Due diligence an important step to take prior to investing
By Tony Monterastelli
Many techies love to invest their money in other tech companies. But whether you’re putting up seed money for a startup, or buying the stock of a public company, look out for more than just the market risk. Look for signs of fraud. Here are some tips for making proper due diligence a regular part of your investment decisions, according to Joe Dickerson, a private financial investigator based in Lakewood. Many of his customers are investors who hire him to check out companies and businesses before they invest.
… Closely examine the structure, even the location, of the company. For example, think twice before investing in a limited liability company and limited liability partnership, Dickerson said. An LLC or an LLP make it easy for the owners to hide financial and business shenanigans, he said. “There are still a lot of legitimate LLCs and LLPs,” Dickerson said. “But it raises a red flag.”
… Location matters, too. Caution lights illuminate when Dickerson sees that a company is incorporated in California or Florida, especially when its offices are in Orange County, Calif., or Boca Raton, Fla. With many wealthy retirees, those areas tend to attract more than their share of scam artists, he said.
… Read the company’s reports. Public companies must file regular quarterly and annual reports with the Securities and Exchange Commission if they have more than 500 shareholders and at least $10 million in assets. All companies that list their securities on the Nasdaq Stock Market or the New York Stock Exchange file reports with the SEC, and anybody can get those reports for free from the SEC’s EDGAR database (located at www.sec.gov). However, the reports never will give you the whole story, Dickerson said. For example, a company will report that it has been sued for patent infringement, but it won’t say whether the suit involves a crucial technology, he said. “It’s going to get couched in minimal terms,” Dickerson said. “But you’re going to have enough information that you’ll be able to make additional inquiries.”
… Beware of penny stock companies. These companies generally have shares priced under $5, have few assets and usually are just in the idea stage, with few, if any, customers and little revenue. In the tech realm, many such companies trade on the National Association of Securities Dealers Over The Counter Bulletin Board (OTC BB), a quotation service that never should be confused with the Nasdaq stock exchange. Penny stocks can tempt tech-savvy investors. Usually, the concept sounds exciting, and at such low prices, they offer the chance to amass a large ownership position, along with the feeling of getting into an investment at the ground level.
But sometimes the people who run these companies engage in “pump and dump” schemes, which are among the 10 most frequent forms of stock fraud listed by the North American Securities Administrators Association (NASAA), a group of state securities officials. Such schemes often involve the use of paid stock promoters who tout the company’s stock in the media and on Internet message boards. Beware of companies that issue press releases that hype the potential of their technology, often saying that it will “revolutionize” their industry, especially when the company has no customers and little, if any, revenue. Stock promoters should clearly disclose whether the company has paid them to tout the firm. The NASD can give a partial disciplinary history on the broker or firm that’s touting the stock through its toll-free disclosure hotline, 800-289-9999, or its Web site at www.nasdr.com.
… Beware of timely or trendy ideas. In the mid-1990s, some investors fell for bogus “wireless cable” investments, despite the oxymoron, because those words sounded like a hot new technology, Dickerson said. While most techies know enough not to fall for such a fabrication, it’s good to look twice at investments in hot technologies. According to the NASD, scams have arisen recently regarding companies – or supposed companies – that make defense, anti-terrorism or biological detection products. Often the company claims that is has technologies or services that will help the war against terrorism or protect the public from biological threats, such as anthrax.
… Finally, know who you invest with. Know your company executives well, Dickerson said. For example, Dickerson starts by checking a company president’s driving records. “I want to know how many times he’s been arrested for driving under the influence. It tells you something. If you’re going to invest your money with somebody, you don’t want all of it going up his nose,” he said. “If people would look at who they invest with, they would avoid a lot of bad investments.” Above all, Dickerson reminds investors to heed these familiar rules: “There’s no free lunch, and if it seems too good to be true, it probably is.”