This post was originally published on Forbes Jun 26, 2015
Pump And Dump
Imagine having the rights to make actual sponges in the image of SpongeBob SquarePants. That was the enviable position of a company called Spongetech.
This appears to be a very good stock. $60m in annualized sales, strong growth, and a lot of advertising. Well the last item bugs me. They appear to be spending way too much money on advertising which is hurting their profitability. I recognize the need for recognition, but the profit motive is best for investors.
I’ll keep an eye on the stock, but it appears to be a very good buy at 0.15.
On the other hand, a brand that seems out of place in this expensive, cluttered marketing arena is SpongeTech, manufacturer of revolutionary sponges. Don’t get me wrong. I’m all for cleanliness, but giving out sponges at a tennis event strikes me as a little off the mark, unless of course the brand stands for good, clean fun.
SpongeTech was no ordinary pump-and-dump penny-stock scheme; it was, to play off Churchill’s famous definition of Russia, a fraud wrapped in a stock-market rig inside a money-laundering conspiracy.
Among the victims were Robert and Penny Greenberger who lost $569,220.
Up Close And Personal
Greenberger heard the rumors that Spongetech was a scam, but he believed they were false. Even as allegations of fraud began to percolate, Furth and Moskowitz both defended Spongetech when they spoke with Greenberger. When Greenberger asked Moskowitz about Spongetech’s delayed SEC filings, Moskowitz blamed the company’s accountants and assured him that the filings were coming. Greenberger believed these reassurances, and went so far as to repeat them by posting comments on internet message boards defending the company against accusations that its executives were committing fraud.
Greenberger’s closeness to Spongetech continued through its bankruptcy. Around the time Spongetech filed for bankruptcy, Greenberger finally received the financial statements that Spongetech had been delinquent in filing with the SEC. Greenberger had sent a letter to Spongetech in April 2010 demanding to inspect the company’s books and records, including its draft SEC filings.
Thus the principals in Spongetech were up close and personal in their deception of Mr. Greenberger.
Due to the lack of direct connection between wrongdoer and victim, the theft-loss deduction is generally not allowed in cases where the value of shares bought on the open market declines due to fraud. In a leading case, Paine v. Commissioner of Internal Revenue, the Tax Court held that a plaintiff who bought shares in a company on the open market could not claim a theft-loss deduction because the corporate officers who issued fraudulent financial records did not specifically target any one individual or sell the stock—they simply published the misleading information, and let market forces drive up the price of the stock.70 The officers, therefore, had not “criminally appropriat” the plaintiff’s property.
The Greenbergers also tried an estoppel argument maintaining that since the Department of Justice had notified them that they might be victims of a crime, that the government could not now argue that they were not theft victims. That just didn’t work because Ohio law requires a privity between the thief and the victim.
There is probably not much of a tax planning point here since nobody plans to get defrauded. The fraud story is a really good one, though. I can’t rate it that highly since the basis was simply inflating sales, but I do think they should get some extra credit for including an animated character.
Forbes contributor Timothy Todd also covered this case – District Court Denies Theft Loss Deduction For Worthless Stock. Professor Todd is new to forbes.com and he has already written quite a few pieces that seem to be very strong technically. You should go over and bid him welcome.
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