OT: The Penny Stock Epidemic - The Tangled Web They Weave
April 10 2007
Where do penny stock crooks find their victims? Everywhere around the globe. This is an international epidemic, spreading at a record pace, thanks to the efforts of boiler rooms, greedy promoters and unscrupulous company insiders.
Lately, we have been hearing from more and more readers around the world who have been touched by securities scams. It makes perfect sense. Con artists know that U.S. regulators are unlikely to raise their colors on behalf of an individual investor in Barbados, Germany or the Philippines who has tossed away his life's savings buying unregistered shares of an obscure U.S. public company. So the clever pitchmen peddle their wares overseas, then sit back stateside and bank their profits.
Most frequently, fraudulent schemes involve shares of obscure companies which have few assets, negligible revenues, and dubious operations. But foreign investors - and many domestic ones as well - do not know this. They only know what the salesman is saying. And for the foreign individual investor the U.S.-based broker has instant credibility. The con artist relies on the fact that most people in other countries - and many right here - cannot distinguish a legitimate brokerage firm from a fly-by-night operation.
Stock schemes commonly involve shares of companies that trade on the OTC Bulletin Board, Pink Sheets, or non-U.S. exchanges. As of March 2007, 3,472 companies were listed on the OTC Bulletin Board. Another 4,874 stocks were quoted solely on the Pink Sheets. Almost 37 billion shares changed hands on the OTC Bulletin Board in March 2007 alone – an average daily volume of well over one billion shares a day.
This arena is a crucible for securities schemes. Regulatory resources are strained, and frequently focused in other directions. The global nature of these schemes, and the ease with which companies can issue unregistered stock and sell it overseas, makes meaningful oversight difficult - and often impossible.
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 accompanied massive corporate frauds at the beginning of this decade - Enron, WorldCom and the like - penny stock frauds usually rely on the garden variety "pump and dump" scheme. In many cases promoters or shady stock brokers gain control of a company and then spread false and misleading information by saturating the Internet with spam email or using cold callers to tout shares. In this way they spark interest in the company, pump up prices, and create an environment in which they can sell stock. Once the promoters dump their shares, 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.
Shady stockbrokers use aggressive tactics, distorting "facts" about companies and intimidating potential investors.
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 video sharing, 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.
Food for thought in the wake of PlastiCON
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