The Art of the Steal (23 page)

NUTS AND BOLTS—AND EVERYTHING IN BETWEEN

Counterfeiters are without scruples. They’ll put anyone at risk for profit (law enforcement agents once came across a shipment of counterfeit Cabbage Patch dolls that had been doused with kerosene to keep rats away while they were transported from overseas). Industrial valves have a long life cycle and are easy to recondition, and so they’ve been targets of counterfeiters for years. The FDA recalled $7 million of intra-aortic pumps used during open-heart surgery, after it discovered malfunctioning counterfeit parts in the devices. Sometimes, genuine used valves are improperly reconditioned so they can be resold as new. In one case, graphite seals that made the valves fire-safe were removed and not replaced.

Counterfeit nuts and bolts caused parts of a building to collapse during an earthquake. In the early 1980s, a contractor building a Saturn plant in Tennessee died because a counterfeit bolt snapped. It looked like the real thing but was made of cheap metal, not the specified high-quality carbon steel. In 1992, a fire erupted on a Navy destroyer, killing two sailors, after a counterfeit bolt connecting a steam line broke in the ship’s engine room. One of the problems with small parts is that to determine if a bolt is inferior, you need to subject it to metallurgical tests, and analyzing a simple 40-cent bolt can cost two hundred dollars.

Every type of car and machine part is counterfeited—brakes, horns, oil filters, radiators, suspensions. Counterfeit brakes were found in Nigeria that were made from compressed grass that burst into flames when they were tested. In 1991, a woman and her child were killed in an auto accident in the United States that was precipitated by a counterfeit brake pad. The pad was made out of wood chips. The U.S. Department of Commerce estimates that 210,000 American workers could be added to the work rolls if the parts were made legally.

THE FRIGHTENING SKIES

Equally frightening is the number of counterfeit parts flooding the airline industry, a full 75 percent of which are used in critical applications. According to the Federal Aviation Authority (FAA), between 1973 and 1993 bogus parts played a role in at least 166 U.S.-based aircraft accidents or less serious incidents. The worst accident of all occurred in September 1989. The tail section of a turboprop plane tore loose, causing the plane to crash into the North Sea. All fifty-five people on board were killed. The cause was eventually traced to counterfeit bolts in the tail. It was never determined where they came from, because the repair station that installed them didn’t have a parts and supplier registration system.

In 1990, Bruce Rice, the president of Rice Aircraft, a Long Island airplane parts distributor, was jailed for four years for stripping and replacing used parts and falsifying documents to suggest that they were new. Between 1977 and 1988, Rice sold counterfeit rivets and fasteners to Grumman, Air France, the Israeli Government, United Airlines, and American Airlines, among others, posing a serious safety threat to thousands of aircraft. Fortunately, no accidents were known to have resulted from the phony parts.

A few years ago, a company in Southern California was caught selling counterfeit parts to McDonnell Douglas. They were small devices that keep an airplane’s landing gear from shaking, and were used on Douglas’s DC-9 commercial airplanes. In 1995, in a separate incident, six hundred light planes were grounded after a supply of parts for Textron’s Lycoming engines were discovered to be fake.

But there have been crashes involving Bell Helicopters in which the only thing truly Bell about the craft was the nameplate. The rest of it was rebuilt with scrap or counterfeit parts. In 1987, a traffic reporter riding in a helicopter was killed when the helicopter crashed while he was broadcasting live. It was determined that the accident was caused by a clutch made of counterfeit parts.

Who’s to blame? A lot of people. And it’s not enough just to make sure there’s good paperwork on a part. Forgers can forge the paperwork. One of the best safeguards is to know your supplier.

A few years ago, undercover Congressional investigators paid a visit to a Miami scrap yard. They came across some jet engine blades marked with a red tag saying they were “unserviceable.” But when the dealer saw they were interested in the blades, he removed the tag. He told them: “I know some of you boys rework these things, but that’s not my concern.” The blades sell for around $1,500 new. The investigators bought them for $1.30.

