Flimflam men and their schemes have long been as plentiful as palm trees in Southern California. Since the trains began rolling in a century ago, con artists and high rollers of all sizes and stripes have been lured by the promise of easy riches and a sunny clime.
Now another swindle has been transplanted here in a big way: penny stock fraud.
“Up until last year, we considered penny stocks to be a Denver and Salt Lake City problem,” said G. William McDonald, chief of securities enforcement for the state. “In the last six months, it has really exploded here. It’s the fraud of ’89.”
Top federal prosecutors and securities regulators in Los Angeles echo McDonald’s concern. They worry that penny stock abuse is a growth industry in a region already plagued by the nation’s largest concentration of the high-pressure sales offices known as boiler rooms.
Indeed, the telephone tactics perfected by fast-talking salesmen who have been peddling bogus investments in precious metals and the like out of Southern California boiler rooms for years have proven very adaptable to penny stock manipulations.
Penny stocks involved in frauds are usually issued by “shell” companies with no real operations. Sales agents claim the companies have great potential, such as a cure for AIDS or a means of making gold out of Costa Rican sand.
The stocks themselves are thinly traded outside the market system, which makes them subject to manipulation by a single brokerage. They are almost always sold over the telephone, most often to unsophisticated buyers who are vulnerable to smooth-talking salesmen.
“We’ve seen telemarketing techniques being used in connection with (stock) market manipulation cases,” said Terree L. Bowers, chief of the major fraud section of the U.S. attorney’s office, which is investigating several penny stock cases.
Irving M. Einhorn, regional administrator for the U.S. Securities and Exchange Commission, acknowledged that the swindlers “are faster than we are” and that the SEC does not have enough people to contain the rising abuses.
Two weeks ago, 45 enforcement officials from the federal government, California, Arizona, Nevada, Hawaii and the National Assn. of Securities Dealers, which registers and polices stockbrokers, held an unpublicized meeting here to plot a joint attack.
“We don’t have the resources to deal with the multitude of people out there doing it,” said Einhorn. “We need a coordinated response. We need criminal cases to send a message.”
Penny stock fraud has been around for a long time, even in California. A current federal investigation with roots in Southern California and plenty of sensational elements is threatening to blow the lid off penny stock abuses nationwide.
The traditional twin centers of penny stock scams always have been Salt Lake City and Denver, where lax state laws allow promoters to operate with relative impunity. But in recent months, the schemes emerged as a national epidemic that has bilked small investors everywhere out of hundreds of millions of dollars--often $500 or $1,000 at a time.
The reasons behind the epidemic are hard to figure.
Small investors have stayed away from Wall Street in droves since getting burned in the crash of October, 1987. Yet they show a logic-defying appetite for far riskier investments in penny stocks.
The name itself is a misnomer. The stocks sell frequently for more than pennies, even in initial offerings. Prices can get pumped up to several dollars a share and, while most investors lose only a few thousand dollars, some are bilked out of far more.
Penny stocks do, however, have some common characteristics.
They are issued in huge numbers. An initial offering of 50 million shares is not unusual.
Since they are traded in the over-the-counter market and not listed or quoted on any exchange, finding the current price of a stock is nearly impossible. This allows a brokerage total control of a stock’s selling price.
The brokerages earn their profits by charging investors a markup over the price the firm pays for the stock, a difference called the spread. The temptation to cheat buyers is enormous in penny stocks because buyers have limited means to check spreads.
Even legitimate penny stocks are issued by companies about which little or no financial information is available. This is a loophole in the SEC regulations created in the late 1970s to make it easier for small companies to raise venture capital from the public.
But most penny stocks today involve shell companies with no business or limited operations that are hyped by brokers and such gimmicks as false news releases. Dishonest promoters have overshadowed the legitimate uses of penny stocks and tainted the entire market.
Increasingly, promoters use so-called “blank check offerings” in which the shell company claims to be issuing stock and raising money with the idea of looking for an unspecified business to buy.
Last year, 60% of the 166 stock issues for under $7.5 million registered with the SEC regional office in Los Angeles were blank checks, according to Frederick B. Goss of the agency.
