This Christmas, Martin Scorsese and Leonardo DiCaprio team up to tell the story of Jordan Belfort’s rollercoaster life in their new film The Wolf of Wall Street. Born in 1962, Jordan Belfort was a savvy entrepreneur from the Bronx, now an author and motivational speaker as a result of how his business efforts turned out. In the 90s, Belfort founded a boiler room (an aggressive, often shifty call centre) stock trading business that marketed penny stocks. Using one of the oldest techniques in stock manipulation, Belfort swindled millions from investors. At the height of its success, his boiler room employed nearly 1,000 stock brokers, a result of the huge growth and success enjoyed by the company until the late 90s, when Belfort was indicted for fraud and money laundering, and ultimately sentenced to 22 months in prison. Belfort’s story inspired the production and release of the 2000 film Boiler Room.
Belfort’s stock manipulation was enormously profitable for him and his firm. He owned mansions around the globe, private yachts, and supported a heavy cocaine addiction. How did Belfort or other boiler rooms lure investors into making particularly large investments without ever seeing a sizeable return? It’s a simple idea that requires effort and coordination.
With magic tricks, there are only a handful of basic kinds of misdirection to employ. With some artistic flair and aggressive presentation, however, one can get many different tricks using slight variations of the same principle. Investment schemes are no different. They use variations in flair and presentation, but are generally all based on the same over-arching principle – sell something that’s not exactly real.
Trick 1: Selling Expired Stocks
In the 2000 film Boiler Room, Seth Davis (played by Giovanni Ribisi) joins a boiler room brokerage where expired stocks are sold to investors. The firm’s brokers use aggressive selling techniques to get investors to buy shares. Once the investor realizes they purchased an expired stock, it’s too late and their investment can’t be sold since the stock is no longer on the market. Selling expired stocks is a simple method that’s unequivocally fraudulent and easily detectable for more experienced investors and law enforcement. These schemes have a significantly shorter shelf life, and frauds are typically caught before significant damage is done. More sophisticated techniques such as those Belfort also exercised on his investors are less detectable.
Trick 2: Pump And Dump
With Belfort, investors actually purchased real penny stocks, and not expired ones. Then Belfort and his team of brokers would pump up the value of the stock, only to dump their shares before other investors could pull out. This method is known as the “pump and dump,” and can be illegal in many cases. It’s a traditional method used by fraudulent brokers to inflate the value of a stock through hyping the product up with positive statements. This form of stock manipulation is the most common among fraud cases. A recent and notable example saw Superstar rapper 50 Cent trying a similar stunt. He invested millions into HNHI and used his Twitter audience to pump up interest, later selling his share for over $8 million.
How It Works
With a “pump and dump” the firm needs to make a heavy initial investment, which causes the stock to experience a jump in value. Then they hype up the investment with inaccurate positive statements and aggressive selling techniques. They use websites and social media to draw attention, or in other cases simply pick up the phone and call thousands of potential buyers using an aggressive sales pitch. Bringing in more external investors actually increases the value of the stock. Of course, what new investors didn’t know was that the firm owned the bulk of the shares, and if the firm sold off all their shares at once, then the stock’s value would plummet, leaving the investors to absorb heavy losses.
Why Pump and Dump?
Frauds such as Belfort target penny stocks because of their volatility and low value. Because the initial value of the stock is so low (under $5), any sizeable investment made by the fraudulent firm is a significant one. It’s an intentionally large investment to then bolster hype. Because penny stocks are highly volatile, they are also very risky even when they are not being manipulated, which is why experienced fraudulent brokers use significant influence and persuasion to lure less experienced investors into buying into a “huge opportunity”. Penny stocks also experience high spikes and sharp declines in very short periods of time, which helps foster the hype. Any shift can bring sizeable returns or significant losses. Most traders invest in penny stocks solely to chase an immediate high return, so a little persuasion can be quite convincing – the old “taking candy from a baby.”
Stopping The Wolves
Strict regulation on Wall Street, which is still recovering from a blow to activity and image have put parameters in place to help prevent frauds like Belfort. As history has shown, despite the mounting regulation and surveillance being put in place, there will always be those who will find a way to cheat the system. We have not seen the last of stock manipulators such as Jordan Belfort or Jonathan Lebed (a 15-year old who used penny stocks and the internet to swindle investors). New variations of the same principle will come around again just as the Big Bad Wolf did with the Three Little Pigs. It’s up to investors to be smart enough not to get caught up in their game.
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