Penny Stocks: Important Things to Know
Penny Stocks are market traded securities which come with very low prices. While that might seem attractive on the surface, these penny stocks come with many hidden dangers as well. Find out more.
Penny stocks is a term used to describe shares of tiny public companies that usually trade for a price lower than one dollar per share. Penny stocks are also sometimes referred to as micro-cap stocks, nano-cap stocks, small cap stocks, or Over the Counter (OTC) stocks. In this post, we will take a brief look at some of the important things associated with penny stocks and answer some key questions associated with them. Let’s get started.
Penny Stocks: Important Questions Answered
What is a penny stock?
The U.S. Securities and Exchange Commission (SEC) uses the term “penny stock” to refer to a security, a financial instrument that represents a given financial value, issued by small public companies that trade at less than $5 per share.
How are penny stocks priced?
Penny stocks are priced over-the-counter, rather than on the trading floor, hence the use of the name “OTC stocks.” The term “penny stock” refers to shares that, prior to the SEC’s reclassification, traded for “pennies on the dollar.”
Why was the Securities Exchange Act passed?
In 1934, when the United States government passed the “Securities Exchange Act” to regulate any and all transactions of securities between parties which are “not the original issuer”, the SEC at the time disclosed that equity securities which trade for less than $5 per share could not be listed on any national stock exchange or index.
Which OTC Exchanges have penny stocks?
Over-the-counter exchanges that list penny stocks include the OTC Bulletin Board (which is a facility of FINRA) or OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.). Penny stocks can also trade on securities exchanges, including foreign securities exchanges. Penny stocks can include the securities of certain private companies with no active trading market.
Which are some popular penny stock operators?
One of the biggest penny stock operators in the 1950s was Tellier & Co. In the 1980s, major penny stock brokerages included Blinder Robinson, First Jersey Securities, Rooney Pace, and Stuart-James. Major penny stock brokerages operating in the 1990s included Stratton Oakmont, Sterling Foster, A.S. Goldmen, and Hanover Sterling.
What are some important things to consider before investing in penny stocks?
When considering penny stocks, investors and experts in the field recognize the low market price of shares and its correlation to low market capitalization. Market capitalization or “market cap” is the total dollar market value of all of a company’s outstanding securities.
Since penny stocks are inexpensive, investors often buy large quantities of shares without spending much money. This tendency makes the penny stock market volatile.
What is volatility?
Volatility measures the dispersion of returns associated with a particular security or market index. High volatility results in a high amount of risks and vice versa. Volatility can also be described as the shift that a security’s value encounters in either direction. This is directly correlated to the price action of a security which, when talking about penny stocks, can change more rapidly than that of a large-cap stock.
How does volatility affect penny stocks?
The volatile nature of penny stocks also leaves these companies open to potential “manipulation” by stock promoters and pump and dump schemes. Oftentimes, investors are led to believe that the ability to purchase large quantities of shares at low prices will result in greater returns, which makes them more susceptible.
Is the penny stock market wrought with fraud?
Prosecutors and the Federal Bureau of Investigation say that fraud is widespread in the penny stock market. Even though the penny stock companies are small, the scams that involve them can be for tens of millions of dollars.
The penny stock market has little liquidity, so holders of shares in penny stock companies often find it difficult to cash out of positions.
In the United States, the SEC and the Financial Industry Regulatory Authority (FINRA) have specific rules to define and regulate the sale of penny stocks.
What is the biggest problem faced by penny stock investors?
The primary concern that most investors have while dealing with penny stocks is the lack of information that often exists surrounding the companies offering said stocks. The lack of public reporting mixed with a thin market is often the perfect recipe for stock manipulation via stock promoters.
What is a “pump and dump” scheme?
A common practice is for these individuals to purchase large quantities of stock and then utilize promoters to artificially inflate the sub-penny stock’s share price, through false and misleading information. When the liquidity and price increase the manipulator will sell their stock, this is called a “pump and dump” scheme which is a form of microcap stock fraud. The “pump and dump” tactic is also known as a supernova and, unlike regular stocks, penny stocks usually move on the momentum of the price action.
How did Zirk de Maison defraud his customers with penny stocks?
On April 3, 2017, the Federal Bureau of Investigation (FBI) reported on a story in which penny stock fraud was the focal point of the piece. According to the article, California resident Zirk de Maison was found guilty of conducting a “pump and dump” scheme. During the time of the scandal, de Maison and his firm tricked a large number of investors to buy shares of firms that were actually shell companies that he had set up himself.