Penny stocks are sold by telephone, usually through unsolicited calls. Salespeople make up to 300 calls a day, promising quick profits with little or no risk. They offer “inside” information or push an opportunity that they claim is available only for a short time to select clients.
But when a buyer tries to cash in on a paper profit, they find penny stocks virtually impossible to sell. The once engaging brokers are evasive at best, gone at worst.
Tough Nut to Crack
The hucksters are no longer relegated to Salt Lake City and Denver. They have grown more sophisticated and more mobile, expanding to places such as a section of Boca Raton, Fla., known as the Maggot Mile, New York, Las Vegas, and to the boiler room paradise of Orange County.
Cracking down has proved difficult.
In the same way that his predecessor, John S. R. Shad, put the heat on insider trading a few years ago, SEC Chairman David S. Ruder said last fall that curbing penny stock abuses would top the agency’s enforcement agenda.
The SEC took 27 enforcement actions against penny stock operators in 1988, and many more investigations are pending. The scams also are a main target of the new Justice Department task forces on securities fraud being formed in six cities, including Los Angeles and San Francisco.
But paying lawyers to fight the regulators is just another cost of doing business for the scammers. One expert has compared the enforcement effort to hitting mercury with a hammer--for every one that’s smashed, a hundred new ones pop up.
There has been progress, however, in an investigation that law enforcement officials believe could make penny stock fraud a front-page story the same way the Dennis B. Levine and Ivan F. Boesky cases publicized insider trading and created some of the deterrence sought by prosecutors.
No criminal charges have been filed in the investigation, which is being conducted by a federal grand jury in Las Vegas with assistance from SEC investigators from Los Angeles and Chicago and the Internal Revenue Service.
But hundreds of pages of court records and interviews show that investigators believe they are on the trail of a loose confederation of penny stock fraud artists that stretches from Denver and Salt Lake City to Palm Springs and the French Riviera.
“This is a zinger of a case that lacks nothing,” said H. Thomas Fehn, a Century City securities lawyer who represents a participant granted immunity by the government in the investigation. “There is no element of penny stock market manipulation that is not present in this case.”
According to papers filed by the government in federal courts in Santa Ana and Denver, one target of the federal investigation is Meyer Blinder, a multimillionaire who controls Blinder, Robinson & Co., the nation’s biggest penny stock brokerage.
Government Found Good Source
Dubbed “Blind ‘em and rob ‘em” by Forbes magazine, the brokerage operates 1,700 offices nationwide and has its headquarters in a nine-story building in the Denver suburb of Englewood.
Blinder has had run-ins with regulators for years. One of his attorneys, Alan C. Jacobson, said Blinder would not discuss the allegations in the court papers. Jacobson refused to comment beyond a blanket denial of wrongdoing by Blinder.
In much the way that Dennis B. Levine’s cooperation with prosecutors broke open the Wall Street insider trading scandal, the penny stock investigators got a big break last summer when a shrewd veteran of the penny stock game decided to spill his secrets.
The government’s good fortune started in July. French police raided a $6-million villa overlooking Cannes in southern France and arrested its owner, Thomas F. Quinn, a disbarred American lawyer with a record of violating securities laws.
Quinn, who is being held without bond in a Paris jail, is suspected by Interpol and others of orchestrating an American-style penny stock fraud in Europe that bilked investors around the world of $500 million. The alleged scheme involved selling grossly overpriced stocks to investors over the telephone.
Visiting Quinn that day was Arnold L. Kimmes, a longtime associate who allegedly ran Quinn’s European boiler rooms as well as Kimmes’ own penny stock scams out of Palm Springs, according to investigators and associates of Kimmes.
Kimmes had the good luck to be away from the villa when the police arrived. He used a yacht to escape and then flew to the United States, said one lawyer involved in the case.
Several months earlier, Kimmes had been awaiting surgery for lung cancer at Little Company of Mary Hospital in Torrance. Two hours before the operation, he was served with a subpoena from the SEC in a stock-fraud investigation. When questioned by the SEC in response to the subpoena, Kimmes took the Fifth Amendment and refused to testify. He also began spending more time in Europe.
