A penny stock is simply a security that trades below $5.00 per share that is generally not listed on a national exchange (Like the NYSE or NASDAQ) and does not meet other requirements under the Securities Exchange Commission (SEC). Penny stocks are usually purchased over the counter (OTC) meaning it is traded via a dealer network as opposed to a centralized exchange. Normally small companies who are just starting out will sell penny stocks in hopes of raising revenue faster.
Unfortunately, there are usually more detriments than benefits associated with penny stocks. Because it is so easy to purchase a penny stock, it is also just as easy to lose your money. Penny stocks trade very infrequently which means you may have problems selling a stock quickly once you purchase it. As a result if may be difficult to accurately price these stocks, which makes them incredibly speculative in nature and highly risky. This also leads to the possible manipulation of stock prices.
“Pump and dump” scams are also popular with penny stocks. In a pump and dump scam, major investors or stock promoters popularize a stock so that the demand for that stock will increase. They will then sell the stock when it is at a high and wait for the inevitable crash to follow. Once the stock does crash, the only people who have benefited are the original investors who popularized the stock in the first place. A famous example of this was in 2011 when rapper, 50 Cent, used Twitter to cause the price of HNHI stock to soar. At the time he held 30 million shares of the company and he used his celebrity to encourage people to invest. As more people invested, the price of stocks shot up and he eventually made $8.7 million in profit.
The Red Tape
Due to their speculative nature, there are certain requirements penny stocks must meet before broker-dealers are allowed to offer them. According to the SEC, a broker-dealer must, among other things, “approve the customer for the specific penny stock transaction and receive from the customer a written agreement to the transaction; furnish the customer a disclosure document describing the risks of investing in penny stocks; disclose to the customer the current market quotation, if any, for the penny stock; and disclose to the customer the amount of compensation the firm and its broker will receive for the trade.” The broker-dealer must also send the customer monthly reports showing the market value of the penny stocks held in the customer’s account.
The Next Step
If you or someone you know has lost money as a result of an investment in penny stocks, the law offers an avenue of recovery for your losses if it is the result of a fraudulent broker or other financial misconduct. The securities attorneys at Fitapelli Kurta can help. Our firm prosecutes cases for investors nationwide on a contingency fee basis. If you don’t win, we don’t win, so do not delay. Call now for your free case evaluation.