By Cassandra Bradford, Fall 2013 Student Intern
Would you invest in a company that sells house slippers with night lights if 50 Cent said you should?
During 2010 and 2011 many people did just that after Curtis James Jackson III, former drug-dealer and amateur boxer turned rap artist, now known to the world as 50 Cent, tweeted several messages about a company in which he was the majority shareholder. 50 Cent owned 30 million shares of penny stock in a company known as H&H Imports (HNHI). In 2010 he tweeted about the stock and encouraged people to buy it, raising the stock price from about 10 cents per share to 39 cents per share at one point. 50 Cent’s stock value increased approximately 8.7 million dollars. The company had few sales and was operating at a loss, yet investors bought it, anticipating huge gains, based on twitter messages from a rap artist.
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Although 50 Cent’s penny stock tweets are ironic and gives a good laugh, it is part of a much larger scheme causing many investors to lose money. 50 Cent may have a song called “Get Rich or Die Tryin,” but that hardly makes him qualified to give investment advice, a point which should be taken seriously.
What is Penny Stock?
Penny stocks are common shares of small public companies that are not traded on a public exchange (like the New York Stock Exchange) and are traded at low prices, generally less than five dollars a share. Investors buy penny stocks hoping that the shares will increase in value and create large and quick profits. Unfortunately, penny stocks present many dangers, such as volatility and manipulation by people who wish to promote the stock to their own advantage.
How is Penny Stock Traded?
Penny stocks are listed on the Over the Counter Bulletin Board (OTCBB), which lists many equity securities that are not traded on a national exchange. The OTCBB allows companies to be listed with no minimum share price or other requirements for corporate governance information to be quoted, and investors can trade penny stocks on this exchange. Because penny stock is not listed on a national exchange that provides more information than the OTCBB, it is a very risky, uncertain investment.
Penny Stock Manipulation
Penny stock is also subject to manipulation by large shareholders. Because there is little information listed about the penny stock on the OTCBB, large shareholders can promote the penny stock, and thus manipulate its price upward, for their own benefit.
Often, large market players that own lots of shares in a company will advertise specific penny stocks to attract buyers. When buyers purchase the penny stock and the price increases dramatically, the large owner then dumps all their shares, making a huge profit. This is called a “pump and dump” scheme. Usually the companies in these scenarios are not stable and the stock ends up plummeting. Many people allege this pump and dump scheme is the reason 50 Cent created several twitter messages regarding his penny stock, but in the end 50 Cent, for reasons that can only be speculated (i.e. his attorneys strongly cautioned him against it), did not sell his stock after the increased gains, and the stock’s price eventually dropped back down.
Recently, several large brokerage firms have been fined by the Financial Industry Regulatory Authority (FINRA) for failure to discover whether or not certain penny stocks were registered and legal for sale to the public. This highlights the danger involved in penny stocks even when you have a broker or brokerage firm.
The lesson to be learned here is to be aware of penny stocks and the risks they involve. Think carefully about a decision to invest in penny stocks before you take the plunge. If you do happen to be an investor who is interested in high-risk, volatile stocks, then before investing in penny stocks you may want to do a few things.
- Research the company to find out as much as you can about it before purchasing the stock, including:
- Checking out the company’s prospectus
- Looking at profits and losses, cash flow, and debt to equity ratios
- Research the company’s reputation in the investment world (two great sources of information are www.saveandinvest.org and www.finra.org/investors)
- Talk to a broker you trust about the stocks and find out the extent of their familiarity with the particular penny stock then get their recommendation
- Most importantly, do not take investment advice from Twitter or from a person who is unqualified to give investment advice (i.e. your favorite rap artist).