Stock scam illustrates growing problem

Article by: DAVID PHELPS , Star Tribune
Updated: March 23, 2008 - 5:02 PM

Penny-stock schemes, like the one allegedly involving Beverage Creations of Mendota Heights, are on the rise, the SEC says.

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The Internet touting was breathless. Beverage Creations Inc. (BCI) was a sure-bet investment.

"DON'T take [BCI] off your radar," implored the website TheStockPic.com. "[BCI] DUE FOR ANOTHER RUN."

But the website announcement was the work of a penny-stock promoter trying to gin up the share price of Beverage Creations in order to make a quick profit off of unsuspecting investors who bought into an eight-month-old Minnesota business that had yet to produce or sell a single product.

The Securities and Exchange Commission stepped in this month, halting trading in Beverage Creations stock and seeking penalties against the Texas investors who it said were behind the frenetic and manipulative "pump and dump" scheme.

Penny-stock fraud -- scams involving low-priced shares of small, obscure companies -- is on the rise, the SEC says, and the regulator says the case of Beverage Creations should be a warning to everyday folks looking for the next best thing. The SEC's website has a page dedicated to pump-and-dump scams on the Internet, offering tips for avoiding overhyped stocks.

"It's like the old snake-oil salesman going from town to town. Only now you just go on the Internet," said former federal prosecutor Peter Henning. "The pitch may change over time, but greed never goes out of vogue."

In the matter of Beverage Creations, according to the SEC, three Texas investors and entities they controlled purchased a large block of stock from the Mendota Heights company at 2 cents a share. For 9,999,999 shares, Beverage Creations received $199,999, the SEC said.

To stimulate interest in the stock, the investors used family and friends to generate trades and build volume and "give the appearance of increased demand for BCI stock," according to the government lawsuit.

Then the hype began, first with a full-color promotional mailer that stated "Early investors could make a fortune with [BCI]" and alluded to potential profits of 250 percent in the first 30 days and 799 percent by 2009.

At the same time, online promotion of Beverage Creations heightened on the website, whose hosting fee was paid for by one of the Texas defendants named in the SEC complaint and administered by the sister of another of the named defendants.

After less than two months on Pink Sheets, an electronic quote system for over-the-counter stocks, trading in Beverage Creations was suspended by the SEC and a lawsuit was filed for a permanent injunction to stop the pump-and-dump activities.

"Our case is based on their failure to register and to sell the stock to the public without the necessary [financial] disclosures," said Robert Burson, associate regional director of the SEC's Chicago office, which is handling the case. "Why do [pump-and-dump] people do this? Because investors don't have any real information to latch onto."

A spokesman for Beverage Creations said the company intends to cooperate with the SEC to "clear its name and resume trading." The company says it is developing a line of sports water that contains an inhalable shot of oxygen.

The SEC has accused the company of fraud and alleged that it lied when it publicly denied any connection to one of the stock promoters.

Pump-and-dump schemes have been around for years but appear to have mushroomed in recent years with the help of the Internet.

The SEC became so concerned with stock fraud on the Internet that it started an "anti-spam initiative" last year when complaints over the practice soared. The agency even monitors YouTube for promotional stock videos.

The digital security firm SonicWall says penny-stock e-mail scams jumped by 400 percent in 2006 and were up at a double-digit rate in 2007.

"In 2005 this wasn't particularly popular, but once people started doing it and it worked, everybody jumped on it," said Andrew Klein, product manager for San Diego-based SonicWall. "People are still making money doing it."

For prosecutors and regulators, penny-stock fraud is a particularly vexing problem, in part because of the number of people who can be affected and because many will simply tuck their tail and lick their wounds when their sure-thing investment goes south, rather than report it to authorities.

"These are hard cases to prosecute," said Henning, a former SEC and Justice Department attorney who now teaches at Wayne State University Law School in Detroit. "The U.S. attorney's office doesn't have time. The SEC is the first line of defense, but there is more than enough [securities] crime out there already. Look at the Beverage Creations case: The promoters are in Texas, the company is in Minnesota, investors are all over the place. That's a lot of [investigative] legwork."

Pump-and-dump schemes haven't been seen much in Minnesota since 1982, when an obscure aviation services firm based at Eden Prairie's Flying Cloud Airport successfully portrayed itself as a fast-growing air charter business. The company, named Flight Transportation Corp., raised more than $34 million from shareholders and millions more from banks before it was discovered that it had virtually no charter operations.

"Minnesota has been grounded in established companies and industries. High-tech companies, medical devices, giants in the food industry. We haven't seen a lot of get-rich-quick schemes," said Tom Fraser, a securities attorney for the Minneapolis firm of Fredrikson & Byron. "The penny stocks can be tempting because the investment can be relatively small. But there's usually a reason these companies are priced with pennies in the first place."

David Phelps • 612-673-7269

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