is a problem, because it means many of us are pied piper bait.
Remember War of the Worlds, that early sci-fi book by H.G. Wells? In 1938 his near namesake, actor and director Orson Welles, decided to broadcast part of the book as a radio dramatisation. Orson thought it would be a bit of fun to throw this story about a Martian invasion out onto the airwaves. Unfortunately he hadn't factored in how gullible the public can be.
Welles' trick was to deliver the broadcast in the form of live news bulletins, as if the events were unfolding as he spoke. The reaction was phenomenal. Time reported that in Newark, New Jersey, 20 families wrapped their faces in wet towels in anticipation of the Martian gas attack. Fifteen people were treated for shock at Saint Michael's Medical Center. A Tennessee newspaper recalled all its editorial staff and began to prepare a special edition on the bombing of Chicago and St Louis. A Pittsburgh man was barely able to stop his wife from swallowing poison. The angry mayor of a midwestern city telephoned the radio station to report mobs in the streets of his city, violence, looting and masses seeking safe haven.
Now if people could swallow this stuff, they'll swallow pretty much anything. When Joe Citizen is sitting in his lounge room with his TV dinner on his lap and Eddie the Economist tells him how things are going to be, he's sure to believe it.
It doesn't even need to be an economist or a stockbroker who's spinning the fiction. At the tail end of the Global Financial Crisis (GFC) in early 2009, a friend of mine was watching one of those tabloid ‘current affairs' shows on TV. You know the type – they sneak into dental surgeries with a hidden camera to get footage of the dentist returning from the bathroom without washing his hands.
For this show they'd consulted a psychic about where the stock market was heading. I have no idea whether it was the cards, the tea-leaves or how Jupiter and Mars were aligned, but the psychic delivered some pretty bad news. After watching the show my friend became worried sick about her stock portfolio.
Even hardened investment professionals can get suckered in. On 11 April 1997 a Financial Times story reported that a fund called Czech Value Fund (abbreviated to CVF) had invested in fraudulent companies and was facing big losses. The news, upon reaching the US, caused Castle Convertible Fund (stock ticker symbol CVF) to plummet. Trouble was, Castle Convertible Fund had no relationship with Czech Value Fund beyond the chance sharing of the three letters ‘CVF'.
And what about this one? In the late 1890s a Baptist minister, Prescott Ford Jernegan, claimed he'd received a ‘heavenly vision' that enabled him to extract gold from seawater. Jernegan saw the opportunity to convert his God-given skill into a profit-making scam. But first he needed to give it some credibility, so he enlisted the aid of lifelong friend and confidence trickster Charles Fisher, who was a professional sea-diver.
Jernegan had constructed a box he called the ‘Accumulator'. He claimed his invention could collect gold when dropped into the sea. It supposedly worked by sending a current of electricity through wires, resulting in detectable deposits of gold forming in the box within 24 hours. Jernegan then invited an unwitting jeweller, Arthur Ryan, to test his ‘gold from seawater' claim.
Ryan and an associate dropped the Accumulator off the end of a pier at Narragansett Bay, Rhode Island. While Ryan was waiting for the gold to ‘accumulate', Jernegan's accomplice, Fisher, donned a diving suit, swam under the pier and slipped a few gold nuggets into the submerged box. Ryan retrieved the box and confirmed the gold was genuine. Word of Jernegan's magic Accumulator spread quickly.
Off the back of his now legitimised business model, Jernegan set about establishing a listed company. Stock in the Electrolytic Marine Salts Company was offered at $1 per share. The first tranche of 350 000 shares sold out in three days, and investors demanded more. Within weeks $2.4 million worth of stock had been subscribed.
To keep the scam rolling, Jernegan and Fisher commenced the planning and construction phase for a new commercial facility based on Accumulator technology. But they didn't stick around to supervise construction; they shot through with the $2.4 million from the capital-raising without so much as a goodbye. And if you think that couldn't happen today, that hardened professionals are too market-savvy to fall for con men and tricksters, I'll give you just two words – Bernie Madoff.
If it makes you feel any better, this whole rip-off thing isn't always about trying to outsmart the common punter. Anyone is fair game. Sometimes investment professionals even turn on their own kind.
Nineteenth-century Wall Street stock trader Daniel Drew was renowned for plenty of scams, but one that served him particularly well was his handkerchief trick. Drew famously once used it to pump up the price of Erie Railroad stock. After dining with fellow stock traders at a New York club, Drew wrapped a note in his handkerchief. It was a list of (fictional) reasons why Erie was a great buy. He placed the handkerchief in his pocket, then, when pulling it out, allowed the note to fall to the floor. After Drew had left, the traders swooped on the discarded note. Acting on Drew's false tip, they bought Erie stock and in the process pushed its price north. Drew was on the other side of the trades, madly selling at the inflated prices.
While Drew might have been cunning, he can't claim that his handkerchief scam was original. Author and businessman Joseph de la Vega traded stocks on the Amsterdam Exchange back in the 17th century, and in his 1688 book Confusion de Confusiones he writes:
If it is of importance to spread a piece of news which has been invented by the speculators themselves, they have a letter written and [arrange to have] the letter dropped as if by chance at the right spot. The finder believes himself to possess a treasure, whereas he has really received a letter of Uriah which will lead him into ruin.
Hey, we live in the digital age now. No longer the need for notes scribbled on pieces of paper. Just find a thinly traded stock and get to work on the internet. Enter 15-year-old Jonathan Lebed, the first minor ever to fall foul of the US Securities and Exchange Commission (SEC) on charges of stock manipulation. From late 1999 into early 2000 Lebed made hundreds of thousands of dollars using the time-honoured technique of ‘pump and dump', also known as ‘buy, lie and sell high'.
Lebed bought shares in small-cap stocks where he had a chance of moving their share price. Then he'd use multiple fictitious names to post hundreds of messages on Yahoo Finance message boards recommending the stock as a strong buy. After the price moved up, he'd offload his holding. No different from Drew or the 17th-century Dutch traders.
Lebed settled out of court with the SEC but kept a fair proportion of his ill-gotten gains, which probably explains why he kept using the internet to hype stocks. In an interview with Fox Business's Cody Willard long after his scuffle with the SEC, Lebed admitted to running a business where he was paid by small caps seeking promotion on his website. Stock research be damned – if they paid up, they scored a buy recommendation.
DRAWING THE LINE OF CREDIBILITY
There is so much information out there. What should we believe? Where do we draw that line separating fact from fiction? It's a pretty important line to draw when investing. Problem is, everyone draws it in a different place. And who's to say you've drawn yours in the right place?
Take 19th-century English economist William Stanley Jevons, who came up with a novel way to predict the business cycle: he linked it to sunspot activity. Jevons wasn't a crackpot. In fact he was a highly respected economist, having presented views on marginal utility theory and the application of mathematical logic to the study of economics – which meant his sunspot idea gained some traction.
While Jevons had observed a loose correlation between sunspots and the business cycle, correlation doesn't prove causation. Bald men are more likely to wear hats, but that doesn't mean hats cause baldness.
But this whole sunspot thing mightn't seem so stupid if you are
