The real wolves of Wall Street

(NYTIMES) – It did not look like a very promising investment opportunity.

SpectraScience’s phone number was out of service. So was its website. And it had also not disclosed financial results since late 2017, when the San Diego medical equipment company reported a quarterly loss – its 12th in a row.

But early this year, SpectraScience’s nearly worthless shares – priced in hundredths of a penny and too minor to trade on a major stock exchange – sprang to life.

On Jan 27, their price doubled, with more than 900 million shares traded. The next day, amid a flurry of social media cheerleading, more than 3.5 billion shares of the company changed hands – a volume roughly equal to half that day’s trading on the New York Stock Exchange. After soaring 500 per cent as trading opened, just as quickly SpectraScience collapsed.

Penny stocks – the name given to more than 10,000 tiny companies like SpectraScience – have been around forever, but they are booming as small investors flood the market. And this time around, social media is fuelling the craze.

Whether traded to fend off the boredom of life amid the coronavirus pandemic or to turn a quick profit, these dirt-cheap but risky shares are another frontier in a world where meme stocks such as GameStop gained overnight stardom; Dogecoin morphed from a joke cryptocurrency into a hot investment; and a digital artwork known as a non-fungible token, or NFT, sold for US$69 million (S$93 million).

Penny stocks occupy a low-rent district of Wall Street, a world rife with fraud and chicanery where companies that do not have a viable product or are mired in debt often sell their shares. Traded on the lightly regulated over-the-counter, or OTC, markets, penny stocks face fewer rules about publishing information on financial results or independent board members. Wall Street analysts do not usually follow them. Major investors do not buy them.

But last month, there were 1.9 trillion transactions on OTC markets, up more than 2,000 per cent from a year earlier, according to data from the Financial Industry Regulatory Authority, a self-regulatory group that oversees brokerage firms.

The lack of oversight that makes penny stocks easy targets for scammers has long accounted for the stocks’ unsavoury reputation. But risk can also be a draw for thrill-seekers or those who fear they have missed a market boom that is creating wealth all around them.

And now it is easier than ever to get in on these stocks; commission-free trades and the proliferation of online trading platforms mean small investors do not have to go through a traditional broker.

Because these stocks are so small and lightly traded, a sudden surge of interest can make their prices go berserk.

Since the start of the year, shares have soared for companies such as Healthier Choices Management, which operates vape stores; For the Earth, which makes cannabis-based sunscreen; and Garb Oil & Power, which, despite its name, spotlighted its planned purchase of a manufacturer of marijuana pipes in one of its most recent business operation updates.

“Everyone wants to get rich,” said Mr Jordan Belfort, whose memoir, The Wolf Of Wall Street, detailed his debauched life as cheap-stock kingpin, complete with helicopter crashes, sunken yachts and copious quaaludes.

“And they want to get rich quick,” he added.

Mr Belfort, now a motivational speaker and writer living in Los Angeles, presided over Stratton Oakmont, one of the notorious “boiler rooms” that manipulated penny stocks to prey on unwitting retail investors before it went out of business in 1996.

“We all want to believe in Santa Claus, the Tooth Fairy and Bernie Madoff,” he said.

Just as they were in Mr Belfort’s heyday, penny stocks remain the backbone of schemes to part newbie traders from their cash. Consider one perennially popular racket: the pump and dump.

First, fraudsters load up on ultra-cheap shares of a small stock hardly anyone trades. Then comes the pump: They pitch the stock as one with hot prospects, spreading around positive information to push up its price. Finally, there is the dump: After the price jumps higher, the perpetrator sells and leaves the new buyers holding a mostly empty bag.

According to a civil complaint filed earlier this month by the Securities and Exchange Commission (SEC), Mr Andrew Fassari of Irvine, California, used his Twitter account – OCMillionaire – to pump up the price of Arcis Resources, a company that has not conducted business since at least 2016 but whose stock still trades.

Mr Fassari, the market regulators said, bought 41 million shares of the company and then posted misleading information, including fictitious e-mails from the company’s purported CEO about expansion plans. Over nine days in December, the share price skyrocketed more than 4,000 per cent – to more than a nickel. Mr Fassari’s gains were US$929,000, according to the agency. Mr Fassari’s lawyer said he denies any wrongdoing.

Current and former regulators say penny stock fraud will remain as long as these stocks are traded.

Mr Joseph Goldstein, a partner at a financial services law firm, said of penny stocks:

“It’s not going away, basically, because it’s greed. I don’t think there will be a successful effort to end greed in this world.” 

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