The Boiler Room Goes Online
In the old days, unscrupulous brokers tried to separate people from their money by setting up operations in the basement (boiler room) of some building and calling prospective victims. Sales pitches were developed to convince people to buy the stock of some obscure company, overpriced gold coins, or oceanfront property in Arizona. It was relatively easy to defend against these boiler rooms: just like you tell your children—don't talk to strangers.
However, there is a new and different breed of scam artist. These scam artists are not different in the scams they perpetrate, only in the way they execute these scams. The Internet and the recent mania surrounding dotcoms have allowed scams to flourish. No longer are boiler rooms needed. No need for phone lines and time-wasting phone conversations. All these scammers need is a computer and a few minutes.
The age-old stock scam is the pump and dump. In the past, an unscrupulous broker would buy shares of a tiny company, which would start to push up the stock price. Then the broker calls you to recommend the stock, saying you had better buy it quickly because it broker sells his shares (the dump) into this high demand at the inflated price and makes a killing. He stops pumping the stocks because he is out. The price plummets back to the original level and you take the big loss.
Today, the same scheme is perpetrated with several online bulletin board postings. Instead of making hundreds of phone calls to reach investors, investors willingly go to the postings. The next time you read a message touting a stock, remember that it could be from someone like Jonathan Lebed, the 15-year-old high school boy from New Jersey. He would buy shares in a tiny stock and then pump it in the after-hours chat rooms. While he was in school, the excitement would build on the Web bulletin boards, attracting investors to buy the stock, starting the upward price spiral. Jonathan would then dump his shares at the inflated price, and all the investors who took the bait on his scam would be left holding the loser when the stock price returned to normal levels. He made hundreds of thousands of dollars from these scams. It doesn't feel very good to get scammed by a teenager. However, the anonymity of the online chat rooms means you do not know who you are dealing with. The SEC gets 300 emails a day complaining about such scams.6
While many investors are wise enough not to take the postings on chat sites seriously, there are other ways you can lose your money. The Internet has fostered a new type of stock scam known as the info bomb. Many investors get their news from traditional news wire services (Reuters, Dow Jones, Business Wire, etc.) that distribute news stories and company announcements. An info bomb is a planted false story that is inadvertently circulated by reputable news services or made to appear that it originated at one of these services. The story is planted to cause a big move in the stock price of a company.
Take, for example, the fake Bloomberg News page announcing a takeover bid of PairGain Technologies. An employee at PairGain created and distributed the phony story. Investors flocked to PairGain hoping to cash in on a quick profit, causing the stock price to soar 30%. Many investors got burned when PairGain officials denied the takeover bid and the stock quickly dropped.
Or consider the info bomb planted by Mark Jakob, a 23-year-old community college student. Mark had been short Emulex stock for several months. (A short position profits when stock prices fall and loses money when stock prices rise.) Emulex stock had risen. So, after quitting a job at online wire service Internet Wire, Mark planted a story on the system to the effect that the Emulex CEO was resigning amid an accounting scandal. The other news wires picked up the story, and the company's stock price quickly plunged 62%. By the time Emulex was able to deny the hoax, Mark had closed his short position at a huge profit. Then he bought shares at the low price and made another huge profit when the stock climbed back to prehoax levels. His total profits were $250,000. As is common with this type of fraud, the FBI caught him before he could spend any of the money. However, that isn't much comfort to investors who panicked and sold Emulex stock when it dropped into the $40 range, only to see it climb back to over $100 a share after the hoax was revealed.
So, how do you steer clear of market mania and investment scams? You are vulnerable to both of these investing pitfalls because of your psychological biases. The first step toward avoiding destructive behavior is to understand its cause, which means you should understand your psychological biases. Hopefully, what you've read so far has helped you to do just that. The next part of this book will tell you about your willpower and introduces rules of thumb for controlling biases and avoiding problems.
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