Penny stocks are booming, which is good news for swindlers

The New York Times
Washington, United StatesWritten By: Matt Phillips © 2021 The New York Times CompanyUpdated: Mar 19, 2021, 10:43 PM IST

Mutual Funds (Representative Image) Photograph:(Twitter)

Story highlights

Penny stocks — the name given to more than 10,000 tiny companies like SpectraScience — have been around forever, but they are booming as small investors flood the market. And this time around, social media is fueling the craze

It did not look like a very promising investment opportunity.

SpectraScience’s phone number was out of service. So was its website. And it had not disclosed financial results since late 2017, when the San Diego medical equipment company reported a quarterly loss — its 12th in a row.

But early this year, SpectraScience’s nearly worthless shares — priced in hundredths of a penny and too minor to trade on a major stock exchange — sprang to life.

On Jan. 27, their price doubled, with more than 900 million shares traded. The next day, amid a flurry of social media cheerleading, more than 3.5 billion shares of the company changed hands — a volume roughly equal to half that day’s trading on the New York Stock Exchange. After soaring 500% as trading opened, just as quickly SpectraScience collapsed.

Penny stocks — the name given to more than 10,000 tiny companies like SpectraScience — have been around forever, but they are booming as small investors flood the market. And this time around, social media is fueling the craze. Whether traded to fend off the boredom of pandemic living or to turn a quick profit, these dirt-cheap but risky shares are another frontier in a world where meme stocks such as GameStop gained overnight stardom; Dogecoin morphed from a joke cryptocurrency to a hot investment; and a digital artwork known as a nonfungible token, or NFT, sold for $69 million.

It is part of a “massive surge” in retail trading reminiscent of the 1920s, when amateurs flooded into the stock market before the 1929 crash, said Tyler Gellasch, a former Securities and Exchange Commission official who leads the nonprofit Healthy Markets Association.

“The only relevant historical precedent seems to increasingly be the days before the Great Depression,” he said.

Penny stocks occupy a low-rent district of Wall Street, a world rife with fraud and chicanery where companies that do not have a viable product or are mired in debt often sell their shares. Traded on the lightly regulated over-the-counter, or OTC, markets, penny stocks face fewer rules about publishing information on financial results or independent board members. Wall Street analysts do not usually follow them. Major investors do not buy them.

But last month, there were 1.9 trillion transactions on OTC markets, an increase of more than 2,000% from a year earlier, according to data from the Financial Industry Regulatory Authority, a self-regulatory group that oversees brokerage firms.

The lack of oversight that makes penny stocks easy targets for scammers has long accounted for penny stocks' unsavory reputation. But risk can also be a draw for thrill-seekers or those who fear they have missed a market boom that is creating wealth all around them.

And now it is easier than ever to get in on these stocks; commission-free trades and the proliferation of online trading platforms mean small investors do not have to go through a traditional broker.

Because these stocks are so small and lightly traded, a sudden surge of interest can make their prices go berserk. Since the start of the year, shares have soared for companies such as Healthier Choices Management, which operates vape stores; For the Earth, which makes cannabis-based sunscreen; and Garb Oil & Power, which, despite its name, spotlighted its planned purchase of a manufacturer of marijuana pipes in one of its most recent business operation updates. (It was published in 2014.)

“Everyone wants to get rich,” said Jordan Belfort, whose memoir, “The Wolf of Wall Street,” detailed his debauched life as cheap-stock kingpin, complete with helicopter crashes, sunken yachts and copious quaaludes. “And they want to get rich quick.”

Belfort, now a motivational speaker and writer living in Los Angeles, presided over Stratton Oakmont, one of the notorious “boiler rooms” that manipulated penny stocks to prey on unwitting retail investors before it went out of business in 1996.

“We all want to believe in Santa Claus, the Tooth Fairy and Bernie Madoff,” he said.

Just as they were in Belfort’s heyday, penny stocks remain the backbone of schemes to part newbie traders from their cash. Consider one perennially popular racket: the pump and dump.

First, fraudsters load up on ultracheap shares of a small stock hardly anyone trades. Then comes the pump: They pitch the stock as one with hot prospects, spreading around positive information to push up its price. Finally, there is the dump: After the price jumps higher, the perpetrator sells and leaves the new buyers holding a mostly empty bag.

“It’s all just a pool filled with sharks,” said Urska Velikonja, a law professor who studies securities regulation at Georgetown University Law Center. “It’s where the unwary go to get eaten.”

Booms in penny stock tend to occur during raging bull markets, when greed abounds. They were hot in the 1980s, when the arrival of cheap, long-distance telephone service gave rise to brokerage firms that specialized in high-pressure, cold-call pitches of worthless stocks.

That was the specialty of Blinder, Robinson & Co., which was led by Meyer Blinder, a New York broker with a flamboyant reputation. In the mid-1980s, it became the largest penny stock brokerage in the country. But by 1990, it had been liquidated, and by 1992, Blinder had been convicted of racketeering and securities fraud. After his conviction was announced, he lunged at a prosecutor, threatening to kill him.

But stock-touting technology changes with the times. Cold-calling went out, followed by faxes and email spam. Today, social media sites such as Twitter and Reddit, which powered the rise of GameStop and other meme stocks, are the preferred method for building unwarranted hype.

According to a civil complaint filed this month by the SEC, Andrew Fassari of Irvine, California, used his Twitter account — OCMillionaire — to pump up the price of Arcis Resources, a company that has not conducted business since at least 2016 but whose stock still trades. Fassari, regulators said, bought 41 million shares of the company and then posted misleading information, including fictitious emails from the company’s purported CEO about expansion plans. Over nine days in December, the share price skyrocketed more than 4,000% — to more than a nickel. Fassari’s gains were $929,000, according to the agency.

Fassari’s lawyer, Jessica Munk, said he denied wrongdoing. “It appears Mr. Fassari has been hit with fallout from the GameStop, Robinhood, Reddit controversy,” Munk said in a statement, including a reference to the Robinhood trading app. She also noted the SEC action’s “lightning pace.”

Art Hutchinson, a 50-year-old construction services salesperson in Fort Worth, Texas, has been making bets on penny stocks — companies that he acknowledges are “absolute garbage” — for about two years. And the activity he watches closely is increasingly being driven by social media, he said.

“Everybody is on Twitter, whatever, these social media accounts, and they’re all lying,” he said. “They’re preying upon people not doing any research on their own or not understanding it.”

A 2017 paper from Thomas Renault, a finance professor at the University Paris 1 Panthéon-Sorbonne, analyzed millions of Twitter messages about low-priced stocks. A surge in tweets about a small stock led to big price increases followed by sudden collapses, he found, saying the pattern was consistent with pump-and-dump schemes.

Regulators appear to be taking some steps to tamp down on such activity. Weeks after SpectraScience crashed, the SEC temporarily suspended trading of the stock, citing “potentially manipulative trading activity.” It was one of nearly two dozen stock tickers sidelined for similarly suspicious trading by late February.

“We proactively monitor for suspicious trading activity tied to stock promotions on social media, and act quickly to stop that trading when appropriate to safeguard the public interest,” Melissa Hodgman, acting director of the SEC’s Division of Enforcement, said in an announcement.

Current and former regulators say penny stock fraud will remain as long as penny stocks are traded.

“Whatever you do, don’t claim victory, because it’ll come back,” said Joseph Goldstein, a partner at Murphy & McGonigle, a financial services law firm. In the late 1980s, Goldstein led the SEC’s task force on penny stocks amid a surge of frauds in the market.

“It’s not going away, basically, because it’s greed,” he said. “I don’t think there will be a successful effort to end greed in this world.”