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Continuation from Part I...

We had just left off with learning that the insiders had been paying a couple people to buy up large portions of their inventory from retail stores to give the impression of massive sales when there really were hardly any sales at all.

What the public doesn't know won't hurt them!

The investing public doesn't know any of this. Instead, they perform their due diligence by calling up the retailers to check and see how sales of the product are doing. The retailers tell them that they are all sold out, the sponges are flying off the shelves, because they are. Except it is the company themselves that are doing the buying and there is not any kind of actual demand...

This deception creates the illusion of massive demand for the product and keeps the stock price chugging higher. It is now sitting in the $.22-$.25 range. Shares are being sold by the founders and insiders the entire time. They have now pulled tens of millions of dollars out of this stock simply by creating fake demand of a real product and by generating massive hype around their stock. None of this would have really been possible without the help of their attorney issuing opinion letters to get restricted legends removed from their stock or the accounting firm signing off on shaky financial statements.

Right around this time I remember seeing their company logo at center court of an NBA finals game, right next to Coca-cola. I also remember seeing their logo at the women's tennis US Open. Right next to Heineken and Nike, something didn't quite fit but it continued to fuel the hype and hysteria in their stock. By this time the stock had touched a high right near $.30 per share. It was a great time to be a company insider. They had already pocketed tens of millions of dollars and their stakes were worth many millions more. The market cap of the company was nearing $800 million.

This is right about the time things begin to unravel...

The Public Company Accounting Oversight Board had been keeping an eye on their auditor and decided they had seen enough questionable activities to revoke their registration. At this point the company would need to find a new auditor in order to keep up their listing on the OTC exchange. Auditor after auditor declined to do business with them when the company could not produce the requested documents. The company even briefly signed on with Deloitte & Touche (one of the big 4 accounting firms) before being dropped shortly after for the same reasons.

The lack of being able to hang on to an auditor was a red flag to many investors and they started contacting the SEC to start doing some digging on the company. It turns out that the company had been on the SEC's radar for some time now. A company coming from nothing to being listed alongside Coca-cola at Madison Square Garden gets a lot of people's attention I guess. The stock price started to drop...

Soon the price fell back down into the $.15-$.17 range but surprisingly held up there. The company continued to defend itself against allegations of wrong doings and it supplied numerous reasons explaining why auditor after auditor had dropped them. A few more sports arena advertising spots were signed and the stock began to climb again, inching it's way into the $.21-$.23 range. This would be the last chance for investors to recoup any of their investment.

The SEC steps in

A few days later the SEC suspended trading in the stock for a period of 5 days and announced that they had subpoenaed the company several months ago for information that the company was unable to provide. The company was now officially under investigation and the stock was halted. Investors were forced to sit on their hands as it would be impossible to buy or sell for the next 5 trading days. When the stock reopened for trading it opened down something around 90% because in the overwhelming majority of cases where the SEC suspends trading and announces an investigation, it means they have found something and have a legitimate reason to do so. The company likely has committed some serious infractions.

Several days after, the FBI raided the homes and offices of the company insiders. It turns out that they had gotten to one of the two main founders a couple weeks back and had convinced him to turn "state's witness" and help gather info on the other culprits involved in the scam in exchange for a reduced sentence. He did just that...

He had been wearing a wire for weeks and had been gathering plenty of hard evidence against his coworkers. He was the first rat off the sinking ship I guess...

Arrests

The two main founders were both arrested as well as 5 others that were all linked to the scam, including the opinion letter writing attorney. I am not sure what kind of jail terms they ended up serving (if any) as the process dragged on for years and there seemed to be many legal loop holes they kept taking advantage of. I know they were barred from ever operating a penny stock company again as well as requested to pay back all of the ill-gotten gains (which of course they couldn't) plus penalties and fines for breaking the law.

The entire scam reportedly netted them close to $50 million in profits according to the SEC, although just looking at the trading volume and the number of shares that "failed to deliver" during that time frame, which could be an indicator of short sales that were done without borrowing the stock first or could be an indicator of more shares in circulation than there should have been, which would have been the case with the restricted stock being sold illegally. Either way, when you add up all those, you get a number much closer to $200 million, but I guess those couldn't be proven as easily so the SEC stuck with their $50 million number.

Aftermath

The really disturbing part in all of this to me is that the insiders made several trips to Europe, Switzerland to be precise, in the weeks and months leading up to their eventual arrest. One has to wonder if they were hiding the money over there on those trips. There was no way they had spent the $50-$200 million they had likely made, so the question becomes, where did it go?

To go further, one has to wonder if this was all part of their grand plan, knowing they would likely get caught eventually and knowing how lax white collar crime is often punished here in the US, maybe getting caught was the "cost of doing business"?! They make $200 million, hide it overseas, serve a couple years for the crime and when they get out they have a huge nest egg waiting for them... I guess we'll never know for sure but I have a sneaking suspicion that is exactly what happened in this case.

Thanks for reading!

Live well my friends!

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