Seems like just the man to assist us, don't you think?: "Boiler-room brokerages survive, but today's crooks are Web-wise.
kiplinger.com.
Kiplinger's Magazine April 2000 | INVESTING | STOCK FRAUD
Stick 'Em Up!
By William Webb Jr.
Boiler-room brokerages survive, but today's crooks are Web-wise.
Upon entering the offices of La Jolla Capital, I noticed something odd, something troubling. My companion, an East
Coast native, missed it. What could you expect from a guy who had yet to own a car?
To his credit, he did notice the cluster of desks and phones, all crammed into an amazingly small space. And walking
down the center aisle toward the 20 square feet that housed the executive offices, he astutely pointed out the quirky
sales force -- the girl in the miniskirt and heavy wool sweater, the guy in the black leather chaps and the others
exhibiting various chunks of metal in places not designed to hold chunks of metal. But that wasn't it.
I introduced myself to the chief financial officer, who wore no shoes, no socks, and not much of anything else, either.
My companion saw that too, but that wasn't it. After enduring a brief tirade concerning overregulation and a longer
sermon on the advantages of auditing the big brokerages, we settled on a place to conduct an opening interview. The
CFO would be there shortly, preferably with shoes.
My companion plopped into a chair. "Notice anything?" I asked. He frowned. "Did you notice that the minute we
walked in, it got quiet? Twenty phones, no noise."
"What does it mean?" he asked.
"Fraud." That was it.
I spent nine years investigating fraud for the Securities and Exchange Commission, and I often felt like a traffic cop who
arrives at an accident scene and finds only skid marks and broken glass. Investigating fraud is a labor-intensive process
and we often lacked the resources and technology to keep abreast of it.
But times have changed. Witness the speedy arrest of Gary Hoke Jr., who attempted to manipulate PairGain
Technologies in April 1999, and of three Californians who manipulated NEI Webworld last November. Now it's up to
customers -- that means you -- to get up to speed.
The Securities Exchange Act of 1934 makes it unlawful for any person to lie to an investor or (by keeping his mouth
shut) not provide information an investor should know. That goes for anybody involved in a securities transaction -- the
broker, the issuer, the promoter and even the anonymous user on an Internet chat board.
Hard to catch and punish
Easiest to spot is the bad broker -- the unscrupulous cold-caller who could convince a cow that the slaughterhouse is a
time-share villa. Toluca Pacific Securities was a haven for such people. I examined the firm along with a couple of
sleepy folk from the California Department of Corporations as part of the penny-stock sweep of 1994.
Toluca's representative, Peter Blowitz, ushered us into a conference room to begin our work. We emerged a few hours
later to find the sales floor empty. "I sent the salespeople home to make their calls," he explained. "They felt nervous
with you here."
No kidding. Toluca -- cited in Business Week's "Mob on Wall Street" cover story in 1996 -- was, like La Jolla, one of
the firms investigators tried for years to nail. When Toluca failed to file required financial information with the National
Association of Securities Dealers, the NASD canceled its membership on March 28, 1997, putting Toluca out of
business.
La Jolla lasted two years longer, until the NASD canceled the membership of Pacific Cortez Securities -- La Jolla's
last-ditch attempt at a name change -- last August. By then the firm had racked up 17 state orders against it, a brief
expulsion from the industry by the NASD, a pending SEC investigation and 23 arbitration cases -- all of which were
public record. Prospective customers can request a broker's "rap sheet" from the NASD's registration-database
subsidiary, the Central Registration Depository.
Crooks seemed to be everywhere in the late 1980s and early '90s. Even my soon-to-be wife received a cold call from
an infamous brokerage named Blinder, Robinson & Co. She listened; the broker wheeled. At the end he asked her,
"Can I send you a confirmation of our call?"
Yeah, sure, she said. Two days later the confirmation came in the mail -- not of the telephone call but of a
10,000-share trade. She freaked. "$1,200! Help!" There was only one way I knew to get her out of this quickly. I
called the broker and said, "She's broke." A crook's worst nightmare is stealing from someone who can't pay. "I'll bust
the trade," the broker offered. Then, scarcely pausing, he asked, "Do you have any money?"
Boss with a mop
My first assignment at the SEC was to assist in the examination of Whitehall Investment Securities, in San Diego. At the
door we met the janitor, who introduced himself as Whitehall's owner.
A quick check of the firm's records revealed that he was the sole owner, although he was camouflage for the man who
really controlled Whitehall. The janitor inquired if we needed pencils or maybe paper. He disappeared into a room and
out popped an 8-year-old boy with an armload of supplies. We later found an account in the boy's name; Whitehall
used his account to deposit penny stocks that were later sold at inflated prices to customers.
Whitehall's offices were adjacent to a public relations firm that touted several of its favorite penny stocks. The building
also housed a research company that prepared Whitehall's glowing newsletters. In other words, the addresses listed for
the PR firm and analyst led us to the back and side doors of Whitehall. Whitehall's customers could have used the
Yellow Pages to learn the same thing.
