Penny stocks tend to excite investors due to their reputation for quick and explosive gains. Conversely, this reputation encourages scammers to lure investors into dumping money into a company that’s just a black hole for investors.
These small companies are a haven for scammers because most of them trade on the pink sheets or over-the-counter exchanges. Since these exchanges are far less regulated than the much larger Nasdaq or NYSE, financial predators can find ways to easily manipulate them.
One such example of penny stock fraud happened back in 2014 when a high-profile “pump and dump” resulted in a career scammer receiving multiple prison sentences…
Case Study
On June 17, 2014, the share price of Cynk Technology Corp. (CYNK) – a mysterious firm that branded itself as a “social networking” company – skyrocketed from $0.06 to $2.25 for a roughly 3,650% gain, more than the entire historical return of the S&P 500. Shares proceeded to soar another 567% to nearly $15 by early July of that year, giving the stock a total gain of 24,900% and a $6 billion valuation.
Naturally, this earth-shattering return in such a short amount of time crossed the desks of both the Justice Department and Securities and Exchange Commission (SEC). It’s highly unusual for the market cap of an obscure social networking company with one employee on the books to exceed those of many private-equity giants, including Apollo Global Management LLC (APO).
The other shoe dropped on Sept. 11, 2014 when Cynk’s stock price crashed to just $0.20. That was less than 1/100th of the $21.95 peak shares saw July 2014.
The ensuing government probe into Cynk’s dramatic whipsaws found that the firm was a shell company, meaning it had zero revenue and zero physical assets. It was only created to defraud investors in what was found to be a $300 million pump-and-dump scheme.
Investigators found their way to Belize, the reported location of Cynk’s headquarters. U.S. prosecutors conducted a sting operation that led to the eventual arrest of six Belizean residents and one Canadian citizen responsible for the $300 million scam.
But the ringleader was Gregg Mullholland, a financial fraudster based in California who was initially arrested in 2015. He set up the network of corrupt brokers in Belize to manipulate Cynk’s value for his own profits, which would then be wired to banks in the country. In February 2017, Mullholland was sentenced to two separate prison stints of six and 12 years, respectively.
Despite horror stories like Cynk, the majority of penny stocks is safe and can actually hand investors returns that are both legal and massive. Anyone can seek out these opportunities with a little bit of due diligence and reading.
Here are two tips that involve both…
Two Tips for Safe Penny Stock Investing
The first tip is to examine the company’s 10-K filing, specifically the executive compensation section. These filings outline a company’s financial performance for an entire fiscal year, including info on the firm’s outstanding shares and organizational structure, among many other details.
But the most important aspect of a penny stock’s 10-K is the executive compensation. It’s often an enormous red flag if investors find that the higher-ups – including the CEO and board members – are only paid in cash instead of vested stock options. This suggests they don’t have enough faith in the company’s long-term performance to own shares, which also suggests they’re looking to cash in on the company before the stock price falls to zero.
The second tip is to avoid like the plague the companies with paid or overly visible promotions. These deceptive advertisements can range from a brochure in the mail to a simple phone call to your house.
Promoters often collude with company execs to engage in “pump and dump” schemes. These are convincing sales pitches or copywriting meant to engage with unknowing investors until they buy into the penny stock. Once investors pour in and the stock price skyrockets, those promoters and insiders sell their positions at the higher price, yielding them massive profits as investors lose money.
A common type of pump-and-dump is the “misdialed” or “robocall” scam. It’s when an unknown number calls and leaves a “hot” tip, enticing the victim to follow the advice. However, these callers are usually paid by the company to leave the messages.
If you follow these two rules, you’ll be on the right track to making safe and profitable investments in the penny stock sector.