Have you received a phone call asking you if you want to get in on the ground floor of a great new company? Did you get an email linking a blog or website touting various companies which were selling shares of their stock for only a few dollars per share? Did you get an email or a phone call from someone you never heard of telling you about a great new investment opportunity?
Penny stocks, also known as micro-cap stocks, are often sold to investors by methods similar to those described above. Penny stocks are typically speculative in nature and investors should be cautious prior to making any investments in them.What is a Penny Stock
Penny stocks are defined by the Securities Exchange Commission (“SEC”) as being stocks with a price below $5. They are stocks of small-capitalized companies that are often new enterprises. Most penny stocks do not trade on the major exchanges. They trade on the OTC Bulletin Board and the pink sheets.
Since many of these companies are new, there is a dearth of information on their past performance, who their clients are, who their competitors are, how their performance compares to competitors in its industry, etc.
While there is the opportunity to profit in trading penny stocks, there is also the prospect of significant losses due to the nature of theses equities.
If a penny stock is not listed on a major exchange, the company is not required to file the financial disclosures/information required of companies whose stocks are exchange traded. Therefore, publically available information about these companies is often severely limited.
Penny stocks are typically volatile investments. Therefore, while there is the potential to realize profits, there is also significant risk of losses. Consequently, investors who are considering trading in penny stocks should understand the inherent risks in these securities and be able to financially absorb any losses that do occur.Risks of Investing in Penny Stocks
In addition to their volatility, penny stocks are also frequently very illiquid. The existence of low trading volume means that there may be periods when shareholders may have difficulty selling shares of a particular penny stock because there are no buyers entering orders in the market place. This may mean that even protective stop loss orders an investor enters cannot be filled.
Have you heard the term “pump and dump scheme?” How about “boiler room sales tactics?” Frequently, unscrupulous brokers who work at firms of questionable integrity will engage in a pump and dump scheme involving penny stocks. In general, in such instances, the brokerage firm induces customers by having its sales persons use aggressive sales tactics (“boiler room”), to buy a particular stock. The firm also buys (or has already bought) shares of the company for its own accounts. The rising demand in the stock results in a jump in price. The firm then sells the shares it bought at the inflated price as customers watch their shares decline in value.
In this scenario, these firms may pay promoters to tout the stock to the investing public through newsletters, email blasts, blog posts, etc. The firm hopes that this will also result in increased demand for the stock, thereby driving up the price.
Recognizing the risk involved with penny stocks, penny stock fraud is often the target of FINRA and SEC enforcement actions. Also, many brokerage firms prohibit their brokers from soliciting customers to purchase penny stocks; some brokerage firms do not permit customers to buy penny stocks that are not exchange traded.
The above should alert any investor that they should think long and hard prior to purchasing penny stocks. If you did buy a penny stock, and have suffered a loss, or if you have questions concerning the handling of your account, contact the experienced securities attorneys at Lubiner, Schmidt & Palumbo for a free consultation.