Contents

§ Concerns for investors

Many penny stocks, particularly those that trade for fractions of a cent, are thinly traded. They can become the target of stock promoters and manipulators. [ 3 ] These manipulators first purchase large quantities of stock, then artificially inflate the share price through false and misleading positive statements. This is referred to as a pump and dump [ 4 ] scheme. The pump and dump is a form of microcap stock fraud. In more sophisticated versions of the fraud, individuals or organizations buy millions of shares, then use newsletter websites, chat rooms, stock message boards, fake press releases, or e-mail blasts to drive up interest in the stock. [ 5 ] Very often, the perpetrator will claim to have inside information about impending news to persuade the unwitting investor to quickly buy the shares. When buying pressure pushes the share price up, the rise in price entices more people to believe the hype and to buy shares as well. Eventually the manipulators doing the pumping end up dumping when they sell their holdings. [ 6 ] The expanding use of the Internet and personal communication devices has made penny stock scams easier to perpetrate. [ 7 ]

§ Notable cases

One notable example is rapper 50 Cent’s use of Twitter to cause the price of a penny stock (HNHI) to increase dramatically. 50 Cent had previously invested in 30 million shares of the company, and as a result made $8.7 million in profit. [ 8 ] Another example of an activity that skirts the borderline between legitimate promotion and hype is the case of LEXG. Lithium Exploration Group’s market capitalization soared to over $350 million after an extensive direct mail campaign. The promotion drew upon the legitimate growth in production and use of lithium, while touting Lithium Exploration Group’s position within that sector. According to the company’s December 31, 2010 form 10-Q (filed within months of the direct mail promotion), LEXG was a lithium company without assets. Its revenues and assets at that time were zero. [ 9 ] [ 10 ] Subsequently, the company did acquire lithium production/exploration properties, and addressed concerns raised in the press. [ 11 ] Penny stocks are not always purchased by manipulators and promoters, they can be given by the company as another way of payment to promote the ticker. The ticker is the stock abbreviation that allows ease of access to market operators, investors, etc. The pump and dump tactic is also known as a supernova and, unlike regular stocks, penny stocks usually move on momentum of the price action. Penny stocks are known to be volatile not only because the margin between the buy and sell price but how the SEC (Security Exchange Commission) regulates the stock as well. For example, if a stock’s price spikes up too fast it can be halted by the SEC for further investigations before it becomes available again. Even with SEC halt, the stock can still move up or down trend and the people who invest in it would have no control over their shares until the company is released to the public again by the SEC.

§ External links

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