Penny stocks are low-priced stocks that typically start out at less than one dollar per share. They are sold on the premise of significant potential growth.
Very often, companies issuing penny stocks are new to the market. They may not have been in business long enough to establish a proven track record or credible financial history. Another characteristic may be an inexperienced management team. These factors undermine market reception and the ease with which penny stocks can be traded.
Anyone investing in penny stocks should be aware that - when they may want to sell his or her stock - a market may not exist. Penny stocks are 'priced low' for a reason.
Despite their bargain basement price, penny stocks are high risk. Unless you have the financial resources to withstand the loss of your initial investment and target returns, penny stocks are not for you.
Get the Facts
Why is it so important to get the facts?
Penny stocks are extremely vulnerable to manipulation. Promoters intent on misleading or defrauding investors are counting on you not to do your homework.
A common scam is the "pump and dump." In this situation, a promoter accumulates an inventory of penny stocks. Using high-pressure sales techniques, the stock is 'pitched' to clients. Clients (or investors) are found by any means in the interest of making a market. In the course of events, the price of the penny stock will rise (possibly to several dollars per share). As long as the promoter is able to locate new investors or encourage current clients to increase his or her holdings at a higher price, the scam continues. All the while, the promoter profits. When the scam has run its course, the stock becomes illiquid and the price falls. Hapless investors are left holding the now-worthless stock.
Where to Go for Information
Unscrupulous promoters are inventive and persistent. Using any means possible, they may spread false information. It pays to double-check their claims through other sources.
Corporate information comes in many forms including:
- Annual and quarterly reports
- Financial statements
These can be obtained from the public library system, your dealer or adviser, and stock exchanges.
Stock exchanges have minimum listing requirements that a company must meet before its securities can be traded on that exchange. Among other things, these requirements relate to a company's finances, management, and share ownership. If a company is not able to meet these minimum requirements, they may trade on the over-the-counter market. The over-the-counter markets consist of a network of dealers who trade among each other either on behalf of individual investors or themselves.
The Changing Markets
Traditionally, penny stocks trade on junior exchanges or over-the-counter markets. Investors benefit from a well regulated, fair and accessible market with enhanced protection through uniform regulatory standards, consistent enforcement, and improved market information.
How Will I Recognize a Penny Stock Scam?
There are a few tell-tale signs:
- Unsolicited telephone calls. Be skeptical of an unknown salesperson calling to offer you "a fantastic investment opportunity.
- Promises of a great rate of return. No dealer or adviser can guarantee an exceptional rate of return, and the law prohibits promises of such future returns.
- High-pressure sales tactics. Do not be pressured into making hasty investment decisions.
- Claims of little or no risk. If the projected rate of return is high, the associated risk is likely to be high as well.
- Offers to discount commissions. Commissions that are charged for sales of penny stocks are often at rates higher than normal.
- Claims of "inside" information. It is illegal to trade on the basis of confidential or "inside" information. The penalties of insider trading can be severe.
- Reluctance to provide shareholder information. A salesperson should not hesitate to provide you with the information, which may include a prospectus that is necessary for you to make an informed decision.
The Offshore Trading Administration has pursued and shut down long-standing securities firms for conducting "pump and dump" scams. Whether it's a cold call or a well known firm in the community, get an independent opinion, or do your own research. The Offshore Trading Administration is at the forefront of investor protection but you can make a difference by understanding how the market works.