Penny Stocks: A Warning for Investors: Scammers try to boost the price of the stocks and then sell their own shares for a profit

Penny Stocks: A Warning for Investors

Scammers try to boost the price of the stocks and then sell their own shares for a profit.

PRIYA ANAND

May 30, 2014 4:07 p.m. ET

Email messages promoting penny stocks have surged, and regulators are warning that scammers try to boost the price of the stocks and then sell their own shares for a profit.

With the stock-market benchmarks near all-time highs, investors are buying up penny stocks—shares of small, risky companies that often have a limited track record—at a record pace. In many cases, investors are betting that a tiny firm will expand rapidly, allowing shareholders to log strong returns in a relatively short period.

Regulators have taken notice of the heightened activity. The Securities and Exchange Commission has suspended trading on such stocks about 1,300 times since May 2012, accounting for more than half of the cases in which it has taken that step since 1995. The agency can suspend trading if it believes information about the company is inaccurate or unreliable, or if it suspects a company is becoming a vehicle for market manipulation.

“If we had a message to deliver, it would be that this is a very dangerous market for retail investors and that they should tread very, very carefully,” says Andrew Calamari, director of the SEC’s New York office.

Last year, the SEC and the Financial Industry Regulatory Authority, the brokerage industry’s self-regulatory group, said that spam email messages represented the “inbox equivalent of a boiler room sales operation.”

Traditional boiler rooms are filled with salesmen promoting stocks by calling investors and claiming that the shares in a company are about to soar, as depicted in the recent film “The Wolf of Wall Street,” which was based on a real case. If investors buy and the share price rises, boiler-room operators can sell their own shares for a profit.

Email messages hyping stocks—mostly penny stocks—accounted for 16% of unwanted email in 2013, up from less than 1% the year before, according to a report by Trustwave, a Chicago-based firm that helps companies protect data.

Stock spam thrived in 2007, before plunging as stock prices fell sharply in the financial crisis, according to Trustwave. The recent surge has coincided with the rally in the stock market.

One company, Beverly Hills, Calif.-based Rich Pharmaceuticals, RCHA -30.77%saw its stock price triple to about 37 cents a share during a spam campaign in mid-April, according to the pharmaceuticals company and Trustwave. Rich said in an announcement about a week after the campaign that it “has not, and does not, authorize, endorse or sponsor this illegal spam stock promotion or any of the information contained in these emails.” Rich says it is working with Finra and OTC Markets Group, which handles trading of many small-company shares, to investigate the messages.

Promoters can “blast spam out saying this is the deal of the century, this company is about to make some major announcement, the stock is going to increase 800-fold, we recommend you buy this as soon as possible,” says Karl Sigler, threat intelligence manager at Trustwave. “The original spammer is going to get a huge increase in their initial stock.”

The SEC says investors should be skeptical of email tips, do their own research and be wary of high-pressure pitches. Investors who consider trading on such messages through their online accounts also should consider consulting their investment advisers.

In March, the SEC charged John Babikian, a stock promoter, for using websites such as AwesomePennyStocks.com andPennyStocksUniverse.com to email about 700,000 people recommending stock in a Utah-based coal company, America West Resources. AWSRQ 0.00%

There wasn’t a single trade in the company’s stock on Feb. 23, 2012, until Mr. Babikian’s emails triggered “massive increases” in the share price and 7.8 million shares were traded in 90 minutes, according to the SEC.

The company’s share price had closed the previous day at 29 cents, and hit a peak of $1.80 after emails went out, according to the SEC. Mr. Babikian unloaded more than 1.3 million shares and recorded more than $1.9 million in “ill-gotten gains,” the SEC alleges.

Neither a lawyer for Mr. Babikian nor America West responded to requests for comment.