Washington State Department of Financial Institutions

Penny Stock Fraud

September 26, 2011

The Washington State Securities Division has received inquiries about investing in penny stocks that appear “too-good-to-be-true.” This alert explains how newsletters, bulletins, and advertisements touting particular penny stocks should be scrutinized by prospective investors.

What are Penny Stocks?

Penny stocks are low-priced shares of small companies. Penny stocks are not cheap. Such stocks may not cost much per share, but transaction costs tend to be high.

Penny Stock Fraud

Penny stock fraud stems from the spread of false information. Fraudsters distribute false advertising through email, telephone calls, mass mailing, on internet bulletin boards/chat rooms, newsletters, reports, radio, television, fax, and press releases. The advertising is often falsely touted as “inside” information, contains exaggerations or lies, and often comes from promoters paid to misinform the public.

Penny stocks often trade infrequently and have limited ownership. These factors make penny stocks a choice vehicle for market manipulation schemes, such as pump and dumps.

Pump and dump schemes are run by company insiders or others who control significant amounts of company stock. These people use advertising to create a buying frenzy that artificially inflates stock prices (the pump), allowing the schemers to dump their shares on the market at a high price. Once the hype dissipates, the price of the shares falls back down to a level more aligned with the company’s true value.

Protect Yourself from Fraud

Before you invest in penny stock, do your own research. Don’t rely solely on information from promoters who have an incentive to inflate penny stock prices.

A good first step is to review the company’s filings on the Securities and Exchange Commission's EDGAR website at http://sec.gov/edgar/searchedgar/webusers.htm.

Also, because advertisers are often paid to hype penny stocks, prospective investors should find out who is behind the advertisement. Look at the fine print for information about who paid for the advertisement and whether the promoter has an interest in the touted stock. Don’t let others profit at your expense by falling for misleading claims about how the stock price is going to soar.

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