Major events and times of uncertainty — such as the current COVID-19 pandemic — have long been exploited by unscrupulous, typically unlicensed, promoters to perpetrate fraud, and microcap securities remain one of their primary tools for such schemes. This and other types of financial fraud continue to be an area of focus for FINRA and other regulators.
FINRA has observed increased indicators of potential microcap fraud, with much of the activity seeking to exploit the COVID-19 pandemic. FINRA has issued two articles that address COVID-19-related fraud, Fraud and Coronavirus and The Coronavirus Is Novel, but Crisis-related Scams Are Nothing New. In addition, the SEC's Office of Investor Education and Advocacy issued an Investor Alert warning of coronavirus-related investment scams, which includes an updated list of trading suspensions in the shares of several dozen issuers for potentially misleading COVID-19-related claims, with many of these being in microcap securities.
What is a microcap stock?
Microcap securities, sometimes referred to as penny stocks, include low-priced securities issued by small companies with low market capitalization. These securities are often traded on the over-the-counter ("OTC") market. While microcap companies can be real businesses developing or offering products or services, the microcap sector has a long history of bad actors engaging in price manipulation and other fraud. However, even in the absence of fraud, microcap stocks can present higher risks than the stock of larger companies.
Information for microcap companies may be limited and many may not file reports with the SEC, making it difficult for investors to get facts about the company's management, products, services, and finances. In addition to having limited publicly available information, microcap stocks have historically been more volatile and often less liquid than the stocks of larger companies — all reasons to invest with extreme care and only with money you can afford to lose.
Due to the difficulty for investors to verify the information provided by the company or promoters, microcap stocks are often the subject of pump-and-dump schemes. These scams tout stocks, products and other investments, with the promise of huge gains and returns — but as the price peaks, the scammers sell their shares, pocketing the profits. After the scammers take their profits, the artificially inflated stock price typically drops, leaving other investors with losses or worthless stock. The scammers who run these frauds will use any hook to build demand, including natural disasters and public health emergencies.
What should I look out for?
To help protect your assets, be alert to these warning signs of a potential microcap investment scam:
- Unsolicited phone calls, emails, or text messages touting investments, particularly those linked directly or indirectly to a recent disaster or the latest trend;
- Heavy promotion of a microcap company or its stock on social media (e.g., on Twitter, Instagram, or Facebook), in research newsletters, and via investor chat rooms or message boards, especially if the communications only focus on a stock's upside, with little or no support for the stock's upside potential or mention of downside risk;
- Unverifiable or questionable claims regarding partnerships, joint ventures, or financing agreements with private entities, especially those related to the pandemic or the latest hot trend;
- Information about a public company that cannot be confirmed on the company's website or in official financial statements and disclosures filed with the SEC or on an inter-dealer quotation system;
- Lacking verifiable evidence of issuer's business activities, such as limited or no operational website, social media accounts, references to the company on employment website or other independent reporting on the company's business activities;
- Abrupt or frequent changes to the business model, issuer name, or ticker symbol, often to give the appearance of a connection to the latest news (for example, COVID-19 cures, test kits or prevention-related products), especially when the company may have previously engaged in a business involving other trends (e.g., e-cigarettes, cannabis, or cryptocurrency);
- Recent reorganization or recapitalization of the company, such as through a reverse merger;
- Stock associated with companies currently or previously classified as a shell company, with no or nominal operations or assets;
- Executives or control persons of the company who have previously been, or currently are, associated with other microcap or shell companies or who have a history of regulatory or criminal violations.
While the existence of any of these warning signs does not automatically mean the investment is a scam, investors should proceed with caution and keep in mind that hints or promises of high returns, with little or no risk, are classic warning signs of fraud. Every investment carries some degree of risk, and the potential for greater returns almost always comes with greater risk.
Never rely solely on information you receive in an unsolicited email, text message, or cold call from a smooth-talking "analyst" or "account executive" promoting a stock. Use FINRA BrokerCheck® to verify registration status and additional information on investment professionals and investment firms. Check the SEC's EDGAR database to find out whether the company whose stock is being pitched files with the SEC. And be extremely wary of buying unregistered products or taking investment advice from unlicensed professionals.
For additional information on microcap stocks, check out these helpful resources from the SEC:
- Investor Bulletin: Microcap Basics (Part 1 of a three-part series of Investor Bulletins on the topic)
- Microcap Fraud (additional tips and videos)
If you're suspicious about an offer, think the claims might be exaggerated or misleading, or suspect you or someone you know has been taken in by a scam, you can do your part by reporting your concerns to FINRA, the SEC, and your state securities regulator.