Stratton Oakmont Scandal Essay

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Wolf of Wall Street, Jordan Belfort, committed a classic pump and dump scam, under the guise of his investment firm, Stratton Oakmont. This crime went on for several years before the company was investigated, closed, and Belfort sent to prison. The following paper outlines this case in detail.

The Crime & How it was Committed

The securities industry is governed by the Securities Exchange Commission, which exists in part to ensure that the capital markets are trustworthy. When investor trust in the markets is compromised, this makes it more difficult for firms to raise capital. Thus, it is imperative for any country to have securities regulators that ensure a fair and honest capital market system, including the stock market. There are many ways to commit fraud in the stock market, one of which is the pump and dump scheme that Stratton Oakmont committed.

The principle is fairly simple. The company buys a large quantity of penny stocks. They then use their brokers to cold call people and convince them to invest. These people, who are usually fairly wealthy but not sophisticated investors, are convinced to put their money into this worthless penny stock. The influx of capital starts to push the stock price upward, so the investors are convinced that this is a good investment -- that they are seeing the gains they were promised materializing.

Then, when a large enough amount of capital has been gathered, the investment house begins to sell its shares. It does this quietly, so that it is difficult to detect. It sells these shares at a premium, because of the influx of the buyers. After it sells its stake, there are still many buyers left holding shares, which are no worthless. The brokerage has artificially inflated the stock price of a security that had basically no intrinsic value, and then sold out at the top of the market for a strong profit. The investors who were convinced to buy the shares usually bought in at the higher end of the market. When the stock returns to its penny status, because the brokerage is finished selling its shares and there is no more demand, the people who still hold shares will have bought high, lost all of it, and then been left with nothing. The scam is called pump and dump because the brokerage pumps up the value of the shares, then dumps them, so that it can turn a profit on all the shares that it had initially bought.

The sales technique was basically just a boiler room. The sales associates were marginally qualified or entirely unqualified. They may have had some investment training and licenses, or there may have only been a couple of actual traders on hand to execute the deals. The sales reps cold called clients, and in most cases they had to sign the clients up, and convince them to send in checks. The clients were subjected to high pressure sales tactics to convince them to sign up. It would be unusual to have a sophisticated investor be duped by this type of scam -- typically Stratton Oakmont's boiler room would prey upon those who were wealthy, but also greedy, and not very sophisticated in terms of their investment knowledge, or their knowledge of common scams.

Who Committed the Crime

The principle in the crime was Jordan Belfort, who was the CEO of Stratton Oakmont and the ringleader behind the scam. He put together a team of friends and associates in order to build this company that would execute these scams. They were large, sophisticated scams so the entire company was involved. This amounted to dozens of people, who performed different roles at the company. When Belfort cut his plea deal, he provided testimony against a number of partners. Thus, even while he was the face of the organization, there were other people involved in positions of power.

Why They Committed The Crime

The main reason, as Belfort himself has noted, is greed. The crime was committed against a backdrop of a group of people not really having much of a purpose in life, but realizing that there was easy money to be made through such scams as this. With the ability to sell people on such stocks, Belfort and his partners realized that they could make an incredible amount of money. The movie and book detailed the lifestyle that they were living, which was all about parties and spending lavishly. There is little doubt that this fast life encouraged this greed, and the pursuit of ever more victims.

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The scam began with greed, doubtless, and this was combined with opportunity. However, they continued the crime for a long time, and that was based on greed, in particular the desire to maintain the fast lifestyle that the people at the company were living.

There was doubtless also some hubris involved. The reason for this assessment is that after a few scams, they had a lot of money. The company was already being investigated by authorities, and there was considerable risk in what they were doing. Apparently, however, they thought that they would be able to continue with such scams, which is evidence of a certain hubris, not just to commit a crime but to keep committing it even when they knew that they were attracting the attention of the authorities.

Who Caught Them and How

A pump and dump is actually quite easy to detect. The stock markets gather information on stock trades, and this information is public knowledge. The penny stocks that were being traded were typically in the pink sheets, or over the counter. These stocks are not on the NYSE or NASDAQ. This makes trading in the more opaque to the general public, but securities regulators are able to track these trades. They can see the trading patterns that illustrate the pump and dump pattern, and they are able to see what brokerage house is driving the trading for that particular security. So Stratton Oakmont came under regulatory scrutiny fairly early on in its existence because the signs of a crime were apparent, and a matter of public record.

Proving the fraud is more difficult. Investing is basically a caveat emptor situation, so in a sense just because people are losing money does not necessarily mean that regulators will be able to secure the warrants needed to build a case. The trading records would need to be gathered. Investigators would need to gather testimony about the company's sales tactics, evidence about the lack of intrinsic value in the stock, and continue to pursue analysis of the sales data. Trading in stocks aggressively is not illegal, so the regulators would have to find intent to defraud, and evidence that the firm's actions specifically constituted a fraud.

The company was shut down, after sufficient evidence was gathered of persistent securities infractions. The principles were pursued for other crime as well, in addition to securities fraud. Money laundering and tax issues were investigated against Belfort, who was eventually convicted of money laundering. The SEC has the authority to shut the company down and strip its traders from the right to transact on the stock markets, but the FBI was responsible for the criminal charges. The SEC was able to bring its actions first, as it has mandate to act very quickly when criminal activity has been demonstrated by a brokerage firm.

Outcomes

Belfort was able to secure a plea bargain, in exchange for testimony against some of his partners. This was an interesting outcome, given his importance, and it raises questions about who those partners were. Belfort received a fairly minor prison sentence, which he served, as was ordered to pay restitution to the people whom he defrauded. This was in excess of $100 million, and of course he will never be able to pay that amount back. At this point, he is still paying money back, but makes money only on his book and speaking engagements.

Thus, it was mainly his victims that paid for the crime. There were other people at Stratton Oakmont who also did prison time, so it was more than just Belfort, but there were likely people at the company who avoided prison. More important is that the restitution will never be paid -- this will be impossible -- and that means that the people who lost money will never see any of that money returned. As a consequence, it is the victims of the crime who are suffering the consequence. Belfort's prison sentence being over, most of his punishment is over, even if he is not allowed to keep very much of his earnings.

Overall, the crime in Wolf of Wall Street was significant mainly for its size. There have been many such pump and dump scams over the years, but this was fairly huge and went on for a few years before regulators were able to make their cases. The resulting high profile of the case has led it to be perceived as….....

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