Penny-Stock SCAM Insider Trading

One of my readers has recently enquired as to the law regarding whether insiders, in penny-stock companies, are required to wait a certain period of time before they can sell their shares. Whilst the question, as asked, was relatively vague, it appears that he sought some insight was to whether the following scenario would be legal: an insider of a penny stock company purchases shares during a “pump-and-dump” at a favorable price and then sells those shares when the price has risen as a result of the “pump-and-dump” scheme. Simply put, “pump-and-dump” stock scams are illegal; however, as with everything in the law, exceptions do exist. Many penny-stock SCAMS have been shut down by the Securities and Exchange Commission. However, these types of SCAMS, by and large, have been successful for decades because: (1) the SEC does not have the manpower to identify, track, indict, and successfully prosecute the perpetrators of these scams; (2) there is a steady supply of suckers that are willing to believe that it is possible to increase their assets “500%” in a single trade without risk.

As to the question: the securities laws are very strict on when, and under what conditions, an insider may either buy or sell shares in the company. Based upon my reading of the security laws, the insider would be buying and then selling the shares knowing that nothing within the functioning of the company would give rise to an increase in the price of the shares and that the only reason that the shares would be increasing is the pump-and-dump scheme. By his actions, he would be sending a signal to the public that the company is worth buying leading other to start buying. By any measure, that is the definition of securities fraud. In legitimate cases, when the insiders do either buy or sell shares, full disclosure must be made to the SEC and they better make sure that they are not buying, or selling, on information that is not readily available to the public.

The broader question is as follows: can an insider, who obtained shares prior to the initiation of the pump-and-dump, sell shares into the SCAM. That is the only method by which a pump-and-dump will work to the advantage of the insiders. Insiders make money during these SCAMs only because the greedy public buys shares that are not worth the paper used to print the certificates. Is that considered to be illegal: based upon my knowledge of the securities laws, it probably is not under certain circumstances. However, I would not want to be in the position of convincing a jury that, as a hypothetical insider, I was not trading based upon information not available to the public. Of course, one could say that anyone who buys on a pump-and-dump scheme should know that it was a scam and, therefore, all relevant and material information was in the public domain. In response, I say: good luck convincing the jury of your position.

To my way of thinking, it does not really matter whether the insiders and promoters are differentially on the inside or outside of the line. The perpetrators make a lot of money during these SCAMS because of gullible, and greedy, people are willing to ante up money hoping to strike it rich. Of course, there are people who also believe that a pot of gold is to be found at the end of the rainbow. Some outsiders do make money if they are clever; most, however, lose money.

I hope that this helps.

Nathan A. Busch


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