INVE$TOR BULLETIN
Volume II, No. 2
FRAUD IN THE TELEMARKETING OF INVESTMENTS
By Attorney General Dennis C. Vacco
NEW YORK AND 19 STATES TAKE ACTION
In response to a growing pattern of investor complaints against dozens of small, brokerage firms with
headquarters in the metropolitan New York area, the Board of Directors of the North American
Securities Administrators Association, Inc. (NASAA) authorized a special project in late fall 1996.
The mission of the special project was clear: To address the problem of fraudulent sales practices in
the micro-cap marketplace.
In January 1997, NASAA created a strike force comprised of representatives from 12 states,
including the New York Attorney General's Office. The strike force was divided into five teams,
each targeting the headquarters of a particular firm. In addition, branch offices in Connecticut,
Florida, Illinois, Massachusetts, and Indiana were also scheduled for coordinated audits.
In late February, the teams struck without warning. As a result of this sweep, as well as the on-going
investigation by the Attorney General's Office, on May 29, 1997, the Attorney General and 19 other
states took action. As part of the biggest nationwide crackdown ever by state securities regulators
against telemarketers that sell small-cap stocks to investors over the phone, New York Attorney
General Vacco filed enforcement actions against two firms, Investors Associates and First United
Equities Corp., and 9 individuals. In total, 20 states filed over 30 enforcement actions.
The February examinations of the firms also revealed four systematic abuses, including:
Evasion of broker-dealer registration requirements. Stockbrokers and the firms that employ them are
required to register in the state in which they do business. This requirement serves an important
purpose: To allow state securities officials to monitor the activities of the firms in order to insure
compliance with laws designed to protect investors. When a broker-dealer or its representative is
not registered, that's a sure sign that something is wrong. Most of the firms, however, were found to
be employing unregistered agents which is also a violation of National Association of Securities
Dealers (NASD) rules. Other requirements triggered by registration include keeping proper books
and records and supervision of employees. But, one firm, for example, kept no customer or trading
records at its principal office and claimed that its branches were franchises in order to evade state
securities laws.
Failure to report investor complaints. Most of the offices failed to have centralized procedures for
handling and reporting customer complaints. At several firms, complaints were found stuffed in
customer complaint files, inquiry files, correspondent files, and stock jacket files. One branch office
had reported only one complaint to the NASD since July 1, 1996, yet over 90 complaints were
recovered at their office. Another firm had no complaints on file with the NASD, but state officials
found over 300 complaints throughout the office.
The following pattern of abuse emerged:
After receiving a complaint of an unauthorized trade, the broker called the investor and convinced
that person to hold onto the trade. The investor was requested to fax a note that indicated the
unauthorized trade was accepted. If the investor later changed his or her mind, the broker claimed
otherwise. Records of unreported settlements were documented as "clerical errors" without any
back-up documentation.
Abusive cold calling practices. All of the firms and branches relied on high-pressure, scripted
telephone "cold calling" practices. Many were classic "boiler room" operations with long tables and
up to seven phone stations per table. At one firm, all the cold callers were on the first floor without
any supervision. They "qualified" clients by determining their market assets and interest in the stocks
that the firm was pushing. Average pay for cold callers is $200 per week.
Clients of several companies were able to recall and identify unregistered cold callers, but had no
recollection of speaking or trading with the licensed registered representative who allegedly signed
off on the accounts. At one office there was a score board listing stocks, customers, and other
production information. Nobody at the firm could explain its use or the information listed on the
board. A broker told an examiner that he made 250 calls on a good day; 70 on a bad day. All of his
calls had been previously "qualified" by an unregistered cold caller.
Sales practice abuses. Unauthorized trading was rampant at all of the firms. Firm and branch records
were falsified. Customer account forms were marked with the number of the registered rep whom
the clients insist they had never spoken to or traded with. Failure to execute sell orders (no
commission is paid on a sell order and there is no market until the next victim is found), unsuitable
recommendations, and other unethical practices were common customer complaints. At one firm, a
review of a thousand customer accounts showed that all of the clients had bought only one or two
stocks stocks that only that particular firm was selling to the public. At a time when the Dow Jones
Industrial Average was being driven by the S&P 500, these firms' clients were investing solely in
never heard of micro-cap companies.
A CHANGED MARKETPLACE
In the late-seventies and early 1980s, so-called "penny stock" frauds were rampant in Colorado and
Utah until state securities officials moved in and shut them down. Although the scams of today are
similar to the swindles of that earlier time, there are significant differences. The most obvious
difference is the marketplace itself.
Today, there are far more mid-income investors than ever. Products are more sophisticated and
choices have multiplied. Due to the growth of 401(k) plans and other self-directed retirement
programs and fears about the future of Social Security, people are encouraged to be more
"aggressive" in their investments. The marketers of the most legitimate firms down to bottom-dwelling
perpetrators of fraud are singing the same siren song: "You've got to be in the market or you're
going to be left behind." The message is everywhere. It's hard to pick up a magazine or watch
television or listen to the radio without hearing advertisements for mutual funds or other securities
products.
TO AVOID BECOMING A VICTIM...
1. Ask your state securities agency for help. When you are contacted by a broker or financial
advisor, particularly if you do not know this person or have not heard of the firm, you must call your
state securities agency in order to learn more about the caller and the firm. The simplest inquiry is to
ask if they are registered to do business in your state. But you should also ask about the record of
the firm and its representative. Are there any past disciplinary events? Are they subject to past
complaints? The majority of this information is available if you only ask.
2. Ask questions. Even if everything checks out with the state, don't rely on a company's glossy
brochure. You need to ask about the investments themselves. Where is the company traded? Is it
listed in the stock tables printed in your local newspaper so you can follow your investment?
Investigate its trading history. Make phone calls. Find out more about it. Ask the salesperson -
who is making a market in the stock? Who else is buying in your area? Is the salesperson's firm
making a market in this company? The reason you want to ask is that they might be the only market
maker. And they might be using cold calling techniques to create demand for a stock that insiders
will sell when the price is driven high enough.
3. Send copies of your complaints to regulators. When you have problems with a firm, you must
send a copy of your complaint to your state securities regulator as well as the NASD. Examiners in
the February sweep found hundreds of complaints that individual investors wrote to the firms that
were never passed on to regulators. If you call to inquire about a firm, and a previous customer's
complaint never made it into the system, you won't be protected. So never forget to send a copy of
your complaint to the regulators as well.
INVESTOR BULLETIN NEWSLETTERS
The Attorney General's Office publishes a quarterly Investor Bulletin Newsletter.
If you would like to receive previous copies or would like to be put on the subscription list, please
call, write to us at the address listed below or visit our website at www.oag.state.ny.us.
Dennis C. Vacco
N.Y.S. Attorney General
Department of Law
120 Broadway
New York, N.Y. 10271
For Help and Additional Information
It is highly advisable to check out a broker, brokerage firm or financial advisor before you make an
investment by writing to:
The New York Attorney General's Office
Bureau of Investor Protection and Securities
120 Broadway - 23rd Floor
New York, NY 10025,
or call (212) 416-8200
If you suspect that you have already been a victim of investment fraud, call or write to us as soon as
possible.
You can also call the North American Securities Administrators Association at (202) 737-0900. In
the U.S., NASAA is the national voice of the 50 state securities agencies responsible for investor
protection. |
