What Have Been the Most Notorious Stock Scams in Recent History?
Having a better understanding of how disasters have occurred in the past can help current investors avoid similar occurrences in the future. Here are some of the most notable instances of corporations betraying their shareholders throughout history.
Some of these cases are downright incredible. Examine them through the eyes of a stockholder’s perspective. Unfortunately, because they had been duped into investing, the shareholders involved had no way of knowing what was really going on.
The Most Important Takeaways
Investment fraud has occurred throughout history, from the Dutch Tulipmania to the South Sea bubble to the Mississippi Company fraud.
In recent history, stock scams have taken the form of accounting fraud, which involves falsifying financial records and concealing losses to pyramid or Ponzi schemes for fictitious companies that otherwise exist.
The following sections examine some of the most significant stock-scam incidents that occurred between the 1980s and the 2000s.
The ZZZZ Best (1986)
Barry Minkow, the owner of this carpet cleaning company in the 1980s, predicted that his company would one day become known as the “General Motors of carpet cleaning.”
1 Minkow appeared to be building a multi-million dollar corporation, but he was actually stealing and forging documents to do so. The fact that nobody was aware of his activities led to the creation of more than 20,000 fake documents and sales receipts. 2
Minkow spent more than $4 million to lease and renovate an office building in San Diego, despite the fact that his company was a fraud intended to deceive auditors and investors. After going public in December 1986, ZZZZ Best had a market capitalization of over $200 million at the time of its initial public offering (IPO). Barry Minkow was only a teenager at the time of the incident, which is incredible. 2 He was found guilty and sentenced to 25 years in prison.
Centennial Technologies is a company that specializes in information technology (1996)
Centennial Technologies’ CEO, Emanuel Pinez, and his management team reported in December 1996 that the company had generated $2 million in revenue from PC memory cards during the previous quarter. The company, on the other hand, was actually shipping fruit baskets to customers. The employees then created fictitious sales records to serve as evidence that they were actually recording sales. A Centennial stock price of $55.50 per share traded on the New York Stock Exchange represented a 451 percent increase (NYSE). 3
In a filing with the Securities and Exchange Commission (SEC), Centennial admitted that it overstated its earnings by approximately $40 million between April 1994 and December 1996. Even more astonishingly, the company reported a profit of $12 million after suffering a loss of approximately $28 million.
The stock price plummeted to less than $3 per share. Over 20,000 investors saw their money disappear almost completely when a company that was once considered a Wall Street darling went bankrupt. 3 Pinez was found guilty of five counts of securities fraud, including insider trading and the recording of fictitious sales of fictitious products in order to boost reported revenue. Pinez was sentenced to prison time. 4
Bre-X Minerals (1997)
This Canadian corporation was a participant in one of the largest stock frauds in the history of the world. A report from the company claimed that its Indonesian gold property contained more than 200 million ounces of gold, making it “the richest gold mine in history.” Bre-stock X’s price soared to a record high of $280 (split-adjusted), transforming ordinary people into millionaires in an instant. Bre-X had a market capitalization of $4.4 billion at the time of its peak.
The celebration came to an end on March 19, 1997, when the gold mine was discovered to be a fraud, and the stock plunged to pennies shortly thereafter. The Quebec public sector pension fund, which suffered a $70 million loss, the Ontario Teachers’ Pension Plan Board, which suffered a $100 million loss, and the Ontario Municipal Employees’ Retirement Board, which suffered a $45 million loss, were the biggest losers. 5
Enron is a corporation that was founded in 1977. (2001)
The Enron Corporation, a Houston-based energy trading company, was the seventh-largest company in the United States in terms of revenue prior to the collapse of the company.
6 Enron was able to keep hundreds of millions of dollars in debt off its books by employing a complicated accounting scheme that included the use of shell companies. 7 In doing so, the company deceived investors and analysts into believing that the company was more fundamentally stable than it really was. Enron executives also used the shell companies to generate fictitious revenues by recording the same dollar of revenue multiple times, a practice known as “multiple dollar recording.” 8 As a result of this practice, the appearance of incredible earnings figures was created. 9
Eventually, the intricate web of deception came crashing down, and the stock price plummeted from more than $90 to less than 30 cents. When Enron collapsed, it also brought down Arthur Andersen, which was at the time the fifth largest accounting firm in the world. 10 After David Duncan, Enron’s chief auditor, ordered the shredding of thousands of documents, Andersen, the company’s auditor, basically imploded. 11 As a result of the Enron scandal, the phrase “cook the books” has become commonplace once more.
WorldCom is a company that provides information technology services (2002)
Not long after the collapse of Enron, the stock market was rocked by another billion-dollar accounting scandal, this time involving a multinational corporation. The telecommunications behemoth WorldCom was subjected to intense scrutiny after yet another instance of serious “book cooking” was discovered. Operating expenses were recorded as investments by WorldCom. According to reports, the company considered office pens, pencils, and paper to be an investment in the future of the company and, as a result, expensed (or capitalized) the cost of these items over a period of several years, rather than all at once. 12
Approximately $3.8 billion in normal operating expenses, which were supposed to be recorded as expenses in the fiscal year in which they were incurred, were treated as investments and recorded over a number of years, resulting in a total loss of $3.8 billion. This small accounting trick resulted in a significant overstatement of profits for the year in which the expenses were incurred.
