Penny Stocks Thrive as Small Investors Flood the Market, Raising Fraud Concerns

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A steep rise in the number of penny stocks being bought by amateur retail investors might be good news for the companies behind those stocks, but it has some industry watchers worried about the potential for massive fraud.

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A Thursday article in The New York Times, citing data from the Financial Industry Regulatory Authority, noted that in February, more than 1.9 trillion transactions were made on over-the-counter markets, an increase of more than 2,000% from the previous year.

OTC markets are a popular place to find penny stocks, which is the designation for more than 10,000 small companies with cheap share prices and questionable business models.

Penny stocks are nothing new — they were particularly popular during the 1920s, when amateur investors flooded the stock markets prior to the 1929 crash. One reason they are booming now is that social media, coupled with boredom during the COVID-19 lockdown, have made it easy for thousands of investors to band together to push up shares of otherwise struggling or worthless companies.

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Two of those companies, GameStop and SpectraScience, became sensations earlier this year when amateur investors poured money into them and sent their stock prices soaring.

The danger for investors is that penny stocks exist in a world “rife with fraud and chicanery,” as The New York Times put it, featuring many companies that either don’t have viable products or are swamped in debt. Another danger is that the OTC markets are lightly regulated compared with other markets, with fewer rules governing what companies must disclose in terms of financial performance and independent review.

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All of this penny stock activity has not gone unnoticed by federal regulators. As the Financial Times reported, the Securities and Exchange Commission last month suspended trading in SpectraScience after the “seemingly defunct” Minnesota-based healthcare company attracted attention from a large number of penny-stock investors.

According to the SEC, a coordinated attempt by social media might have “artificially influenced” the share price of SpectraScience — a company that The Financial Times said doesn’t have a working phone line or website and hasn’t filed quarterly financial results since 2017.

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About the Author

Vance Cariaga is a London-based writer, editor and journalist who previously held staff positions at Investor’s Business Daily, The Charlotte Business Journal and The Charlotte Observer. His work also appeared in Charlotte Magazine, Street & Smith’s Sports Business Journal and Business North Carolina magazine. He holds a B.A. in English from Appalachian State University and studied journalism at the University of South Carolina. His reporting earned awards from the North Carolina Press Association, the Green Eyeshade Awards and AlterNet. In addition to journalism, he has worked in banking, accounting and restaurant management. A native of North Carolina who also writes fiction, Vance’s short story, “Saint Christopher,” placed second in the 2019 Writer’s Digest Short Short Story Competition. Two of his short stories appear in With One Eye on the Cows, an anthology published by Ad Hoc Fiction in 2019. His debut novel, Voodoo Hideaway, was published in 2021 by Atmosphere Press.
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