By Patricia Uceda, Fall 2014 Graduate Research Assistant
The SEC is warning investors that some penny stocks that are being aggressively promoted are actually stocks of dormant companies that currently have no business operations and are essentially empty shells. Penny stocks are highly susceptible to market manipulation through the use of pump-and-dump schemes.
As we’ve told you before, pump-and-dump schemes involve a fraudster buying a large amount of low-priced penny stocks and then using aggressive advertising techniques to pump up the price of the stock. Once the stock price is artificially inflated, the fraudster will then dump their shares, causing the price to fall and leaving investors with worthless shares of stock.
Fraudsters often use dormant shell companies in these pump-and-dump scams because of the low price and visibility. Dormant shell companies are typically bankrupt companies that no longer have any officers or management. Fraudsters will buy shares in the shell company and claim that it has developed some new product or that it has new management. Through these false claims and misleading promotional campaigns they will pump up investor interest in the dormant shell company so that it is actively traded again, despite the fact that it is still virtually worthless.
Here are some tips that can help you avoid pump-and-dump schemes involving dormant shell companies:
- Make sure the company is not a dormant one that has been brought back to life. Check the SEC’s EDGAR database to see when the company last filed periodic reports and ensure that they are not filing for the first time in a large period of time. You can also check with the Secretary of State in the state where the company was formed or incorporated to learn more about the company’s history.
- Be wary of stocks that are traded on over-the-counter platforms. Ideally you should only invest in stocks that trade on the NASDAQ Stock Market, the NYSE, or some other registered national securities exchange. These exchanges have minimum listing standards that every company must meet and that insures that you are not investing in a dormant shell company.
- Be wary of frequent name changes or business focus. If a company has frequently changed their name or business focus in the past few years, that is a very big warning sign that they are merely a shell which is being used for manipulative trading schemes. You can find this information on EDGAR or even through an internet search.
- Check that the company has not filed for bankruptcy. Dormant shell companies are usually bankrupt companies that are no longer active. Bankrupt companies are typically denoted by a “Q” in their stock symbol. If you see this additional letter, definitely be cautious before you invest in that company. We’ve warned about investor confusion over bankrupt companies that sound like active companies – read Michael McLaughlin’s post here for more information.