Penny Stock - Concerns For Investors

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. 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" 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, press releases, or e-mail blasts to drive up interest in the stock. 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. The expanding use of the Internet and personal communication devices has made penny stock scams easier to perpetrate. Though not a scam per se, 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. 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. Subsequently, the company did acquire lithium production/exploration properties, and addressed concerns raised in the press.

Penny stock companies often have low liquidity. Investors may encounter difficulty selling their positions after the buying pressure has abated, and the manipulators have fled.

Another fraudulent scheme is the sale of chop stocks, in which shares acquired below market under Regulation S are illegally sold to overseas or domestic retail investors.