Feds Take a Bite Out of Fraud

By Richard McCaffery (TMF Gibson)
July 18, 2000

Stock scams aren't anything new, but the Internet has breathed new life into an old act.

On June 14, prosecutors in U.S. District Court charged 120 people -- some associated with high-profile organized crime families -- with various forms of securities fraud. Never before had so many been arrested at one time for securities fraud-related charges.

The defendants allegedly bribed, manipulated, and threatened brokers into defrauding investors out of more than $50 million over the last five years. In some cases, plain-vanilla companies were given the dot-com label as a way to beguile investors.

The recent Mafiosi case reads like a Hollywood script. More often than not, however, investors get pitched fraudulent investments in the safety of their own homes. The Internet has made this more possible than ever. With more than 200 million people surfing the Internet, it's never been easier for con artists to target investors with bogus offerings, Ponzi and pyramid schemes.

Don't let the pressure of finding the next Cisco Systems (Nasdaq: CSCO) lead you to dump money into penny stocks, roughly defined as companies trading for less than $5 per share. Sure, there are great turnaround stories -- companies like Chrysler that went from bankruptcy to minivan heaven -- but there are many more examples of stocks that hit $5 per share for good reasons and then sank like the kitchen sink. Better to let them hit bottom without you tied to the faucet.

Penny stocks or microcap stocks reportedly bilk investors out of about $2 billion per year. How does it happen? Remember, any company that has more than 500 shareholders and $10 million in assets is required to file annual and quarterly reports with the SEC. Thousands of publicly traded company don't meet that criteria, which means investors in many of these companies are flying blind.

There are roughly 6,400 companies on the Over the Counter Bulletin Board (OTCBB), an index of electronically traded stocks that don't meet the Nasdaq's minimum listing requirements. Many of these companies are there for a good reason and the Fool argues strenuously against considering an investment in any company that doesn't trade on a major exchange for at least $5 per share, and file regular financial statements with the SEC.

Law enforcement officials and regulatory agencies are tightening the noose. Both the SEC and the National Association of Securities Dealers are taking steps to require all OTCBB companies to file reports with the SEC beginning this summer.

It's a start, but lawmakers will never be able to fully prevent fraud. That's up to investors.

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