Fraud comes to the Net
Whitehall, La Jolla and Toluca used cold calls as their weapon of choice, and most investors know not to buy stocks
based on a telephone call from a stranger. But lately the Internet has created a whole new venue for fraud, involving
people such as Arash Aziz-Golshani, Allen Derzakharian and Hootan Melamed, who fell from the ranks of investor to
the status of accused criminal.
The SEC has accused the three young men of collecting $364,000 in illegal profits by posting hundreds of bogus tips
on Internet message boards about NEI Webworld, a commercial printer. The three men allegedly started hyping NEI
on Friday evening, November 12, using fake e-mail accounts. By Monday, the stock opened at $8, from a Friday
close of 13 cents.
According to Erich Schwartz, the SEC's assistant director of enforcement, many investors reacted to the "news" and
entered orders over the weekend to buy shares on Monday at the market price. They paid up to $15 a share. Later
that day, the price fell back to 75 cents. All three of the accused sold their shares at $8 or more.
A Web page filled with flashy graphics, boastful press releases and links to legitimate Web sites can snow even a savvy
investor. For example, the NEI chat-room messages contained a hyperlink to a telecommunications company that was
supposed to be engaged in merger talks with NEI but wasn't. The link lent credence to the phony claim.
Speaking of lending credence, NEI was listed on Nasdaq's OTC Bulletin Board. OTCBB's Web site lists prices of
stocks on the board. Although the OTCBB was never intended to act as an actual real-time market, regulators found
that investors didn't make distinctions between it and Nasdaq. So the OTCBB recently told companies to make
current filings with the SEC, just like the big boys, before they post prices. Those that don't will be dropped.
That leaves the pink sheets, published by the National Quotation Bureau, as the last high-visibility location where a
no-name stock can post a price. The pinks used to be printed on slender pink paper and were filled with outdated,
inaccurate prices.
Now the NQB sells Web subscriptions, where you can find outdated, inaccurate prices online. The pink sheets' Web
availability may actually make things worse. Says Valerie Caproni, Pacific regional director of the SEC: "People can't
tell the difference between listed prices and OTCBB or NQB prices. If they see a price on the Internet, they think it's
real."
Deciphering Edgar
It all boils down to your doing a little homework, especially on tiny companies. You can use the same publicly available
sources used by regulators -- and crooks, too, for that matter. Go to the Edgar database and peruse an issuer's public
filings.
The goal is to discover how much of the stock has been issued via warrants, convertible debt, stock options or, worse,
a bridge loan that converts to stock. These "sweeteners" provide insiders with incentives to manipulate the stock.
A case study is Numex, an OTCBB stock I ran across early in 1998. At one time, Numex supposedly made a
massage device it intended to sell through infomercials. A review of Numex's 10KSB (the annual filing for a small
business) dated March 31, 1997, revealed 5,967,750 shares outstanding and $600,000 in loans to Numex from two
relatives of Jack Salzberg, then the chairman (and later CEO). The loans were convertible to stock at $1 a share.
Salzberg also lent the company $300,000 -- again, convertible to stock at $1. At the time the stock was trading at
about $1.
The September 30 filing showed that the number of shares outstanding had risen to 7,455,581. By December 31, the
number had climbed to 10,116,219, of which 1.2 million shares were created when Salzberg's relatives converted their
notes. The math doesn't add up.
A closer reading of the filing shows that Salzberg's relatives had exercised their conversion options at 50 cents, for a
total of 600,000 shares each, making each of them a 5.9% owner. SEC rules require that a Form 13D be filed by any
stockholder who owns more than 5% of a stock. No such forms were filed.
Then on February 4, 1998, Numex announced it would acquire Modular Structures International, a maker of prefab
office units and classrooms. Numex's stock had hit a high of $3.75 on January 20, two weeks before the merger
announcement. Volume picked up as others reacted to the news, and Numex remained above $3 until March 2.
Shortly thereafter Numex declared that merger talks had stalled because of a lack of financing. In the interim, the
insiders sold their shares, earning a handsome profit. Remember this: If the number of shares outstanding rises as the
price rises and insiders sell, chances are somebody is omitting a material fact or two.
Numex recently merged with Jeffrey A. Stern & Associates, a media company. It also filed an SB-2, which is required
when a small business wants to offer more stock. The SB-2 lists a complicated ownership structure of convertible
preferred stock and at least 40 selling shareholders, including ex-CEO Salzberg and replacement Jeffrey Stern.
Altogether, 5,146,290 shares are on the block at $1.25 a share. And the SB-2 reveals that Numex converted some
debt into stock. Is this history repeating itself?
Reporter -- Courtney McGrath
Former SEC branch chief William D. Webb Jr. is now chief compliance officer for a brokerage firm." |
