How to Avoid a Web Stock Scheme


Federal officials charged 11 longshoremen with orchestrating a $7 million online stock scam on Tuesday.

The defendants allegedly used more than 15 websites, including Facebook and Twitter, to promote penny stocks and then take advantage of increases in price and trading volume to turn a profit. The scheme, commonly referred to as a “pump-and-dump,” isn’t exactly a new trick, but the use of social media definitely helped the accused longshoremen cast a wider net.

“Social networks can spread a scam faster than typically in the past,” certified financial planner Katherine Holden says, adding that these networks, while not inherently the problem, allow scammers to sucker in their targets at a much faster pace. At the same time, information about a bogus deal also travels faster on such networks. Regardless, more people fall for the scam than you may think.

“People fall for this stuff for the same reason they buy lottery tickets,” Jim Heitman, a financial adviser with Compass Financial Planning, says. “Easy money sounds like, well, money that comes easy.“

How can the average person protect themselves from being enticed by similar schemes? MainStreet consulted experts affiliated with the National Association of Personal Financial Advisors to find out.

Be wary of making stock picks through social networking sites.

All stock suggestions should be handled with care. However, those obtained through social networks should inspire diligent fact-checking.

“Stock tips in 140 characters or less really should be viewed with suspicion, especially true if the stock price in pennies is less than the number of characters in the tweet,”  Heitman says.

If you are particularly loyal to social networks, though, only take suggestions from big names or basic sources such as MorningStar, Standard & Poor’s or TheStreet’s own StockPickr.   

Rely on third-party verification.

Always double-check that whoever you are taking stock advice from does not have a vested interest in the stock they are trying to sell. If you find yourself drawn to a certain stock through outside influences, take the time to go to someone with no connection to the investment before you commit to what the person is selling.

“Always ask the question, ‘why would someone be providing free advice?’,” says financial planner Jennifer Hartman of Greenleaf Financial Group.

Those exceedingly unfamiliar with the stock market shouldn’t shy away from paying someone for financial advice. Of course, finding a credible financial planner requires some research as well. At the very least, you should require that your financial adviser be certified, which means they are recognized as an expert by the Certified Financial Planner Board of Standards in the U.S. Don’t be afraid to ask them for a more expansive list of credentials as well.  

Don’t purchase penny stocks.

It’s easy to see why a stock novice would consider purchasing a penny stock. After all, it is, by definition, a stock that sells for under $5 a share. Some can cost as little as one cent, hence the name. Buyers, however, need to be increasingly aware of anything valued so low. Penny stocks tend to be traded on obscure markets, are not followed by analysts and are not subjected to the rules and regulations of the Securities and Exchange Commission (SEC).

As such, Heitman compares buying a penny stock to planting a seed in a minefield. “It’ll work out just fine if you survive the plowing, and the seeding, and the weeding, and the harvest,” he says. “That’s a lot of ‘ifs.’”

Consider initially sticking to index funds.

First-time stock buyers should consider investing in index funds, which allow investors to purchase multiple securities in large companies in the market. The S&P 500, for example, allows investors to purchase stock in a large number of publicly held companies that trade on the New York Stock Exchange and the NASDAQ. These companies include Apple, Verizon, AT&T and Bank of America. These types of funds traditionally provide broad market exposure, low operating expenses and low portfolio turnover. In other words, they’re a safer investment with less volatility.

“Index funds are the extreme opposite of buying a penny stock,” certified financial planner Eve Kaplan says, explaining that they allow investors to purchase a snapshot of the market without having to make any big decisions about how a particular stock is going to perform.  “They’re as safe as you can get when you’re investing in stocks.”

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