Why an Old Scam Keeps Landing in Your Inbox

By Daniel Huang and Aruna ViswanathaStocksDow Jones Newswires

Matthew Eldridge was on Manhattan's A-train heading to a bar when he spotted the email on his phone.

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"A major opportunity for you," it read, touting a mining company called Mustang Alliances Inc. "I don't think the investment community is aware of it yet."

Before his first drink, the 29-year-old mechanical engineer had logged on to his broker's website and bought the stock--in the process falling for one of the oldest securities frauds around, the "pump and dump."

The tactics are simple. Promoters talk up lightly regulated penny stocks, then sell them off to unsuspecting investors.

This time, though, the scheme would feature a computer-age twist. Regulators and prosecutors say that men who allegedly manipulated Mustang Alliances and at least five other stocks also hacked into J.P. Morgan Chase & Co.--a breach of such scale that some initially speculated it was the work of a foreign intelligence service.

Now prosecutors and regulators say the high-tech exploit powered a fairly lowbrow purpose: lining up targets for stock scams and other crimes.

The case was a reminder that despite awareness fanned by popular movies such as "The Wolf of Wall Street," the well-worn pump and dump continues to thrive. The Securities and Exchange Commission has suspended trading on stocks about 1,800 times in the 3 1/2 years since May 2012, compared with fewer than 1,300 times in the seven years before.

Many of those were penny stocks in which regulators cited suspicious behavior. The agency declined to comment further.

While the classic pump and dump unfolded in so-called "boiler rooms" staffed with slick salesmen working the phones, technology has made the scams easier to perpetrate--and in some ways harder to catch.

A former regulator at the Financial Industry Regulatory Authority, Alma Angotti, recalls examiners showing up unannounced at brokerage offices to find panicked brokers holding armfuls of sales scripts. Now, she says, the game is email.

"Everybody thinks they are investing in the next Microsoft," she said.

Messages promoting stocks jumped to 7.5% of all unwanted email in 2014 from 1% in 2012, according to Trustwave, a Chicago-based cybersecurity firm. Promoters can also use social-media services such as Twitter to draw attention to a penny stock. In one case last year, shares of social-network operator Cynk Technology Corp. surged from six cents to $21.95 amid buzz generated over Twitter. The stock quickly collapsed; Philip Kueber of Canada this year pleaded guilty to securities fraud in the case. Others have also been charged.

In the J.P. Morgan hacking case, criminal charges announced last month allege that 31-year-old Gery Shalon, 41-year-old Ziv Orenstein and 31-year-old Joshua Aaron orchestrated a chain of cyberattacks on the major U.S. bank and other large financial institutions.

J.P. Morgan and Mr. Shalon's attorney in Israel declined to comment. Mr. Orenstein's lawyers didn't return calls seeking comment. Mr. Aaron is still at large, federal authorities said.

Even before the breaches, the three men had already made millions from manipulating penny stocks, according to court documents. The documents allege that the defendants touted shares of at least six companies with very small market capitalizations, including Mustang Alliances, by distributing mass emails from domains including StockCastle.com and WallStreetPennyStockAdvisors.com.

The SEC alleges the three men began their promotion of Mustang Alliances shares in early 2012. Mr. Eldridge received his email about the stock in February that year, although it wasn't clear where that email came from.

"The first thing I ever got was that email saying Mustang was about to blow up," he said.

He wasn't the only one. In a 2012 lawsuit, George Sharp, a California-based investor who has brought lawsuits against penny-stock operators, said he received 149 unsolicited emails touting Mustang stock over roughly a two-month stretch that year.

A day after Mr. Eldridge bought 200 shares at $1.44, the price of Mustang Alliances stock rose three cents. Emboldened, the Belleville, N.J. resident added to his position.

Then, the bottom fell out. Mr. Eldridge kept waiting for the shares to recover, but after his investment sank about 80%, he gave up. "By the time you figure out what it is," he said, "you're just a bag holder."

Multiple efforts to reach Mustang Alliances executives weren't successful.

"A lot of smart people have been duped," by pump-and-dump schemes, said Gregg Berger, a former stockbroker who was sentenced to two years in federal prison for his involvement in a $30 million stock-fraud case. From 2005 to 2007, he sold shares to investors on behalf of an international group of conspirators that distributed millions of emails a day.

"I turned a blind eye to my clients who were running a pump and dump," he said. At the peak of the scheme, Mr. Berger estimates investors bought more than $1 million worth of shares a day.

The promise of a quick windfall can be hard to resist, particularly as an economic rebound and consecutive years of a rising stock market leave investors with more money to spend, said Richard Peterson, managing director at MarketPsych LLC, a consulting firm focused on behavioral finance. Many stock promotions bluff investors by quoting a perceived authority or insisting they need to act immediately. "It's basically a formula for what stimulates risk-taking," he says.

Even Mr. Eldgridge wasn't completely turned off.

After being burned on Mustang, he bet on about a dozen more penny stocks before giving it up to focus on his 401(k) plan.

"Everyone wants to put in a little money and walk away with a whole lot more," he said. "It's the American dream."

(END) Dow Jones Newswires

December 07, 2015 05:30 ET (10:30 GMT)

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