Yahoo Finance 3 Penny Stock Scams To Watch Out For
According to CNBC, a penny stock is a low-priced stock that can be a speculative, high-risk investment. Now, many investors are buying penny stocks and getting scammed.
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Jacob Zamansky, an attorney with his firm Zamansky LLC, told CNBC, “I’m getting a lot of calls from investors who are duped and getting scammed by penny stock operators.”
Established stock exchanges like Nasdaq or The New York Stock Exchange (NYSE) have the stocks of well-known companies such as Apple (AAPL) or Alphabet (GOOGL). Buying stocks like these gets you shares of a stable, well-established business. But, penny stocks are traded elsewhere in the over-the-counter (OTC) exchanges, such as the “pink open market” or “gray market.” It’s within these more unregulated markets that some investors are getting into financial trouble.
Penny Stocks: What They Are And The Issue With Them
The Securities and Exchange Commission (SEC) now defines “penny stocks” as stocks priced at $5 or less. Generally, OTC exchanges have stocks of smaller companies or startups since OTC exchanges have less expensive and less stringent requirements to get listed. Ultimately, being listed on OTC exchanges provides smaller companies with the opportunity to raise capital. Data from the Financial Industry Regulatory Authority indicated that there was nearly a 50% increase in total OTC trades annually from 2020 to 2021.
While penny stocks aren’t “wrong” per se, they do experience higher volatility and lower liquidity. You might buy a penny stock and then decide to sell it, but it could be more difficult for you to find a buyer later on. One of the biggest issues with penny stocks is that purchasers get very little financial information about the company. Usually, it’s not easy to learn about the company’s earnings, their balance sheets, or even the background of the people who are promoting the companies.
With stocks traded on major exchanges like Nasdaq and the NYSE, you can always check company financials and reports before purchasing. With penny stocks, you’re taking a gamble since you’re provided with little to no financial information in advance. This lack of financial information and visibility makes it easier for scammers to take advantage of potential buyers by misrepresenting a company’s financials.
“At the end of the day, when you buy something on the stock market, someone else is selling it. So you have to think about who might be the person on the other side of the trade,” said Andres Vinelli, Chief Economist at the CFA Institute.
To mitigate this issue, the SEC has implemented a “penny stock rule” which requires a stock broker or dealer to obtain, before effecting any transaction in a penny stock, written acknowledgment from the customer that the customer has received the Risk Disclosure Document required.
3 Common Penny Stock Scams
Pump and Dump Scams: Jordan Belfort, a.k.a “The Wolf of Wall Street,” is one of the most infamous players on Wall Street. His fraudulent tactics are a great example of what is known as a “pump and dump” scheme. His brokerage firm, Stratton Oakmont, pitched penny stocks to eager investors who bought into bogus sales pitches and purchased shares. This in turn artificially “pumped up” stock valuations. Then, the firm would sell the shares to make a profit, defrauding their investors. Belfort’s firm collapsed after he was prosecuted and served nearly two years in prison.
COVID Scams: The onset of the pandemic spurred speculative trading related to potential medical solutions or pandemic-related products. It was a great way to promote little-known companies that were “all of a sudden” part of the solution. For example, companies that created hand sanitizers, PPE, at-home COVID tests, etc. Some companies twisted the narrative about what they were actually offering to make them sound more exciting and relevant, which pumped up their stock prices.
Social Media Manipulation: Within the past two years, social media has played a big role in promoting stocks to investors, creating a broad appeal and a sense of “fear of missing out” (otherwise known as FOMO). The FOMO driven by social media along with people’s access to self-directed trading accounts has promoted further investment in more high-risk penny stocks by investors who may be new to trading altogether.
Investing in the stock market can lead to great returns and significant financial growth. But investing without sufficient knowledge of the stock itself is financially dangerous and can spell trouble. Be sure to do your due diligence as an investor by thoroughly investigating and researching the companies that you’re investing in, especially if you’re purchasing penny stocks.
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This article originally appeared on GOBankingRates.com: 3 Penny Stock Scams To Watch Out For
