The Fraud Industry part 1: It takes a village to raise a fraud

Pump and dump is its own industry with industry conferences and specialists who provide helper services like shady legal advice, illegal transfer agent services, stock promotion, etc.  This industry operates a lot like other industries, except some effort is made to conceal their activities.

In this series of blog posts, I will go over how the industry works and how you can figure out the interconnections between industry players.  Industry insiders consistently use the same service providers: lawyers, accountants, investment banks, brokers, stock promoters, investor relations firms, and transfer agents.  All of that leaves behind a footprint that you can use to sleuth out connections behind the industry’s output.

This series will go over:

  • How to quickly spot a pump and dump.
  • How you can bet against these stocks and why you shouldn’t do it.


Stock promotion

Every pump and dump starts with stock promotion.  The pumpers build up interest in a scam through “boiler rooms” (call centers), online websites, e-mail, physical mail, shill articles on Seeking Alpha, etc. etc.  Most stock promoters follow the rules and disclose their conflict of interest.  There will be some disclaimer stating how much they were paid in cash, registered stock, and/or unregistered stock.  The boilerplate legalese often looks something like this:

[STOCKPROMOTER] has been compensated up to Seven Thousand Five Hundred dollars cash, for this one day marketing and awareness campaign on [TICKER] ending on Tuesday, June 13th, 2017.

Working backwards, you can use a search engine to find examples of paid stock promotion on the internet.  For example, you could search for COMPANY NAME + “sponsored by”.  This will sometimes find webpages where some stock promotion shill has disclaimer text mentioning their conflict of interest.

Figuring out if a company is paying for stock promotion shills

  1. Go to the company’s investor relations website and open up a presentation.  If you read enough of these presentations from companies listed on the OTC BB exchange, you start to get a feel for the buttons that they try to push.  There are certain copywriting styles that get copied over and over because they work.  If the pumpers are targeting degenerate retail investors, the pumpers will tell a story about how the stock can go to the moon.  The retail investor doesn’t know about most financial analysis terms like EBITDA, TAM, CAGR, ROIC, etc. so the language will assume a retail investor audience.
  2. Skim through the press release titles.  Some companies will identify the shills that they paid for, e.g. they will point out that somebody put out a positive report on the company.
  3. Watch out for companies that trade on junior exchanges like OTC BB, Pink Sheets, TSX Venture (formerly Scamcouver Stonk Exchange), AIM for UK stocks, etc. etc.  Most of them are products of the fraud industry.
  4. Watch out for junior mining, development-stage biotech, China story stocks, marijuana, and (to a lesser degree) independent oil & gas.  The fraud industry will consistently pile into the investment themes that work on retail investors.
  5. Watch out for reverse mergers.  Virtually all of them are scams now.
  6. Skim through the financials.  A few pump and dumps have almost zero revenue because they didn’t put much effort into making the stock look like a real company.  More commonly, the pump and dump guys will find a failing business (or some failed biotech drug candidate) and buy that failing business to quickly create the veneer of a real stock.  Most of the failing business owners don’t realize that the buyer is running a pump and dump scheme.  Hilarity can ensue when the business owner starts fighting with the pump and dump people.
  7. While you are in the annual report, hit Crtl +F and look for the phrases “investor relations” and “investor awareness”.  If the annual report talks about how much they are paying for these activities, it is because they are paying for pump and dump-style stock promotion.  Ignore sentences that talk about their investor relations employee (it doesn’t count).

I try not to waste time on this step.  Once you look at enough scumbag companies and enough real companies, you can get a feel as to what the investor relations website will look like.  That is the fastest way to figure out if a company is a pump and dump without having to search through Google and figure out where they definitely paid for stock promotion.

Undisclosed stock promotion

A few of the pump and dump guys are a little crazy and will pay for stock promotion that illegally breaks the rules about disclosing their conflict of interest.  Those stock pumps will use fake identities to post positive articles about a stock on Seeking Alpha and other platforms.  Richard Pearson did an excellent expose of one stock promotion ring- start here and here.

It takes too much time to figure this stuff out so I wouldn’t bother.

The best way to find frauds that are shortable

You will quickly figure out that the frauds targeting the retail investor isn’t worth your time.  Retail bagholders tend not to lend their shares out to short sellers and the small market caps make it difficult to short those stocks.  You want institutional investors to bet against because those bagholders will lend their shares out.

To find frauds targeting institutional shareholders, you want to look at the companies presenting at investor conferences from small investment banks.  They hold promotional conferences that promote stocks to the institutional investor.  I don’t want to specifically name any of those small ibanks because I don’t need that drama.  However, if you watch the film China Hustle, you should be able to figure out the name of at least one small investment bank.  That bank’s similarly-sized peers also hold investor conferences targeting institutional investors.  The pump and dump industry loves these CONferences and frequently presents at them.  The presenter lists of those conferences is one of the best places to look for short selling targets.

Actually making money?

Unfortunately, while the pump and dump crap destroys a lot of shareholder wealth, shorting those stocks is not a good idea.  See my post on short selling for a long-winded answer.

What killed it for me was the coronavirus, which made short selling incredibly painful.  Everyday people stayed home and started gambling on stocks instead of going to the casino, causing bad stocks to massively outperform the market.  This happened with almost every kind of bad stock, so diversification did not work at all.  It turns out that diversified short selling is exceptionally risky and is not worth doing.

There may be some validity to buying put options.  However, very few stocks coming from the fraud industry have a liquid options market.  You are more or less limited to the Chinese reverse mergers that happen to have market caps in the billions.  Even then, buying put options is not the most worthwhile activity because the options all have high implied volatilities.  The mispricings on the options aren’t that big.

Large-cap China frauds may be worthwhile

Let’s start with a little bit of history.  The first wave of fraud from China came from the Chinese reverse mergers, which profited both Chinese mainlanders as well as the various Westerners working in the fraud industry.  The Western fraud industry had been doing reverse merger scams for a while and starting selling China-themed pump and dumps.  Chinese mainlanders started figuring out how the game is played and joined the fraud industry.  Some of the scams were particularly egregious because insiders ran off with the money and the company.  Because there is no extradition treaty between the US and China, they can get away with such egregious behaviour.  Normally insiders “only” sell their shares illegally and break insider trading laws (e.g. by not reporting their sales, by selling when they aren’t allowed to, etc.).

The current wave of China frauds have much higher market caps and became public through the IPO (initial public offering) route rather than the reverse merger route.  They tend to be much bigger and often have liquid options markets because of their size.  Because the implied volatility on some of those options is low, it may be worthwhile to bet against these stocks.

In future installments of this series, I will explain how insiders illegally sell their shares and the footprints that they sometimes leave behind.  However, I don’t believe that you would gain much of an edge from figuring this stuff out.  All China stocks are problematic because the country does not have Western-style rule of law and because the CCP sort of encourages listed companies to steal from foreign investors.  The laws there are designed to be broken so that powerful government officials can selectively enforce those laws for personal gain.  See my post on understanding China.

Up next in this series

I will do a deep dive into the mechanics of pump and dumps, e.g. how they launder money.  It probably won’t make you a better investor because short selling common stock is a bad investment strategy.

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