NEW YORK – Most investors take e-mails advertising a 300 percent return on penny stocks and relegate them to the trash bin. But those Internet promotions are still irresistible for some beginners lured by the promise of making a killing.
The Securities and Exchange Commission is increasingly taking legal action against individuals and companies that falsely promote penny stocks online. In one of its recent cases, involving Ives Health Co., the SEC reported a final judgment against the company’s former president, M. Keith Ives, for disseminating misleading information on the Internet.
A federal court ordered Ives to compensate investors a total of $1.25 million for, among other things, falsely claiming the effectiveness of T-factor, an HIV medication the company developed.
Defined by the SEC as stocks that sell below $5 a share, penny stocks have always been considered speculative and easily manipulated. But stock market experts, seeing an increase in penny stock promotion online, say investors should be wary of swindlers – especially as the stock market continues its recovery.
“When markets are going up, people are more apt to dabble in stocks. So when you receive this information – no matter where it’s coming from – if it’s a bull market, you may be more willing to listen to it,” said Peter Wysocki, assistant professor of accounting at the Massachusetts Institute of Technology Sloan School of Management.
Penny stocks generally trade on over-the-counter markets, such as the Pink Sheets or the OTC Bulletin Board, where, because of their size, they are not required to meet listing standards set by the SEC. In addition, many smaller companies do not have to file reports with the SEC, making it relatively simple for almost anyone to spread false information.
By influencing investors with misleading data on a company, fraudulent brokers or companies can hype up the price of a stock, then sell their own shares once the price reaches a certain level. This scam, known as “pump and dump,” is practically as old as the stock market.
Experts say that since the earliest days of the Internet, promoters, phony research groups and unscrupulous brokerage firms have used spam, message boards, chat rooms, Web sites and newsletters to lure novice investors into believing a given penny stock was the next Microsoft.
Often, they do not actually explain why a company is so successful or what it actually does; they distract readers with fancy financial charts and details of their successful track record, said J. Randall Woolridge, professor of finance at the Smeal College of Business at Penn State University.
“They try to suck you in with these huge returns, but there’s no accountability as to what’s behind them,” Woolridge said.
There are many truthful, legitimate companies that issue penny stock. But major increases in trading volume or sudden changes in a stock’s price, especially when limited financial data on the company is available, may indicate that some sort of fraud is taking place, John C. Edmunds, professor of finance at Babson College in Wellesley, Mass., said.
Some companies use false press releases. According to the SEC, Penny King Holdings Inc. owner Gabor S. Acs deceived investors with misleading releases and Web sites in 2002. The government also said he failed to acknowledge payments from two penny stock companies in exchange for his promotional services. In May, the SEC ordered Acs to make payments totaling nearly $643,000.
Acs could not be reached for comment; no address or phone number could be located for him.
Ives, who is serving a prison term on criminal charges related to the SEC’s civil case against his company, also could not be immediately reached for comment. Ives had two co-defendants in the civil case, James Kosta and Michael Harrison. Christopher Bruno, a lawyer for Kosta, whose case is still pending, said his client denied the charges against him, “and looks forward to having the matter resolved.”
Harrison, in a consent agreement, was ordered to pay nearly $9,500 in penalties. A phone call to his home was answered by a woman who said she doubted Harrison would want to comment.
While some brokers still operate out of 1920s-style “boiler rooms,” where false information is given out over the telephone, the Internet is the cheapest, fastest and most anonymous way to pressure and mislead investors about penny stocks.
“As a vehicle for securities fraud, it’s really got to be up there with pornography,” Edmunds said.
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