Gelf Magazine - Looking over the overlooked

Internet

February 8, 2007

How Stock Spam Works

Gelf talks with researchers who have examined how spammers are profiting by manipulating the penny-stock market.

Hadley Robinson

The subject of the email reads: Strong Buy Alert! This "Financial Insiders Report" notifies the reader that the China World Trade Corporation (CWTD) is the hottest new stock to buy. The price is $4.80 cents per share, up from $1.50 two weeks ago! It is projected to get to $6.50 by the week's end, and thus it is the "Play of the Month."

The email touting CWTD was one of hundreds of stock-spam emails that landed in Jonathan Zittrain's inbox. Zittrain, a professor of internet governance and regulation at Oxford University, knew that there had to be a monetary incentive behind stock spam, so together with Laura Frieder, assistant professor of finance at Purdue University, he dug into the financial data to find out if the market responds to spam. Their recently released study shines a bright light on how spammers play the penny-stock market.

Jonathan Zittrain
It's amazing that it works at all, since the recipient of the spam must not only choose to read it, but to engage in a financial transaction on the basis of it. Maybe some know it's a scam, but think that if they get in early enough, the price will still go up—a classic pyramid scheme.

Jonathan Zittrain

Here's how it works: The spammer likely bought a large portion of shares from CWTD, driving up the prices, then sent out the spam to thousands of email addresses. The inflated stock values looked attractive to certain gullible buyers, and trading activities surged the day the spam was sent. When the spammer was happy with his gain, he sold his shares and prices plummeted. The buyers were stuck with shares worth little to nothing, CWTD lost integrity, and the spammer ran away with a profit. At the close of trading Thursday, CWTD was trading at $.46.

"It's amazing that it works at all, since the recipient of the spam must not only choose to read it, but to engage in a financial transaction on the basis of it," Zittrain tells Gelf. "Maybe some know it's a scam, but think that if they get in early enough, the price will still go up—a classic pyramid scheme."

Every 10 out of 12 emails messages are unsolicited and stock schemes account for nearly 15 percent of all spam, according to Postini, an email protection and management company that processes billions of messages per week. Zittrain and Frieder studied 304 touted email stocks and 525 non-touted penny stocks listed on Pink Sheets LLC. They analyzed the trading activities and values of the shares from five days before the spam was sent until five days after.

They found that on average, an investor loses 5.5% when they buy a stock the day it was most heavily spammed and sell two days later. In contrast, the spammer earns 5.79% if he buys at the ask price a day early, then sells at the bid price the day he sends the spam.

The results show that what happened with the CWTD is typical. People are responding to spam that pitches stock purchases. "[The spammers] buy the stock at one price, and then spam in order to induce others to buy it when they are ready to sell," Zittrain says. When spammers sell, the artificial demand they had created is no longer there.

The CWTD provides trade agency business connecting Chinese companies to markets in other parts of the world. According to Zittrain, this obscure company is like many others targeted by spammers. They are publicly traded but don't have to meet the requirements to stay listed on NASDAQ or the NYSE. These companies also have a lower number of outstanding shares, so spammers buy a large percentage of them and influence the prices.

The businesses do not gain from these schemes. Heavy spamming that causes buyers to invest can increase the company's share prices temporarily, but this surge is usually followed by a sharp fall. In an interview with Gelf last year, one business owner targeted by spammers complained that the spam was hurting his credibility with investors. "Those guys have put me in a bad situation with their shitty spam," he said.

The stocks being pushed through spam are known as penny stocks, which include any stock that trades for less than $5 a share. These low-cost shares are attractive to risk-averse people, Frieder says, suggesting that the buyers are people who want to get into the stock market, but aren't confident enough to invest with more money.

Sending spam and manipulating markets are both illegal. The low prices of the stocks involved may be the reason most spammers get away with this scheme. "Exactly because it's such a little bit of money, it escapes the radar," Frieder says. "If people were paying $200,000, this would be caught right away. It is exactly because they are penny stocks that they don't get caught."

Though these stocks sell for nominal amounts of money, electronic spam is sent so cheaply that any gain is worthwhile for spammers. And the small profits add up. Some of the higher-profile cases prosecuted by the SEC—including the 2001 case of 15-year old Jonathan Lebed (New York Times)—suggest spammers have made hundreds of thousands of dollars on this ploy.

Laura Frieder

Laura Frieder

The study has implications for spam in all markets. Frieder and Zittrain point out that if spam is successful, it must not always be unwanted by the recipient. The authors both agree it is difficult to say if spam in other markets is as effective as the stock spam they studied. But, if spam is still being sent, it's probably because it works. "[The study] explains why spam continues—enough people really do read it to make it worth sending. And the percentage need not be great to generate profits," Zittrain says.

The U.S. Securities and Exchange Commission (SEC) is the enforcer that spammers are avoiding. The SEC protects investors and maintains fair markets, but it is generally more concerned with fraud and illegal practices for higher cost securities. Also, spammers complicate investigations by concealing their identity, generally sending spam from manipulated IP addresses and hijacked PCs.

Though the SEC isn't heavily tracking internet stock schemes yet, they have prosecuted some spammers. "I have a hunch as we go forward the SEC will crunch down a little more and internet authorities will come up with better methods," Frieder says.

Others are also doing their part to stop these illegal practices. Pink Sheets LLC provides trading information for stocks and bonds not listed with major exchanges or with NASDAQ. They now warn buyers by placing a skull and crossbones emblem on stocks poisoned by spammers, and are pressuring the SEC to increase regulation.

The SEC, companies like Pink Sheets LLC, and virus protectors can help eliminate spam and protect the consumer. However, as the regulators close in, spammers are likely to become savvier too. "Spam will work unless we crack down on it," Frieder says. "They are dealing in a market that is off the beaten path."

Related on the Web

•Salon's Alex Koppelman pretended to invest $9,000 in spam-touted stocks. Here's the story of how his portfolio took a nose dive.

Hadley Robinson

Hadley Robinson is a Gelf contributor and a staff writer for the
Webster Times.







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Article by Hadley Robinson

Hadley Robinson is a Gelf contributor and a staff writer for the
Webster Times.

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