7 Signals to Spot a Scam


The chart shows the share price trend of the South Sea Company, with the famous South Sea Bubble popping in 1720, and being the first of countless such scams in global stock markets. As Edwin Lefèvre points out in the wonderful book Reminiscences of a Stock Operator, “Nowhere does history indulge in repetitions so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics the one thing that strikes you most forcibly is how little either stock speculation or stock speculators to-day differ from yesterday. The game does not change and neither does human nature.” Plus ca change...........

I was reminded of this last week – it was a busy week for corporate governance experts, as they were trotted out to talk about three equity price plunges in Hong Kong and a fourth in London. I know little about the two Goldin companies, a little more about Plus500 (and I shall return to this), but I thought Hanergy had some tell tale signals. This article is intended to shed some lights on how to spot potential scams, and to avoid such traps.

I stress for the benefit of my lawyer that I have no idea whether Hanergy, Goldin and Plus 500 are honest or dishonest companies. The point is that even if they are perfectly reputable, their shareholders have been through the wringer. There is no need to take such risk and here are a few pointers which are red flags to me when analysing companies.



7 Ways to Detect a Scam (or a risky stock)

1              Dislocated Listing

You have to have a reason to list somewhere other than your home market. Often, this is perfectly legitimate – for example, a European tech company listing on Nasdaq to achieve a higher rating in a market which has a more sophisticated approach to valuing such companies.

Being suspicious of such listings is usually fruitful, and I have enjoyed the benefits both ways. One Kazakh mining company listing in London struggled to receive any attention, and by paying careful attention to the assets, it was possible to make 4x your money on the IPO price. Conversely, an Indian energy company listed in London; its promoter-founders had a poor reputation in India, it was not a good business and it was clear that the stock would fall and indeed it collapsed.

Moral here is dislocated listings require close investigation.

2              Heavy Insider Holding

This is usually a positive sign, but in certain cases it can spell trouble. A founder who is increasing his stake may simply believe that the share is cheap, but sometimes there is an ulterior motive. Often such shares have limited liquidity which can fuel the share price, and sometimes that is the purpose because the founder has pledged his shares for security against debts. I cannot think of many occasions where there was an indebted founder with a big shareholding that ended well – there are lots of cases when this ended badly.

3              Meteoric Share Price Rise

When the chart ranks steeply from left to right, this is often a danger signal. Obviously sometimes it shows a great company but when the rise is really steep and this is combined with the conditions in 2 above, be careful.

4              Young/inexperienced founder

The young founder or the founder who appears out of the woodwork with no obvious background experience, can often be a sign of trouble. Obviously many highly successful tech companies were started by university students. And some scams are run by highly experienced executives, but just as often there is a clue in the background of the founder.

5              Isolated industry

How often has there been a scam at a a widget maker, with a large supply chain and established customers? Usually a scam company has no obvious supply chain, or as in the case with Hanergy, it has an internal ie intra--group supply chain which it is impossible for the outsider to penetrate. Talking to competitors, to customers and to suppliers will help you spot scams.

6             Accounting restatements

Restatements and changes of auditor are tell-tale signals that something is wrong. I have no idea whether Plus500 is an honest company or not, but its UK subsidiary accounts are very unusual. I can accept that a change of auditor could cause a wholesale revision of its financial statements – if that were properly explained, I could believe it. But two things stood out for me – one was that the cash balances were revised, and that is peculiar. Another was that the company had received an equity injection of £5m and had paid a dividend of £4.5m. Conceivably this could have a quite normal explanation, but it certainly raises some questions. And if a company cannot or will not explain these items, it’s usually best to leave the shares alone.

7              No analyst coverage

If there is no analyst coverage, or only from the connected broker, you should ask why. Sometimes the explanation is that the management is not trusted and if the brokers don’t trust them, neither should you, unless you have done your homework very carefully.

This is by no means a comprehensive guide, it’s long enough already, but I wanted to have a checklist to remind myself of what to be wary of, and I thought it should be shared.


If you have got this far, you probably have had enough, but for those wanting a quick summary:


Posted in Investment