Fraud in the Securities Area

By Michael A. Collora
Send Email to: mcollora@dwyercollora.com

  This article first appeared in the Boston Business Journal, January 15, 1999.

  It is frequent that businessmen will receive cold calls from brokerage salesmen. Their methods of getting through vary– early a.m. calls at the office, later p.m. calls at home, or using a second person on the line to serve as a introducer. Occasionally you will listen. The point of this article is to alert you to a pattern which can result in a substantial loss if you are not careful.

Recent cases brought by the State Securities Division against brokerage houses such as Hibbard Brown & Co., H.J. Meyers, and Duke & Co. (all now in bankruptcy) highlight the potential problem. There are numerous poorly capitalized brokerage firms cold calling prospects. Some, such as H.J. Myers, had a branch in Boston, others often have only a small office in New York or Miami. The salesman is typically young, barely qualified and working in a brokerage firm selling primarily stocks it owns or has brought to market. Often the initial call is low key, with the goal to instill some confidence. On this first call, the salesman will try to qualify the prospect by finding out if he or she is in the market, is "liquid" (that is, has $10-20,000 to spend) and would be interested in a later recommendation.

The second call is more forceful. The stock salesman will try to close a deal, often by suggesting a legitimate stock which he claims his research department supports. It may be one that the prospect will know and it could well be a legitimate purchase.

However, that purchase is only the opening salvo. The later calls become more frequent and often have an urgent tone to them. The stock this time will be issued by a little known company, selling around $5 and often in a high tech field. The salesman will be getting a higher commission– often two or three times the standard rate. He has a script drafted to overcome your objections. Unknown to you, the brokerage house likely owns this security, obtained at a considerable discount to the then market price. It may have obtained these securities due to sponsoring the initial public offering, or have gotten them illegally through deals with the principals of the stock company. (See NASD complaint against Maidstone, a defunct New York brokerage house with Massachusetts victims).

The salesman may claim the brokerage house is registered with the National Association of Securities Dealers and your about to be opened account is insured by SIPC. This should be of little comfort. It is relatively easy to start a brokerage house and the capital requirements are minimum. A larger brokerage house may clear the trades with the exchange and actually hold your securities, but will claim they owe no duty to you. SIPC, a federal insurance corporation, insures against theft or embezzlement of your securities, not against market losses.

In their haste to unload the stock, due diligence is generally ignored. Little financial information about the company will be given and that will only be favorable. The salesman will urge the prospect to act now and put all his cash into this one stock. He may claim to have inside information as to a major transaction by the issuer. While normally a NASDEQ traded stock, the issuer's stock is usually thinly traded, the company has little or no operating income, and a short trading history.

If you buy the stock, the calls may stop if you are not likely to buy more. Then, try to sell the stock. Unless you are buying another proprietary stock of that brokerage firm, the salesman will ignore your calls. He might even be penalized if he takes and executes your sales order rather than receive a commission on the sale. Often another person such as a manager will come on the line and urge you to hold the stock even if it has dropped in value. This is because any sale might further depress the stock price, causing the brokerage house difficulty in keeping up the price. This was allegedly the scheme with Duke & Company, a New York brokerage house, now defunct which was barred from further business in the Commonwealth.

Since not every cold call is fraudulent, you should at least deal with a company here in Massachusetts. Meet the salesman in his office. Check out the company and the salesman nationally (NASD 800-289-9999) or locally (the State Securities Division at (800-269-5428). Information on the brokers can be obtained on line through the NASD-R Public Disclosure Program (www.nasdr.com). Information about the security being offered can be obtained on the Internet, or from the SEC (annual reports called 10ks are available on line through www.sec.gov or by calling 1-800-SEC-0330). Above all, do not buy without hesitating and doing some due diligence of your own. Follow the stock price for a few days and get a sense of the volume and volatility. There is rarely a need for haste, despite what the salesman says.