group. In the 1990s, when trades were completed through actual brokers, criminals could use threats or actual violence to control such unwanted participants. However, technological trading platforms have made this more difficult.
A less common, yet also profitable, technique is to put downward pressure on a stock (or cause the price to decrease) after buying the equity on loan through a contract, or option, with the hopes of buying the stock or settling the contract once the stock has dropped in price. Fraudsters can initiate this manipulation technique, commonly known as ‘short and distort,’ by promoting rumors such as a bad quarter or failed new drug test.
The ability to manipulate microcap stocks with relative ease also makes the activity an ideal tool to hide payments between parties and launder money. Instead of paying cash or wiring funds to settle a drug debt, one can simply provide a tip relating to a microcap stock that’s about to be manipulated. The party who’s owed the debt then only has to buy the stock cheaply and await for the pump to make the sale and generate the profit.
Perpetrators also have used the same process to offer bribes to public servants. Troublesome envelopes or bags of cash aren’t required. The profit appears as a simple lucky or astute stock pick, and culprits can even report them as capital gains thus removing the risk of highly feared and powerful tax investigators becoming involved in a possible money-laundering investigation. Police and securities regulatory authorities have observed and reported such suspicious activity. However, it’s often difficult to link those who profit from the manipulation with the culpable manipulators. Also, considering that organized crime elements employ microcap manipulation for debt payments and as profitable crimes, it’s again challenging for authorities to identify the exact goals of their participation without some inside knowledge. Proving all the elements of the crime is nearly impossible without wire taps or a co-conspirator witness.
With all this said, it’s ironic, yet not surprising, that more than one organized-crime figure has said they don’t invest their own criminal earnings in microcap stocks because they deem such markets to be too risky and plagued by manipulators.
So, in summary, if you, as a CFE, come across information relating to a microcap investment involving a case you’re working, you might want to take a closer look.
With regard to preventing investment fraud schemes in general … caution your clients:
• to not invest in anything based upon appearances. Just because an individual or company has a flashy website doesn’t mean it is legitimate. Websites can be created in a matter of hours and taken down even faster. After a short period of taking money, a site can vanish without a trace.
• to not invest in anything about which they are not absolutely sure. Do homework on an investment to ensure it is legitimate.
• to thoroughly investigate the offering individual or company to ensure legitimacy.
• to check out other websites regarding this person or company.
• to be cautious when responding to special investment offers (especially through unsolicited e-mail) by fast talking telemarketers. Know with whom you are dealing!
• to inquire about all the terms and conditions involved with the investors and the investment.
• Rule of thumb: If it sounds too good to be true, it probably is.