Let me guess what's inside your inbox -- or at least its spam folder. Chances are that 15% of your spam is made up of stock tips on numerous "microcap" stocks traded on Pink Sheets, an over-the-counter quotation system. These tips come in many forms: from usual text messages to blurry pictures that bypass any spam filters, all of which draw your attention to obscure but sure-to-shoot-through-the-roof stocks.
If all you've done so far was to delete these emails forever, you are on the safest track to financial prosperity. However, there are plenty of Internet users who not only read such emails, but who also act on them, making trades on the recommended stocks. And the more they trade, the more spam we get (e.g. in January 2005, stock-related spam was less than 1% of all spam versus 15% today).
According to a recent paper entitled "Spam Works: Evidence from Stock Touts and Corresponding Market Activity" by Jonathan Zittrain of Harvard Law School and Laura Frieder of Purdue University, this increased trading in selected stocks (which have hibernated for the better past of the year) brings good bucks to the spammers. The spammers might expect to make up to a 6% return if they sell at the right time.
A real life example: the SEC has just brought civil fraud charges against a married couple in Connecticut who have made a $1,000,000 through a process known as stock-market pump-and-dump scam, where they first bought 288 million shares of an obscure start-up, then tipped thousands of people via spam about an expected stock price rise, and then ripped off the benefits when the stock price rose more than 300% amid increased demand.
Such arrangements are being institutionalized and have become a lucrative business, where a large shareholder of a poorly performing microcap stock can hire a spamming company to tout the stock as "this year's success story". Given the small trading volume, it would take only a handful of individuals to act on the email to drive up the price of the stock. At which point, the shareholder gets rid of the stock and makes a hefty profit.
How can the regulators help to solve this problem, which, according to R. Cromwell Coulson, the CEO of Pink Sheets, might turn the OTC market into "a tar pit"? His own suggestion, expressed in his April letter to SEC, is to have stricter disclosure requirements. However, this would hardly work due to the anonymity of the Internet; and what about enforcement? Ironically, some spammers already go as far as to include fine-print disclaimers, making them quasi-compliant with some of the SEC's requirements.
Zittrain thinks that many of the people who act on such spam emails are well aware of what they are doing, but decide to try to beat the odds anyway. Therefore, a sensible strategy would involve increasing awareness about such scams for those who apparently have little idea of what they are doing -- and allowing those who want to take the bet to do it. To deter the spread of such spam in the future, future economic studies should be directed at highlighting not how much money the spammers make, but at how much money those who to decide to invest lose. Increasing awareness of such statistics might quickly kill most of the interest in investing in the hottest of stocks.
The problem with the solution that Zittrain himself advocates -- which involves introducing "speed bumps" and "neighborhood watches" that would limit the ability to trade in touted stocks -- is that those who have firmly decided to take the risk and bet on a stock are unlikely to be deterred by an extra 5-10 seconds or a red flag popping up next to the stock.
This, however, might create even more problems on the OTC market, where genuine trades in a given stock would be blocked just because somebody decided to spam about it a few hours before. I can see competing firms hiring spamming agencies to spam each other's stock daily just to block trading in it. Spam-blackmailing might be on the horizon too: why not tout the company's shares to death unless it pays you a ransom?
Besides, it looks like a step backwards -- the whole point of electronic trading seemed to be cutting down on slack time -- the proposed measures seem to bring it back. Another problem is that, even if Zittrain's solution might help to prevent some short-term losses, it is not sustainable in the longer run; spammers will always find a solution to overcome the fragile regulatory environment -- especially when it comes to online trading.
The author is a TCS Daily contributing writer. He blogs at www.sharpandsound.com.