Six Tips to Avoiding Shell Company Fraud
Shell companies—companies that have no or nominal business operations or non-cash assets for an extended period of time—can be used for legitimate purposes. However, they can also be used by fraudsters as vehicles for stock manipulation.
The shares of shell companies, for example, are prime targets for fraudsters looking to pull off a pump-and-dump scheme in which the fraudster goes out and buys up shares of a forgotten, very low-priced stock with little to no trading activity. They then aggressively promote the stock by spreading misleading—or outright false—information about that company to pump up the price. Fraudsters might also engage in manipulative trading in the stock to artificially increase its price and volume, which can lead to increased attention and interest from new investors.
Once the share price jumps, the fraudsters will dump their shares and leave investors holding stock that likely now has no value beyond the initial hype and baseless claims touted by its promoters.
Market manipulation schemes related to shell companies aren’t new, but the industries involved are always shifting. Recently identified fraud in this space has attempted to take advantage of increased public interest in artificial intelligence and crypto assets, for example.
Learn the signs of this type of fraud and what you can do to protect yourself.
Understanding the Pump and Dump
Fraudsters can be quite adept at manipulating public perception and discussion around a low-priced stock shell company. The fraudsters might issue a company announcement, initiate discussions on social media, or use promotional material (such as spam emails and texts) stating that the company is under new management, that it has been reincorporated—maybe under a new name—or both. The fraudsters might also tout a new business line or company focus. Those changes might coincide with a reverse stock split that makes it seem like the company’s shares have increased in value.
Any of those actions can cause public communication around the once-dormant company—including false or exaggerated press releases, social media and stock chat room discussion—to increase, thus “pumping” the stock up. Unfortunately, this is soon followed by the “dump,” leaving the investors who bought stock with hefty losses and worthless, or nearly worthless, stock.
Avoiding Shell Company Fraud
The following tips can help you avoid fraudulent shell company investment schemes:
1. Consider the source. Be skeptical of press releases, spam emails or texts, and promotional materials from unknown senders. They often come from paid company insiders or promoters to hype a company and its products. And those offering investment advice on social media could be working with the fraudsters or attempting to encourage others to purchase a stock. These advice-givers then take advantage of the resulting stock increase by selling into the inflated market, unbeknownst to their followers.
Be wary if you’re flooded with information over a short period of time, especially if the communications primarily focus on a stock's upside with limited mention of risk. Also, find out who’s at the controls of a company before you invest. A basic internet search is a good place to start. Proceed with caution if you turn up indictments or convictions of company officials, find news reports that raise red flags, or learn of their affiliation with other speculative low-priced stocks.
2. Research whether the company has been dormant—and brought back to life. You can search the company name or trading symbol in the Securities and Exchange Commission’s (SEC’s) EDGAR database to see when the company last filed periodic reports, if ever. OTC Markets provides information about stocks that haven’t previously filed with the SEC, as well as red flag designations—including shell, shell risk and bankruptcy—and a list of prohibited attorneys, accountants and other service providers.
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 reincorporated in a new state. If possible, contact company management to determine why it ceased operations and why it decided to reinstate operations.
3. Know where the stock trades. Many pump-and-dump schemes involve stocks that trade over-the-counter (OTC). Companies that list their stocks on exchanges must meet minimum listing standards such as minimum amounts of net assets and minimum numbers of shareholders. In contrast, companies quoted OTC may face less rigorous standards or not have to meet any minimum standards.
Also, OTC stocks have fewer disclosure and other requirements—such as corporate governance or quality standards—than listed stocks. It can be difficult for investors to adequately judge a stock traded OTC without access to information on the company’s earnings, debts, operating expenses and other critical financial information.
- 4. Be wary of frequent changes to a company's name or business focus. The potential for manipulation often goes hand in hand with name and business focus changes. You can check out a company’s history of corporate actions, including symbol and name changes, through FINRA’s Daily List.
- 5. Check for very large or frequent 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. Investors should also be wary of companies with a history of engaging in multiple reverse stock splits.
- 6. 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. Even without a “Q” designation, companies that have excessive debt or a history of engaging in convertible debt financing can be risky investments.
If you have information about potentially fraudulent, illegal or unethical activity related to financial securities, you can file a regulatory tip with FINRA.
Learn more about how to protect your money.
