Opinion and Investing Column

Kim: Investors--watch out for penny-stock 'wolves'

August 16, 2014

KimMartin Scorsese’s 2013 “The Wolf of Wall Street,” based on convicted stock swindler Jordan Belfort’s memoir of the same name, made an over-the-top spectacle of the debauchery at Belfort’s “boiler-room” brokerage, Stratton Oakmont. The film also provided a rudimentary portrayal of how its “pump-and-dump” fraud was perpetrated on unwary investors.

Stratton was shuttered in 1996 and Belfort pleaded guilty to securities fraud and money laundering in 1999. So you might think this type of fraud is extinct. Not so. In fact, today’s technology has made it easier for fraudsters and tougher for regulators.

“Penny-stock” companies typically have limited assets and operations. Penny stocks trade for less than $1 per share, sometimes for just a few pennies or even fractions of a penny. They trade in the “over-the-counter” market (i.e. OTC Markets Group), rather than on a national exchange with stringent standards such as NYSE or NASDAQ.

Accurate information about these low-priced stocks issued by the smallest of companies can be difficult to find. Many penny-stock companies do not file financial reports with the SEC, making it difficult for investors to get the facts. This makes it easy for fraudsters to spread false information. It’s truly the Wild West of speculation.

The “pump-and-dump” playbook calls for a group of insiders to control a high percentage of the stock of a company ostensibly operating in a “hot” industry, like social media or medical marijuana.

The “pump” stage entails these insiders trading small amounts of stock among themselves at ever-increasing prices, creating the illusion of a skyrocketing stock. Pam and Sam control 10 million shares of XYZ. Pam buys 10,000 shares of XYZ from Sam at a penny a share. Sam buys the shares back from Pam for 3 cents per share. Voila, XYZ has tripled, creating catnip for the unsuspecting for a total outlay by Pam and Sam of $400.

Paid promoters then step in, posting messages on the Internet and Twitter touting XYZ as a “can’t miss” opportunity. Gullible investors jump on the bandwagon, driving XYZ’s price even higher and allowing Pam and Sam to “dump” their 10 million shares at a huge profit. When the buying is eventually exhausted, XYZ collapses, leaving the duped holding the bag.

Cynk Technology (CYNK) is a self-described “development-stage company focused on social media.” Its financials indicated from its May 1, 2008, inception through March 31, 2014, it generated exactly $0 in revenue and accumulated $1.6 million in losses. As of March 31, it had assets of $39 (no zeroes omitted) and just one employee (its CEO).

CYNK traded for 6 cents per share on May 15, 2014, where it remained dormant until miraculously surging to $2.25 per share on June 17, a gain of 3,650 percent. About a dozen penny-stock promoters posted tweets in unison. CYNK reached an intraday high of $21.95 per share on July 10, giving it a peak market value of more than $6 billion.

Alas, the SEC halted trading in CYNK the following day, prompted by “concerns regarding the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in CYNK’s common stock.” I have no idea if CYNK was a “pump and dump,” but the stock closed at $2.10 when trading resumed on July 25 and is currently 40 cents.•

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Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. He can be reached at (812) 376-9444 or mickey@kirrmar.com.

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