When rap artist 50 Cent tweeted about an obscure headphone distributor last January to his 3.8 million followers, its stock tripled in value and gave him a brief profit, on paper, of roughly $ 10 million.
A few hours later 50 Cent, aka Curtis Jackson, Tweeted a disclaimer that he owned shares in H&H Imports and that people should talk to a financial adviser about investing in it. The value of the stock plunged.
You might think that a celebrity blast followed by a hasty retreat would dampen touting of H&H Imports. But go on the Internet and plug in ticker symbol HNHI and you’ll come up with a new posting by stock promoter HoleinOneStocks that says H&H’s value could double by Tuesday.
Securities regulators say the H&H story and thousands like it are a testament to one of the most durable investment pitches around: the chance that you might have the inside track on a little-known, about-to-explode stock. That in turn can lead to another feature of the stock market that came to prominence in the 1990s and seems to be regaining Internet-driven strength: The pump and dump.
While pump and dumps 20 years ago were operated out of boiler rooms with small armies of high-pressure salespeople making cold calls to potential investors, today the mechanisms are more likely chat boards, spam emails, text messages and Tweets.
A bankrupt Pennsylvania company that claims insiders pumped up the value of its shares — before dumping their holdings for a profit and leaving honest investors owning almost worthless stock — is expected to file amended complaints Monday against people it said participated in its financial collapse. The complaints would give automotive chemicals supplier Industrial Enterprises of America a shot at potentially bigger damages from the defendants, including several lawyers and accountants from Northeast Ohio.
Trading in penny stocks such as H&H Imports — low-priced shares issued by the smallest of companies — is legal. But the Securities and Exchange Commission warns that promises of “click here to buy the next Microsoft” should be viewed with skepticism because the penny stock market is a playground for unscrupulous operators.
Penny stocks are traded over the counter or on the “Pink Sheets,” a reference to the color of paper on which they were historically printed, not on traditional exchanges like NASDAQ. They also are known as microcap stocks because they have low or “micro” capitalizations, which is the total value of a company’s stock. How low? In cases where the SEC suspended trading in microcaps because of suspected illegalities, the average company had only $ 6 million in assets, and nearly half had less than $ 1.25 million.
Penny stock companies often don’t have to file reports with the SEC, so it’s hard for investors to get information on their management, products and finances, even for businesses that are legitimate. Many of the companies are new, without bricks-and-mortar operations. And they often trade at low volumes, so transactions of any size can cause large price swings.
The lack of reliable information opens the door to fraud, regulators say, including the penny stock classic, the pump and dump.
The scheme usually involves insiders who spread flattering information to drum up interest in a low-volume, low-value stock — one that sells for pennies, or at most about $ 5 — to increase the number of buyers and the price (the pump), before unloading their shares in advance of the stock’s collapse (the dump).
“Information technology allows con artists to reach victims more easily,” said George Samragdis, a spokesman for the Financial Industry Regulatory Authority, or FINRA, which polices U.S. brokerage firms.
Among the psychological tactics fraudsters use are scarcity — creating a false sense of urgency by claiming limited supply — and source credibility — claiming to have special credentials or experience, FINRA says.
Tapping into business developments in the news can give a pitch some plausible buzz.
The SEC last year charged three stock promoters at Wall Street Capital Funding with touting small companies that supposedly brought Russian oil wells into production and built wind-energy projects in China. They actually were fake businesses headquartered out of rented mailboxes at UPS Stores.
Last month it charged Geoffrey Eiten, who called himself “America’s Leading Micro-Cap Stock Picker,” and National Financial Communications Corp. with fraudulent promotion of companies that manufactured wireless routers and fuel additives from crushed seed oil, recycled valuable metals from electronic waste and mined gold in Russia.
50 Cent isn’t the only celebrity to have pitched low-priced stocks. Larry Wilcox, who played Officer Jon Baker on the 1970s cop show “CHiPs,” was sentenced to three years’ probation in 2011 for conspiring to commit securities fraud in a penny stock swindle. NBA star Shaquille O’Neal took to Twitter to promote a small nutritionals company in which he held stock, though the shares later plunged.
In December the SEC charged seven men in a pump and dump that the agency said used former Chicago Bears football speedster and Olympic athlete Willie Gault as a figurehead executive. The fraud artificially inflated the value of the penny stock firm Heart Tronics, which purportedly sold a heart monitoring device, the SEC said.
Suspecting increased fraud among penny stock companies, FINRA started giving closer scrutiny to over-the-counter stocks beginning in 2010.
“There are legitimate companies in every category of investing,” said Gerri Walsh, vice president for investor education. “But investors should be aware that a penny stock brings a pound of risk.”
