Stocks, or shares, are a type of security that denote ownership in a corporation. The holder of a stock owns a claim to a percentage of the corporation's earnings and assets. Penny stocks are stocks that normally trade for under $1, often for under a penny. They are poorly regulated and penny stock fraud has become so prevalent a colorful vocabulary has sprung up in response.
The most common penny stock fraud is the Pump and Dump. A small group of speculators will accumulate a large number of shares in a penny stock. Once their positions are in place, they will release positive financial porn, news so unexpected and titillating it can drastically affect people's perception of the stock. The intent is to get small-time investors to start trading irrationally. The news is almost always false, but before this is discovered, the price of the stock often skyrockets and the original speculators exit with large profits.
The converse of a Pump and Dump is a penny stock fraud called the Poop and Scoop. Here the manipulators spread highly negative false rumors about a company in order to drive the price down. They buy as the stock plummets, counting on a rebound in price once the rumor is dispelled. In a related fraud, manipulators first short sell stock before releasing the rumors. On the subsequent decline, they cover their positions at a profit.
Another common penny stock fraud is Front Running. In this case, the news is actually true; insiders or brokers, knowing what is coming, take large positions ahead of the news becoming public. If insiders are involved, this is also referred to as insider trading, and is illegal.
When a stock has been laying dormant for a long time, insiders may attempt to increase interest with a type of penny stock fraud known as Circular Trading. Using multiple accounts, often established overseas, they will trade the same shares back and forth between their own accounts to create the appearance of activity. With the assistance of a complicit broker, they may complete Cross Trades, where large blocks of stock are traded without appearing on the exchange records. Once third party interest is generated, one of the schemes described above may be executed.
Collectively, these techniques are referred to as Guilt-Edged Investments. The internet, with its ability to instantaneously spread information, has brought with it an explosion in the number of penny stock frauds. Stock-related chat boards and forums have become ground zero of such schemes, and regulatory agencies such as the SEC have begun monitoring them as a first line of defense.
