Don't Get Suckered By The Latest Stock Scams As the market booms, so do stock frauds, which cost investors more than $6 billion a year. Here's how to avoid becoming the next victim.
(MONEY Magazine) – "I probably hear more ideas in the morning going down to have coffee than [your broker] hears in an entire week. By the time we go home here on Wall Street... I'm showing you 30% to 40% to 50% on your money... I want to see you own the stock... You take 300 shares now, on my timing and pricing... Matt, how do you typically title your accounts?"
The broker who delivered that cold-call telephone pitch last July tried to persuade an individual investor he'd never met to buy shares of a small software firm, based on a promise that the stock's price would triple within three months. Unfortunately for the broker, he hooked the wrong fish. At the other end of the line was J. Matthew Jenkins, a director of the Utah Division of Securities, who recorded the call, capturing what he describes as three classic elements of a stock scam: the lure of lofty returns, a claim of inside connections and a pressurized pitch to open an account on the spot.
Utah authorities have since filed administrative charges against the broker, Daniel Hernandez, now 21, alleging that, among other things, he gave an investor false and misleading information. But even if the charges against Hernandez stick, investigators say, he would likely face only a few thousand dollars in fines or a few months' suspension. Paul May, an attorney for Hernandez, declined to comment on the allegations except to say that he and Hernandez believe that they are close to resolving this matter with Utah authorities.
If you haven't already been targeted by a fast-talking salesman reading a script, chances are you will. As the bull market in stocks enters its seventh year, small investors have come to expect higher and higher returns, providing fresh opportunities for a growing swarm of deceitful brokers. State securities regulators contend that stock fraud has tripled since 1989 and currently costs investors at least $6 billion a year.
Now, say investigators, the Mob wants a piece of the action. In November, a federal grand jury in New York City indicted 19 men--including four alleged members of the Genovese and Bonanno crime families--on charges that they defrauded investors in seven states of millions of dollars. "It's an irony of history that the best markets bring out the worst elements," Securities and Exchange Commission chairman Arthur Levitt told the Senate Permanent Subcommittee on Investigations at a recent hearing on stock fraud.
After all, when blue chips like Coca-Cola have returned 35% annualized gains for the past three years, a broker's promise of a 50% return over a few months in a small stock doesn't seem so outlandish. The bull market has also swelled the ranks of brokers to 560,000, leaving a combined staff of fewer than 5,000 regulators at the National Association of Securities Dealers and the SEC hopelessly outmanned.
Regulators add that they are facing cagier crooks. For example, responding to rampant rip-offs in low-priced shares known as penny stocks, Congress passed legislation in 1990 requiring rigorous disclosure on stocks selling for less than $5 a share. Deceitful brokers have adapted by hawking equally problematic stocks priced at just over five bucks. Another recent ploy is the Name Drop. To put skeptical investors at ease, a slippery broker implies that his tiny, little-known shop is closely associated with a Wall Street powerhouse like Bear Stearns. In reality, the prestigious firm is typically acting only as a clearing agent--that is, executing trades and sending out account statements for the small brokerage. A Bear Stearns spokesman says the firm is working with regulators to resolve such problems.
Predatory brokerage firms often manage to avoid being drummed out of the business for years. For example, within a few years of its launch in 1987 on New York's Long Island, brokerage Stratton Oakmont began racking up dozens of investor complaints, ranging from misrepresenting securities to unauthorized trading in client accounts. But it wasn't until December 1996 that the NASD finally shuttered the firm, claiming that it "posed an ongoing risk to the investing public."
To help you protect yourself from scamsters, MONEY gathered advice from state securities regulators, attorneys general and officials at the SEC and NASD. What follows are four of the latest pitches that sleazy brokers are likely to spring on you--followed by advice on what you should do if you are targeted.
Ploy No. 1:
Promising an inside deal. At the heart of virtually every stock scam is a promise of huge, quick gains--often 50% to 100% over a period of a few days or weeks. If investors express skepticism, rogue brokers often claim--falsely--that they are privy to special deals or inside information or are able to grab stocks at below-market prices.
In 1994, Denver investor Carol Reed (pictured on page 120), 54, let PaineWebber broker David Ramsdale convince her to sink $50,000 into an investment that could supposedly provide a substantial profit within two or three days. Reed admits she didn't know exactly what Ramsdale wanted her to invest in. But, she says, "I trusted him because he worked at a major brokerage firm and was a friend of my sister's." Reed did not even get suspicious when Ramsdale told her to wire the $50,000 to his personal bank account. He claimed that to take advantage of this special opportunity, he had to invest the money with another brokerage.
Months passed, but the great returns never materialized. In addition, Ramsdale talked Reed into investing more of her money in a variety of tiny speculative firms. With her losses totaling $86,000, she hired an attorney to look into her investments. Reed soon discovered that Denver district attorney William Ritter was investigating Ramsdale for allegedly defrauding 10 investors of more than $436,000. In September, Ramsdale was sentenced to a suspended prison term and 12 years of probation; he is now serving a year in a work-release program. The NASD has also barred Ramsdale from the industry for life. A PaineWebber spokesman said that the brokerage dismissed Ramsdale in November 1994, after it learned that he had "violated company policy."
