Penny stocks are booming, which is great for con artists.
After meme stocks and bitcoin, small businesses are seen as the next major opportunity by retail investors. Shares, on the other hand, are a common target for fraud.
It didn't seem to be a very promising investment prospect.
The phone number for SpectraScience was disconnected. Its website was as well. And it hadn't released financial reports since late 2017, when the San Diego-based medical equipment firm posted its 12th consecutive quarterly loss.
SpectraScience's virtually worthless shares, priced in hundredths of a penny and too small to trade on a major stock exchange, sparked to life early this year.
With over 900 million shares traded on Jan. 27, their price doubled. The next day, amid a whirlwind of social-media cheerleading, more than 3.5 billion shares of the company changed hands, nearly half of the New York Stock Exchange's regular trading volume. SpectraScience rapidly plummeted after soaring 500 percent as trading began.
Penny stocks, as the name for over 10,000 small companies like SpectraScience suggests, have been around for a long time, but they're exploding as small investors flood the market. This time, it's social media that's driving the craze. These dirt-cheap but risky shares are another frontier in a world where meme stocks like GameStop became overnight celebrities, Dogecoin morphed from a joke cryptocurrency to a hot investment, and a digital artwork known as an NFT sold for $69 million.
According to Tyler Gellasch, a former Securities and Exchange Commission official who now heads the charitable Healthy Markets Association, it's part of a "huge boom" in retail trading reminiscent of the 1920s, when amateurs flooded into the stock market before the 1929 crash.
“It appears that the only relevant historical precedent is the period preceding the Great Depression,” he said.
Penny stocks are traded in a low-rent section of Wall Street, a world rife with deception and fraud, where companies that don't have a viable product or are in debt frequently sell their stock. Penny stocks, which are traded on the lightly regulated over-the-counter, or O.T.C., markets, are subject to fewer regulations regarding transparency of financial reports and the appointment of independent board members. They are rarely followed by Wall Street analysts. They are not purchased by major investors.
According to data from the Financial Industry Regulatory Authority, a self-regulatory organization that oversees brokerage firms, there were 1.9 trillion transactions on OTC markets last month, up more than 2,000 percent from a year ago.
Penny stocks have a bad reputation due to their lack of regulation, which makes them easy targets for scammers. Danger, on the other hand, may be appealing to thrill seekers or those who fear missing out on a market boom that is generating wealth all around them.
And now is a better time than ever to invest in these stocks: Small investors no longer need to use a conventional broker thanks to commission-free trades and the emergence of online trading platforms.
Since these stocks are so small and exchanged infrequently, a sudden increase in interest can send their prices soaring. Shares of companies including Healthier Choices Management, which operates vape shops, For the Earth, which produces cannabis-based sunscreen, and Garb Oil & Power, which, despite its name, highlighted its planned acquisition of a weed pipe manufacturer in one of its most recent business activity updates, have soared since the start of the year. (The book was published in 2014.)
“Everyone wants to get rich,” said Jordan Belfort, whose memoir “The Wolf of Wall Street” detailed his hedonistic life as a cheap-stock kingpin, which included helicopter crashes, sunken yachts, and copious quaaludes. “And they want to make a lot of money quickly.”
Until it went out of business in 1996, Mr. Belfort ruled over Stratton Oakmont, one of the infamous "boiler rooms" that exploited penny stocks to prey on unsuspecting retail investors. He is now a motivational speaker and writer based in Los Angeles.
He said, "We all want to believe in Santa Claus, the Tooth Fairy, and Bernie Madoff."
Penny stocks are now the backbone of schemes to defraud newbie traders, just as they were in Mr. Belfort's heyday. Consider one of the most famous rackets of all time: the pump and dump.
To begin, fraudsters stockpile ultracheap shares of a limited stock that few people trade. Then there's the pump: they promote the stock as having a bright future, distributing good news to drive up its price. Finally, there's the dump: the perpetrator sells after the price rises, leaving the new buyers with a mostly empty bag.
“It's all like a shark-infested pool,” said Urska Velikonja, a law professor at Georgetown University Law Center who specializes in securities regulation. “It's where the unwary go to get eaten,” says the narrator.
During raging bull markets, when greed is at its peak, penny stock booms are common. They became popular in the 1980s, when the advent of low-cost long-distance telephone service spawned brokerage firms specializing in high-pressure, cold-call pitches for worthless stocks.
Blinder, Robinson & Company, which was led by Meyer Blinder, a flamboyant New York broker, specialized in this field. It grew to become the country's largest penny stock brokerage in the mid-1980s. However, it was liquidated by 1990, and Mr. Blinder was accused of racketeering and securities fraud in 1992. He lunged at a lawyer after his sentence was confirmed, threatening to kill him.
However, stock-touting technology evolves over time. Cold calling, faxes, and email spam were all sent out. Today, the favored approach for creating unwarranted excitement is to use social networking sites like Twitter and Reddit, which fueled the rise of GameStop and other meme stocks.
Andrew Fassari of Irvine, Calif., used his Twitter account — OCMillionaire — to drive up the price of Arcis Resources, a firm that has not done business since at least 2016, but whose stock still trades, according to a civil lawsuit filed this month by the S.E.C. Mr. Fassari, according to regulators, purchased 41 million shares of the company and then released false details, including fake emails about growth plans from the company's purported CEO. The stock price jumped more than 4,000 percent in nine days in December, to just over a nickel. According to the firm, Mr. Fassari made $929,000 in profits.
Jessica C. Munk, Mr. Fassari's lawyer, confirmed that he denies any wrongdoing. Ms. Munk said in a statement that “it seems Mr. Fassari has been hit with fallout from the GameStop, Robinhood, Reddit controversy,” referring to the Robinhood trading app. She also remarked on the SEC's "lightning speed."
For the past two years, Art Hutchinson, a 50-year-old construction services salesman from Fort Worth, has been betting on penny stocks, which he admits are "absolute garbage." And, he claims, social media is constantly driving the behavior he monitors.
“Everyone is on Twitter, Facebook, Instagram, and other social media accounts, and they're all lying,” he said. “They prey on people who don't do their own homework or who don't get it.”
Millions of Twitter messages regarding low-priced stocks were analyzed in a 2017 paper by Thomas Renault, a finance professor at the University Paris 1 Panthéon-Sorbonne. He noticed that a spike in tweets about a small stock resulted in significant price rises followed by rapid declines, and that the trend was consistent with pump-and-dump schemes.
Regulators tend to be taking action to curb such conduct. The SEC briefly stopped trading of SpectraScience stock weeks after it collapsed, alleging “potentially deceptive trading activity.” By late February, nearly two dozen stock tickers had been suspended due to suspicious trading.
In one announcement, Melissa Hodgman, acting director of the Securities and Exchange Commission's Division of Enforcement, said, "We proactively search for suspicious trading behavior related to stock promotions on social media, and act quickly to stop the trading when necessary to safeguard the public interest."
Present and former regulators, on the other hand, believe that penny stock abuse can continue as long as penny stocks are exchanged.
“No matter what you do, don't declare victory,” said Joseph I. Goldstein, a partner at Murphy & McGonigle, a financial services law firm. Mr. Goldstein chaired the S.E.C.'s task force on penny stocks in the late 1980s, when the market was rife with fraud.
He explained, "It's not going anywhere, basically, because it's greed." “I don't believe there will ever be a fruitful attempt to remove greed from the world.”