The market where 'caveat emptor' has become a charter for fraud

The statisticians marked 2005 as a record year for the Alternative Investment Market, the London Stock Exchange's market for small and growth companies. A record number of companies from the UK and abroad have floated on the AIM, and these new and existing companies have raised a record amount of cash.

But the champagne that was popped to celebrate AIM's 10th anniversary in June has gone pretty flat in the months since. For 2005 will also go down as a momentous year for scandal, a year when investors got to understand the downside of the market's fêted "hands-off" regulatory regime.

A new low-point was reached yesterday. The Serious Fraud Office said it had seen enough to begin an investigation of what looks like AIM's biggest-ever fraud. Langbar International claimed to have raised £140m in 2003 for unspecified future investments. It later claimed those investments had grown to £365m, and some of the City's most august fund managers handed over a further £4.3m fundraising this summer.

Last week the company's "forensic accountant" Kroll Associates revealed it "has not been able to establish the existence of, nor verify the company's entitlement to, any relevant assets at any time in the company's history". Those left holding the shares, now suspended, fear they have now lost everything.

The Stock Exchange and the "nominated advisers" (nomads) who specialise in working with AIM companies are all desperate to shore up the reputation of the market. While the Stock Exchange keeps rules and regulations for AIM companies to a minimum, it is the nomads' responsibility to ensure honest dealing and accurate reporting by the companies they advise.

Dru Edmonstone, the head of corporate broking at Seymour Pierce, which advises the largest number of AIM companies, said that part of the problem could be the growing number of small, inexperienced nomads. From 60 firms licensed to act as nomads a couple of years ago, the total has risen to over 80.

Mr Edmonstone said: "Some nomads are better than others, and I get nervous when I see names I haven't even heard of applying for licences. Everyone has thought, 'there's money to be made here boys'. Grown-up companies still go to use grown-up nomads, and these other outfits end up with the dregs. "So it has been a record year for AIM in terms of quantity, but has it been a record year for quality, that is the question?"

The Stock Exchange has given its AIM team more resources to oversee nomads, and it plans to step up visits to those firms deemed to have the most high-risk clients. And it has promised to come down hard on Nabarro Wells and Arden Partners, Langbar's two nomads, if they are found to have lapsed in their duty to try to prevent fraud and sharp practices.

A Stock Exchange spokesman said: "We are looking very intently at what went on and at all the actors. We know the individuals, we know the nomad, and if we find that they were not acting in the best interests of AIM then we will move on them, and we won't want to wait for the outcome of the SFO investigation." Nomads face private or public censure, fines or the removal of their licences if they are found wanting in their duty to try to root out fraud and sharp practice.

Inevitably, AIM will have more than its fair share of business failures because it is specifically aimed at more speculative, early-stage companies, often little more than a business idea at the time they come to market. One in six companies on AIM is in the natural resources sector, and about the same number are cash shells or investment companies with no trading business. Laurie Beevers, the chief executive of WH Ireland, says the speculative nature of AIM companies means nomads must ensure a significant emphasis is put on good corporate governance. His firm has become so worried about the quality of corporate governance at AIM companies that it presented a paper on the subject at a recent conference for mining companies.

He said: "There are more than 1,300 companies on AIM with a total market value of £50bn so Langbar and other incidents have to be seen from that perspective. Serious fraud can happen in any market in the world. But some people are still not taking good corporate governance seriously and we are always looking for good non-executive directors for companies."

The increasing number of overseas companies on AIM offers a great opportunity for UK investors and a revenue generating opportunity for the Stock Exchange, but it is also a reason to fear we have not seen the last of these great scandals.

Companies operating in corruption-riddled emerging markets, many with directors forged from the anarchic proto-capitalist days after the collapse of Communism, need the greatest guidance in UK corporate governance and the greatest supervision from nomads - but the further away they are from London, the harder it is to get a grip on them. Langbar may not hold the record for AIM fraud for very long.

