FINRA and the SEC’s Office of Investor Education and Advocacy are issuing this alert to warn investors that some low-priced “penny” stocks that are aggressively promoted may in fact be stocks of dormant shell companies – companies that have no or nominal business operations or non-cash assets for an extended period of time. Many dormant shell companies that continue to trade in the over-the-counter (OTC) market are susceptible to market manipulation. This alert follows action by the SEC to suspend trading in 255 dormant shell companies in February 2014 and subsequent suspensions of other thinly traded penny stocks.
Rise and Fall of the Dormant Shell Company
FINRA and the SEC continue to be concerned about pump-and-dump schemes in which a fraudster deliberately buys shares of a very low-priced, thinly traded stock and then spreads false or misleading information to pump up the stock’s price. The fraudster then dumps his shares, causing the price to fall, leaving investors with worthless or nearly worthless shares of stock. A shell company is often used in these types of scams. These dormant shell companies may be on the brink of insolvency or even bankrupt. These companies also may not file periodic reports with the SEC that would provide public information about their business and financial condition and may no longer be in good standing in their state of incorporation. Dormant shell companies often have no officers or management. As the name implies, these companies are simply shells.
Fraudsters have been known to use dormant shell companies in pump-and-dump schemes. For example, fraudsters may buy shares in the shell company and then claim that the company has developed a “hot” new product. In some cases, the company will also announce that it has new management or corporate officers. The company may also be re-incorporated, possibly under a new name. These actions may also coincide with a reverse stock split that increases the company’s share price.
These actions often cause public communication about the once-dormant company to increase. Press releases, promotional campaigns, social media and penny stock chat rooms begin to tout the stock. (Typically, regulatory filings remain dormant.) The stock gets “pumped” back to life. Trading becomes more active, and the stock price can soar.
Unfortunately, investors drawn in by these promotional campaigns often find themselves on the receiving end of the “dump.” Fraudsters cash out by selling their shares at higher prices and reaping significant profits, while tanking the stock price and leaving investors with worthless or nearly worthless stock.
These tips can help you walk away from manipulation schemes involving stocks of dormant shell companies:
- Research whether the company has been dormant—and brought back to life. You can search the company name or trading symbol in the SEC's EDGAR database to see when the company may have last filed periodic reports. Another resource is the Secretary of State’s office in the state where the company was formed or incorporated. The charter documents filed with the state may provide details of the company’s history. See if the company recently reinstated business operations in its original state of incorporation, or re-incorporated in a new state. If possible, contact company management to determine why it ceased operations to begin with, and why it decided to reinstate operations. Internet searches may also turn up information on the company or its management, such as information about key officers and directors of the company.
- Know where the stock trades. Most stock pump-and-dump schemes involve stocks that do not trade on The NASDAQ Stock Market, the New York Stock Exchange or other registered national securities exchanges. Instead, these stocks tend to be quoted on an over-the-counter (OTC) quotation platform like the OTC Link Alternative Trading System (ATS) operated by OTC Markets Group, Inc. Companies that list their stocks on exchanges must meet minimum listing standards. For example, they must have minimum amounts of net assets and minimum numbers of shareholders. In contrast, companies quoted on OTC Link generally do not have to meet any minimum standards (although companies quoted on the OTC Link’s OTCQX and OTCQB marketplaces are subject to some initial and ongoing requirements).
- Be wary of frequent changes to a company's name or business focus. Name changes and the potential for manipulation often go hand in hand. You can learn about name changes and other corporate events on the OTC Markets website. If the company files periodic reports, you can search changes in a company name or business focus in the SEC's EDGAR database. Internet searches may also turn up this information.
- Check for mammoth reverse stock splits. A reverse stock split reduces the number of shares outstanding and increases the price per share without changing the total economic value of the shares. A company might perform a reverse stock split with a 1-for-5 or similar ratio (in an effort to meet minimum bid price requirements for continued listing on an exchange). A dormant shell company, on the other hand, might carry out a 1-for-20,000 or even 1-for-50,000 reverse split. This may be done to inflate the price of the stock. Check for reverse splits on the OTC Markets website.
- Know that "Q" is for caution. A stock symbol with a fifth letter "Q" at the end denotes that the company has filed for bankruptcy. Like other non-reporting shell companies, dormant, bankrupt companies can be candidates for manipulation.
If a Problem Occurs
- FINRA Alert: Avoiding Investment Scams
- FINRA and SEC Alert: Inbox Alert—Don't Trade on Pump-And-Dump Stock Emails
- SEC News Release: SEC Continues Microcap Fraud Crackdown, Proactively Suspends Trading in 255 Dormant Shell Companies
- SEC Alert: Be Alert When You Receive Spam E-mail or Faxes And When You See "Unsolicited Quotations" Posted for Stocks
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The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.