WHAT’S BEING DONE

Because of the sophistication and growth of counterfeit products, far more attention is being paid to preventing them, but a lot more needs to be done. Packaging is an essential ingredient in deterring counterfeiters, particularly in the pharmaceutical industry, where bottles are reused by counterfeiters. I do a fair amount of work with drug companies, and I find that the best security is to combine overt with covert security features, features you can see with features you can’t see.

The most common overt technique is the tamper seals common on over-the-counter medications. These days, that technology is being combined more and more with holograms. They’re a very strong tool, and are widely used on closure seals and hang tags. They’re even increasingly put on packaging to make a product more visibly vibrant. If you go to the toothpaste aisle at the supermarket, you’ll notice that all the premium toothpastes have holographic packaging.

I like holograms, but the problem is that they’re normally not registered. Anyone can go to a company in Taiwan and get a hologram duplicated. Often, they’re silver foil with white screen printing on them. Counterfeit holograms are easy to slip through Customs. You can stuff enough fake holograms in a matchbox to put on ten thousand dollars or twenty thousand dollars worth of counterfeit packages.

So a hologram is fine if it’s in conjunction with another feature that you can’t see. For instance, you could use a hologram combined with a covert feature like machine-readable information encrypted on the hologram. Other covert features include putting a fluorescent dot on the label of the packaging that’s invisible to the naked eye and which can’t be removed even by washing—you use a reader light to pick it up. There are also special coatings like microthin metals that change when slit or punctured. There is reactive invisible ink or visible coloring-changing inks. There are reactive threads that are woven into fabrics and emit a fluorescent color when put under a hand-held ultraviolet reader. There are scratch and view labels that reveal the words “original.” And there is chemical tagging, for fuels, drugs, and pesticides. There’s even a “biocode technology” where marker chemicals can be added to capsules of drugs that can then be authenticated with test strips.

Another new technique is DNA (deoxyribonucleic acid) marking. Joe Barbera, the creator of “The Flintstones,” and “The Jetsons,” used to employ a DNA pen with ink that contained fragments of his own genetic code to authenticate his drawings. And now a company called DNA Technologies has come up with a means of mass-marking items with an ink containing DNA. The company marked millions of items of official merchandise at the Sydney Olympics, using an ink that contained DNA strands from an Australian athlete and a chemical that can be identified with an optical scanner. The company gets the DNA either from a blood sample or a swab of the mouth, and then makes copies of it that it mixes into the ink. The ink was put right on the souvenirs or on a tag attached to them. Among other things, DNA Technologies put a DNA tag on Mark McGuire’s seventieth homerun ball.

Holograms can be copied, but DNA is pretty much counterfeit-proof. The company estimates that there’s about one chance in a trillion that a counterfeiter could duplicate the DNA sample. Those aren’t the kind of odds that any sane criminal would take.

One shortcoming is there’s no hand-held device that can test for the DNA. Vendors can scan a shirt and pick up the chemical in the ink, but not the DNA. If something seems fishy, the product has to be sent to the company for further testing.

EVERYONE HAS TO GET INVOLVED

Fighting counterfeit goods is going to take a lot more dedication, and I don’t mean simply on the part of manufacturers. Stores have to do a better job of training their employees to discriminate the real from the fake. Packaging with blurry lettering or misspellings—“certifidate” instead of “certificate” of authenticity—is a giveaway. Sometimes, counterfeiters will try to protect themselves by slightly altering a product name—for instance, “Yeal” locks that resemble and are packaged to look like “Yale” locks.

If the problem is ever going to be contained, the general public has to start to care. You can’t perpetuate a scam unless there’s an honest person willing to go along. Years ago, I was visiting New York with my family. My boys were young then. We had eaten lunch at Wolf’s Delicatessen, and while I was paying the check, my kids asked if they could wait outside. I said, fine, as long as they were close enough so I could see them through the windows. Almost immediately, some guy came up to them with a satchel. He swung it open and it was filled with watches. By the time I hurried out to them, they were already picking out famous designer watches at ludicrously low prices. I shooed the guy away, and I had to explain to my kids that the watches were counterfeit and the guy was a crook.

Adults know better, and ought to behave better. Do you really want to keep buying those fakes on the street corner and putting money in the pockets of criminals, or do you want to support legitimate business?

