Despite the long history of securities fraud, many investors are drawn to penny stocks. A penny stock is a stock that trades for below $5, and its allure comes from the power to purchase more shares with less money.
The dream of owning the next big thing has driven many investors into the hands of penny stock scammers. The majority of penny stock scams are pump-and-dump cases. A pump-and-dump scheme is an illegal act of promoting stocks you own with false and misleading statements to sell when the stock price inflates.
Top 5 Penny Stock Scams in History
Take time to review the most popular penny stock scams in the past to identify and avoid future scams. Start now with Benzing’a list of the top five penny stock scams.
1. Jordan Belfort
Jordan Belfort is a convicted felon who pled guilty to stock manipulations in 1999. Through his brokerage company Stratton Oakmont, he peddled misleading information about stocks he owed.
These statements inflated the prices of the stocks, and he sold them at a profit. In 2007, he published a memoir titled "The Wolf of Wall Street.'' This memoir was later adapted into a movie with the same title.
2. Cynk Technology Corp.
Cynk Technology Corp. is a penny stock company that briefly rose to a $6 billion value despite having no revenue.
Investigations exposed that Cynk was a shell company with no physical assets or revenue on record. The company's main purpose was to create a $300 million pump and dump that involved at least 100 investors.
3. ZZZZ Best Inc.
Barry Minkow, the owner of ZZZZ Best Inc., a carpet cleaning company, managed to convince investors he was building a multi-million dollar corporation. He did so by creating more than 10,000 fake documents and sales receipts. Investors bought his vision, and the stock rose from $4 to $18 a share before he was caught.
4. Jonathan Lebed Scam
Jonathan Lebed was a teenager when he bought penny stocks, promoted them on a message board and sold them when the price increased for a profit. The U.S. Securities and Exchange Commission (SEC) filed a civil suit against him for security manipulation. Lebed settled the suit with the $272,826 earnings he made from the pump and dump.
5. Bre-X Minerals
The Canadian company Bre-X claimed to have discovered a gold mine in Indonesia in the 1990s, which caused its stock prices to skyrocket. However, it was later revealed that the samples had been tampered with and there was no gold. Shareholders lost an estimated $3 billion when the stock collapsed.
How to Avoid Penny Stocks Scams
Scammers most often promise or guarantee unusually large profits with little or no financial risk. If you pay attention, you can spot a penny stock scammer. Here are five surefire signs to identify scammers and avoid losing money to pump-and-dump schemes.
Promised High Profits
If an offer seems like it's too good to be true, it most often is. Penny stock scammers convince investors to purchase stocks by promising huge, unrealistic returns.
Guaranteed Returns
In a bid to attract unsuspecting victims, scammers promise investors a guaranteed return on investment (ROI). This is often a red flag because no one can 100% guarantee an outcome from the stock market. This kind of promise is a Ponzi-level joke of a sales talk.
Cold Calls to Invest
Anyone who reaches out via email or phone urging you to invest in a particular stock is most likely a scammer trying to promote a pump-and-dump scheme. These calls may involve high-pressure sales tactics.
The best course of action is to terminate such calls and block the person. Avoid subscribing to newsletters and email alerts produced by stock promoters you don’t trust and seek financial information from a reliable source.
Trust Your Research
Due diligence means you conduct your own research, ask questions and seek professional advice and opinions.
Penny stock scammers go the extra mile to convince you and satisfy your curiosity. They may produce official-looking press releases that announce new product development, sales, acquisitions and revenues. It's left for you to carry out your research through a neutral financial source. Be sure to ask relevant questions and seek expert advice.
The balance sheet and income statement are usually a good tell. Avoid companies that can't produce a statement. Many penny stock companies don't file SEC-required reports since the bulletin board does not mandate it. The lack of reports puts you in a position to make investment decisions or trades based on pure rumors.
Invest Within Your Risk Limit
Investing can be a risk-fraught process that requires extra boldness and confidence in taking and managing risk. Volatility in stock price is inevitable and expected. However, there's a fine line between reasonable risk and recklessness. Only risk money you can afford to lose.
Penny Stocks Broker Regulations
The U.S. Congress legislated the Penny Stock Reform Act in 1990 as part of measures to prevent penny stocks fraud. In September 20202, the SEC issued new rules preventing brokers from quoting OTC stocks unless companies issuing shares release up-to-date financial information. This move was designed to crack down on pump-and-dump schemes associated with penny stocks.
Investigate Online Stocks Brokers
The right online stock broker that matches your trading or investing goals can be the difference between a frustrating trading experience and a profitable investment journey.
Before selecting a broker, consider the broker's reputation. Check feedback and reviews online to gauge customer satisfaction.
Best and Trusted Penny Stock Brokers
The best brokers to trade with are brokers with excellent customer support, access to the penny stock market exchanges, reasonable fee structure and trading tools. Benzinga has compiled a list of some of the best penny stock brokers available for you.
Are Penny Stocks Good Investment?
Through research, you can find and invest in legitimate penny stocks and reap significant upside. Many penny stock companies became successful.
However, inexperienced investors are advised to tread with caution to avoid falling prey to penny stock scams.
Frequently Asked Questions
Are most penny stocks scams?
Not all penny stocks are scams. However, there are a lot of scammers looking to prey on inexperienced investors.
Can you get rich off penny stocks?
While it is possible to make a huge fortune from penny stocks, few people make money or become rich off penny stocks.
Are penny stocks worth the risk?
Penny stocks are low-priced stocks that can be highly volatile and risky. However, they also have the potential for significant gains if the right investment is made. Investing in penny stocks requires thorough research and understanding of the company and its financials. It is important to consider the potential rewards and risks before investing.
About Chika Uchendu
Chika Uchendu is an investing writer and investment platform analyst passionate about helping people learn more about managing their finances, making informed investment decisions, and navigating the complex landscape of investment platforms to find the best options for their financial goals and needs. He has over 8 years of experience writing compelling articles for various reputable publishers across diverse topics. When he’s not writing content, he’s wrangling and analyzing data to help businesses make informed decisions.