“Operation Pennypincher” Highlights the Risks of Penny Stocks

Gerald Rome

Gerald Rome

Recently, I read a newspaper article about an FBI investment-fraud sting operation called “Operation Pennypincher.” An FBI agent posed as a wealthy investor who offered executives of penny-stock companies large investments of up to $5 million. In return for the investments, the undercover agent asked for huge illegal kickbacks of 50% of the investment. Not surprisingly, the FBI busted more than 20 people, including penny stock executives, for attempting to participate in this scheme. Reading about the FBI sting did remind me of just how dangerous investing in the murky world of penny stocks can be, particularly for senior citizens.

Penny stocks, shares of small companies that trade at prices ranging from a few cents to approximately $5, typically trade on over-the-counter systems such as the “Pink Sheets.” These stocks are usually tied to small, unproven companies with no history of solid financial performance. These stocks are ripe for scams and stock price manipulation.

One popular scheme fraudsters like to pull is called the “pump and dump.” In this investment-scheme, company insiders artificially increase demand for the company’s stock by putting out misleading press releases that highlight the company’s promising future and low-priced stock that is ready to “blow up,” or increase dramatically. Once the insiders have pumped up the stock price, they dump their holdings by selling them to unwitting investors.

Stock tips for these types of scams can arrive in a number of different forms, including newsletters, emails, and even phone calls. In one such scheme, fraudsters pretending to have the wrong telephone number leave a message on the unsuspecting victim’s answering machine purporting to give an inside tip to their friend. Not surprisingly, these messages are left on hundreds, even thousands, of answering machines across the country to encourage unknowing investors to invest in the shady company. This drives the share price up so that insiders can profit when they dump their stock.

It’s always important for investors to be vigilant and understand what they’re investing in before they hand their hard-earned money over, but this is even truer when investors are dealing with penny stocks. If you can buy a share of a company for less than $5, it should be a “red flag” that means you need to spend some extra time checking them out before you invest. Most public companies make electronic filings with the SEC and there are computerized databases to check out brokers and advisers. If anything, don’t hesitate to contact your state securities regulator. The Colorado Division of Securities can be reached at 303-894-2320.

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