As I write this article the Wall Street Journal is reporting that the Chinese government is taking the first direct action to curb a surge in its stock market. More and more, their stock market has been the investment choice for China's growing middle class. Over the past two years more than two trillion dollars worth of Chinese yuan has poured into their market fueling a rally in which market indexes have quadrupled. It now appears Chinese government officials fear their market will overheat leading to inevitable declines and huge losses.
Whether the Chinese stock market is over-priced or just beginning to grow makes no difference to investment con men. Many years ago a CBOE trader told me “money follows money.” Con men know this saying well. They use the hot investment of the day to lure their victims. In the 1980's and again recently, oil and gas schemes were hot. In the 1990's technology investments were hot. Now, “China” stocks are hot.
Swindlers are using faxes, e-mails, and even cell phone text messages to hype the latest “hot” China stock and give information on how to buy it. You will see statements such as "grabbing massive profits in China has never been easier than right now!", “this stock is ripe to pop”, and "load up on the stock now!"
Often, these are nothing more than Ponzi schemes or Pump and Dump scams. With Pump and Dumps the con artists promote a stock to pump up the stock's price. They then sell off their shares at a huge profit. After their sale the stock price usually collapses leaving investors with huge losses.
Ponzi schemes are scams where a thief promises great returns with limited risk. Often, the thief sells his victim a phony stock. Usually those who buy into the scheme early do see the promised returns because the crook uses new investor's money to pay the promised dividends to the earlier investors. He robs Peter to pay Paul. In the end, the thief runs out of new investors and the scheme collapses.
Here are some things to watch for if you or your clients are pitched a hot “China” stock:
• Statements relating growth in the touted company with success stories of other Chinese companies. Sometimes the only similarity is the use of "China" in the company name.
• Claims of actions by the Chinese government that bolsters a company's product or service.
• Statements that use verifiable demographic facts to bolster claims of a price
run-up; such as those making a direct link between a stock's growth prospects and China's growing middle-class.
• The use of headlines from respected financial news sources regarding China, which can easily be taken out of context.
• Claims that making profits in China are "easy."
• Statements that mention the names of major investment banks doing business in China to give the air of credibility.
• Statements about how much easier it is for lower-priced stocks to skyrocket in value in comparison to higher-priced stocks.
• Inflated price targets or predications of the touted stock's rapid growth.
• Pressure to invest immediately.
Here are some things you and your clients can do to avoid being the victim of one of these scams:
• Look beyond a company's name. The fact that a company has "China" in its name can be misleading. The company might not be incorporated or based in China and it may be very difficult to assess how much, if any, business the company actually derives from China.
• Get the company's background. You can learn about the company by checking the Securities and Exchange Commission's EDGAR database online at www.sec.gov/edgar . If the company is not registered with the SEC it is a red flag. If the company is registered with the SEC read all its reports carefully. SEC Form 8-K will tell you if the company has changed its name or trading symbols. Stock promoters often change a company's name and trading symbol to align it more closely with a current event or issue. SEC Form 10-K contains a wealth of information. Along with other information this form will give you the nature of the company's business, risks it faces, legal actions involving the company, the identity and background of the company's executive officers, and most important, the company's financial statements.
• Find out where the stock trades. Most unsolicited spam recommendations involve stocks that can't meet, or choose not to meet, the listing requirements of the NASDAQ, the New York Stock Exchange, or the American Stock Exchange. Instead, these stocks are usually quoted on the OTC Bulletin Board or in the Pink Sheets. There are no minimum quantitative standards that a company must meet to have its securities quoted on the OTC Bulletin Board or in the Pink Sheets. Many Pink Sheet companies have no obligation to file annual or quarterly reports or to publicly disclose current material information. Many of the securities quoted on the OTC Bulletin Board or in the Pink Sheets don't have a liquid market. They are infrequently traded and can move up or down in price quickly. This may make it difficult to sell your security at a later date.
• Understand the risks of investing internationally. International investments, including China stocks, are subject to political, economic, and social risk factors. In addition, accounting and regulatory standards differ from those in the U.S. Other risks include currency risk, the risk of inadequate or imperfect disclosure of financial information, differing legal procedures, differing stock market operations, and the potential lack of liquidity.
If you or your clients want to make international investments it is always best to work with a registered U.S. investment professional with experience making investments in foreign companies and a positive track record of doing so. You can check out a broker or brokerage firm by using the NASD's BrokerCheck online at www.nasd.com under “Investor Information.” As always, it pays to investigate before you invest.