Copyright © John E. Lux
2012, all rights reserved
September 19, 2012
Introduction
On February 1, 2011, the SEC filed a complaint in a case involving a $33 million international microcap scheme involving the stocks of eight small U.S. Companies headquartered in China, Canada and Israel.
Micro cap companies can be easier to manipulate as these companies have smaller public float in dollar terms.
The Pattern
The pump-and-dump schemes in the stocks in this SEC complaint typically followed the same pattern. The defendants located a private Chinese company to reverse merge with a U.S. public shell company. As part of the reverse merger, the shell company typically conducted a reverse stock split and changed its name.
The public companies then issued large blocks of unrestricted shares at little or not cost, purportedly pursuant to Form S-8 or Rule 144 of the Securities Act, to nominees, whose names were being used to disguise the defendants’ beneficial ownership. These shares were often the only unrestricted shares issued by the public companies. This enabled the defendants to control the entire float of the issuer’s stock. Prior to the spam e-mail campaigns, there was little or no trading volume in the securities of any of the public companies, which often traded at prices below $1.
In the weeks leading up to the promotional campaign, either some of the defendants, the corporate insiders of the Public Companies, or others acting at their direction, opened brokerage accounts in the names of straw parties or nominees and deposited the public companies’ securities. The nominees were generally Chinese nationals or entities that were beneficially owned by Chinese nationals.
Next, the defendants coordinated the launch of spam e-mail campaigns touting these low-priced stocks, which corresponded with press release campaigns purporting to announce positive, newsworthy events that hyped the public companies’ business. The spam e-mails for each issuer contained the same false and misleading information and baseless price projections. Some of the e-mails contained false and misleading language concerning purported acquisitions and IPOs. These e-mails were intended to pump or increase the prices of the securities and/or create demand for the securities. These campaigns often created a short term spike in volume and price.
The spam e-mails were primarily drafted at the direction of one of the defendants, who enlisted a team of “spammers,” to draft and send false and misleading spam e-mails.
Simultaneous with, or shortly after, the spam e-mail campaigns were launched, the defendants sold all the stock in these public companies. These holdings often represented the only stock traded in the accounts.
Finally, often pursuant to instructions from the defendants and the corporate insiders of the public companies or others working on their behalf or at their direction, one of the defendants immediately wired out the entire proceeds of those sales to foreign bank accounts in the name of those nominees. Subsequently, the proceeds were used to pay the defendants, and the spammers. Also, in some instances, a portion of the proceeds was also sent directly back to the issuer or corporate insiders, who had concealed their beneficial ownership and trading in their respective issuer’s securities.
We now look at one of the eight stocks in the complaint.
The Stock
This company was a Nevada corporation headquartered in Hong Kong, which purportedly developed real estate, software programs and provide financial consulting to companies seeking to be listed on the U.S. Markets.
In 2006, the company issued 30,000,000 shares of Common Stock to a consultant in consideration of business restructuring service provided. This increased the outstanding common stock to 31,162,902, and the 30 million shares were 96% of the outstanding common stock.
Using an invalid S-8 filing for six million shares filed in July 2006, the defendants sold 5.78 million shares in the pump an dump.
On April 25, 2007 the Over- the-Counter Bulletin Board re-listed the stock, effective as of March 8, 2007.
On May 21, 2007 the company filed a 10-Q with the SEC showing $53 in cash and a negative net worth of $10,000.
From June 2007 to November 2007 the defendants allegedly used false and misleading spam emails and press releases to pump up the stock.
The 10-Q for the quarter ended September 2007 reported a loss of $19,886, assets of $468,127, no liabilities, revenues of $68,804, and a cash balance of $2,929.
The Pump
From June 13, 2007 to September 26, 2007, the company was the subject of a spam e-mail coordinated with a press release campaign.
The spam emails falsely said that the company was to acquire a $75 million project, that it was in partnership with a multimillion dollar developer, a potential agreement with a brake manufacturer in China, and the prospect of build an auto exhibition center in China.
The spam e-mail often predicted the news in the press releases (“get on XXX before the news hits. . .”). The company coordinated 13 press releases with the spam e-mail.
