Stock Fraud Stampede Tramples the Unwary

Top securities watchdog Arthur Levitt likens this tale to a Hollywood movie script: A penny stock promoter in Nevada was arrested last week after trying to have an accountant pushed down a stairway to prevent his testimony in a stock fraud case.

The charge is unusual in the securities business. Rogue brokers often perpetrate financial mayhem, not physical violence. But it illustrates the degree to which stock fraud has accelerated in the shadow of Wall Street's success.

With stock prices up dramatically, securities crooks are cheating investors out of record amounts of money. Stock fraud this year has reached at least $6 billion, say officials, triple the peak of the 1980s.

"In a market like this, parasites crowd in to feast on the bull's success," Mr. Levitt, chairman of the United States Securities and Exchange Commission (SEC) told a congressional subcommittee Monday.

Fraud in low-priced stocks, especially so-called penny stocks, has soared. The cheap prices, less than $5 per share for penny stocks, make these securities easy targets for price manipulation.

"With more and more new investors in the market and the Internet becoming more available, it is easier to reach and tap that investor enthusiasm," notes Barry Goldsmith, head of enforcement in the self-policing arm of the National Association of Securities Dealers (NASD), the regulatory body of the brokerage industry.

The amount of fraud may sound large, but it forms a tiny part of the US securities business. The Nasdaq Stock Market alone trades about 600 million shares daily, some $17 billion worth, and accounts for just over half of all US securities trading in share volume.

But a flood of investor complaints has invited not only congressional attention but an array of remedial measures by regulators. These range from a new SEC pamphlet on how to handle fast-talking brokers to stepped-up investigations into fraud.

In May, regulators in 20 states began a crackdown against 14 brokerage firms accused of fraudulent sales practices. And the FBI has been working with securities regulators to investigate stocks of 19 small companies allegedly manipulated by organized crime.

"We have stepped up both our civil and criminal enforcement efforts - we are working with [law enforcement] authorities as never before to lock up bad brokers and deter wrongdoers," Levitt testified.

He said the agency also is looking to close loopholes in the rules governing the penny-stock market and is focusing more attention on unscrupulous brokerage firms, not just individual brokers.

New York attorney general Dennis Vacco talks of asking the New York state Assembly for a law to help track unethical brokers, who often jump from one boiler room operation to another.

The NASD already maintains a central registration depository, which incorporates a broker's disciplinary history into a permanent record. This information is available to investors through a telephone hot line (see story, below) and is scheduled to become available on the Internet early next year.

Another plan calls for tighter listing restrictions for stocks on the NASD's Bulletin Board, a favorite area for unscrupulous brokers, issuers, and promoters.

The Bulletin Board is not the NASD's Nasdaq Stock Market, which requires extensive financial disclosure from listed companies, such as Intel and Microsoft.

But it is part of the over-the-counter market, a vast amalgam of publicly traded firms loosely regulated by the NASD. Many of these companies report no information to the SEC, presenting a "virtual blank slate" to investors, Mr. Goldsmith says. And the available information may not conform to accepted auditing or reporting standards.

The Bulletin Board offers an electronic price quotation service for about 7,000 companies, and trading on it zoomed to $38 billion last year.

Scam artists often refer to an OTC stock as listed on the "Nasdaq's OTC" or "some other deliberately confusing variation that links the OTC stock to the reputable Nasdaq market," Goldsmith says.

Tougher listing standards for the Nasdaq market itself were approved last month by the SEC.

One proposed reform would limit Bulletin Board stock-price quotes to companies filing periodic financial reports with regulators.

Another proposed reform would prohibit broker dealers from recommending a trade in an OTC security unless they have first reviewed the company's current financial statements and reasonably believe that they are accurate.

Goldsmith also wants authority for the NASD to halt trading on the Bulletin Board under specific circumstances, tighter restraints on cold calling, and stepped-up surveillance of brokerage Web sites.

He predicts tougher regulation by year's end, but adds that securities regulators do not want to impede legitimate market activity by small firms.

To deal with rising fraud, the NASD has doubled the number of lawyers in its enforcement department to about 70 nationwide.

Last year, the NASD brought 1,200 disciplinary actions, up 12 percent from last year.

It can fine firms or individuals that break the rules or suspend or bar them from the industry. It can also refer criminal charges to local, state, or national authorities.

The SEC, the biggest stock market regulator, has a staff of 3,000, more than 900 directly engaged in preventing and suppressing fraud. Pending investigations rose from 1,264 in 1991 to 1,615 last year.

Anatomy of a Stock Fraud

ibbard Brown might seem at first like an ordinary brokerage firm, albeit one with aggressive sales pitches from brokers.

But, in at least one instance, it went over the line, generating $8.7 million in illicit profits in eight days.

Hibbard's brokers touted the stock of a company called Site-Based Media. Problem: It was a shell company whose shares were all but worthless. To boot, brokers used scripted sales pitches, guaranteed against loss, pressured investors to buy, and even made unauthorized trades, according to the the National Association of Securities Dealers.

The NASD, working with the New Jersey Bureau of Securities, investigated the case and continues to prosecute brokers involved.

Hibbard was expelled from the NASD, ordered to return the $8.7 million to investors, and owner Richard Brown and the firm's head trader were barred and fined.

The case illustrates the elements of a classic "boiler room" operation, where brokers spend virtually all day making cold calls to potential investors and can be fired if they depart from rosy-scenario scripts.

"If it sounds too good to be true, it probably is," advises the NASD's Barry Goldsmith. "Check it out first. We have seen too many examples where people are victimized."

Some ways to counter fraud:

The NASD, which regulates all brokers, has a hot line that will provide detail on a broker's regulatory history: 800-289-9999.

Investors can get a new pamphlet, "Cold-Calling Alert," from the Securities and Exchange Commission by dialing 800-SEC-0330.