FINRA Cautions Investors Regarding Dormant Shell Companies and “Pump and Dump” Schemes

FINRA recently issued an Investor Alert, “Dormant Shell Companies–How to Protect Your Portfolio from Fraud.” In the Alert, FINRA warns that some low-priced “penny” stocks being aggressively promoted may actually be stocks of dormant shell companies, which have little or no operations or non-cash assets for an extended period of time. Dormant shell companies which trade in the over-the-counter (OTC) market are susceptible to market manipulation, and in February 2014, the SEC suspended trading in 225 dormant shell companies.

FINRA warns that stock scams frequently use a “pump and dump” scheme. The scheme begins with “the pump,” in which the promoters aggressively market the business using optimistic statements, press releases, emails and other public relations tactics to create demand for stock shares. As soon as the share price and volume spikes, the promoters sell of their shares at a profit, and leave investors with worthless, or almost worthless, stock – “the dump.”

In the case of dormant shell companies, fraudsters may claim that the company has developed a “hot” new product, announce new management or corporate officers, or re-incorporate the company, perhaps under a new name. Such actions are designed to drive up the price of stock initially held by the fraudsters In addition, these machinations may occur in conjunction with a reverse stock split that increases the company’s share price. Such actions create buzz about once-dormant companies, which increases stock interest, trading, and prices.

In fact, the dormant shell company may be on the brink of insolvency or even bankrupt. Dormant shell companies also may not file periodic reports with the SEC, which would provide public information about their business and financial condition. In addition, dormant shell companies may not be in good standing in their state of incorporation, and frequently have no officers or management. As the name indicates, the company is simply a shell.

In its Investor Alert, FINRA offers the following tips to avoid stock schemes involving 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 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.

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