Mining stock fraud: an old trick that still works

Investors can’t resist the lure of striking it rich and that mentality is a goldmine for scammers. Preying on investors’ fever for treasure they make money on worthless gold, oil, diamond and iron ore claims. Modern technology makes it easier for investors to guard against being cheated – but it still happens every day.

The colorful vocabulary of mining investment fraud – pump and dump, boiler rooms, stooges – has been associated with fleecing investors at least since the creation of the modern stock market. Frauds themselves have been around as long as people have been digging holes in the ground.

Experts by now have a good sense of how the schemes work, how technology has changed the game, and why people continue to fall for these scams even though the warning signs are well-publicized.

Con artists committing mining stock fraud usually do it by way of “pump and dump.” They pump up the stock price with skullduggery, then dump the shares by selling them when the price is high.

“One would start with stock that’s thinly traded – not McDonald’s or Microsoft or Coca-Cola – this would be stock for XYZ Company that no one has ever heard of,” said Fred Joseph, president of the North American Securities Administrators Association (NASAA), and head of Colorado’s Securities Commission. “The individuals who are going to do the pump and dump are going to acquire a bunch of those stocks and acquire them cheaply – let’s say a penny a share. Now they start the scheme – touting (the stocks) over the Internet, over the phone, newsletters and mailing, (saying to investors) ‘This is going to be the next big gold discovery, or oil field in North America, and you want to get in on the ground floor, because we think the price will triple in a short amount of time.’”

When investors start buying, and the price rises, the promoters sell. “By the time the price drops, the individuals promoting it have got out and sold all their holdings,” Joseph said. “They’ve cashed out, leaving the unwary investor holding the bag worth of worthless stocks.”

The method has netted scammers millions and tens of millions of dollars in short periods of time. And no extractive industry – oil, natural gas, uranium, diamonds – has been immune to the frauds. But according to the author of a 2007 study on precious-metals mining scams, gold mining investment fraud is in a league all its own.

“There’s nothing in the world that makes people suspend their critical judgment more quickly than gold,” said Thomas Naylor, a McGill University economics professor who authored the study. “It’s naïveté combined with greed. Gold is unique in that sense. It dazzles in a way that others don’t, but it’s ordinary in the way they pull off the scams. They become almost routine, and a template for many other types of financial fraud. If you went back in history, gold mining ventures – everything from alchemy to King Solomon’s Mines – they’re the leading in the terms of attention of forms of financial fraud.”

Naylor’s study notes that these inflated tales go at least back to the Spanish exploration of the New World. Aboriginal people may have made up El Dorado and the Seven Cities of Cibola to send the Spanish invaders to the wilderness to die.

“Others were invented by Spanish adventurers for the opposite reason, to secure more men and money for slaving and pillaging expedition,” he wrote. In the 1800s, penny stock swindles in the North American west centered around gold; by the 1950s, the US state of Utah became the focal point for uranium penny-stock fraud. Technology also moved the scams along nicely. Widespread telephone ownership in the 20th century meant the rise of “boiler rooms” – rented office space with desks and telephones worked by a small army of persuasive and often unregistered brokers. (Scammers and crime groups have used boiler rooms so named because they were once hidden away in basements and boiler rooms to flog worthless stocks of all kinds along with other valuables like antique stamps and gems.)

Another jiggery-pokery done by fraudsters trying to pump stock is the “salting” of drilling samples with gold or whatever else is supposed to be mined, so the sample appears to be laden with riches. Combined with “stooges” or shills – experts, advisors, or even investment banks that will either be in on the scam to help build buzz around the stock, or unwittingly help build the hype, the results can be disastrous for investors, as was the case with the famed collapse of Bre-X Minerals in 1997. When the small Canadian company claimed to have found the world’s largest gold deposit in Indonesia, Lehman Brothers joined in hyping the find, strongly recommending a buy on what it called “the gold discovery of the century.” The frenzy spiked Bre-X shares, once worth 30 cents per share, to Canadian $286.50 (today US$261.89). At one point, the company’s on-paper worth was C $5 billion.

Bre-X was exciting, not just because of the gold, but because of other elements added to the mix – corrupt Indonesian politics, big mining companies battling for control of the development, and the private eyes and spies hired to help them do so. But it all started to fall apart when the site’s geologist committed suicide by jumping from a moving helicopter en route to a meeting with the US-based mining company that wanted some answers about the allegedly rich drill core samples. By the time the company announced there was no gold at the site, and Bre-X collapsed, the CEO, his wife and the vice chairman had made about $50 million from their stock, according to Forbes. (The Canadian press reported the CEO had made $35 million and the vice chair $84 million.) The samples had been salted, most likely by the site geologist – who some believe was merely trying to keep the development money flowing until Bre-X actually found the Indonesian gold. The CEO died in 1998 and faced no charges. The vice chairman absconded to the Cayman Islands; in 2007, a Canadian court acquitted him of insider trading.

Today, though millions have email and the Internet, the scams are still the same, said Fred Joseph, the NASAA head.

“There’s nothing new under the sun, It’s just that now instead of a broker on the phone, you get a spam email,” he said. “We all get the Nigerian spams, we all get the questionable, ‘This is the investment of the year’ in our email. There are different means and methods now than just the phone.”

Nevertheless, new technology also means that potential investors are a few clicks away from investment guides and securities commissions that provide “buyer beware” information. Those warnings include claims that the mining can be done only with new or proprietary methods, and phrases promoters use such as “no risk” and “you must act now.”

Even with the warnings out there, the lure of easy money, and the lure of the myth of the lone prospector striking it rich continue to draw in investors.

By Beth Kampschror