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A chop stock is a type of microcap stock fraud in which an equity, usually trading on the Nasdaq Stock Market, OTC Bulletin Board or Pink Sheets listing services, is purchased at pennies per share and sold by unscrupulous stock brokers to unsuspecting retail customers at several dollars per share.
This practice differs from a pump and dump in that the brokerages make money, in addition to hyping the stock, by marketing a security they purchase at a deep discount. In this practice, the brokerage firm generally acquires the block of stock by purchasing a large block of the securities (usually from a large shareholder who is not affiliated with the underlying company) at a negotiated price that is well below the current market price (generally 40% to 50% below the then-current quoted offer/ask price) or it acquires the stock as payment for a consulting agreement.
The subject stocks usually have little or no liquidity prior to the block purchase. After the block is purchased, the firm's participating brokers will sell the stock to their brokerage customers at the then-current quoted offer/ask price, to the often victimized investors who are generally unaware of this practice. This large difference, or "spread" between the then-current quoted offer/ask price and the deeply discounted price the block of stock was purchased is almost always shared with the stockbroker at the firm who solicited the trade. For this reason, there is a large benefit and an inherent conflict of interest for the firm and the broker to sell these "proprietaty products".
Because the firm is technically "at risk" on the block of stock (if the price of the stock drops below the price at which the block was purchased, the firm will be at a loss on the stock) and stock is usually sold at or even slightly below the then-current prevailing market price offer/ask, the practice is still legal in the United States. In fact, it is not required that this profit spread be disclosed to the client, since it is not technically a "commission". Only the amount of fees charged over and above the offer/ask are commissions, and must be disclosed. But even though it is still legal, it is frowned upon by the Securities Exchange Commission, and they are using other laws and methods of attack to inadvertently thwart the practice.
Organized crime elements were believed to have been short-selling chop stocks in the late 1990s.
A chop shop brokerage firm was depicted in the film Boiler Room.
See also
References
- Investors Beware: Chop Stocks Are on the Rise," by Gary Weiss, Business Week, Dec. 15, 1997
- Microcap Fraud, North American Securities Administrators Association
- "Investor Beware," Business Week
- "The Mob is Busier Than the Feds Think," by Gary Weiss, Business Week, Dec. 15, 1997