http://www.usatoday.com/money/markets/us/2005-11-10-pink-sheet-cover-usat_x.htm

The article describes the techniques scammers use to profit from the lightly regulated pink sheets stock market. This stock market is known for trading stocks that don’t meet the requirements to be on a larger stock exchanges such as the NYSE. Most of these stocks, which trade at low prices and volumes, are “shell companies,” which means they don’t have any real assets or operations. Scammers use a “pump-and-dump” scheme to advertise the penny stock to uninformed investor. Some of the methods scammers use to pump the stocks include questionable correspondences, fake research reports, reverse mergers, and multimedia assaults. We will discuss how the pink sheet stock market is a perfect framework for a simple one-way information cascade and how the internet can be used to maximize the probability of a successful pump scheme.

The pink sheet market provides an excellent framework for information cascades because of the nature of the stocks and investors. Compared to reputable stock markets, the pink sheet market contains stocks of low volumes. When a few investors buy into a stock, it can raise the share trading volume by hundreds of percent versus the small percentage in other stock markets. The drastic volume changes can give strong buy signals to pink sheet investors. Most of these pink-sheet investors are less informed than ones who trade on the reputable stock markets and are more likely to make investments decisions based on other people’s actions rather than their own information. By ignoring outside information, investors make the cascade more likely to accelerate rather than stop.  In short, they buy stocks more mechanically based on the other people’s actions, similar to the simple one-way cascade effect we discussed in class.

All the scammer needs to do is get a few unsuspecting investors to buy the stock, which will send “buy” signals to other buyers. Since the internet allows for the mass dissemination of information, it enhances the scammer’s opportunity to reach uninformed investors. Old forms of advertising like fax and voice mails are not nearly as useful as spamming and posting in investing communities. Spamming allows scammers to reach millions of people, and chances are that a few people will believe the sensationalistic email stating the stock that will go up 500% in the next week. Investing communities are another great place for scammers to promote their stocks, pretending that they have some inside information about the stock. On top of all of this, financial sites such as Yahoo finance list these stocks, which appear more legitimate than they really are. The pink sheet stock market needs more oversight to help protect unsuspecting investors from scams.