Penny stocks scam millions. Here’s why they’re so dangerous

Outside of the mainstream stock exchanges, there is a lesser known marketplace with divergent regulations and low-priced “penny” stocks — which despite the name — trade at $5 and below and may lure in unsuspecting investors looking for wealth on Wall Street.

Through the years, authorities have busted massive penny-stock scams that have defrauded thousands of investors out of millions of dollars, but fraudsters are still out there.

“I’m getting a lot of calls from investors who are duped and getting scammed by-penny stock operators,” Jacob Zamansky, attorney with his firm Zamansky LLC, told CNBC.

These so-called over-the-counter equities markets have experienced steady increases in trading activity, spiking in 2021, according to data from the Financial Industry Regulatory Authority.

Penny stocks

Although there is nothing inherently wrong with low-priced stocks, they are considered speculative, high-risk investments because they experience higher volatility and lower liquidity. For example, if you buy a penny stock and then decide you want to sell it, it could be more difficult for you to find a buyer.

“At the end of the day, you’re buying something in the stock market, someone else is selling it. So, you have to think about who might be the other person on the other side of the trade,” Andres Vinelli, chief economist at the CFA Institute, told CNBC.

OTC markets require different, varying financial reporting. This lack of transparency makes it easier for fraudsters to manipulate information and misrepresent financials. If paired with unscrupulous stock promoters making exaggerated claims, investors can become victims.

“It all kind of comes together as the perfect storm of opportunity for criminal enterprises,” Greg Ruppert, head of FINRA’s member supervision organization, told CNBC. “Certain statements or claims could be made that are not readily verifiable or easily investigated or tracked.”

The Wolf Of Wall Street

Jordan Belfort orchestrated one of the most notorious penny-stock scams in history through his brokerage firm, Stratton Oakmont, which was portrayed in the 2013 movie “The Wolf Of Wall Street,” starring Leonardo DiCaprio.

“He really was a character as Leonardo DiCaprio portrays him in the movie,” Zamansky told CNBC. “He had an expression. He sold steaks to restaurants to start with. And he said, If I can sell steaks, I can sell stocks.” 

Before Zamansky started representing investors who were abused by Wall Street firms, he was an attorney for Stratton Oakmont. That’s where he learned about the business of penny stocks.

“I have to say I learned all the dirty tricks of Wall Street from representing those folks, and I used my knowledge to help investors, starting in 1998,” Zamansky told CNBC.

Innocent investors bought into Belfort’s sales pitch, which artificially pumped up stock valuations. Then, the firm would sell its shares. That’s known as a “pump and dump” scheme.

“What I didn’t know, which the SEC later found out, is that [Stratton Oakmont] had their own positions in these stocks. They would sell out,” Zamansky said, referencing the Securities and Exchange Commission. “And, the customers would be left holding the bag.”

Eventually, the scam collapsed, and Belfort was convicted of fraud and served time in prison.

Belfort did not respond to CNBC’s request for an interview but in CNBC’s “Bitcoin: Boom or Bust” 2018 documentary, he spoke about his time as a scammer and how he’s turned around his act.

“I was a scammer. I was. [I’m] the first to admit it,” Belfort told CNBC in 2018. “I would say most of my firm was legitimate, but there was a portion of my firm that wasn’t.”

But, this is just one example of penny-stock fraud.

Watch the video above to learn more about how ultra low-priced stocks inspired a new breed of investors, high-stakes gamblers, risk-taking fraudsters and enforcement crackdowns.

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