More On Legal & Compliancefrom The Advisor's Professional Library
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
On Friday I laid out a schematic explanation of how to operate a pump and dump scam, because that seemed like news some people could use. At about the same time, the Securities and Exchange Commission was publishing its own handbook of pump-and-dumping, in the form of a civil complaint against five guys involved with a stock called Amogear. (They were also charged criminally.)
The Amogear scheme, according to the SEC, started out brightly: Amogear's controlling shareholder "owned or otherwise controlled all but a few thousand shares of Amogear's purportedly unrestricted stock," which is important if you want to pump and dump without outside interference.1 He engaged some stock promoters, Gabe Nix and Christopher Putnam, to pump that stock. "Nix was the owner of the GMM, a promotional firm that owned and operated a number of websites that tout penny stocks, and Putnam was a Senior Account Executive at GMM."
The company didn't do much, which to you and me might be an obstacle, but to them was more of an opportunity to paint on a blank canvas:
Nix and Putnam also were told, and understood, that Amogear had no operations. When Nix asked, “[Y]ou know, what’s the plan for the actual company,” Putnam stated, “[W]ho gives a f*** about the actual company,” and the [controlling shareholder]2 referred to a cardboard box in the corner of the office where they were meeting and said, “[T]hat’s it [the company] right now.”
Meanwhile, the controlling shareholder also engaged Mike Affa and Andrew Affa, cousins who live in New Jersey and Long Island respectively,3 as well as a guy named Mitch Brown, to do some manipulative trading in the stock. They laid out the plan:
Andrew Affa, Brown, Mike Affa and the [controlling shareholder] then discussed performing arranged trades to increase Amogear’s stock price before the touting campaign began. The trades they discussed were to be rigged trades between participants in the scheme to manipulate Amogear's stock price in which the participants would trade with and among accounts they controlled to create the appearance of a false market, with inflated prices, for Amogear stock. Brown and the [shareholder], with Andrew Affa present, discussed the "cross trades" and the plan to follow the trades with false touting, or "media."
Mitch Brown allegedly had strong preferences about exactly how you do the fake trading: "Every other penny, so you do the 10, you do the 12, you do the 14, you do the 16, all the way to 20 ... 5 prints ..." I don't know why you have to do every other penny; I would have thought that throwing in a few odd-numbered trades would make it look more naturalistic. But then I am not an expert on penny stock manipulation, and the SEC at least thinks Mitch Brown is.
So they did some fake trades to take the price from 10 cents to 12 cents, and then they launched the media campaign on websites including "TheStockScout.com, PennyStockPlayers.net, PennyStockCircle.com, PennyStockPros.net, 123StockAlerts.com, and StockMarketQuote.us."4 Since the company had no actual business, they made one up:
Amogear is focused on providing sports and training apparel for the world-wide mixed martial arts (MMA) audience as well as for other custom athletic sports fans.
Amogear could quickly become a force to be reckoned with in the MMA industry!
I feel like, if I were describing an imaginary company, I could probably do better than "this company sells T-shirts to martial arts fans," but, again, I am not the expert. Perhaps this pitch was exquisitely tailored to the audience of TheStockScout.com et al.
But we'll never know, because "On or about February 10, 2014, before the defendants’ touting campaign could artificially increase the price and trading volume of Amogear’s shares as intended, the Commission issued an order pursuant to Section 12(k) of the Exchange Act, 15 U.S.C. § 78l(k), suspending trading in Amogear stock."
Because, while the pump-and-dump scheme was almost a textbook effort, there were a few small flaws. The main one:
Unknown to the defendants, meeting and interacting with them in the scheme to manipulate the stock price and trading of, and to pump and dump, the publicly traded stock of Amogear was an individual cooperating with federal law enforcement authorities (the “CI”) as well as undercover agents of the Federal Bureau of Investigation (the “FBI”).
