Is Stock Scalping Illegal? l Securities Lawyer 101
Stock scalping refers to the illegal and deceptive practice of recommending that others purchase a security while secretly selling the same security. In recent years, the Securities and Exchange Commission (the “SEC”) and Justice Department have brought an increasing number of cases alleging securities violations for stock scalping activity. Stock Promotion entails the dissemination of information about a publicly traded company intended to increase its stock price and trading volume.
The person who publishes this information is called a “Stock Promoter”, “Stock Banger” or a “stock tout.” Stock Scalping is most often practiced by unsavory Stock Promoters who are engaged to generate price and volume increases in penny stocks so their clients—one or more individuals or entities with very large positions obtained at deep discounts often for services—may liquidate their shares.
Scalping l The OTC Markets Platform
Over the past decade or so, stock scalping has become an epidemic in stocks traded on the OTC Markets platform.
Until around 2010, when depositing penny stock certificates became much more difficult than it had been, most promoters were paid in “free trading” shares of the stocks they promoted. Well aware that they were engaging in pump and dump schemes, they needed to dump their own stock before the price crashed. And so they sold into their own exhortations to buy. Nowadays, they’re mostly paid in cash, but that doesn’t mean they don’t frontload in advance of the promo and sell into the volume and price increase they create.
Stock Promoters sometimes call themselves “investor relations” professionals. They rarely are professionals. Real Investors Relations people object strenuously to being lumped in with stock pumpers. The honest ones work for companies, not anonymous “third parties,” and provide normal services with full disclosure to the public about their services and compensation. They disseminate press releases, place favorable articles in industry publications, answer investors’ questions, and so on.
Using Stock Promotion in Stock Scalping Schemes
Stock promoters use a variety of media including email, internet,direct mail newsletters, and their own websites. Some buy mailing lists and send spam to the individuals named, but the CAN-SPAM Act and organizations like Spamhaus can create serious consequences for spammers, so most limit their mailings to recipients who opt to receive them. A very few still use boiler rooms staffed by cold-callers.
Promoters’ communications are generally over-the-top, dealing in absurd exaggeration of the company’s worth, crazy sector comparisons such as, ”Apple’s working on the same thing!”–meaningless charts and graphs, and irrelevant quotes purportedly from the likes of Warre n Buffett.
Stock Promotional activities are not illegal. But stock scalping is, along with securities manipulation, and promoters often engage in both, as a recent string of SEC enforcement actions—and a few DOJ criminal prosecutions—attest.
For the most part, scalpers are promoters; sometimes professional, sometimes semi-pro. Any individual or group can buy stock on the cheap, and then create a website to pump it, or use a financial message board for the same purpose. Though elite touts are paid large sums of cash these days, when possible they no doubt also pick up shares of their own before they get down to work.
The people who hire promoters are less likely to be accused of stock scalping than the promoters themselves. That is probably because they do their very best to conceal their identities, as do the promoters themselves. SEC Rule 17(b) requires stock promoters and paid publishers of information about public companies to disclose the amount and source of their remuneration, but often the “third parties” named are anonymous corporate egos, nonexistent entities or offshore nominee companies.
Those parties—the clients—may have got their stock in the first place as seed shareholders in the public company often a shell eventually used for the pump job. Often just before the stock starts trading and the promo hits, the company does a forward stock split, considerably increasing the amount of stock held by the seed shareholders. In other cases, the clients may have got their stock through a debt conversion or a fraudulent offering under Rule 504 or Rule 144.
If the stock promoter made the required disclosure fewer investors would purchase the security. A promoter that can’t generate the necessary high volume, will have trouble finding work in the future. Recent SEC enforcement actions suggest that many promoters’ disclosure is often unclear, incomplete, or entirely untrue.
A few should be given credit: they announce in their disclaimer how much cash they’ve been paid. They name the “third party” payer, and disclose how much stock he owns, adding that he intends to sell it all. Such honesty rarely inhibits the pump, in part because most investors don’t bother to read disclaimers.
Anyone who intends to sell during a stock promotional campaign should specifically state that he or she intends to sell during the campaign. Prior sales should also be disclosed in the disclaimer.
Promoters should remember that the securities laws require stock promotional materials to disclose certain information to investors. In addition, the disclosures provided must be truthful and complete. The SEC has charged stock promoters for disclosing false and misleading information concerning the origin of faxes used in promotional campaigns, who paid for the promotional campaign, and the type or amount of compensation paid. Due to increasing SEC scrutiny, stock promoters should work closely with a securities lawyer in building an SEC defense compliance strategy.
More information about the SEC’s regulation of investor relations activities and a sample disclaimer can be found here.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
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