WorldCom earned more than $1.3 billion in profits during the year 2001. In fact, the company’s operations were becoming increasingly unprofitable. Who has suffered the most as a result of this transaction? Employees were laid off in large numbers; tens of thousands of people lost their jobs. 13 The investors were the next to be affected by the betrayal, as they were forced to witness the gut-wrenching decline in the value of WorldCom’s stock price, which plummeted from more than $60 to less than $1.14.
Tyco International is a multinational corporation (2002)
Tyco executives made certain that 2002 would go down in history as a memorable year for stocks, despite the fact that WorldCom had already eroded investor confidence. Tyco was considered a safe blue chip investment prior to the scandal because it was a manufacturer of electronic components, health care products, and safety equipment. As CEO of Tyco International Corporation, Dennis Kozlowski, who was named one of the top 25 corporate managers by BusinessWeek, siphoned hordes of money from the company through unapproved loans and fraudulent stock sales during his tenure.
Kozlowski, along with CFO Mark Swartz and CLO Mark Belnick, received $170 million in low-to-no-interest loans without the approval of the company’s shareholders. An agreement was reached between Kozlowski and Belnick to sell 7.5 million shares of unauthorized Tyco stock for a reported $430 million.
15 These funds were smuggled out of the company under the guise of executive bonuses or other benefits, among other things. With the money, Kozlowski was able to continue his extravagant lifestyle, which included a slew of houses, an infamous $6,000 shower curtain, and a $2 million birthday party for his wife, among other things. In early 2002, the scandal began to unravel slowly, and Tyco’s stock price plummeted nearly 80 percent in a six-week period as a result.
However, they were eventually convicted and sentenced to 25 years in prison after their first hearing was called a mistrial. The executives were initially exonerated by the court. 16
HealthSouth is a non-profit organization dedicated to improving the health of the people of South Carolina (2003)
When it comes to large corporations, accounting can be a difficult task, especially when executives want to fudge earnings reports. In the late 1990s, CEO and founder Richard Scrushy began instructing employees to inflate revenues and overstate HealthSouth’s net income in order to increase the company’s stock price. At the time, the company was one of the largest health-care service providers in the United States, experiencing rapid growth and acquiring a number of other healthcare-related businesses along the way. 17
The first indication of trouble appeared in late 2002, when Scrushy allegedly sold HealthSouth stock worth $75 million prior to the company reporting a loss for the quarter. According to the findings of an independent law firm, the sale was not directly related to the loss, and investors should have heeded the cautionary tale.
The scandal began to unfold in March 2003, when the Securities and Exchange Commission (SEC) revealed that HealthSouth had overstated its revenues by $2.7 billion.
17 It was discovered when CFO William Owens, working with the FBI, recorded Scrushy discussing the fraud and played it back to the authorities. The repercussions were severe, with the stock dropping by 97 percent in a single day to close at 11 cents per share. Amazingly, the CEO was acquitted of 36 counts of fraud, but he was later found guilty of bribery and sentenced to prison.
According to reports, Scrushy arranged for $500,000 in political contributions, which enabled him to secure a position on the hospital’s regulatory board.
Bernard Madoff is a fraudster who defrauded investors (2008)
Bernard Madoff, the former chairman of the Nasdaq and the founder of the market-making firm Bernard L. Madoff Investment Securities, was arrested on December 11, 2008, after his two sons turned him in for running a widespread Ponzi scheme, according to court documents.
The then 70-year-old managed to conceal his hedge fund losses by compensating early investors with money raised from other sources. For the past 15 years, this fund has generated an average annual return of 11 percent. 18 A proprietary option collar strategy, which was claimed to be the reason for the fund’s consistent returns, was used to reduce volatility, according to the fund’s alleged strategy, which was provided as justification.
A total of approximately $50 billion was stolen from investors through this scheme. 19 He was found guilty and sentenced to 150 years in prison. Madoff died in prison on April 14, 2021, at the age of 82, after a long battle with cancer. 20
What’s the bottom line?
The worst part about these scams is that investors were completely unaware of what was going on. Those convicted of fraud may be sentenced to several years in prison, which increases the financial burden on investors and taxpayers even further. The Securities and Exchange Commission works to prevent such scams. 21 In North America, however, where there are thousands of publicly traded companies, it is nearly impossible to guarantee that a disaster will not strike again.
Is there a lesson to be learned from this story? Yes. Always invest with caution, and diversify, diversify, and more diversify your portfolio. Maintaining a well-diversified portfolio will ensure that occurrences such as these do not throw you off the road, but rather serve as minor speed bumps on your journey to financial independence and financial independence.