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Penny stock

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Penny stocksarecommon sharesof smallpublic companiesthat trade for less than one dollar per share.[1] TheU.S. Securities and Exchange Commission(SEC) uses the term "Penny stock" to refer to asecurity,a financial instrument which represents a given financial value, issued by small public companies that trade at less than $5 per share. Penny stocks are priced over-the-counter, rather than on the trading floor. The term "penny stock" refers to shares that, prior to the SEC's classification, traded for "pennies on the dollar". In 1934, when the United States government passed theSecurities Exchange Actto regulate any and all transactions of securities between parties which are "not the original issuer",[2]the SEC at the time disclosed that equity securities which trade for less than $5 per share could not be listed on any national stock exchange orindex.

Trade

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Over-the-counterexchanges that list penny stocks include theOTC Bulletin Board(which is a facility ofFINRA) or OTC Link LLC (which is owned byOTC Markets Group, Inc.,formerly known as Pink OTC Markets Inc.). Penny stocks can also trade onsecurities exchanges,including foreign securities exchanges. Penny stocks can include the securities of certainprivate companieswith no active trading market.[3]

Risk and investment

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When considering penny stocks, investors and experts in the field recognize the low market price of shares and its correlation to low market capitalization.Market capitalizationor "market cap" is the total dollar market value of all of a company’s outstanding securities.

Since penny stocks are inexpensive, investors often buy large quantities of shares without spending much money. This tendency makes the penny stock marketvolatile.Volatility is "a statistical measure of the dispersion of returns for a given security or market index".[4]Typically, the higher the volatility, the greater the risk in investing in said securities. Conversely, the lower the volatility, the "safer" the investment is. Volatility can be also understood as the frequency of large changes in the value of a given security in either direction. This is directly correlated to the price action of a security which, when talking about penny stocks, can change more rapidly than that of a large-cap stock.[5]

Fraud

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Prosecutors and theFederal Bureau of Investigationsay that fraud is widespread in the penny stock market.[6][7][8]Potential fraud that involves even what are considered very small or micro market cap companies can still involve losses of tens of millions of dollars.[7]

The penny stock market has littleliquidity,so holders of shares in penny stock companies often find it difficult to cash out of positions.[9]However, academic research shows that the risk created by small market cap size and lower liquidity results in higher expected returns due to thesizeandliquidity premiums.[10][11]

In the United States, the SEC and theFinancial Industry Regulatory Authority(FINRA) have specific rules to define and regulate the sale of penny stocks.[citation needed]

Concerns for investors

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There are inherent concerns that individuals should be aware of when investing in penny stocks, namely the lack of information that often exists surrounding the companies offering said stocks. The lack of public reporting mixed with a thin market is often the perfect recipe forstock manipulationviastock promoters.[12]A common practice is for these individuals to purchase large quantities of stock and then utilize promoters to artificially inflate the sub-penny stock’s share price, through false and misleading information. When the liquidity and price increase, the manipulator will sell theirstock‍—‍known as a "pump and dump"scheme‍—‍which is a form ofmicrocap stock fraud.

On April 3, 2017, theFederal Bureau of Investigation(FBI) reported on a story in which penny stock fraud was the focal point of the piece. According to the article, California resident Zirk de Maison was found guilty of conducting a "pump and dump" scheme, during the course of which de Maison and his associates convinced large groups of investors to purchase shares of companies that he had set up as shell organizations.[13]

From 2008 to 2013, de Maison created five small public companies which, unbeknownst to the investing public, did no actual business and had no legitimate assets. Once he set these companies up, he offered public shares of the company’s penny stocks for investors to purchase.[13]

According to the FBI investigation, de Maison would use fictitious names to convince investors to purchase shares of his shell companies, thus driving up the price of his shares and giving the illusion that investors were realizing profit. Once these prices went up, de Maison and his original conspirators would then liquidate their shares at the stock's highest level, and this mass selling caused the shares to drop dramatically, leaving investors with near-worthless shares.[14]

In more sophisticated versions of the fraud, individuals or organizations buy millions of shares, then use newsletter websites,chat rooms,stockmessage boards,fake press releases, or e-mail blasts to drive up interest in the stock.[15]Very often, the perpetrator will claim to have "inside" information about impending news to persuade the unwitting investor to quickly buy the shares. When buying pressure pushes the share price up, the rise in price entices more people to believe the hype and to buy shares as well. Eventually the manipulators doing the "pumping" end up "dumping," when they sell their holdings.[16]

The expanding use of the Internet and personal communication devices has made penny stock scams easier to perpetrate.[17]Since the Securities & Exchange Commission allowed for the use of social media outlets like Twitter to disclose public information in lieu of press services, many fraudsters have set up accounts to take advantage of this higher level of traffic on social media,[18]giving investors another thing to consider when searching for viable sources of information.

