Financial crime is not limited to bank robbers and charlatans. Today’s criminal may be found sitting behind a glossy boardroom table or on the internet. As a due diligence investigator, I am hired by clients who suspect financial malfeasance from within their company or from their competitors. There are varying levels of intensity in due diligence investigations. On one hand, you can check out someone’s Facebook page or LinkedIn profile and get a sense of who they portray themselves to be. On the other hand, you can spend tens of thousands of dollars on a battalion of investigators to ferret out every last bit of information available.
After twenty years of conducting both types of investigations, Hg has developed the Phased Approach—a systematic process that enables us to explain to our clients the various types of due diligence investigations. The benefit of a phased approach for the client is their understanding of what is supposed to happen when and the costs involved. Much of our work is concluded after Phase 1, because we are able to answer the client’s key questions through online research. Phase 2 is needed in the event there are outstanding questions that require boots-on-the-ground work.
In this blog series, we examine the most common types of financial fraud—Ponzi Schemes & Manipulation, Backdating Stocks, Insider Trading, Short Selling, and Pump and Dump Schemes—and how due diligence investigators can protect your company’s assets and investments by tracking down fraudsters.
Pump & Dump Schemes
Pump and dump schemes are an illegal manipulation of stock prices based on fraudulent claims. Companies promise advances in science, cures for diseases, big investment returns, and technology that exceeds standards. In return, investors clamor to get behind the latest and greatest company. When the company fails to deliver their product(s), the demand for new capital wanes, and the company stock is dumped.
Pump and dump schemes were very common during the tech bubble years, when companies would continually profess that their emerging products would change the industry. Investors would be inspired to get in early and fast. Venture capitalists and everyday investors were all jumping on the bandwagon, putting money into false promises. Once the promotion stopped and the fraudulent truths were discovered, the demand disappeared—causing a collapse in the price of the investment and leaving many investors out of pocket. Key indicators in a pump and dump scheme are monthly or regular press releases making outlandish claims with no support. A primary point of interest is how the company is funded. Are they completely funded by venture capital, or do they produce some other product or service that can buoy them?
Remember, if something appears too good to be true, it likely is.
Hg Case Study: Not So Smart
My client was concerned that a competitor was outpacing technological advances of his Smart Cards in the market. The time frame was the mid-1990’s when Smart Cards were still a hot item, with years of development yet to come. This competitor claimed to build gigabyte cards that were indestructible. My client was concerned that the current standard of megabyte cards was going to be surpassed. Being a top scientist and business professional in the industry, he was stumped as to how the competitor was beating him to market.
The target of our investigation immediately was suspect, because the competitor had only discussed the coming release of his Smart Cards. The competitor actually didn’t have a product in place. When all the news articles were retrieved, I noticed that at the middle of every month this company placed its press release, disclosing all sorts of improvements and relationships. Like clockwork, each month one would read about how this company improved compression ratios, aligned themselves with a ballistic grade plastic laminating company, and new investors in an effort to impress even the savviest of Wall Street tycoons. This ongoing pump of new information generated a lot of buzz, and investors were hungry to invest in the company.
While researching the news, I focused on the target’s management. They came from Canada, recently settling in California’s Silicon Valley. I started looking into Canadian companies where these executives may have previously been employed. I found a mention of the Toronto Stock Exchange delisting a company where the CEO worked. This company was producing portable medical testing units that could scan for viruses such as HIV without the need for electricity—a sort of finger-prick analysis. While researching this company, I discovered the same pattern of monthly articles professing major accomplishments every month, until one day they stopped. As it turned out, Canadian officials suspected the claims as fraudulent. The CEO and others were investigated. The Canadian company remained open, but the stock was close to worthless, and many investors were left without reprise.
The same CEO was doing the same pump and dump in the U.S. with his supposed leading-edge Smart Card. For our client’s sake, we knew the claimed technology didn’t exist, and we exposed the fraudulent person to the SEC for further scrutiny.
Taking it Online
Pump and dumps and misinformation campaigns can also be generated online. Online chat boards found on warriortrading.com, motleyfool.com and Ragingbull.com are famous for getting insider news. Even social media chat boards such as Reddit.com can generate a lot of discussion, enough to take a bullish stock and shine a bright light on it to garner so much attention, accusations of naked short selling are made. Such as in the case of Gamestop in 2021.The poster’s anonymity shields them from being exposed, when they talk about fights in the boardroom, product releases, marketing schemes, etc. Companies need ongoing monitoring of their own message boards for any truths or half-truths. It is not uncommon for a former employee or current disgruntled employee to post proprietary information in these chat forums.
An example is Dendrite vs. John Doe. Dendrite, based in Morristown, N.J., is a provider of products and services for the pharmaceutical and consumer package goods industries. At one point, several anonymous people posted defamatory information on the Yahoo Dendrite message board. Each poster was independent of the other, but all were suspected employees of the company. In at least two of the cases, the court ruled that Yahoo did not have to expose the identity of the posters, claiming first amendment rights; and in the second case, no harm occurred. But according to court papers, Dendrite said John Doe No. 3 made a series of posts on a Yahoo bulletin board specifically devoted to the company’s financial matters. “The company alleged that negative comments by several posters about Dendrite and its management constituted breaches of contract, defamatory statements and misappropriated trade secrets.” The misappropriation of trade secrets is what opens the individual to criminal misconduct. Individuals posting on the internet, through blogs, message boards, social media, and in forums do not realize they are not invisible.
With so many types of financial fraud, continuing education is necessary to understand and investigate in this arena. Two classic resources for continuing education regarding financial investigations include the white paper titled, Short Selling, Death Spiral Convertibles, and the Profitability of Stock Manipulation written by John D. Finnerty, Professor of Finance, Fordham University Graduate School of Business (March 2005) and the website of the Association of Certified Fraud Examiners website, which offers articles and trainings in their Fraud Resource Center. Hg experts offer a variety of monthly virtual webinars and presentation conferences. Check out the Hg calendar to ensure access to the latest offerings!
Cynthia Hetherington, MLS, MSM, CFE, CII is the founder and president of Hetherington Group, a consulting, publishing, and training firm that leads in due diligence, corporate intelligence, and cyber investigations by keeping pace with the latest security threats and assessments. She has authored three books on how to conduct investigations, is the publisher of the newsletter, Data2know: Internet and Online Intelligence, and annually trains thousands of investigators, security professionals, attorneys, accountants, auditors, military intelligence professionals, and federal, state, and local agencies on best practices in the public and private sectors.
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 Bartlett, Michael. (July 11, 2001). New Jersey Court Upholds Anonymity On Net Bulletin Board – Dendrite International. Newsbytes News Network