Scandal writ large

A ... is for Audacious remuneration

By the start of this year, it seemed that every third company floating on AIM was not a company at all, but a "cash shell" whose prospectus contained only a vague promise to make investments or an acquisition in due course.

Many of these shells were little more than get-rich-quick schemes for the founders who, if you were minded to read the small print, had bought their own shares in the company at a much lower price than its float price. Many can sit without doing a deal for years, while the directors continue to receive a salary.

One of the most egregious examples this year has been White Nile, the shell company created by Phil Edmonds, a former England spin bowler, who bought £15,000 shares at 0.1p only to float it on AIM at 10p, netting a 9,900 per cent profit within three months.

There was so little stock available for the public on flotation that it then soared to over 100p - incurring the wrath of the Stock Exchange, who suspended the shares. At least Mr Edmonds has since put a Sudan oil exploration business into his shell (although Total, the French oil giant, claims it has in effect been stolen from them).

Ian O'Neill's e-primefinancial was created in 1999 to set up a US internet bank during the dot.com era but failed to do so and has lain dormant since, making it one of AIM's longest inactive shells. It returned £8.1m of its £22m cash to shareholders but still sits on £1.8m. It has been renamed EP&F Capital and Mr O'Neill continues to harvest £20,000 a year in consultancy fees plus expenses.

I ... is for Indecent timing

City veterans sigh at the familiar cycle of "wonderstock" hype followed by disappointment, but even they were shocked when Regal Petroleum announced that its offshore oil wells in Greece, the jewel in the company's portfolio of exploration assets, were dry.

The announcement came within a month of a £45m share placing in April, and sent the shares to one-fifth of the level at which the fundraising had been conducted. The debacle cost Evolution Securities, Regal's broker, its reputation and several clients, and cost Frank Timis, the founder of Regal, his job as chairman. Further revelations - firstly that Mr Timis, a former drug dealer, was involved in a corruption investigation in his native Romania and secondly, that he had done a secret deal to sell Regal's Ukrainian assets - threatened to undermine investor confidence in AIM's natural resources companies over the summer. Wham Energy and Bowleven have also turned up dry wells shortly after fundraisings this year, and confidence remains shaky.

The Regal debacle also led indirectly to the resignation of Evolution's founder, Richard Griffiths, as the firm tried to turn round its reputation later in the year. Mr Griffiths had sold £1.6m of shares in Incite, a sports text-messaging business which generated excitement because of the involvement of rugby star Lawrence Dallaglio, at their high point in October 2003 before the company ran short of money and the stock collapsed. The share sale was not disclosed for three months - against stock market rules - and both sides blamed each other for the lack of disclosure.

M ... is for Missing money

Perhaps investors would have been less than enthusiastic about buying into Langbar International if they had been told that Mariusz Rybak, its founder had been known in Canada as the "Baltic Barracuda" because of his aggressive business tactics.

When the company was floated in October 2003, under its original name, Crown Corporation, it claimed to be AIM's biggest-ever cash shell, with £140m to invest in North American companies. Instead it secured construction contracts in Argentina worth £365m, it said, and sold them to a financial partner.

News that accountants could find no trace of the original investments shocked City institutions such as Merrill Lynch, Gartmore and Ennismore Fund Management.

They built up substantial shareholdings in Langbar in the autumn, paying 40p to 60p a share, believing the company had 220p a share in the bank, but while these institutions and countless private investors were buying into Langbar, it emerged Mr Rybak had been selling down his shareholding aggressively.

His share sales, at 55p to 65p, prompted the question, if Langbar had 220p a share in cash, why was he selling at such low prices? He had left the board, he said this week, "so why shouldn't I have?"

Langbar is not the first cash shell to have difficulty proving the existence of its main asset. Easier, which certainly did once have £5.4m in the bank, and its controlling shareholder, an offshore outfit called Fulton

Partners, have been unable to prove to two sets of auditors that the cash has not gone missing. The stock was automatically delisted for failing to file accounts and shareholders believe they could have lost everything.