In the 90 days prior to the spam, the stock was traded sporadically with prices ranging from $0.00013 to $0.22, volume ranging from zero to 47,166 shares. Most of the trading volume was by the defendants to create the appearance of trading activity in the stock.
In the two weeks leading up to the spam e-mail, June 1 to June 13, 2007, the stock only traded 12,200 shares on two trading days at $0.11 to $0.12.
Let’s look at the chart and see how that looks in the market.
Analysis of the Trading
I see three stages in the trading. First, up until the spam campaign starts, the defendants created some trading in the market that pushed the stock from virtually nothing to twenty cents on light volume. March 8, 2008 the stock trades as high as 30 cents, volume 13,524.
As the spam campaign starts, the week of June 1, 2008, the stock spikes to 69 cents, volume is 2,099,473. As the spam continues, the week of July 22, volume is over five million shares and the price closes at $0.20. Assuming that most of the sell volume was from the defendants, their take during this week was probably over $1 million.
In October, after the spam ends, the stock still trades at about ten cents per share, hundreds of thousands of shares per day.
By January of the next year, the price is down to three cents and the volume is only tens of thousands of shares per day.
Thus, we can see that this stock followed the pattern I describe in my books “How to Pick Hot Reverse Merger Penny Stocks”: accumulation, markup and distribution. The stock was accumulated by the insiders at low prices when they watered the stock and in their early purchases in the market. When the spam started the stock was marked up and then distributed.
What caused the great spike and the great public enthusiasm for this stock? Seeing the great “news” speculators buy hoping that there is a “greater fool” to take them out at higher prices. Some of these buyers are day traders who do not care how high the stock is; they only care that the stock goes higher.
What Can Be Learned
Note that the stock rose to a market value of some $15 million or more at its peak when in actual fact the company only had a minimal or negative net worth, minimal or no revenues, and little or no cash.
Anyone paying up for the stock was betting on the future, rather gambling on the future. In most of the these stocks, this future rarely materializes.
My advice?
First, beware of companies that have “watered” their stock by selling blocks of stock for little or nothing that can now be dumped on the market.
Second, beware of stocks selling far in excess of any intrinsic value as measured by assets and earnings. Buy stocks that are selling below their true value, as I describe in my book “How to Find a Home Run Stock.”
Third, beware of this kind of news that is easy to fake, especially if it is pushed out by spam. Even real deals often go astray. While small companies need to promote themselves or they will be ignored, spam is a red flag. When you buy stock far in excess of its intrinsic value based on future hopes, you are taking a huge risk and possibly setting yourself up for a big loss.
You want to buy when the stock is down, not when it is up. This stock traded at a very low price before the spam started. Any smart speculator who bought at a fraction of a cent would have been very happy when the stock hit its peak over $0.50.
For More Information
Go to http://www.investing-performance.com and subscribe now to get a free e-copy of “How the Shorts Raid Your Stock, Destroy Your company, and What to Do About It.”
Get my books on Amazon.com:
http://www.amazon.com/Pick-Reverse-Merger-Penny-Stocks/dp/1450726887/ref=sr_1_1?ie=UTF8&s=books&qid=1294103675&sr=8-1 last time I looked, amazon says this is the second best selling book on reverse mergers
http://www.amazon.com/How-Find-Home-Run-Stock/dp/1599711818/ref=sr_1_1?ie=UTF8&qid=1294103637&sr=8-1 how I got 300% per year returns steadily
http://www.amazon.com/Shorts-Stock-Destroy-Company-About/dp/B003TVN5VS/ref=sr_1_11?ie=UTF8&qid=1294103637&sr=8-11 I believe the naked shorts reverse engineered this book to cause a lot of damage, see also www.short-stoppers.com
http://www.amazon.com/Bash-Stock-Bashers-John-Lux/dp/1450728219/ref=sr_1_6?ie=UTF8&qid=1294103637&sr=8-6 this is part of the campaign against abusive short selling
Go to my blogs:
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http://reverse-merger-shell.blogspot.com/
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Disclaimer
This material is from a recent SEC complaint. The complaint contains allegations only and is not proof of anything. A case is pending in which a court will decide if the defendants are found innocent. We note that some of the defendants have pled guilty or entered into pending settlement agreements. We assume here, for the purposes of discussion and education only, that the allegations are substantially accurate.