In fact the controlling shareholder was the CI, a veteran stock manipulator cooperating with the FBI in the hopes of getting his sentence reduced.5 And the "chief executive officer," such as he was, of Amogear, who met with the conspirators a couple of times, was actually an undercover FBI agent.6
So the main lesson here is, if you want to run a pump-and-dump scam, the FBI is not a great partner.7 That or "just don't run a pump-and-dump scam," I guess, take your pick. There are other lessons, though. One is how strangely close this all was to being legal. From the SEC complaint:
On all of these websites it was falsely stated in disclaimers that those promoting and touting the Amogear stock on the websites expected to be compensated in cash in connection with their promotion of Amogear. In reality, all compensation would be from the proceeds from the sale of Amogear stock. All of GMM’s websites stated in disclaimers: “[website name] is owned and operated by Global Marketing Media LLC. Global Marketing Media, LLC expects to receive up to one hundred thousand dollars cash compensation for a one week marketing and promotional effort on AMOG.”
In fact, the confidential informant told the promoters that they'd get 5 percent of Amogear's stock, with the aim of selling at 20 cents: "I think it'd be an opportunity for you guys to make 150, 200 thousand dollars over the course of a couple weeks’ time." So the disclaimers understated the amount, and misstated the form, of the expected compensation, but they weren't that far off: The promoters readily admitted on their websites that they were expecting to be paid six figures for a week of work touting Amogear. If they'd just gotten a check for $100,000, instead of some stock, that would have been fine.8
But I guess that doesn't prevent it from working. One model of penny-stock touting schemes is that the victims don't buy because they think the company will be the next Apple: They buy because they think the scheme will continue a little longer and they'll be able to flip their stock to a greater fool. (That's why they subscribe to newsletters, to get penny-stock tips before those tips go out to other suckers.) So the goal of the scam is to scam aspiring scammers. The FBI just took that approach one step further.
1. One of the defendants, Mike Affa, on learning that "there's 2,000 shares against us," allegedly said "2,000, this is as clean of a deal as you can get, obviously." The worry of course is that if you pump the stock and someone else dumps it, then you've done all your work for nothing. You want to be the only seller.
2. This bracket is mine; the rest are the SEC's. Also note that Nix was Putnam's boss? Rude.
3. I know.
4. Most though not all of those websites still seem to exist, as of this morning anyway. My favorite is PennyStockPlayers.net, which redirects me to fortunestockalerts.com, which advertises itself as "THE 100% FREE STOCK ALERT SERVICE, FEATURING ... stock picking ROBOTS from the future." There's a footnote though:
FortuneStockAlerts.com does not claim to be, or have possession of stock picking robots from the future. Robots from the future do not exist... yet. All references to robots on our website, in our newsletter, emails, social media, and any other source that we may provide, are for entertainment value only and are not to be considered as fact.
The robots are for entertainment value only. But the rest is ... still pretty entertaining? E.g.:
Is this safe? You bet your sweet bippy! Our service is just a simple newsletter. We’ll never contact you unless we’re hot on the trail of a juicy stock investment that’s itching for attention.
I also like this, from StockMarketQuote.us:
When speculating on a company to purchase shares in, it is wiser to invest in a fresh company than one that is trying to fix itself. In general, it's easier to make a new company work than fix a failing one. You can check the previous prices for a company; if that company used to be traded above penny stock prices but has fallen off the exchanges this can be a good indicator that the investment is a poor one. New companies in developing markets tend to be better investments, more likely to pay off with profits and less likely to collapse. Additionally, companies whose prices have fallen are less likely to rise to a profitable level because much of their stock is being held by people who purchased it at a more expensive price and are waiting for any excuse to unload this stock and depress the price again.
Pretty good argument for investing only in fake companies.
The CW is a stock promoter who has engaged in "pump-and-dump" schemes and has agreed to plead guilty to an Information charging conspiracy to commit securities fraud, as well as substantive counts of securities fraud and wire fraud, pursuant to a plea agreement with the United States Attorney's Office for the District of Massachusetts. The Information has not, to date, been filed. The CW has a criminal history that includes arrest for operating a vehicle with a suspended license, cocaine possession, and being a disorderly person. The CW has provided law enforcement with information that has been corroborated by additional sources of information and other investigative efforts, including, among other things, trading records and consensual recordings. The CW is cooperating in the hopes of obtaining leniency in sentencing.
