Investors Beware of "Bad Penny" Penny Stocks

The Trouble with Penny Stocks

Issued by startup or emerging companies with little to no track record but lots of promise and chutzpah, penny stocks trade at low prices (“pennies”) with small market caps, outside the major exchanges. These stocks are generally extremely risky and difficult to regulate. And because of their small market caps, penny stocks are also notoriously easy to manipulate. Coordinated attacks and raids by rogue traders and hedge funds are by now the stuff of investing legend.

Pump-and-Dump Scams Plague Penny Stocks

More common, however, are the pump-and-dump scams that periodically rock the share price of penny stocks--and rock the fortunes of those who invest in them. Pump-and-dump schemes involve a variety of tactics aimed at artificially moving the market price of a penny stock, whether by coordinated attack or phony news stories. Typically, the fraudsters behind the scam will disseminate a campaign of positive news that will inflate a penny stock’s share price, before reversing that stock’s fate through a catastrophic press release or financial analysis, often coupled with excessive shorting of the stock, which will drive the price sharply downward.

SEC and FINRA Issue Investor Warning about Shell Companies

A somewhat less common occurrence, but one that is getting more and more attention from regulators and media outlets, concern penny stocks issued by companies that simply do not exist. Just the other day, the Securities and Exchange Commission (SEC) and securities industry watchdog, the Financial Industry Regulatory Authority (FINRA) jointly issued an investor alert warning investors about the perils of penny stocks, pump-and-dumps, and the sham shell companies that often support them. This new wrinkle on an old story is worth paying attention to. As stock promoters and pump-and-dump fraudsters find it easier and easier to circulate false or misleading information without accountability through various internet outlets and portals, opportunities for manipulation have reached an all-time high.

The investor alert includes the following tips to help investors avoid being drawn into a scam involving a dormant shell company:

  • Research whether the company has been dormant—and brought back to life. You can search the company name or trading symbol in the SEC's EDGAR database to see when the company may have last filed periodic reports.

  • Know where the stock trades. Most stock pump-and-dump schemes involve stocks that do not trade on The NASDAQ Stock Market, the New York Stock Exchange or other registered national securities exchanges.

  • Be wary of frequent changes to a company's name or business focus. Name changes and the potential for manipulation often go hand in hand.

  • Check for mammoth reverse splits. A dormant shell company might carry out a 1-for-20,000 or even 1-for-50,000 reverse split.

  • Know that "Q" is for caution. A stock symbol with a fifth letter "Q" at the end denotes that the company has filed for bankruptcy.

For the full FINRA Investor Alert, please click here.

If you or anyone you know has been the victim of investment fraud or misconduct, please contact our experienced securities attorneys at 1-855-462-3330 or via email by clicking here.