ANATOMY OF A SWINDLE
PART ONE:
NEW YORK (AP) – The charges include racketeering, extortion and solicitation of murder. Not too surprising for an indictment against reputed mobsters. But this case centers on Wall Street and is being called the largest crackdown on securities fraud in U.S. history.
Besides organized crime, the indictments released accuse stock promoters, a retired policeman and executives of Internet start-ups of strong-arming brokers and manipulating penny stocks to gain more than $50 million in illegal profits.
This past month we saw an episode of the “Sopranos” come to life in the heart of our financial district. We at Markowski Investments commend law enforcement efforts in foiling conspiracy’s that bilk investors out of money. Such firms and their actions make our jobs that much more difficult. However, a much greater swindle has been taking place in our markets for the past couple of years that has amounted to investor losses of one trillion dollars.
Since the Nasdaq Composite’s peak on March 10, Internet stocks have lost 50% of their value, now worth about $693 billion, down from 1.4 trillion, according to Pegasus Research International. According to statistical-informational firm CommScan, 14 separate initial public or secondary offerings valued at 1.3 billion have been withdrawn or postponed since March.
Investors who bought into many of these companies failed to realize that the dot com companies with little exception are cash-flow negative. This translates into “They spend more than they make.” This includes dot com heavy weights such as Amazon and DoubleClick. Amazon.com, the premier brand name in e-retail, has taken quite a plunge this past month dropping more than 20% on June 23.
NOT ROCKET SCIENCE
AMAZON.COM has 1.08 Billion dollars in cash.
It burns through $115.7 million a month.
At the current rate: Amazon will run out of funds in nine months.
According to a research report by Morgan Stanley Dean Witter, the firm estimates that within the next year or so, 70 percent of Internet IPOs will trade below their issue price and only 30 percent above the issue price.
Internet traffic doubles every 100 days. One third of the public goes online for news at least once a week, compared to a fifth two years ago. Fifteen percent get daily reports from the Internet, almost three times the number two years ago. According to the Industry Standard, The average annual earnings growth for the Internet over the next five years is expected to be 51.8 percent. These facts are tempting for investors looking to get involved in such a growing market. However, there is a point to where it gets ridiculous. In 1999 there were 548 initial public offerings. Many of these companies had no business going public at all. Due diligence and business plans were not nearly as important as getting Nasdaq symbols.
PART TWO:
A “boiler room operation” is a brokerage firm that uses a small of army of brokers to get individuals to invest in companies with little to no value. By getting a wide array of investors, the brokerage firm can manipulate the price of the stock and make it go up. Then the insiders in the company dump their stock on the public at large causing the price of the stock to fall. This is effectively called “the pump and dump.” The North American Securities Administrators Association estimates that unwary investors lose billions a year to investment fraud promoted over the telephone. Self-employment scams and high-tech schemes are among investments most recently heavily promoted by phone.
Manhattan U.S. Attorney Mary Jo White stated after the recent arrests, “The greed and reach of this racketeering enterprise knew no bounds. No kind of market professional or kind of offering or company or type of victim was excluded.”
The thing that struck home about this case is just the utter shock over the losses of $50 million dollars. Did the District Attorney realize that over the past few months close to a trillion dollars was lost in the Internet sector? At the same time did she watch the trading profits and investment banking revenues of the major brokerage firms skyrocket?
We at Markowski Investments feel and have felt that the individual investor has been railroaded and fed with false and misleading information by the media and by the sources of investment research, the wirehouses themselves.
We also feel that the major investment houses have had a lot to do with the extent of losses. Major brokerage firms make the bulk of their money in investment banking and proprietary trading. They made a small fortune taking all those startups public. Not only did they receive their standard banking fees but being able to have all your “insider” clients sell the stock the same day to the masses at 200-500% premiums.
The North American Securities Administrators Association gives advice on how to avoid boiler room scams. These examples we will expand on.
High-pressure sales tactics
Salesmen may make repeated calls and even become abusive, questioning, for example, the intelligence of anyone who would pass up such a “sure thing.”
