FINRA and SEC Release Guidance on Avoiding Penny Stock Schemes

shutterstock_183525503Recently, FINRA and the SEC’s Office of Investor Education and Advocacy issued an alert to warn investors that some low-priced “penny” stocks are being aggressively promoted to engage in investment fraud schemes. In many cases the stocks of dormant shell companies, businesses with nominal business operations, are susceptible to market manipulation. To help prevent these types of fraud, the SEC suspended trading in 255 dormant shell companies in February 2014.

The typical investment scheme concerns pump-and-dump frauds in which a fraudster deliberately buys shares of a very low-priced, thinly traded stock and then spreads false or misleading information to promote and inflate the stock’s price. The fraudster then dumps his shares causing a massive sell off and leaving his victims with worthless shares of stock. Among the more common schemes is a fraudsters who uses a dormant shell company to buy its shares and then claim that the company has developed a “new” product that has caused the price to jump higher or the company will announce new management.

The SEC provided 5 tips to avoid becoming a victim of a penny stock scheme.

  1. Research whether the company has been dormant in the past. Use the SEC’s EDGAR database to see when the company filed periodic reports. The Secretary of State’s office in the state where the company was formed or incorporated may also provide details of the company’s history. If its possible, contact company management to determine why it ceased operations and why it decided to reinstate operations.
  2. Where the stock trades. Most stock pump-and-dump schemes do not trade on nationally recognized exchanges such as The NASDAQ Stock Market or the New York Stock Exchange. Instead, these stocks trade on an over-the-counter (OTC) quotation platform like the OTC Link Alternative Trading System (ATS). Companies quoted on OTC Link generally do not have to meet any minimum standards for trading on other exchanges which in itself should alert the investor to the extreme risk that is being taken.
  3. Stay away from companies with frequent changes to a company’s name or business focus. Name changes and the potential for manipulation often come together.
  4. Mammoth reverse stock splits. A reverse stock split reduces the number of shares outstanding and increases the price per share. Such reverse splits may be done to inflate the price of the stock artificially without any real change in the value of the company.
  5. Stock symbol “Q”. A stock symbol with a fifth letter “Q” at the end signals that the company has filed for bankruptcy and can be a candidate for manipulation.

The attorneys at Gana LLP are experienced in representing investors in cases of securities and investment fraud. Our consultations are free of charge and the firm is only compensated if you recover.