Despite the long history of fraud, many investors are drawn to penny stocks. A penny stock is a stock that trades for below $5, and their allure comes from the power to purchase more shares with less money.
But 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 is the illegal act of promoting stocks you own with false and misleading statements to sell when the stock price inflates.
Take time to review the most popular penny stock scams in the past to identify and avoid future scams. Start now with our list of the top 5 penny stock scams.
1. Jordan Belfort
Jordan Belfort is a convicted felon who pled guilty to stock manipulations in 1999. Through his brokerage company Straton Oaks, he peddled misleading information about stocks he owed.
These misleading 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 to a movie with the same title.
2. The John Babikian Scam
John Babikian was guilty of the stock fraud known as scalping. Scalping is the act of recommending others to purchase a stock and then immediately selling the stock without adequately disclosing your intent to sell.
Babikian reaped $1.9 million profit by selling approximately $1.4 million shares of America West Resources Inc. Babikian sent emails to about 700 email addresses recommending the stock to investors. After other investors bought the stock and drove up the price, he sold his stocks at an average price more than 4 times the price he bought.
3. 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.
4. 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 rocketed from $4 to $18 a share before he was caught.
5. Jonathan Lebed Scam
Interestingly, Jonathan Lebed was a teenager when he bought penny stocks, promoted them on the message board and sold when the price increased for a profit. The 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.
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 5 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.
In a bid to attract unsuspecting victims, scammers promise investors guaranteed returns on investments (ROI). This is often a red flag because no one can 100% guarantee the outcome of 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 from reaching out to you. 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 will 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. It’s good to 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 trade 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. Still, there’s a fine line between reasonable risk and recklessness. Only risk money you can afford to lose.
Volatility in stock price is inevitable. Usually, for a legitimate company showing real earnings, your ROI for the buy-and-hold strategy will potentially be greater in the multi-thousand based on percentage.
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 was 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 penny stocks market exchanges, reasonable fee structure, and trading tools. We have 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 upsides. There are numerous examples of penny stock companies that are now hugely 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.