Saturday, April 21, 2012

Recipe for Fraud: A Fake Robot to Choose Penny Stocks

For individual investors on the stock exchange, the biggest risk is simple investor fraud. As noted this week in the Financial Times, the US SEC has accused two British twins of touting a phony robot that was able to choose stocks about to double in price. This is a classic example of penny stock fraud, found in all developed capital markets but particularly in the U.S. and the U.K. (where pennies are still used as coin of the realm.)

Alexander and Thomas Hunter allegedly began their scheme in 2007, when they were just 16 years old. Their newsletter talked about a robot named Mari, which supposedly used “algorithms” to identity their stock picks. However this was no ordinary robot stock-picker. The brothers’ newsletter, Doubling Stocks, exclaimed, “Just think, had you put $5,000 on each of Marl’s recommended trades over the last 4 months – you would now have $387,684 clear profit sitting in your bank account.”

However this was not all it seemed to be. According to the SEC’s complaint, the brothers separately advertised to find a programmer to create the necessary software. However one of the brothers, Hunter, clarified that the software should “not actually find stocks at all”, according to the complaint.  Rather, “It should connect to my database and simply request any new stocks I have put in.”

The Hunter brothers made money in two ways. About 75,000 investors (primarily Americans) paid in total $1.2 million to subscribe to the newsletter and obtain a copy of the robot software for installation on their personal computers. In addition, according to the complaint, a stock promoter paid $1.8 million to the brothers to tout certain stocks.

As early as January 2009, the U.K. authorizes froze the bank account of the two brothers. However according to the SEC, they simply opened an offshore account in Panama under a new company name, Regency Investment Group.

Growing up in Canada, I was taught, “if it’s too good to be true, it probably is.” However for many consumers, even those with advanced college degrees, the financial markets appear to be an insider’s game they cannot win. Traditionally investors in U.S. stock market have been 60 percent retail investors (folks like you and me) and 40 percent institutional investors, such as insurance companies and pension funds. However following the stock market crash of September 2008, retail investors have largely pulled out of the stock market and by 2009 represented just 30 percent of the market.

Safe and Fair Finance Blog argues that investor fraud, through schemes such as penny stocks, further erodes that base of retail investor support for the stock market. Safe and Fair Finance Blog thus strongly supports work by financial regulators such as the SEC in cracking down on schemes such as the Mari stock-picking robot.

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