But when he returned to this country last summer, Kimmes was singing a different tune. Quinn and about 20 others across Europe were arrested and Kimmes faced the possibility of spending time in a French jail, which would not be as comfortable as its American counterpart for someone approaching his 67th birthday.
So Kimmes telephoned an attorney friend, who told him to hire a lawyer and consider cooperating with the Las Vegas investigation. It offered, among other things, a way to avoid extradition to France.
Kimmes took the advice. According to an affidavit by IRS agent Robert H. Salisbury filed in connection with a four-day search of Blinder’s headquarters in November, Kimmes has been providing valuable evidence for the ongoing investigation of Blinder and others.
In the affidavit, Salisbury said Kimmes and a partner, Michael D. Wright of Salt Lake City, operated an elaborate penny stock scheme from 1985 until 1988 that involved Blinder.
Wright allegedly set up the shell companies and found the nominees to serve as officers and buy the initial stock with money he provided. Wright’s lawyer in Las Vegas, Donald Campbell, would not comment.
Kimmes’ job was finding cooperative brokerages to handle the initial trades that made the companies appear to be public. He was renting a large house in Palm Springs much of that time, and his wife lived in another house in Palos Verdes Estates.
One brokerage used by Kimmes, according to the affidavit, was Chelsea Securities in Newport Beach. Chelsea shut down shortly after being raided by the IRS last September as part of the investigation. Robert Killen, a former owner of Chelsea, denied any wrongdoing and said the office was closed because it was not profitable.
According to court papers, the use of the nominees enabled Wright and Kimmes to control the shell companies and deliver 100% of the stock in 15 of them to Blinder. The stock then was pumped into Blinder’s network of penny stock salesmen who peddled it to investors nationwide.
For their part, Wright and Kimmes collected several million dollars and transferred much of it to Switzerland, where it was laundered through an elaborate scheme, the government claims.
Despite being sued by regulators for years, Blinder has remained in business and won several important courtroom victories against the government. Along the way, he has grown wealthy and is contributing $2.1 million for a medical research center at UCLA.
His lawyers accuse the government of conspiring to shut him down in the current probe. In an interview with Forbes in January, Blinder called Kimmes a liar and said he had only met him for 15 minutes on one occasion.
But federal agents who raided Blinder’s headquarters last Nov. 19 found evidence that they said linked his brokerage to 10 shell companies created by Kimmes and Wright, according to court papers.
Also seized by the agents from Blinder’s penthouse office were two items that seem to symbolize the rapidly expanding penny stock business--a craps table and a slot machine.
1. A penny stock promoter forms a shell corporation, using friends or acquaintances as the officers. He registers the company with the SEC so its stock can be sold to the public. The SEC is little more than a rubber stamp, doing nothing more than making sure the paperwork is OK.
2. The promoter arranges for the initial stock to be sold to another tier of nominees. He even provides the nominees with the cash they use to buy the stocks. The promoter retains control over the stock and pays the nominees a small fee for using their name to create the illusion of a public offering.
3. Now the promoter controls all the stock in a public company and it can be peddled to naive investors. In cases known as “box stox,” the swindler will sell the whole large package at a huge premium to a single, large penny stock brokerage with the power to market around the country. A brokerage may pay the equivalent of 1/2-cent a share for the stock.
4. The brokerage earns its money by selling the stock to investors at a price higher than what it paid the promoter. The 1/2-cent a share may be sold to investors at 2 or 3 cents. Multiply by several million shares and the money gets big.
5. Salespeople working in “boiler rooms” at the brokerages earn $10,000 a month and up in commissions by selling stock usually through unsolicited “cold calls.” They often use a carefully scripted three-call method: A prospecting call to say there might be something to sell, a second call to say a terrific investment is coming up, and the closing call to get the sucker to buy the stock and send in the payment.
6. The sales techniques are used over and over to push the stock price higher by foisting the stock on new investors. Early investors are told the value is soaring. People who want to sell out are persuaded to re-invest in a newer, hotter issue. No one is ever allowed to sell for cash and eventually the stock collapses and the investors lose their money.