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Stock Scalping 101

Author: 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 SEC and Justice Department have brought an increasing number of cases involving securities violations that involve scalping activity.

Scalping is most often practiced by stock promoters. Promoters are engaged to generate heavy volume in OTC issues so their clients—one or more individuals or entities with very large positions obtained on the cheap—may liquidate. Over the past decade or so, scalping has become an epidemic in stocks traded on the OTCMarkets platform.

Until around 2010, when depositing penny stock certificates became much more difficult than it had been, most promoters were paid in stock. Well aware that they were engaging in pump and dump schemes, they needed to unload their own stock before the price crashed. And so they sold into their 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 they create.

Promoters sometimes call themselves "investor relations" professionals. They rarely are. Real IR people object strenuously to being lumped in with pumpers. The honest ones work for companies, not anonymous "third parties," and provide normal services. They disseminate press releases, place favorable articles in industry publications, answer investors' questions, and so on.

What is a stock promoter?

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 "promoter" or a "tout." 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 difficulties 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--"Apple's working on the same thing!"--meaningless charts and graphs, and irrelevant quotes from the likes of Warren Buffett.

Stock promotions are not illegal. But 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.

Who does the scalping?

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 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 touts to disclose the amount and source of their remuneration, but often the "third parties" named are nonexistent entities or offshore nominee companies. If a lengthy investigation results in charges against them, those charges will likely be securities fraud, securities manipulation, money laundering, and perhaps conspiracy.

Those parties—the clients—may have got their stock in the first place as seed shareholders in the shell eventually used for the pump job. That stock would be legally free trading, as it was registered by the S-1 filed by the company before the promo began. Often just before the stock starts trading and the promo hits, the company does a forward 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. That stock may not be legally free trading.

When do scalpers sell?

The scalper already owns his free trading stock before the promotion begins, in order to maximize his chance of profit. If the company paid him in stock for his services, he'll probably begin selling as soon as the stock price begins to rise. He knows his client will be selling into the pump as well.

Promotions are expected to take the stock's price up considerably. Sometimes that happens; other times it doesn't. The promoter may not end up a big winner, but his client always will, because he paid practically nothing for the stock he wants to dump. All he needs is increased volume.

The semi-pro promotional groups that infest message boards sometimes get lucky; other times they don't. The smart ones start dumping immediately; their "unofficial" promos don't last long.

If scalping is illegal why doesn't the stock promoter make the required disclosure?

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 players don't bother to read disclaimers.

Is a compensation disclaimer or general disclaimer sufficient to avoid an SEC action for scalping?

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. Disclosure of stock compensation or of the number of shares held is not sufficient if sales will be made during the promotion.

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 at these blog posts:

http://www.securitieslawyer101.com/investor-relations-go-public/

Article Source: http://www.articlesbase.com/investing-articles/stock-scalping-101-6572915.html

Brenda Lee Hamilton, our law firm's founder and a securities lawyer has counseled clients in legal and compliance matters involving securities and financial transactions including underwritten and direct public offerings, equity and debt offerings, corporate legal and compliance matters and restructurings, go public direct transactions and disclosures, corporate identity theft and hostile takeovers. Brenda Lee Hamilton as a securities lawyer assists clients in all aspects of the go public direct process including filing of Form S-1 and other Registration Statements, Form 211's with the Financial Industry Regulatory Authority ("FINRA") and electronic trading applications with Depository Trust Company ("DTC").In her capacity as a securities lawyer, Brenda Lee Hamilton counsels clients in stock exchange listings involving the New York Stock Exchange, American Stock Exchange, NASDAQ and the OTC Markets. She also assists clients with obtaining dual and single go public direct listings on international exchanges such as the Frankfurt, TSX Venture Exchange , Toronto and London exchanges including legal and compliance with regulatory requirements of the various Securities Commissions, including corporate governance matters, liaising with the various Securities Commissions, continuous disclosure and other filing requirements with the various Securities Commissions, prospectus preparation and filings (IPO and non-IPO), domestic and international direct public offerings, preparation and filing of stock exchange listing submissions, compliance with various stock exchange policies.

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