Now that our mind is aware and alert to the perils of investment fraud, the next order of business is to review a few of the more clever scams that pervade the world of penny stock investing. Although there has been much progress in recent years by the FBI, SEC and State law enforcement agencies, investment fraud continues to evolve. It is not just the high profile cases, like Bernie Madoff or Kenneth Starr, that make the headlines that should concern us. Our knowledge base must include the tried and true schemes that return season after season.
To begin with, despite all of the problems and potential scams, there are an enormous number of legitimate, fledgling companies with low stock values, fighting for their very existence and for your investment dollar. Their valid attempts to succeed are the very veil that the criminal element hides behind and mimics with their offers that sound and look legitimate. In many cases a company will only have one broker-dealer as a market maker for its stock. Under these circumstances, the price for the stock is very susceptible to manipulation.
A broker may accumulate shares at a low price. Then, with the aid of a complicit boiler room high-pressure sales outfit, news will be spread to hype the demand for the stock. When the stock rises in price, the broker sells his shares for a high profit margin. The hype stops, and new investors are soon left to see the stock value plummet as demand ceases. The well-known phrase for this type of operation is “pump-and-dump”, and even though a few variables may change in the scenario, the outcome of large investor losses is always the same.
Many small companies, including companies traded in the OTC markets, raise funds by selling stock privately via a Private Placement Memorandum, or PPM. These offerings are high risk. Have your broker review the paperwork before making any decision. A con artist will claim he is doing you a favor and will insist upon the need for urgency to prevent any third-party review or intervention. High-pressure sales techniques are always a warning sign that should be heeded. Always be sure how your money is to be used, and avoid giving anyone a blank check because “prices have not been nailed down yet”.
Miss-marked trade confirmations and unauthorized purchases appearing in your account are warning signs that you may be dealing with an unscrupulous broker. He may be trying to unload IPO shares on you or avoid registration requirements by marking sales as “unsolicited” when, in fact, he solicited the sale in the first place. Complain immediately both verbally and in writing to your broker’s manager and the Securities Division in your State.
Some swindlers dress for success and attempt to gain your confidence by their professional look and demeanor. The promise of extraordinary earnings is a siren call that is often heard. Ponzi schemes are dressed in such “wolf’s clothing”. Generally speaking, if an investment proposal sounds too good to be true, it most likely is.
Investing in penny stocks is a highly speculative venture and involves a high degree of risk. If a salesman discounts the level of risk, be on your guard. The amount of your investment capital should only be a small portion of your entire portfolio, and you should be prepared to lose it all, even when investing in legitimate companies. However, there are “golden nuggets” out there, and our next episode will tell you how to go about finding them.