**The major investment firms are much too sophisticated to cold call your home eating dinner. They use an assortment of fancy advertising usually fronted by the startup to spark your interest. “Look honey, XYZ.com is going public; I see their advertisements on TV all the time. Lets buy some.” The news media adds fuel to the fire in this cycle with the constant coverage of IPOs and no diligence on the actual substance of the company itself.
Outrageous promises of extraordinarily high profit at little or no risk.
The rule is: The higher the return, the higher the risk. Listen for salesmen who claim it is possible to make extremely high (15, 20 or 30 percent) or even “guaranteed” profits without any risk of loss. Most legitimate firms will provide written materials clearly disclosing the potential for loss in an investment, as well as its short- and long-term tax implications.
**This needs no explanation.
A reluctance to provide information about the sales firm or the investment.
If a boiler room is uncovered, it may be subject to state or federal action. Therefore, some phone scam operators are not forthcoming when asked information about the sales operation and investment.
**Most of these dot com start-ups had little to no information about them because that is all they were, startups. They had no business trading public.
Mumbo-jumbo about “inside information” or “secret” technology.
In order to close a sale, the voice on the other end of the phone may tell you that this is a “sure thing.” A common claim is that celebrities, major corporations or banks will be investing shortly. Alternatively, the salesman may claim that a new geological report is coming out shortly. In other cases, the claim may be that the company is using some sort of hush-hush “black box” technology that makes it possible to process gold at a fraction of the cost paid by other firms.
**Many dot com startups used the power of the Press Release to add fuel to the fire. These press releases got them interviews on major networks. Because of SEC guidelines, they are not allowed to discuss specifics about the company until 30 days after the offering. This made many interviews misleading. FOR EXAMPLE:
INTERVIEWER: Tell us about your proprietary technology?
CEO: I cannot discuss specifics right now because we are in our quiet period. I will just say that we are VERY excited.
Then, more often then not their technology was obsolete 30 days later.
The wool was pulled over America’s eyes. Unfortunately, America has no one to blame but themselves. The major brokerage firms calculated and pushed the greed buttons of the public at large in perfect sequence. We had commercials on television with tow truck drivers owning their own country and kids with their own helicopter. The market should be treated as a business that will grow and prosper over time. Trading in and out of securities trying to quadruple your money over night is exercise in futility. Go to Vegas if you wish to do this. I hear the drinks are free.
NUMBERS DO NOT LIE!
An MSNBC study just released sums up the fact that investing in dot com startups was a disaster for the individual investor.
The 170 IPOs brought to market since 1996 by Wall Street’s eight largest and best-known equity underwriters reveals that the stocks of the dot com sector have turned out to be a gold mine for institutional investors but an albatross for individual investors.
The IPOs of the dot com mania are currently trading for roughly a 68% premium to the offering prices that institutional clients paid in the pre-market.
YET THESE SAME IPOS ARE SELLING AT A 23% DISCOUNT FROM THE PRICES AVAILABLE TO RETAIL INVESTORS.
BOTTOM LINE:
Institutions and large brokerage firms have realized a tremendous return. Individual investors have lost more than 20 cents on the dollar.
The manic dot com boom created by the media and the major brokerage firms created such a demand in the aftermarket that the institutions could bail out of these high risk investments for huge premiums on the first day.
This cycle allowed the major brokerage firms to bring shoddy merchandise to the public marketplace. Individual investors did not seem to mind continuing to pay extraordinary premiums for garbage offerings.
Christopher Byron of MSNBC puts it so eloquently when he states…
“In the end, the retail investors became the dot-com bubble’s GREATER FOOLS, standing with outstretched arms to eagerly buy what the smart money was so willing to sell.”
The question that hangs over our heads at Markowski Investments like a cartoon bubble is:
“What is the real difference between what the mafia was doing and what the major brokerage firms were doing?”
ANSWER:
THE MAJOR BROKERAGE FIRMS MADE MORE THAN 50 MILLION DOLLARS.