10

[EMPTY
PROMISES
]

U
niprime Capital Acceptance was a small automobile dealer based in Las Vegas. Its shares were publicly traded, but it hadn’t made much earth-shattering news in awhile, and its stock price reflected that. You could buy a share for less than a buck, and normal volume was a meager 20,000 shares a day. Then one day in the summer of 1999, it made a stunning announcement for any company, but particularly for a car dealer: it had come up with a cure for AIDS.

Not surprisingly, the news was the talk of Internet stock chat rooms. There was, of course, patter about the considerable medical and humanistic ramifications of this development, but the chat room talk was more focused on monetary impact. One message called Uniprime “the greatest stock ever.” Another spoke of it as “a once in a lifetime opportunity!!!” and was like “buying Microsoft now at a nickel.”

The day of the announcement, Uniprime’s stock rocketed from $1.75 to $5.00, and 5 million shares changed hands. Just like that, the company had a market value of $100 million. One bulletin board message said: “Hallah! Hallah! Hallah! Shout it from the rooftops of the banks.” Thousands of messages were posted about the stock.

The AIDS cure was reported as the work of a new Uniprime subsidiary, New Technologies and Concepts, which was headed by a man named Alfred Flores, who described himself as a doctor. According to the news the company put out, New Technologies had developed an intravenous treatment called Plasma Plus that Flores had been testing for fifteen years at General Hospital in Madrid. It said the treatment reversed infections from HIV in five patients treated at the hospital.

It seemed too amazing to be true—and it was. The Securities and Exchange Commission (SEC) determined there was no cure for AIDS. It said Alfred Flores was a con man. In fact, during much of the time he was supposedly testing the AIDS treatment, he was in a Colorado prison serving time for a conviction for conspiracy to commit murder. But he had been in the vicinity of the medical profession. He had apparently spent some time as a janitor in a nursing home.

Alfred Flores was arrested and trading in Uniprime stock was halted. When trading resumed, the stock settled down at a quarter a share. Investors who bought in the heat of the frenzy collectively lost millions of dollars.

Unfortunately, securities and investment opportunities are a particularly ripe focus for crooks, because there have been so many real rags-to-riches tales brought about by the stock market. And, as we’ve seen again and again, there’s a slender line between what’s real and what isn’t. A band of criminals posted an actual SEC warning about online scans on a website of theirs that was itself promoting an online securities scam.

The money funneled into investment scams is breathtaking, even to me. One well-executed scheme can attract $100 million in ill-gotten gains. And if you’re one of the hapless victims, the chances of getting your money back are abysmal, even if the swindler is caught.
USA Today
did an analysis of how well the SEC has performed in recovering illegal gains that convicted financial scam artists have been ordered to hand over. The newspaper found that between 1995 and 2000, the agency collected less than 17 percent. A decade earlier, the recovery rate was more like 50 percent. In a number of large cases, the SEC had recovered nothing.

PUMP AND DUMP

One easy way callous con artists make money in the market is with “pump and dump” cons. Popular as far back as the 1920s, they are now going stronger than ever. These days, stocks are hyped with fictitious positive news on Internet message boards and in chat rooms by scam artists posing as experts. But all they know is how to take your money. Then the scam artists dump their shares, sending the price down before investors can get out.

A man who worked for a company called PairGain Technologies set up a website to resemble the Bloomberg business news site that many investors turn to for the latest business and financial news. He then posted an article on the site saying that PairGain was about to be bought by an Israeli company. To create further buzz, he wrote messages on bulletin boards with links to the fake Bloomberg site. The day he concocted the fraudulent story, PairGain stock rose about 30 percent before the company put out a release disavowing the report.

In another case, several criminals bought a hundred and thirty thousand shares in NEI Webworld, a bankrupt company whose assets had been liquidated several months before. Then they posted fake e-mail messages on hundreds of Internet bulletin boards, suggesting that NEI Webworld was going to be acquired by a wireless telecommunications company. Before the postings, the stock was trading at between nine and thirteen cents a share. On the morning of the postings, the stock rocketed to $15 5/16, before plunging back to a quarter a share. The criminals realized a gain of $362,625.

