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SEC and FINRA Issue Joint Penny Stock Scam Investment Alert

FINRA and the SEC issued an alert warning investors of certain penny stocks being aggressively promoted as great investment opportunities when, in fact, they are little more than stocks of dormant "shell" companies with little or no actual business operation activity.

In its alert, FINRA refers to a new twist on pump-and-dump schemes in which fraudsters actively invest in and promote a very low-priced and thinly traded stock, spreading misleading and downright false information in order to solicit further investments in the target stock.

In the dormant shell company variation of the penny stock's pump-and-dump, fraudsters pick an inactive (e.g., "dormant") stock with very low trading activity and low selling prices.

After generating enough interest and investments in the target stock through manipulation and spreading false or misleading information, the trickster then dumps, or sells, his or her own shares in the stock for a profit while duped investors are left holding a worthless stock. The amount of money the scheme's victims lose depends on when—or at what share price—the victim purchased the target stock.

As a basic example, a fraudster might find a dormant shell company stock worth five cents per share. The fraudster then purchases thousands of shares of this nearly-worthless stock while soliciting business from investors to further artificially manipulate and inflate the stock's value. When the value reaches its apex, the pump phase is complete and the fraudster dumps by selling the thousands of shares initially purchased. Because the fraudster sells off these shares when the stock value is high—say, nearly a dollar per share—profits can be substantial. Meanwhile, investors who bought into the hyped stock when it was worth nearly a dollar per share will lose significant money when the stock's price drops back down to five cents (or less) per share.

To avoid falling into this trap, FINRA recommends investors ask five questions:

1. Has the company been dormant and then brought back to life? By researching—through the internet, FINRA or SEC EDGAR databases and otherwise—investors can find and understand the history of the touted stock and whether its history is reliable enough to consider investing in. For instance, a company whose business operations has been minimal for five years before suddenly seeing a dramatic increase in trading activity over the past month may very well be a red flag for dormant shell penny stock manipulation.

2. Where does the stock trade? Stocks that trade on registered national securities exchanges and other regulated markets, such as NASDAQ or the New York Stock Exchange (NYSE) are far less susceptible to pump-and-dump schemes than unregulated platforms, such as over-the-counter (OTC) mediums, due to the rules, restrictions, policies and procedures that regulation-bound platforms must abide by.

3. Has the company's name or business focus changed recently or frequently? Recent or frequent changes to a company's name and/or business focus may be a red flag. For instance, a company may nefariously change a name in an attempt to distance itself from a past incident of fraud or other misconduct. The OTC Markets website is one place to research name changes and other corporate events.

4. Has there been a reverse stock split? This action reduces the number of outstanding shares, thus increasing the price per share without changing the total economic value of the shares (think algebra: If 500 stocks at one-cent per share = $5.00 in total economic value, so too does 5 stocks at one-dollar per share). This may be one method in which a stock's value is artificially increase even if the company as a whole keeps the same value.

5. Has the company "Q"ualified for Bankruptcy? If a stock symbol contains the letter "Q" at the end, then the company has filed for bankruptcy. Dormant and bankrupt companies may be a candidate for untoward manipulation and schemes due to their low value and tendency towards less regulation.

If you have invested with any broker or in any company that fits the bill of a dormant shell, and have lost money in a resultant pump-and-dump or other fraudulent scheme due to misinformation or unwanted solicitations, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for investigation and consultation.

Investment Alert: Dormant Shell Companies—How to Protect Your Portfolio from Fraud (FINRA)

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