Sounds like a disorderly person.
6. This bothers me to no end. Here's the SEC complaint:
From on or about September 2013 through February 2014 an undercover agent of the FBI served as Amogear’s Chief Executive Officer (“CEO”) as part of the undercover operation (“undercover operation” or “undercover investigation”).
The FBI affidavit says the same. (Neither names the undercover agent.) For one thing, why do you need a CEO of a fake company that doesn't do anything? But, also, Amogear is and was a public company that files with the SEC. Here is its 10-Q from December 2013, during the period when its CEO was an FBI undercover agent. The 10-Q is signed by the CEO, as required by SEC regulations. The signature is from a Richard Brutti. Here is his Bloomberg Businessweek bio:
Mr. Richard Brutti, also known as Rick, serves as Chief Executive Officer and President at United Bullion Exchange, Inc. Mr. Brutti has also been Chief Executive Officer, President, Chief Financial Officer, Treasurer and Secretary of Amogear, Inc. since March 27, 2012 and serves as its Principal Accounting Officer. Mr. Brutti has been Chief Executive Officer of VizStar, Inc. since February 28, 2011. Mr. Brutti has been an Independent Management Consultant since 1980. Over a career of more than 30 years, he has founded multiple companies, served in top management positions, and assisted startups and turnarounds in a consulting capacity. He founded and co-hosted Mind Your Own Business, a radio show for entrepreneurs by entrepreneurs. Mr. Brutti served as the President of Advanced Visual Systems, Inc. (formerly, General Gas Corp.). He served as a Sole Officer of Advanced Visual Systems Inc. since July 2009. In 2002, Mr. Brutti merged his consumer products company, Rephresh Inc., with Taker Products Inc., where he served as a Consultant until 2006. From 2004 to 2007, he served as the President of New England Ringside, a sports marketing company. From 2007 to 2009, he provided management consulting services to a number of businesses, primarily in the area of corporate finance. Mr. Brutti was Chief Financial Officer at New Balance and a consultant with Ernst & Young. He has been Director of Amogear, Inc since March 27, 2012. He became Director of Advanced Visual Systems Inc. since July 2009. He served as a Director of General Gas Corp. since July 2009. Graduating from Bentley College in 1976 with a degree in Accounting, Mr. Brutti also has an MBA which he earned at Boston College from 1977 to 1983.
What is going on here? Was Brutti not actually the CEO at the time? Is Brutti actually an undercover FBI agent? (Who "founded and co-hosted Mind Your Own Business, a radio show for entrepreneurs by entrepreneurs"?) Was the FBI agent just posing as Brutti?
The group also discussed steps to conceal their scheme to illegally pump and dump Amogear stock. During the conversation, which was secretly recorded by federal law enforcement agents as part of an undercover investigation, Putnam suggested that the members of the group purchase “throw-away phones” to communicate about the scheme. The throw-away phones were to be pre-paid cellular telephones that could be registered in false names or without a name associated with them. Nix, Putnam and the CI agreed to purchase the telephones and only to speak about the pump and dump scheme on those pre-paid cellular telephones.
Isn't it ironic, don't you think?
8. I mean, the other claims -- "could quickly become a force to be reckoned with" etc. -- seem to have been false too. But they're not that false; they're not claiming big contracts or giant inventories or inflated revenues. They're not claiming any contracts, or inventories, or revenues. They're just saying "this company plans to make T-shirts some day." Now that seems to have been false but really planning to make T-shirts is not that high a bar. You could always go to court and be like "oh, yeah, I was gonna get around to making T-shirts eventually." All the "the company is over there in that box" stuff hurts, but maybe the box was full of T-shirts.
The manipulative trading isn't great, I admit.
Check out FBI Sting Busts Group of 5 for Microcap Fraud on ThinkAdvisor.