A twenty-three-year-old California man sent out a fake news release to Internet Wire, a company that distributes business news releases, saying that the chief executive officer of Emulex Corporation had resigned. He hadn’t, but within an hour of the release’s posting, the stock of the communications equipment maker plunged from $113 to $45. The actual value of the company declined by a staggering $2.5 billion. The hoax was quickly revealed, and the stock recovered. But investors who sold during the selling spree lost more than $100 million. In this case, the scam artist had sold shares short, betting on their decrease in price, and thus profited from the sharp fall.

The explosion in online trading has allowed mere kids, between their math and social studies classes, to dabble in securities fraud. We saw that when a fifteen-year-old New Jersey boy was caught by securities regulators in 2000, after he racked up profits of hundreds of thousands of dollars in a pump and dump scheme. The kid, who became the envy of a lot of other teenagers for his prowess, bought shares of lightly traded companies and then promoted them with hundreds of messages on Internet bulletin boards. When they soared, he bailed out. He was the youngest stock swindler the government has ever come across, but I fear he won’t be the last. When asked why he did it, he said, “Everybody does it.”

Part of the problem is that greed obscures judgment. Even though it makes no sense to risk your savings on unknown people who call you up or post messages on online bulletin boards, otherwise intelligent people seem to do just that with outright fervor. Here’s my favorite illustration of how ridiculous it can get. In 1994, the Motley Fool, a popular personal finance website, concocted a fictitious stock as an April Fool’s joke. They mentioned a company, Zeigletics, in their newsletter, and said it developed technology that connected sewage disposal systems in Chad and traded on the Halifax Exchange. Almost at once, messages turned up on financial bulletin boards discussing the merits of the company, and people actually tried to buy shares in it.

CAPER CRUSADERS

It’s astounding how far a con artist can take a securities scam. No matter how outlandish the pitch, there are investors who swallow it. Two New Jersey scam artists collected nearly $2 million by promising safe, high yields investing in wishing wells that solicited money for charity. In another case, a bunch of people saw no reason not to invest in an eel farm. If this seems far-fetched, it isn’t. The animal kingdom is actually quite well represented in the scam world. There are schemes centered on snail ranches and ostrich stud farms. There was an ostrich farm in Australia where the ads claimed, “The birds just won’t stop laying.” A coconut production business in Costa Rica was promoted on a website. The promoter said he had agreements with A&P for coconut chips.

A popular fraud has to do with selling “U.S. Dollar Bonds.” Scamsters who market them spin colorful tales of how they were issued in the 1930s and 1940s by the Central Intelligence Agency (CIA) to assist Chiang Kai-shek in fighting the communists. The way they tell it, the bonds were buried in caves by his generals and their descendants, and then lay there untouched until they were recently discovered; now you can buy them for just a fraction of their face value. The con artists print up official-looking Treasury bonds that they sell, and people do buy them, often clients in China, Taiwan, and Singapore.

No such Treasury securities were ever issued, and they don’t even look like anything the Treasury ever issued, as they often list the Ministry of Finance of the United States and the Washington Bank of America as their place of origin. Neither ever existed. Confront the con artists with this information, and they’ll say, “Well that’s the CIA for you, you know how they are.”

There are many instances of criminals essentially creating a shell company simply to attract investors. One of the most ambitious was the infamous ZZZZ Best carpet-cleaner caper. This was the one where a teenage swindler named Barry Minkow truly constructed a house of cards. In 1982, when he was sixteen and living in Reseda, California, he began a rug-cleaning business in the garage of his parents’ house. He called it ZZZZ Best. Friends admired his drive and lofty aspirations. The business always seemed prosperous, although in fact it lost money. But Minkow had thievery in his blood, and he raised capital to fund the business in ways that most corporations rarely consider. He orchestrated burglaries to collect insurance money. He forged money orders from a local liquor store. When customers paid with credit cards, he would add fraudulent charges to the accounts.