From 2008 to 2013, de Maison created five small public companies which, unbeknownst to the investing public, did no actual business and had no legitimate assets. Once he set these companies up, he offered public shares of the company’s penny stocks for investors to purchase.
The FBI investigation exposed that de Maison utilized fictitious names in order to fool investors to purchase shares of his shell companies. This artificially inflated the price of the share and gave the investors an illusion that they were making profit. Once these prices went up, de Maison and his original conspirators would then liquidate their shares at the stock’s highest level, and this mass selling caused the shares to drop dramatically, leaving investors with near-worthless shares.
Are all penny stock frauds similar?
What de Maison did, was a more direct and simplistic version of fraud involving penny stocks. It’s also carried out in a very complex and sophisticated way as well. Rich investors can buy millions of shares, then use newsletter websites, chat rooms, stock message boards, fake press releases, or e-mail blasts to exponentially increase the interest in the stock. Very often, the perpetrator will claim to have “inside” information about impending news to persuade the unwitting investor to quickly buy the shares. When buying pressure pushes the share price up, the rise in price entices more people to believe the hype and to buy shares as well. Eventually, the manipulators doing the “pumping” end up “dumping,” when they sell their holdings. The increasingly penetrative reach of the internet and personal communication tools has resulted in penny stock scams becoming even easier to carry out today.
When was the Penny Stock Reform Act passed?
The Mafia had infiltrated Wall Street by the 1970s. In the 1980s Lorenzo Formato conducted penny-stock manipulations. Formato testified in Congressional hearings that during the years he promoted and sold penny stocks, he was involved in organized crime, and testified to rampant penny stock manipulation by organized crime. By 1989, American investors were being cheated out of at least $2 billion a year by schemes involving penny stocks. The Congressional hearings led to the passage of the Penny Stock Reform Act of 1990.
Is the American Mafia involved in penny stock fraud?
Mob activity on Wall Street reportedly increased in the 1990s. On February 10, 1997, The New York Times reported that “Mafia crime families are switching increasingly to white collar crimes” with a focus on “small Wall Street brokerage houses.”
In May 1997, an FBI sting operation led to charges against Louis Malpeso, Jr., a reported Colombo crime family associate, for conspiring to commit securities fraud with stockbroker Joseph DiBella and Robert Cattogio to inflate the price of a penny stock, First Colonial Ventures. All three defendants pled guilty.
Another example of an activity that skirts the borderline between legitimate promotion and hype is the case of LEXG. Lithium Exploration Group’s market capitalization soared to over $350 million after an extensive direct mail campaign. The promotion drew upon the legitimate growth in production and use of lithium, while touting Lithium Exploration Group’s position within that sector. According to the company’s December 31, 2010 form 10-Q (filed within months of the direct mail promotion), LEXG was a lithium company without assets. Its revenues and assets at that time were zero. Subsequently, the company did acquire lithium production/exploration properties, and addressed concerns raised in the press.
Are all low priced securities classified as penny stocks?
In the United States, regulators have defined a penny stock as a security that meets a number of specific standards. The criteria include price, market capitalization, and minimum shareholder equity. Securities traded on a national stock exchange, regardless of price, are exempt from regulatory designation as a penny stock, since it is thought that exchange-traded securities are less vulnerable to manipulation. Therefore, Citigroup (NYSE:C) and other NYSE-listed securities which traded below $1.00 during the market downturn of 2008–09, while properly regarded as “low-priced” securities, were not technically “penny stocks”.
Which was the first American state to pass a proper penny securities law?
Penny stock trading in the United States is now primarily controlled through rules and regulations enforced by the SEC and FINRA, the origins of this control are found in State securities law. The State of Georgia was the first state to codify a comprehensive penny stock securities law. Secretary of State Max Cleland, whose office enforced State securities laws, was a principal proponent of the legislation. Representative Chesley V. Morton, the only stockbroker in the Georgia General Assembly at the time, was the principal sponsor of the bill in the House of Representatives. Georgia’s penny stock law was subsequently challenged in court. However, the law was eventually upheld in U.S. District Court, 29 and the statute became the template for laws enacted in other states. Shortly thereafter, both FINRA and the SEC enacted comprehensive revisions of their penny stock regulations. These regulations proved effective in closing or greatly restricting broker/dealers, such as Blinder, Robinson & Company, which specialized in the penny stocks sector. Meyer Blinder was jailed for securities fraud in 1992, after the collapse of his firm.
So those were some of the key questions about penny stocks whose answers are critical for any potential penny stock investor to know. Hopefully, you will be able to make better and more well-informed decisions about investing in penny stocks now