To protect yourself: Never invest with a broker who touts quick gains that are double or triple the returns of reputable stocks. Legitimate investments don't produce those kinds of profits. Be wary if a broker suggests buying investments outside your regular brokerage account. That tactic, known as "trading away," is almost always a tip-off that the broker is pushing a phony investment and doesn't want his firm to know. If your broker proposes such an arrangement, call the brokerage's compliance department. If that doesn't bring action, get in touch with your state securities regulator, whose number is available from the North American Securities Administrators Association (888-846-2722; www.nasaa.org) or from the NASD (800-289-9999; www.nasdr.com).
Ploy No. 2:
Bait and switch. When agents from a task force of securities regulators from four states raided five suspect brokerage firms in February 1997, they turned up more than 100 cold-call scripts that have since been obtained by MONEY. One insidious sales tactic that shows up again and again in these scripts is a version of the old bait and switch. Essentially, a dishonest broker persuades you to invest a relatively small amount, say $1,000, so he can prove how good he is. Within weeks, the stock he's peddled appears to climb to big gains. (In fact, in the case of a penny stock, the broker has usually driven the share price up by pushing it on other investors.)
Having won your confidence, the broker then calls back and tells you it's time to make some real money and pressures you to invest $10,000 or more. The second stock is usually one the broker bought for himself, sometimes for pennies a share, before pushing its price up by reeling in other investors. Once you invest at the inflated price, the broker will begin dumping his shares, driving the price down and leaving you with big losses.
To protect yourself: Don't go along when a broker asks you to start small and then asks for a much larger subsequent investment. To avoid stocks that brokers can manipulate easily, stick with issues that trade on the New York or American stock exchanges or the Nasdaq National Market.
Ploy No. 3:
Trading without your permission. Virtually all brokers are compensated by the commissions and other fees they generate when they trade securities for customers' accounts. That arrangement creates a powerful incentive for them to induce you to buy and sell stocks. In some cases, brokers go further and trade without informing you or even against your wishes.
Jim Surgent, 45, owner of a carpentry firm in Bothell, Wash., says he had been a customer at Investors Associates, a Great Neck, N.Y. brokerage firm, for just over a year when, in November 1996, a new broker who called himself R.J. Bingham took over his account. (Surgent subsequently learned that his broker's real name was Salvatore Clark.) One day that month, Surgent says, Clark began pressuring him to sell his 3,000 shares of Speedfam, a firm that makes chemical coatings for semiconductors, and buy 2,000 shares of a company that produces metal sculptures. Surgent claims that when he refused, Clark retorted, "If you're not going to make the trades, get [your account] the hell out of here."
Surgent did just that. But within days he received a trade confirmation by mail showing that Clark had already sold his Speedfam shares and bought the sculpture firm the day before they spoke. Surgent reported his allegation of unauthorized trading to the Washington State Securities Division, the NASD and the SEC. Two months later, Investors Associates reversed the trades. That move allowed Surgent to reap the $28,875 his Speedfam shares had appreciated after the broker sold them. Clark has subsequently been accused by another client of making trades without getting permission. The investor in that case has filed an arbitration claim with the NASD against Clark. Investors Associates was shut down by the NASD this past summer for failure to pay fines on regulatory violations. MONEY was unable to reach Clark for comment.
To protect yourself: Before doing business with a broker, especially with a little-known firm, check his and his firm's record with state regulators and the NASD. Had Surgent done that, he would have found a long record of investor complaints lodged against Investors Associates. If you feel a broker is unduly pressuring you, complain to the compliance officers at the brokerage as well as to regulators. If the brokerage doesn't act, or if you find that other clients have complained about similar tactics, move your account to another firm.
Ploy No. 4:
Promising safety but delivering risk. Dean Witter broker Michael Oberholzer called Leona Svogar, 70, in 1991, shortly after her husband died. Having no experience in financial matters, Svogar was looking for someone to help her manage her money in retirement. "All I wanted was a place to put my money that would allow me to take so much out a month and keep the rest of it growing steadily," she says. Svogar claims that Oberholzer agreed to help her do that, and she eventually invested over $300,000 with him.
But Oberholzer immediately began investing Svogar's stash in small companies, including a Canadian telecommunications firm. Even as that telecom stock began to slide, Oberholzer continued to buy and sell more shares over a 15-month period, generating $49,000 in losses for Svogar. "I was getting concerned, but he always told me not to worry--that he'd take care of it," Svogar says. After racking up $211,000 in losses in the Canadian telecom company and other stocks, in September 1995 Svogar filed a complaint with the NASD, alleging, among other things, misrepresentation and negligence on Oberholzer's part. That same month, Dean Witter fired Oberholzer. In January 1997, Dean Witter paid Svogar $200,000 to settle the matter. A Dean Witter spokesman declined to comment on Oberholzer's firing or the Svogar case. In September 1997, Oberholzer settled SEC charges contending that he had defrauded four elderly clients of $320,000 over a six-year period. Oberholzer neither admitted nor denied guilt but agreed to be banned from the securities industry for life. Oberholzer's lawyer, David Greenberg, says: "It was an unfortunate combination of customers not paying enough attention to their investments and a broker who should have known better but didn't."
To protect yourself: To assure that you and your broker agree on how your money should be invested, prepare written investing goals together, including examples of holdings that are--and are not--appropriate. If your broker then takes risks that make you uncomfortable, switch your account immediately. Accepting excuses and waiting can be the biggest risk of all.