Institute for Individual Investors

Member Login
3 votes
Thumbs Up! Thumbs Down!
Thank you for voting!

Watch Out For This Stock Scam

Friday, May 18, 2007 | Teeka Tiwari

(Editor's Note: This article was originally published on February 7th, 2007)

Two Saturdays ago marked some important milestones for me.  I turned 36 and was instantly transformed from being in my mid 30s to my mid to late 30s, and it also saw my 18th year as a professional investor.  Over the last 18 years, I have seen many different markets and just about every stock scam out there.

In the immortal words of Edwin Lefevre, there is nothing new under the sun when it comes to stock speculation.  If you live long enough, you will see it all.  That’s why I had quite a chuckle when I recently read in the Wall Street Journal that SPACs are making a comeback.

SPAC stands for special purpose acquisition companies, and they are essentially “blind pools”. Here’s how it works.  A sponsor (that’s a fancy word for promoter) creates a corporate shell entity. They then add some impressive names to the company’s management and start raising money in the hopes that at some point in the future, they will buy a business.  The sponsor has 18-24 months to buy a business, or they must return the money to the shareholders, minus investment banking and other sundry fees, of course.

In the meantime, while management is looking for a company to buy, the SPAC will actually trade shares and sometimes warrants (a warrant is similar to a long-term option in that it gives you the right to buy stock at a certain price) on an exchange.

SPACs proliferated in the 80s and early 90s, and their “special purpose” was to relieve you of your investment cash!  They were rife with fraud.  The typical scam would include the purchase of a business at a wildly inflated premium.  The business, of course, was typically secretly controlled by the sponsors.  Other scams included outrageous fees and various forms of self-dealing, not to mention outright manipulation, of the often highly illiquid shares and warrants.

It seems that the bulge bracket investment boys are reviving this old war horse to quite good effect.  They have raised billions over the last year using the SPAC vehicle.  The problem is that their activity now sets a precedent that will make it difficult for the SEC to turn down SPAC deals from smaller operators whose only intent is to fleece the general public.

Don’t be surprised if over the course of the year, you get cold-called with a SPAC deal.  You will invariably be regaled with tales of untold riches just waiting for you to pick up.  They will minimize the risks and magnify the potential rewards.  Don’t fall for it.

In fairness, some SPACs have done fabulously well in the past, but they are the exception rather than the rule.  Buying lottery tickets may be a good investment strategy for some, but I think I’ll pass, and you should, too.

So much of Wall Street is already geared towards self-enrichment that it’s shocking that the SEC still allows these vehicles to flourish.  The potential for abuse and fraud is just too large for them to be considered as a serious investment.

So when they call you, you might want to listen to the pitch - it will be highly amusing - then politely tell them, "No, thanks," and hang up.

You’ll be glad you did.
Teeka Tiwari signature
Teeka Tiwari
Chief Investment Officer
ETF Master Trader
3 votes
Thumbs Up! Thumbs Down!
Thank you for voting!

Comments: