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The Penny Stock Epidemic - The Tangled Web They Weave Investor Information November 15 2005 Penny stock fraud has become an international epidemic, spreading at a record pace thanks to the efforts of boiler rooms, greedy promoters and unscrupulous company insiders.
These fraudulent schemes generally involve the shares of obscure companies which have few assets, negligible revenues, and dubious operations. Most of these companies trade over-the-counter, on the OTC Bulletin Board, Pink Sheets, or non-U.S. exchanges. As of September 2005, 3,280 companies were listed on the OTC Bulletin Board. Another 4,773 stocks were quoted solely on the Pink Sheets. Over 35.5 billion shares changed hands on the OTC Bulletin Board in September alone – an average daily volume of well over one billion shares a day.
This arena is a crucible for securities schemes, yet the OTC Bulletin Board has few listing requirements and the Pink Sheets have none. In fact, the Pink Sheets are a private enterprise with no regulatory or disciplinary oversight functions.
The term “penny stocks” is something of a misnomer, since it includes stocks that trade for $5 a share or less. Penny stock rules are designed to protect the public since investments in these low priced securities tend to be speculative and risky. When stock brokers recommend these penny stocks they are required to have an existing relationship with their customer or to determine that such investments are suitable for a new customer. Unscrupulous promoters and boiler room operators generally ignore these rules.
Although penny stock schemes are frequently successful, they seldom are subtle. Unlike the elaborate accounting schemes that accompany massive corporate frauds, like those that unfolded at Enron, WorldCom and other major companies of that ilk, penny stock frauds usually rely on the garden variety “pump and dump” scheme. The promoters gain control of the company, often through a reverse-merger with a shell company. They then spread false and misleading information about the company to spark interest in the company, generate volume for the stock, and pump up prices. Once stock prices rise, the promoters dump their shares and stock prices slide back toward oblivion. The game takes on several variations, but the basic framework seldom differs.
Often, these schemes employ one or more of the following tools:
• E-mails touting little known struggling companies with virtually no chance of success. These spam e-mails seldom identify the sender or provide accurate contact information. They do not provide a balanced view or disclose investment risks. E-mails promoting worthless companies have proliferated in recent years, appealing to investors around the world.
• Unrealistic financial reports and research reports that tout a company without presenting a balanced view and occasionally include unsupportable financial projections.
• Press releases that are issued to create a buzz about a company. Upon close examination, these press releases are short on details and long on unrealistic promises. They provide just enough information to whet an investor’s appetite.
• Announcements that an obscure under capitalized company is about to become a player in a cutting edge industry. After a season of brutal hurricanes, promoters seized upon the plight of storm victims to tout tiny companies that claimed to be poised to profit from relief efforts. For the most part, these claims were without substance.
• Internet message boards used to tout or attack a company. Message boards have become a haven for zealots who are prepared to defend worthless companies, even though every available fact indicates that the company has virtually no chance of success. They offer little opportunity for honest debate; just a forum for a company’s fans, where negative messages are labeled as “bashing” and critics of the company are accused of undermining the stock.
As we noted, these schemes are transparent. There are a number of bright red flags that should trigger concern:
• Claims that an obscure company is poised to capitalize in a “hot” sector, like homeland defense, hurricane recovery or AIDS research. In the wake of September 11th many of these schemes claimed to have developed cures for anthrax and other biological threats.
• Companies claim to have relationships with better known, successful businesses. Usually, these relationships are non-existent or insignificant.
• The company being promoted does not file regular public financial reports with the SEC.
• The company being promoted has negligible assets or revenues
• There has been unusual, excessive trading in a stock.
• There have been sudden dramatic price swings for the stock of a company with no track record, discernible business or demonstrated revenues.
• The Company routinely uses Form S-8 to register shares for insiders, employees or consultants. Form S-8 allows companies and promoters to flood the marketplace instantly, with registered shares that have been issued to anonymous individuals and companies.
• A company with little operating history employs numerous consultants and awards them shares.
• The company sells unregistered stock overseas under Regulation S. Regulation S has created a virtually unregulated environment for offshore sale of U.S. securities. Companies listed on U.S. exchanges may sell unregistered stock to non-U.S. residents. U.S. investors are protected because those shares cannot be resold in the U.S. for at least one year. Overseas investors? They are on their own.
• The company has engaged in one or more reverse-mergers.
• The company has offshore investors whose principals are undisclosed.
• A public company frequently changes its business plan, while maintaining the same management.
• The business is incorporated in Nevada. Nevada corporate law affords the individuals in control of a company to make significant decisions without first notifying or gaining approval from public shareholders.
• Canadian connections. Tiny companies have proliferated with the following in common: they are incorporated in Nevada, have offices in Canada (usually British Columbia), have attorneys in Florida, California or New York, and often use transfer agents housed in Utah. Their goal is to create a jurisdictional blend that allows them to scam investors in the U.S., Canada and around the world. In order to catch these crooks, regulators from these various jurisdictions must cooperate. That takes time and resources – and plays into the hands of promoters who are operating at a far quicker pace.
Where does this leave investors? The red flags are there – and obvious to even the most nearsighted and shortsighted. The bottom line remains, as always – before you invest, investigate.
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Posts: 10729 | From: oregon | Registered: Feb 2005
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