What Are the "Red Flags"? of a bad investment?
It can be extraordinarily difficult to detect fraud or a manipulative scheme. But when you're researching a company, watch out for these "red flags":
* SEC Trading Suspensions The SEC has the power to suspend trading in any stock for up to 10 days when it believes that information about the company is inaccurate or unreliable. Think twice before investing in a company that's been the subject of an SEC trading suspension.
* Company Recommended But No Current Information Be especially careful if you receive an unsolicited fax or e-mail about a company -- or see it praised on an Internet bulletin board -- but can find no current financial information about the company from other independent sources. Many fraudsters use e-mail, faxes and Internet postings to tout thinly traded stocks, in the hopes that the resulting buying frenzy will push the share price up so that they can sell their shares. Once they dump their stock and quit promoting the company, the share price quickly falls.
* High Pressure Sales Tactics Beware of salespeople who pressure you to buy before you have a chance to think about and investigate the "opportunity." Dishonest people may try to tell you about a "once-in-a-lifetime" opportunity or one that's based on "inside" or "confidential" information. Don't fall for a promise of spectacular profits or "guaranteed" returns. These are the hallmarks of fraud. If the deal sounds too good to be true, then it probably is.
* Assets Are Large But Revenues Are Small Companies will sometimes assign high values on their financial statements to assets that have nothing to do with their business. Find out whether there's a valid explanation for low revenues, especially when the company claims to have large assets.
* Odd Items in the Footnotes to the Financial Statements Many fraud schemes involve unusual transactions among individuals connected to the company. These can be unusual loans or the exchange of questionable assets for company stock that may be discussed in the footnotes.
* Unusual Auditing Issues Be wary when a company's auditors have refused to certify the company's financial statements or if they've stated that the company may not have enough money to continue operating. Also question any change of accountants.
* Insiders Own Large Amounts of the Stock In many fraud cases - especially "pump and dump" schemes - the company's officers and promoters own significant amounts of the stock. When one person or group controls most of the stock, they can more easily manipulate the stock's price at your expense. You can ask your broker or the company whether one person or group controls most of the company's stock, but if the company is the subject of a scam, you may not get an honest answer.
Additional Warning Signs Don't deal with anyone who refuses to provide you with written information about the investments they're promoting. Never tell a cold caller your social security number or numbers for your banking and securities accounts. And be extra wary if someone you don't know and trust recommends foreign or "off-shore" investments.
What If a Company Has Filed for Bankruptcy?
Watch out for ticker symbols ending with a fifth letter "Q." The addition of a "Q" to a company's stock ticker symbol indicates that the company has filed for or is involved in bankruptcy proceedings. Investors often snatch up the low-priced shares of companies that have filed for Chapter 11 protection, speculating that the price will rise once the company emerges from bankruptcy. But that's not how bankruptcy typically works.
Be cautious when buying common stock of companies in Chapter 11 bankruptcy. Doing so is extremely risky and will likely lead to financial loss. Although a company may emerge from bankruptcy as a viable entity, in most instances, the company's plan of reorganization will cancel the existing equity shares. It is generally the creditors and the bondholders who become the new owners of the company's new shares - not the stockholders. This happens in bankruptcy cases because creditors are paid from the company's assets before common stockholders. And in situations where shareholders do participate in the plan, their shares are usually subject to substantial dilution. If you have questions about what happens when a company declares bankruptcy, you can get information from the SEC on the subject.
Where Can I Turn for Help?
If you've been asked to invest in a company but you can't find any record that the company has registered its securities with the SEC or your state, or that it's exempt from registration, you may have come face to face with a scam. Call or write your state's securities regulator immediately with all the details. You can also file a complaint using the SEC's online Complaint Center.