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Microcap Fraud

Information is the investor's best tool when it comes to investing wisely. It may be difficult to find accurate information about microcap stocks (i.e., low-priced stocks issued by the smallest of companies), including penny stocks (i.e., the very lowest priced stocks). Many microcap companies do not file financial reports with the SEC, so it can be hard for investors to get the facts about the company's management, products, services, and finances. When publicly-available information is scarce, fraudsters can easily spread false information about microcap companies, making profits for themselves while creating losses for unsuspecting investors. Here's how some fraudsters disseminate false information about microcap companies:

  • Paid Promoters. Some microcap companies pay stock promoters to recommend or "tout" the microcap stock in supposedly independent and unbiased investment newsletters, research reports, or radio and television shows. Paid promoters are often behind the unsolicited "junk" faxes, e-mail messages, online advertisements or high-end glossy mailers you may receive touting a microcap or penny stock company. The federal securities laws require the publications to disclose who paid them for the promotion, the amount, and the type of payment. But many fraudsters fail to do so and mislead investors into believing that they are receiving independent advice.
  • Internet Fraud. Fraudsters often use aliases on Internet bulletin boards and chat rooms to hide their identities and post messages urging investors to buy stock in microcap companies based on supposedly "inside" information about impending developments at the companies. For more information about Internet fraud and on-line investing, read Internet Fraud and Tips for Online Investing: What You Need to Know About Trading in Fast-Moving Markets.
  • Email Spam. Fraudsters distribute junk e-mail or "spam" over the Internet to spread false information quickly and cheaply about a microcap company to potential investors. Spam allows the unscrupulous to target many more potential investors than cold calling or mass mailing.
  • "Boiler Rooms" and Cold Calling. Dishonest brokers set up "boiler rooms" where a small army of high-pressure salespeople use banks of telephones to make cold calls to as many potential investors as possible. These strangers hound investors to buy "house stocks" - stocks that the firm buys or sells as a market maker or has in its inventory. To learn more about cold calling, read Cold Calling - Know Your Rights.
  • Questionable Press Releases. Fraudsters often issue press releases that contain exaggerations or lies about the microcap company's sales, acquisitions, revenue projections, or new products or services. These fraudulent press releases are sometimes then disseminated through legitimate financial news portals on the Internet.

If you are considering investing in a microcap company, watch out for these “Red Flags”:

  • SEC Trading Suspensions
  • E-mail and Fax Spam
  • Assets are Large but Revenues are Small
  • Odd Items in the Footnotes of Financial Statements
  • Unusual Auditing Issues
  • Insiders Own Large Amounts of Stock

Even in the absence of fraud, microcap stocks historically have been more volatile and less liquid than the stock of larger companies. To invest wisely and avoid investment scams, research each investment opportunity thoroughly and ask questions:

  • Find out whether the company has registered its securities with the SEC or your state securities regulator.
  • Make sure you understand the company's business and its products or services.
  • Read carefully the most recent reports the company has filed with the SEC and pay attention to the company's financial statements, particularly if they are not audited or not certified by an accountant. If the company does not file reports with the SEC, be sure to ask your broker for what's called the "Rule 15c2-11 file" on the company.
  • Check out the people running the company with your state securities regulator, and find out if they've ever made money for investors before. Also ask whether the people running the company have had run-ins with the regulators or other investors.
  • Make sure the broker and his or her firm are registered with the SEC, and licensed or registered to do business in your state. If the broker or firm is not registered, do not trade with them. Visit FINRA's BrokerCheck website or call FINRA's toll-free BrokerCheck hotline at (800) 289-9999, to determine whether the broker or firm is registered with the SEC, and to check whether there is a history of investor complaints or problems with regulators. Also contact your state securities regulator to determine whether the broker or firm is licensed or registered with your state securities regulator to do business with you, and ask about any complaints.

Additional Information

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