A few years ago, British Columbia had a big problem. Unscrupulous operators were using the loosely regulated US over-the-counter (OTC) markets to fleece investors.

These markets are not like a regulated stock exchange, such as the Toronto Stock Exchange or the New York Stock Exchange. Instead, many of these penny stocks trade on little more than hype, unproven rumour and speculation.

From 2000 to 2008, there was, simply put, an explosion of growth of these companies either based in BC or using BC promoters. The numbers were growing at an alarming rate. While the stories about these companies were somewhat amusing, the problem was not. It was beginning to affect the reputation of our capital markets, and BC investors were at risk.

Here are just a few examples of the types of companies that promoters tout as being the “next big thing”.

One company was supposed to be in the wine storage business. We discovered that all it had rented was 265 square feet of space – smaller than even the standard size storage locker. Another example was the dance studio located in a strip mall in Langley with “vice-presidents” of dance and Pilates – this tiny business would not normally be a public company.

Also, many of these companies listed bogus shareholders, creating so-called “shell” companies. In one case, the company listed the coach and some players of a local BC community college basketball as its shareholders. Once a “shell” company is built, it is sold for hundreds of thousands of dollars to promoters who use it to carry out “pump and dump” schemes that harm investors.

“Pump and dump” is a type of stock fraud that involves artificially inflating the price a stock, by making false or misleading announcements. This type of promotion leads to an inflated stock price, or the “pump”. Meanwhile, the operators of the scheme dump their overvalued shares into the market.

When the dust settles the price falls, the shares become nearly worthless, and investors lose their money. The promoters, on the other hand, stand to make millions.

This is why investors should be extremely careful when they see the stock of a company trading on the over-the-counter markets hyped through e-mail, on Internet, or in newsletters. There’s a chance it may be a pump and dump, and you could end up losing all of your money.

In Part Two, we will talk about how we have tried to protect investors and reduce the damage these types of companies doing to BC’s reputation.

Suggested Reading

BC Securities Enforcement Roundup – November 2012

New InvestRight app video series launched

Tip shuts down illegal trading by Orion Advisory Services and IS Markets

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