Micro-cap Stocks

Micro-cap stocks can pose a risk to the public as they are attractive to fraudsters. Companies may be newly formed with limited assets, operations and revenue. They may be traded or listed on exchanges with lower listing standards such as the OTC, CSE or TSXV. These factors make it more difficult to obtain reliable information about the company. Micro-cap stocks are also prone to manipulation and are highly volatile. Fraudsters may use micro-cap companies to create (or attempt to create) a misleading appearance of trading activity and/or an artificial share price, and they may conceal their role and/or identity from the public and regulators through beneficial share ownership.

While many micro-cap companies operate legitimately, lawyers should be alert to the presence of risk factors indicating that a micro-cap company may be part of a market manipulation (i.e. a “pump and dump” scheme). A market manipulation is prohibited by securities legislation including section 57(1)(a) of the Securities Act. Risk factors which may indicate a potential market manipulation include one or more of the following:

  • The principals of the company have little or no relevant experience and/or knowledge in the industry. Fraudsters may use nominee principals to avoid detection by securities regulators.
  • The principals of the company have little or no participation in the retainer, with instructions, even on key issues, coming from other individuals.
  • There is no face to face meeting between the lawyer and the company’s principals and/or there is difficulty obtaining necessary, reliable information to identify and verify the principals.
  • The company, its principals, instructing individuals, beneficial owners or promoters have been the subject of trading suspensions or orders issued by securities regulators or criminal investigations/proceedings involving drug trafficking, money laundering, civil forfeiture, loansharking, fraud, or similar activity.
  • The client offers to pay unusually high fees for the legal services being sought.
  • The company or associated entities/persons seek to use the lawyer’s trust account to move funds in circumstances where the lawyer is not providing legal services in relation to those funds. Lawyers are prohibited from handling funds in the trust account in the absence of legal services directly related to those funds. See Law Society Rule 3-58.1 and Discipline Advisory-Lawyers are Gatekeepers.
  • Funds, including retainers, are received by wire transfer from a jurisdiction with a reputation for banking secrecy and/or weak anti-money laundering regulations.
  • Funds, including retainers, are received from a third party whose relationship to the client is unknown.
  • The company has no real business operations with minimal assets and no significant revenue.The company’s purported profile does not match its actual operations or lack thereof.
  • The company changes its business type or name for no plausible purpose and may do so frequently.
  • The company completes a reverse share split at a time when there is no increase in the company’s assets or revenues.
  • The company undergoes a reverse merger within a short time frame of a reverse share split.
  • Large amounts of the company’s stocks may be owned by insiders or by entities or individuals associated with insiders, including the instructing individuals.
  • The company engages in aggressive promotional campaigns to increase stock prices:
    • Online promotional campaigns and/or direct mail or email campaigns at a time when the stock price is rising.
    • Promises of high returns, with inflated claims intended to create a demand for the stock and to pressure investors to buy.
    • Promotional activity or press releases with statements of future events that do not occur.
  • Large payments are made to companies to orchestrate the promotional campaign. The source of the funds used to pay these companies may be concealed. (see, for example, Re Deyrmenjian, 2018 BCSECCOM 125).
  • Significant increase or decrease in stock prices without explanation. Following promotional campaigns, stocks are quickly sold by promoters/insiders/nominees, and stock price then drops.

A pump and dump scheme, if successful, may generate significant funds that fraudsters need to move through financial systems without detection. Fraudsters may also attempt to use a lawyer’s trust account to launder the proceeds of a securities fraud. As gatekeepers of trust accounts, lawyers must guard against being used to facilitate the movement of illegal proceeds.

Be on guard to avoid unwittingly facilitating securities fraud. Know your clients and understand the facts relevant to their retainers including the source of any funds they provide. Where there are suspicious circumstances, make reasonable inquiries to satisfy yourself on an objective basis that the transaction is legitimate prior to acting or continuing to act.

Further information is available on the Law Society’s website including:

Law Society Practice Advisors are available to provide confidential advice to lawyers. You may contact them at practiceadvice@lsbc.org or 604.443.5797.

The Law Society acknowledges, with gratitude, the assistance provided by Leah Shepherd of Hakemi & Ridgedale LLP and Michael Pesunti of the British Columbia Securities Commission in preparing this Risk Advisory.