Finra Warns of Pump-and-Dump Frauds on U.S. Exchanges
Price manipulation involves many China-based issuers, Wall Street’s self-regulator says
The Financial Industry Regulatory Authority, Wall Street’s self-regulator, alerted its members to what it calls “a heightened threat of fraud” associated with unusual price spikes in small-cap IPOs on U.S. stock exchanges.
The regulatory notice published Thursday warned that certain small-cap issuers, typically those that raised less than $25 million, may be subjected to pump-and-dump-like schemes, which appear to be linked to social media scams known as “pig butchering.”
These schemes often begin with a seemingly misdirected online message leading to a relationship between victims and bad actors, sometimes romantic in nature. “After a relationship is established, the bad actor will make a recommendation to the victim to place limit orders in certain securities at a specific time and price,” Finra said.
Many of these issuers’ operations are based in China, with broker-dealers in Hong Kong being allocated a significant portion of the IPO shares, sometimes as much as 90% or more of the public float, according to Finra. The concentration of shares being held in very few hands makes these listings vulnerable to price manipulation.
The regulator also raised concerns about the role of nominee accounts primarily held by foreign nationals. It noted that these individual accounts are often controlled by an undisclosed person or group, and can be traced back to similar IP addresses, bank account information, as well as trading history.
Thursday’s warning follows the volatility seen in many new listings in recent months. Hong Kong-based fintech company AMTD Digital Inc. briefly jumped over 320-fold after its July listing, while Chinese garment maker Addentax Group Corp. rose more than 130-fold on its market debut in August. The two stocks have since lost more than 99% of their value.
The Nasdaq Stock Market has quietly halted listings of small-cap Chinese companies since late September and demanded more information about related parties in deals, The Wall Street Journal previously reported.
The New York Stock Exchange and the Nasdaq Stock Market released separate notices Thursday highlighting some of their concerns about recent small cap IPOs. Both exchanges said they would continue to investigate underwriters and other exchange members involved in fraudulent and manipulative practices. Nasdaq has been scrutinizing these deals over the last two months, but it hadn’t previously issued a public notice on book building standards.
In recent communication with attorneys, Nasdaq has re-raised the requirement that companies from restrictive markets, including China, would have to raise at least $25 million in their IPO, or more than a quarter of their post-listing market capitalization, said Daniel McClory, head of equity capital markets at Boustead Securities. “The idea is that when there are enough shares in the market, it reduces the likelihood of wild price swings,” he said.
The Securities and Exchange Commission has begun asking prospective issuers to include “the potential of rapid and substantial price volatility” as a risk factor for companies with relatively smaller public floats, and that value of the stock may be unrelated to operating performance and financial condition, according to comment letters reviewed by The Wall Street Journal.
Douglas S. Ellenoff, a partner in the law firm Ellenoff Grossman & Schole, said Finra’s alert sent a clear message to the brokerage industry that they should be aware of certain trading dynamics overseas. “This should allow people to have greater comfort proceeding with the transaction so long as they don’t run afoul,” Mr. Ellenoff said.
Meanwhile, Mr. McClory has taken steps in diversifying away from China by focusing on domestic and European markets, as U.S. regulators continue to step up scrutiny of Chinese IPOs. “We probably had two-thirds to three-quarters weighted toward Chinese deals about four to five years ago, now it’s only 15 to 20%.”