Fraud in the Telemarketing of Investments

Fraud in the Telemarketing of Investments

"You’ve got to understand," said the voice on the other end of the telephone. "Typically, I don’t make these type of calls. I’ve got people to do that. I’ve got 11 years in this business and worked my way up to senior vice president with 400 clients and $40 million dollars under management. I don’t need this account, but I want it."

The caller was attempting to close a deal for an unknown micro-cap stock by trotting out some of his most impressive facts. But it was all a lie. In fact, he had been on the job for less than a month and was reading from a script supplied by his employer.

"Perhaps a return of 100 percent in 20 minutes sounds a bit unrealistic," the scam artist continued. "But that’s exactly how all our initial public offerings trade. We did three deals last year yielding collectively 34 points within the first ten days of trading. That’s a fact! All I ask for is your vote of confidence this one time. I won’t let you down."

Taken from an actual script seized by state securities examiners in February 1997 from a small brokerage firm, these words sum up the danger faced today by investors who purchase shares of stock in unknown companies over the phone from people they don’t know. Although the companies are all small, the dishonest way the stock is manipulated and sold has a large impact.

Unfortunately, far too many investors are falling for the lure of this latest trend in boiler room scams. And the telemarketers, playing upon people’s desire for ever-greater financial returns, have been running away with millions of dollars of hard-earned-money.

Among the victims: An elderly New York woman was convinced to buy $14,000 worth of high risk stock. Her broker proceeded to make unauthorized trades and left the firm as her account dwindled to nothing. The firm, and the broker, never returned her calls. A Connecticut senior citizen who was swindled out of $40,000 and suffered a stroke that his wife claims was directly tied to the loss. A Utah man in his forties who lost $11,000 through the payment of commissions after being promised that his transactions would be commission-free. A 78-year-old Missouri man who purchased $6,000 of stock, then was charged with $24,000 in six unauthorized trades, leaving him with $350.

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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, the Attorney General's Office 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.

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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.

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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.

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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
Investor Protection Bureau
28 Liberty Street, 15th Floor
New York, NY 10005
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.

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