Last Friday, the SEC suspended trading of Cynk Technologies -- a social network with zero assets, no revenue, and one employee -- after its stock price inexplicably surged 25,000% in less than a month. The penny stock, which only started trading in June, jumped from $0.06 per share to $21 per share, giving it a market value of $5 billion -- making it nearly twice as valuable as Zynga (NASDAQ: ZNGA).
Cynk bills itself as a "social marketplace" that claims to sell contact information of "celebrities, business owners, and talented IT professionals" through a website, IntroBiz. However, the company reported a $1.5 million loss last year and its only employee, CEO Javier Romero, has a non-existent address in Belize, according to The Wall Street Journal. Romero reportedly bought 210 million shares back in February, giving his stake a "notional value" of over $3.5 billion when the stock peaked last Thursday.
Cynk Technologies, which is likely a "pump and dump" scheme, joins the shameful list of over 1,300 stocks that the SEC has suspended over the past two years. While these schemes have been around for decades, three new factors -- paid promoters, Twitter ( TWTR -1.36% ) bots, and high-frequency trading programs -- have made it much easier to manipulate these stocks. Let's take a closer look at how these three factors aid market manipulators and ensnare gullible investors.
The business of paid promotions
In the past, microcap companies traditionally used direct mail and email to promote their penny stocks. The problem is that these promotions were easy to spot as ads for get-rich-quick schemes.
That's why these companies started paying freelancers to post legitimate looking articles on well-known finance websites. Last year, Seeking Alpha admitted that five of its articles recommending the penny stock Goff were paid promotions, after fellow Fool Brian Richards explained how Goff inexplicably rallied from $0.01 to a peak of $0.65.
Promotional articles on legitimate finance websites can spread across the Internet very quickly. Once the article is published, paid promoters start spamming the article on message boards and Twitter. Those tweets are then picked up by Twitter bots, which retweet posts based on keywords. That, in turn, causes high-frequency trading (HFT) bots that "read" Twitter feeds to execute trades. This sudden surge in volume then tricks human traders and investors into buying shares as well.
The business of Twitter bots and trading bots
As I discussed in a previous article, Twitter has a major problem with fake users and bot accounts. A recent analysis at Bot or Not of 18,000 Twitter users who tweeted content from popular tech websites discovered that roughly 15% were bot accounts. Meanwhile, an entire industry selling randomly generated fake Twitter users now rides on the coattails of Twitter's success. These services deliver hundreds to thousands of fake followers for as little as $1.
Meanwhile, HFT bots are traditionally plugged into news aggregating and filtering services like RavenPack. This was considered a safe way to filter financial news, since RavenPack would weed out the fake headlines from the real ones. However, trading firms have recently started paying Twitter and its partners like Gnip for a "firehose" feed that pours tweets directly into their HFT algorithms.
The difference is huge -- RavenPack delivers 20,000 to 50,000 "approved" messages daily, but Twitter's firehose delivers 400 million tweets daily. HFT algorithms then adjust their trades, which are fueled by trading volume and technical levels, based on the flow of positive or negative tweets. That kind of robotic dependence on Twitter caused the Dow to briefly fall more than 100 points last May in response to a fake AP report about an explosion at the White House.
The two-headed beast
Cynk Technology likely rode this two-headed beast from a penny stock all the way to $5 billion. Cromwell Coulson, president and CEO of OTC Markets Group, recently stated in Bloomberg Businessweek that Cynk's meteoric rise was likely due to a flood of blog coverage and positive Twitter posts. Indeed, footprints like these remain all over Twitter:
But this isn't the first time Twitter has been used to manipulate a penny stock. In 2011, rapper 50 Cent was accused of pumping a penny stock, H&H Imports, to his 3.8 million Twitter followers. 50 Cent's G-Unit owned 12.9% of the tiny company, which sold his Sleek by 50 headphones. 50's stream of enthusiastic tweets caused H&H's price to surge from $0.10 to $0.39 per share.
Should Twitter be held accountable?
Yet Twitter's problems extend far beyond financial headlines. Last year, a study found that after the Boston Marathon bombing, only 20% of related tweets contained any relevant information. 29% were rumors and fake content, while half comprised of people's opinions.
Put all of these pieces together -- bots, fake followers, and unreliable news -- and Twitter's entire business model falls apart.
How can a social media site, built on the idea of being a real-time news feed from real people, continue functioning when it becomes a clogged-up river of bot-generated garbage? How can Twitter reliably calculate average revenue per user when it doesn't even know how many users are human? Why would advertisers continue paying Twitter to promote ads to a river of bots?
The Foolish takeaway
In conclusion, if this nasty cycle of fake news, Twitter bots, and HFT algorithms continues, we could see other spikes in penny stocks like Cynk Technology in the near future. Unless Twitter wants to be known as the market manipulator's best friend, it seriously needs to clean house and crack down on these pumpers and dumpers.