Posted by Latha Do NADARAJAN , Year 3 undergrad at the School of Accountancy, Singapore Management University
Bernard L. Madoff’s escapade has made you suitably wary of Ponzi schemes. Now here’s another investment scam, equally venerable, that you should be sensitive to. It is called pump-and-dump. It involves the building of feverish excitement around a tiny company in such a way that insiders can unload worthless shares on suckers.
The Securities & Exchange Commission has brought a number of cases recently against what it considers pump-and-dump artists. Unfortunately, there are slim prospects of meaningful restitution for aggrieved investors. As Bernie’s victims can tell you, assuming that securities cops will nab the bad guys in a timely fashion is a ticket to the poorhouse.
The good news is that pump-and-dumps, like many frauds, throw off plenty of recognizable warning signs. The (as yet unproved) case of My Vintage Baby is a good example of what to watch out for.
In Pictures: 10 Ways To Spot A Pump-And-Dump Scam
In three civil suits dating back to 2008 and still pending, the SEC alleges sharpies using pump-and-dump tactics hosed investors in the Dallas-area maker of high-end infant clothing. In a pattern that’s classic pump-and-dump, the promoters (so it is alleged) cheaply acquired a large position in My Vintage Baby’s stock in the summer of 2007. Then they began touting the company via e-mail and Internet stock sites and trading shares among themselves. Together these activities created what looked like a buoyant market to those who didn’t look too closely.
The share price went from 40 cents to $2.88. Along the way the pumpers dumped their stock for a $9 million profit.
Today My Vintage Baby is essentially worthless: A buck buys 5,000 shares. That’s too bad for those who bought on the rise and held on. One such victim, regulatory filings say, was someone in the United Airlines pilots’ self-directed retirement plan.
The SEC says that the My Vintage Baby scam was one of several orchestrated by Ryan M. Reynolds, Jason Wynn and Carlton Fleming. For this one, the feds say, the trio had help from Robert Feeback, a Plano, Tex. financial consultant who sat on My Vintage Baby’s board, and New York lawyer Stephen A. Czarnik, who signed letters saying things were fine.
Each man is a defendant in one of the SEC cases. None has acknowledged wrongdoing; to forbes they or their lawyer either denied culpability or didn’t comment. My Vintage Baby and its boss, Jessica Wiswall, aren’t named as defendants in the SEC suits; they are aiding authorities, according to their lawyer.
Inquiring investors would have had a hard time uncovering the well-disguised role of the promoters or their backgrounds. Reynolds, for example, is a former stockbroker who’s been banned from the industry and whose name did not appear in the early public documents of My Vintage Baby. Still, there were plenty of telltale signs that a pump-and-dump might be under way. Watch for these if you ever get excited about a fast-moving stock, especially one with a low share price.
Special Offer: Free Trial Issue of Forbes
Reverse Merger. There’s nothing inherently wrong with a reverse merger, which involves a formerly private company gaining access to the stock market by allowing itself to be acquired by a firm whose shares already trade. However, this variety of reorganization happens to be a common first step in penny stock scams. It allows insiders to take a venture public without filing the usual registration statement with candid disclosures about assets, liabilities, insiders and risks.
My Vintage Baby was private until May 2007, when the promoters arranged for it to merge into, take over and give its name to something called Comprehensive Medical Diagnostics Group. As little more than a publicly listed shell, Comprehensive Medical had shares capable of being quoted and traded, even though it had last reported financial results in 2001.
Pink Sheets. Shares of the newly public My Vintage Baby were listed in the Pink Sheets, a thinly regulated public marketplace that contains 9,300 companies with, for the most part, unimpressive balance sheets. Some of these companies are tiny but honest; some are larger but possess more hot air than assets. Most Pink Sheet outfits are too small or have too few shareholders to be required to file financial statements with the SEC, a group that includes My Vintage Baby. But SEC filings are no guarantee of anything; over the years plenty of pump-and-dumps have involved reporting companies.
Pink Sheet companies are usually marked on financial Web sites with a “PNK” or the like next to the ticker.
In Pictures: 10 Ways To Spot A Pump-And-Dump Scam
Sketchy Financials. Before it started trading publicly, My Vintage Baby filed three pages of unaudited, bare-bones financials with the Pink Sheets that contained results for 2007′s first quarter. The paucity of information was itself a red flag; the numbers were not reassuring. They showed a negative net worth and little cash. My Vintage Baby lost $173,000 on $429,000 in sales in the quarter. A potential investor should have asked why, in five weeks starting that June, the shares enjoyed a 600% run-up that endowed the firm with a $225 million market capitalization.
Horn-Blowing. Immediately upon going public, My Vintage Baby became the subject of promotions via mail, e-mail and Internet sites touting it as a “strong buy” that “could make a fortune” for early investors. The company issued press release after press release announcing new deals and products.
Lots of legitimate outfits have busy p.r. departments. What should make you suspicious is self-promotion out of alignment with discernible financial results.
Dubious Connections. Many of the early press releases listed as the contact for My Vintage Baby the phone number of Cervelle Group, an “investor relations” firm now in Winter Haven, Fla. Internet research would have shown that the shares of a number of other companies promoted by Cervelle had risen and then crashed. Among them: Superior Oil & Gas and Itronics , a fertilizer firm. Cervelle, which often was paid in shares of the outfits being flogged, did not respond to requests for comment. It is not a defendant in any of the SEC’s three My Vintage Baby cases.
Trading Surge. According to the SEC, My Vintage Baby’s promoters obtained 20 million of what became 77 million shares outstanding at prices ranging from a half-cent to 7 cents and traded among themselves and associates to create the appearance of investor interest. Share volume went from zero one day to 1.5 million the next in June 2007. Did no one among the marks find that odd? As the stated price climbed, volume topped 3.5 million shares on one day five weeks later, when, the feds say, the pump really turned into the dump.