The truth behind penny-stock spam

Draining the swamp

Suspending trading may help drain the swamp, although how effective the tactic is remains to be seen. Other methods of dealing with the surfeit of stock spam are shutting down or prosecuting promoters, educating investors and flagging stocks that are ripe for manipulation.

Although illegal e-mail touts are generally untraceable, other markets have developed ways of stopping criminals from pumping up share prices. For example, the freewheeling Vancouver Stock Exchange was long home to many penny stocks that were subject to "pump-and-dump" schemes. But in the late 1990s, Canadian regulators began requiring executives and promoters of small-company stocks to register their promotional activities and submit to background checks.

As a result, Canada eliminated the most egregious penny-stock scams, says Martin Eady, the director of corporate finance for the British Columbia Securities Commission. Regulators crack down hard against those who violate the rules.

In November 2005, for example, the commission suspended Ray Dabney, the president of Xraymedia, after he admitted sending out 22 false news releases about the company. Several Xraymedia directors serve on Goldmark's board, and the two companies share the same Vancouver address, according to filings with the Pink Sheets. Xraymedia was the subject of a 2003 spam campaign, according to spamnation.info, a Web site that tracks penny-stock spam. Shares of Xraymedia are quoted on the Pink Sheets. Although barred from the Pink Sheets, Goldmark shares may still trade if a broker is willing to sell them to investors (few are).

Because markets north of the border are unfriendly to stock scammers, they focus their efforts on Canadian companies that trade in the U.S., where they face fewer restrictions, says the Pink Sheets' Coulson. Eady estimates that more than 660 companies from British Columbia are quoted on the OTC Bulletin Board and the Pink Sheets but don't trade on a Canadian exchange. Canadian regulators are considering even tougher measures to restrain their home-grown stock scammers, Eady says, even though most investors ripped off by their spam live in the U.S.

Not all spam involves Canadian companies. Coulson believes that groups of scammers based in Florida, Nevada and Texas hype many U.S. companies that are the subjects of pump-and-dump campaigns.

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As a practical matter, prosecuting spammers isn't easy. For a promoter's claims to run afoul of the SEC, the law states that a "reasonable" person would have to believe a touter's claims are true, says Donald Langevoort, a Georgetown University law professor and a former SEC special counsel. But because most reasonable people would not believe the claims, the law doesn't view many of these assertions as illegal, he says.

What's needed next

The best way to protect investors is to keep reminding them of the dangers of acting on e-mail touts. Over the past three years, NASD has issued six alerts on its Web site about stock spam, but the gullible continue to be taken in. "Only investor education can have a real effect," Langevoort says.

There may be a better solution than education: identifying stocks that are ripe for manipulation. Coulson plans to label Pink Sheets stocks suspected of being involved in pump-and-dump schemes with a skull-and-crossbones on the Pink Sheets Web site. He has also proposed that the SEC require more information about promoters who legally tout stocks. An SEC spokesman says the agency is reviewing Coulson's proposal but adds that the commission doesn't have the power to impose Canadian-style rules without congressional action. Congress hasn't considered any legislation to limit penny-stock spam or restrict stock promoters.

Meanwhile, stock spammers mock efforts to impede them. On March 11, only three days after the SEC announced its crackdown, a flood of spam touted United Environmental Energy (UTEV, news, msgs) as a "HOT NEW SEC APPROVED STOCK FOR YOUR ATTENTION!" The spam asserted that United was not a pump-and-dump stock. Over the next four days, the shares rose from 5 cents to 40 cents, then quickly fell to 10 cents. The Fort Lauderdale, Fla., company, which does not file financial statements with the SEC, says it was not involved in the spam campaign.

Calculated risk: A safe approach to penny stocks

Penny stocks get the greed glands going -- with good reason. It's a lot easier for a 10-cent stock to double or triple in no time than it is for a $100 stock, even though price, by itself, is not a measure of value. But penny stocks -- defined by the SEC as those that don't trade on Nasdaq or on an exchange and sell for less than $5 -- are generally far riskier than higher-price stocks.

If you're still tempted by low-price stocks, here are some ways you can avoid being ripped off:

• Look for the financials. Tiny companies don't have to file audited financial reports with the SEC. If a company you're interested in doesn't file, stay away. Financial data for most penny stocks touted in e-mails are either crummy or nonexistent.
• Check the market value. Not all low-price stocks are small companies. If a company's market value (share price times shares outstanding) is $50 million or more, chances are it's legit. Among the stocks recently recommended by the Turnaround Letter, a newsletter with a superior stock-picking record, five traded in mid-April for less than $5 but sported market capitalizations of $218 million and up. The best known: Gateway, the computer maker, with annual sales of $4 billion and a market value of $848 million. It traded at $2.23.
• Don't bet the ranch. Use only a small portion of your money to dabble in penny stocks and buy only if you can afford to lose 100% of your investment.

This article was reported and written by Thomas M. Anderson for Kiplinger's Personal Finance Magazine.

Published June 19, 2007

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