Penny stock

From Wikipedia, the free encyclopedia

Penny stocks are common stocks that trade for less than $5 a share.

1 Definition
2 High-Risk Investments
3 Penny Stocks & Spam
4 Penny Stock Fraud
5 External links (all in English unless otherwise indicated)
6 References

[edit] Definition

In the U.S. financial markets, the term penny stock commonly refers to any stock trading outside one of the major exchanges (NYSE, NASDAQ, or AMEX), and is often considered pejorative. However, the official Securities & Exchange Commission definition^[1] of a penny stock is a low-priced, speculative security of a very small company, regardless of market capitalization or whether it trades on a securitized exchange (like NYSE or NASDAQ) or an "over the counter" listing service, such as the OTCBB or Pink Sheets. The terms penny stocks, microcap stocks, small caps, and nano caps are also all sometimes used interchangeably, however per the SEC definition, penny stock status is determined by share price, not market capitalization or listing service.

In the UK markets, penny stocks, or penny shares as they are more commonly called, generally refer to stocks and shares in small cap companies, defined as being companies with a market capitalization of less than £100 million and/or a share price of less than £1 with a bid/offer spread greater than 10%...^[2] In the UK Penny Shares are covered by a standard regulatory risk warning issued by the Financial Services Authority(FSA)^[3]

In France, penny stocks generally refer to risky stocks with a price of less than 1 euro.[1]

Penny stocks generally have market caps under $500M and are considered extremely speculative, particularly those that trade on low volumes over the counter. The Securities and Exchange commission warns that, "Penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. Because it may be difficult to find quotations for certain penny stocks, they may be impossible to accurately price. Investors in penny stocks should be prepared for the possibility that they may lose their whole investment."^[4]

[edit] High-Risk Investments

Many new investors are lured to the appeal of penny stocks due to the low price and potential for rapid growth which may be as high as several hundred dollars in a few days. Similarly, severe loss can occur and many penny stocks lose all of their value in the long term. Accordingly, the SEC warns that penny stocks are high risk investments and new investors should be aware of the risks involved. These risks include limited liquidity, lack of financial reporting, and fraud.^[5]

Since a penny stock has fewer shareholders, it is less 'liquid', meaning it will not trade as many shares per day as a larger company. Any sudden change in demand or supply of stock can lead to a lot of volatility in the stock price. This lack of liquidity can send a stock price soaring up quickly or crashing down quickly. Lack of liquidity and volatility also makes penny stocks much more vulnerable to manipulation by management, market makers, or third parties. A lack of liquidity can also make it extremely difficult to sell a stock, particularly if there are no buyers that day. This can also make the stocks extremely difficult to short.

Secondly, unlike NASDAQ or the NYSE, there are only minimal listing requirements for a stock to remain on the OTCBB, namely that they make their filings with the SEC on time.^[6] In fact, companies that fail to meet minimum standards on one of the broader exchanges and are delisted often relist on the OTCBB or the Pink Sheets.

Furthermore, stocks trading on the Pink Sheets (recognizable with a .PK suffix) have little to no regulatory or listing requirements whatsoever, at least compared to major markets. There are no minimum accounting standards, change in notification of ownership of shares, and reported other material changes affecting the financial viability of a company, all of which are designed to protect shareholders.^[7]

The SEC notes most the same about Internet message boards, where fraudsters claiming to be unbiased investors who've carefully done their due diligence may in fact be company insiders, and that a single person or a small team can create the appearance of a huge interest in a stock simply by creating a huge number of aliases, while banning the most vocal or perceptive critics of these offerings.

[edit] Penny Stocks & Spam

Almost any Internet user with an e-mail address will have been exposed to penny stock promotions through e-mail spam. Approximately fifty-five billion unsolicited "spam" e-mail messages are sent each day, a significant proportion of which tout penny stocks, usually as part of a pump and dump scheme. According to a study conducted at Oxford,^[8] 15% of all spam was related to penny stock fraud. According to the study, "People who respond to the "pump and dump" scam can lose 8% of their investment in two days. Conversely, the spammers who buy low-priced stock before sending the e-mails, typically see a return of between 4.9% and 6% when they sell."

[edit] Penny Stock Fraud

The reason for all this relentless promotion of penny stocks is because of the profits to be made through illegal pump and dump schemes. The SEC^[9] explains how it works:

"A company's web site may feature a glowing press release about its financial health or some new product or innovation. Newsletters that purport to offer unbiased recommendations may suddenly tout the company as the latest "hot" stock. Messages in chat rooms and bulletin board postings may urge you to buy the stock quickly or to sell before the price goes down. Or you may even hear the company mentioned by a radio or TV analyst. Unwitting investors then purchase the stock in droves, creating high demand and pumping up the price. But when the fraudsters behind the scheme sell their shares at the peak and stop hyping the stock, the price plummets, and investors lose their money. Fraudsters frequently use this ploy with small, thinly traded companies because it's easier to manipulate a stock when there's little or no information available about the company."

There are all sorts of variations of the classic pump and dump, from short-and-distort to selling chop stocks — the last being a scam in which shares are acquired for pennies under Regulation S and then illegally sold to overseas or domestic retail investors.^[10] Other features of the typical penny stock scam include spam e-mails^[11] and junk faxes^[12] that tout ludicrous and fraudulent claims, crooked newsletter writers who promote a stock for a fee,^[13] message boards swarming with "buy now!!!" postings about a stock from anonymous, paid posters,^[14] fake or misleading press releases issued by the company,^[15] or boiler rooms full of cold-callers targeting naive, elderly, or foreign buyers^[16] all in attempt to drive up the share price while the insiders sell.^[17]

A more recent outbreak of penny stock fraud is far more brazen, and is based mostly overseas.^[18] Organized crime gangs in Eastern Europe and Asia will acquire a large number of shares of a moribund penny stock. Then using passwords and logins to electronic brokerages, such as E*Trade, stolen at public computer terminals in hotels and elsewhere, they will then use the hijacked customer accounts to buy up shares, while at the same time selling their own shares, draining the customer accounts and leaving their victims holding thousands of shares of worthless penny stocks.

While not all stocks listed on the Pink Sheets or the OTCBB are fraudulent, one Business Week article estimated that chop stocks alone "make up perhaps half the 85 million-share daily volume of the OTC Bulletin Board."^[19]