Feeling the need for a bigger arena, he created a fake appraisal company that purportedly arranged restoration work for insurance companies. A bizarre friend of his became the company’s head. The fake appraisal company created fictitious paperwork indicating that Minkow’s company had received contracts from insurers to restore fire-damaged buildings. Minkow used this fictitious business, confirmed by the appraisal company, to persuade bankers and investors to give him money. Out of thin air, he concocted endless contracts from insurance companies to tackle office buildings that had been devastated by fire and water. He had an associate draw up forged documents representing the contracts, but there were no actual carpets to restore. Investors looking into the business would be referred to the fake appraisal company, which confirmed the deals. One time, when an auditor wanted to look at a restoration, the company hurriedly leased a building and dressed it up to look like a work site. It fooled the auditor.

In 1986, Minkow took his ruse of a carpet-cleaning company public, and the market capitalization swelled to more than $200 million. His young age captivated the press, and he gained wide publicity, which served to further stimulate investor interest. The fraud began to unravel when word got out about Minkow’s credit card overcharges. Once investigators began probing the company, the end was near. In 1988, Minkow was convicted of fifty-seven counts of fraud and sentenced to twenty-five years in jail. Investors lost more than $100 million.

THE FORECAST? STORMY

Many of the most successful investment scams work their prey slowly, reeling them in like a trout. That’s how the forecaster scam works. A man who identifies himself as a broker calls or writes you and, insisting no obligation on your part, offers you an investment tip. He tells you about a stock to watch that he thinks is going to do very well in the near term. “I don’t want you to buy the stock, or even think of investing any money with me,” he insists. “After all, you don’t even know me. Just keep an eye on this stock and see how it does.” Ostensibly, his point is to demonstrate his market savvy, and the sort of market intelligence he’s privy to. His real point is to set a trap.

So, out of curiosity, you watch the stock and, sure enough, it goes up. A couple of weeks later, he contacts you again and offers a second tip, a stock he dislikes that he predicts will take a beating. “I don’t want you to short it or anything,” he says. “Just notice how it does.” Sure enough, that stock goes down. Now you’re hooked. He calls again, and this time he has an investment opportunity for you, a sure-thing stock that he strongly urges you to buy. You’ve been mightily impressed by his uncanny feel for the market, so not only are you willing to invest, but also invest heavily. You send him $10,000 or $25,000 to buy the stock he suggests. He doesn’t buy it. He vanishes with your money.

How was he so insightful about those two predictions? He really wasn’t. He starts with a base of potential dupes. Say he identifies a hundred people. With his first call, he tells half of them that the stock he chooses will rise, and the other half that it will fall. It has to do one of the two, and so fifty people are going to be impressed with his prediction. Those are the fifty he calls back with his second prediction; again, he tells half a stock will go up and half that it will decline. He’s left with twenty-five who have seen him be right two out of two times, more than enough to fleece.

PONZI SCHEMES—TRIED AND TRUE

One of the oldest investment tricks of scam artists is the notorious Ponzi scheme, a persistent type of securities fraud where money is never invested in anything, but instead the cash that comes in from new recruits is used to pay obligations to earlier investors. And the scam artist, of course, always keeps a healthy apportionment for himself. The fraud is named for Charles Ponzi, who defrauded Italian-Americans in Boston in 1920 with a scheme purportedly involving postal reply coupons, which were prepaid return postage used in foreign correspondence.

Ponzi schemes come in every imaginable variety. You read about a new one almost every week, and they always promise enormous returns for short periods of time. I have to laugh at how absurd the pitches are. Some years ago, a group of companies in Kansas touted a get-rich-quick investment involving fungus. They sold investors “Activator Kits” that would grow fungus cultures. Most people wouldn’t imagine that much of a market for fungus exists, but these promoters convinced people that these cultures would be bought by a cosmetic manufacturer they were connected to for a hefty profit. To remove any worries, the promoters “guaranteed” the profit. Something like twelve thousand people in thirty states sent in their money. As in any Ponzi scheme, the promoter strung investors along by paying early ones with money from subsequent recruits, always keeping some for himself. Eventually, the pool of investors is exhausted and most people end up getting nothing back from their investment.