Tuesday, November 15, 2016

What is a Penny Stock?

The term "penny stock" generally refers to a security issued by a very small company that trades at less than $5 per share. Penny stocks generally are quoted over-the-counter, such as on 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 may, however, also trade on securities exchanges, including foreign securities exchanges. In addition, the definition of penny stock can include the securities of certain private companies with no active trading market.

Penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. Moreover, because it may be difficult to find quotations for certain penny stocks, they may be difficult, or even impossible, to accurately price. For these, and other reasons, penny stocks are generally considered speculative investments. Consequently, investors in penny stocks should be prepared for the possibility that they may lose their whole investment (or an amount in excess of their investment if they purchased penny stocks on margin).

Because of the speculative nature of penny stocks, Congress prohibited broker-dealers from effecting transactions in penny stocks unless they comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934 ("Exchange Act") and the rules thereunder. These SEC rules provide, among other things, that a broker-dealer must (1) approve the customer for the specific penny stock transaction and receive from the customer a written agreement to the transaction; (2) furnish the customer a disclosure document describing the risks of investing in penny stocks; (3) disclose to the customer the current market quotation, if any, for the penny stock; and (4) disclose to the customer the amount of compensation the firm and its broker will receive for the trade. In addition, after executing the sale, a broker-dealer must send to its customer monthly account statements showing the market value of each penny stock held in the customer's account.

For more information, read the penny stock rules section of our Broker-Dealer Registration Guide. You may also want to review the penny stock rules (Exchange Act Section 15(h) and Exchange Act Rules 3a51-1 and 15g-1 through 15g-100).

Before you consider investing in the stock of any small company, be sure to read the S.E.C. brochure, Microcap Stock: A Guide for Investors.

Other links which may be helpful in obtaining a better understanding of what penny stocks are include:
  • https://www.sec.gov/answers/penny.htm
  • https://www.law.cornell.edu/cfr/text/17/240.3a51-1
  • https://en.wikipedia.org/wiki/Penny_stock
  • http://www.investopedia.com/terms/p/pennystock.asp

Investors should be aware of penny stocks and be extremely cautious when buying penny stocks for several reasons.  Among them include the thinly traded volume of penny stocks and the wide spread fraud that happens in the penny stock markets.  The wide spread fraud includes pump and umps schemes and fraudulent and misleading press releases or online promotions including but not limited to chat room talk, message board postings, social media conversations and email blasts.  These tactics have been used before to talk up the stock (pump up the stock) with discussions of who great the company is doing or how the stock is on the rise.  Promoters and investors on the other side use these tactics to increase the awareness of these companies and sell out of the stock (dump the stock) when the prices rise. 

It should be understood that penny stock investing is of the utmost most risky and speculative investing within the stock markets.  Investors whom are novice or amateur should not invest in penny stocks without consulting with a trusted professional. 

Hope this helps you become a better investor.

-Nick Coriano

About the Author: Nicholas Coriano is a Business Consultant.  He is a graduate of The University of Connecticut Business School and the John Marshall Law School in Chicago.  He has worked at Merrill Lynch, The New York Stock Exchange and is currently a partner at Cervitude Intelligent Relations, which specializes in Investor Relations for companies valued under $1 Billion USD.

About MicroCapCompany.COM: MicroCapCompany.COM (The Blog) is a blog focused on providing articles, news and information on the micro cap sector and start-ups.  The Blog is a free service offered by Cervitude™ Investor Relations - a micro cap investor relations firm for micro cap companies and penny stocks.  If there is a particular topic you would like to see covered on The Blog, email us. If you would like to advertise on The Blog, click here. 


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