In its ongoing "Operation Shell Expel" to protect investors from fraud, The Securities and Exchange Commission suspended trading last week in the securities of 61 empty shell companies. The initiative is a crackdown against the manipulation of microcap shell companies that are “ripe for fraud as they lay dormant in the over-the-counter market,” the SEC announced in a statement.

From A (Austin Farms Inc) to Z (Zone Mining Ltd), these 61 companies are delinquent in their public filings and seemingly no longer in business. “Once they become dormant they have great potential to be hijacked by fraudsters who falsely hype the stock to portray it as a thriving company and coerce investors into ‘pump-and-dump’ schemes,” the SEC said.

A “Pump-and-Dump” scheme is one of the most common types of fraud against investors. False and misleading statements about a company’s stock are posted on social media sites, as well as on bulletin boards and chat rooms. Scammers purchase the stock at a low price before pumping the stock price higher by creating the appearance of market activity and drawing investor interest. Then they dump the stock for significant profit by selling it into the market at the higher price once investors have bought in. Once they dump their shares, the stock price tumbles and investors lose their money.

Stock manipulators look for empty shell companies that they can use to conduct pump-and-dump schemes and line their pockets with illicit trading profits by taking advantage of unsuspecting investors. A pump and dump scheme takes advantage of the fact that stock prices are only partially tied to the real value of a given company. Sometimes, a stock, or group of stocks or even the entire market will rise or fall purely because of speculation. A catastrophe occurs, such as 9-11, investors think companies will be worth less money in the future, and so they sell, starting a self-fulfilling prophecy. Or a company puts out a press release anticipating future progress, and so investors buy in, raising the price of the stock.

It sounds like something right out of Gordon Gekko’s playback – “Greed is good,” as Gordon said in the movie Wall Street. Over the years many of us have equated greed with our capitalist system of economics. Those in the know take advantage of those looking in from the outside. The pursuit of self-interest rules the day rather than making decisions after considering the effects of possible actions on the stakeholders.

This isn’t the way it is supposed to be in America. It is sometimes hard to remember, however, these cases are the exception and not the rule. If they were the rule, all chaos would break out and the stock market would collapse out of a lack of trust in the entire system.

However, financial fraud seems to be on the rise and the fraudsters are getting greedier by the minute. A good example is the decisions of many financial institutions that ushered in the great recession. And then there are the Ponzi schemers like Allen Stanford and Bernie Madoff. Stanford received a 110 year prison sentence for bilking investors out of more than $7 billion over two decades. In March 2009, Madoff pleaded guilty to 11 federal felonies that defrauded thousands of investors of about $65 billion. On June 29, 2009, he was sentenced to 150 years in prison, the maximum allowed.

So, it was not surprising to me that the SEC uncovered the pump and dump schemes. The crooks always seem to be at least one step ahead of the regulators. The SEC needs to develop a forensic accounting and auditing division that focuses on spotting the red flags that fraud may be present. It also needs to encourage tip-giving and whistleblowing.

The Dodd-Frank Financial Reform Act contains whistleblower provisions. I have mixed feelings about blowing the whistle on one’s employer without first following prescribed steps to identify and stop fraud. However, once that has been done whistleblowers should be encouraged to come forward and provide information about the fraud to the SEC. It is perhaps the best way to protect the public interest.

It is a sad fact in business today but all too many will engage in unethical, and even illegal actions, so long as they can and will only stop once they get caught.

Blog posted by Steven Mintz, aka Ethics Sage, on June 13, 2013