Notable cases

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TheMafiahad infiltrated Wall Street by the 1970s.[19]In the 1980s Lorenzo Formato conducted penny-stock manipulations.[19][20]Formato testified in Congressional hearings that during the years he promoted and sold penny stocks, he was involved inorganized crime,and testified to rampant pennystock manipulationby organized crime.[19][20]The Congressional hearings led to passage of the Penny Stock Reform Act of 1990.[19]

By 1989, American investors were being cheated out of at least $2 billion a year by schemes involving penny stocks.[20]

Mob activity on Wall Street reportedly increased in the 1990s. On February 10, 1997,The New York Timesreported that "Mafia crime families are switching increasingly towhite collar crimes"with a focus on" small Wall Streetbrokerage houses."[19]

In May 1997, an FBIsting operationled to charges against Louis Malpeso Jr., a reportedColombo crime familyassociate, for conspiring to commit securities fraud with stock broker Joseph DiBella and Robert Cattogio to inflate the price of penny stock "First Colonial Ventures". All three defendants pled guilty.[19]

Another example of an activity that skirts the borderline between legitimate promotion and hype is the case of LEXG. Lithium Exploration Group's market capitalization soared to over $350 million after an extensive direct mail campaign. The promotion drew upon the legitimate growth in production and use oflithium,while touting Lithium Exploration Group's position within that sector. According to the company's December 31, 2010, form10-Q(filed within months of the direct mail promotion), LEXG was a lithium company without assets. Its revenues and assets at that time were zero.[21]Subsequently, the company did acquire lithium production/exploration properties, and addressed concerns raised in the press.[22]

The "pump and dump" tactic is also known as a supernova and, unlike regular stocks, penny stocks usually move on momentum of the price action.

One of the biggest penny stock operators in the 1950s was Tellier & Co.[23]In the 1980s, major penny stock brokerages included Blinder Robinson (nicknamed "Blind'em and Rob'em" ),[24][25]First Jersey Securities,Rooney Pace,[26]and Stuart-James.[27]Major penny stock brokerages operating in the 1990s includedStratton Oakmont,Sterling Foster, A.S. Goldmen, and Hanover Sterling.[19]

Regulation

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In the United States, regulators have defined a penny stock as a security that meets a number of specific standards. The criteria include price,market capitalization,and minimumshareholder equity.Securities traded on a nationalstock exchange,regardless of price, are exempt from regulatory designation as a penny stock,[28]since it is thought that exchange-traded securities are less vulnerable tomanipulation.[29]Therefore,Citigroup(NYSE:C) and otherNYSE-listed securities which traded below $1.00 during the market downturn of 2008–09, while properly regarded as "low-priced" securities, were not technically "penny stocks".

Although penny stock trading in the United States is now primarily controlled through rules and regulations enforced by the SEC and FINRA, the genesis of this control is found in State securities law. TheState of Georgiawas the first state tocodifya comprehensive penny stock securities law.[30]Secretary of StateMax Cleland,whose office enforced State securities laws,[31]was a principal proponent of the legislation. RepresentativeChesley V. Morton,the onlystockbrokerin theGeorgia General Assemblyat the time, was principal sponsor of the bill in the House of Representatives. Georgia's penny stock law was subsequently challenged in court. However, the law was eventually upheld inU.S. District Court,[32]and the statute became the template for laws enacted in other states. Shortly thereafter, both FINRA and the SEC enacted comprehensive revisions of their penny stock regulations.

These regulations proved effective in closing or greatly restricting broker/dealers, such as Blinder, Robinson & Company, which specialized in the penny stocks sector. Meyer Blinder was jailed for securities fraud in 1992, after the collapse of his firm.[33]

References

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  1. ^Penny stock definition oxford Dictionary,archived fromthe originalon May 12, 2021
  2. ^"Securities Exchange Act of 1934".LII / Legal Information Institute.RetrievedJune 3,2020.
  3. ^"SEC.gov | Penny Stock Rules".sec.gov.RetrievedMarch 25,2019.
  4. ^Kuepper, Justin."Volatility".Investopedia.RetrievedJune 3,2020.
  5. ^"What is a Penny Stock?".Warsoption.March 9, 2021.RetrievedSeptember 7,2021.
  6. ^Eaglesham, Jean (August 17, 2015)."Mob-Busting Informant Resurfaces in SEC Probe".Wall Street Journal.RetrievedNovember 14,2018.
  7. ^abEaglesham, Jean (July 7, 2014)."Inside One of the U.S.'s Biggest-Ever Investment-Fraud Stings".Wall Street Journal.RetrievedNovember 14,2018.
  8. ^Friedrichs, David O. (June 25, 2009).Trusted Criminals: White Collar Crime In Contemporary Society.Cengage Learning.ISBN978-0495600824.RetrievedNovember 14,2018– via Google Books.
  9. ^Davis, Blayne (August 25, 2015)."Former Mob Snitch All But Indicted".HuffPost.RetrievedNovember 14,2018.
  10. ^"Liquidity Premium".
  11. ^Fama, Eugene; French, Kenneth (July 1992)."Common risk factors in the returns on stocks and bonds"(PDF).RetrievedJuly 8,2021.
  12. ^SEC (January 11, 2005)."Pump&Dump.con".U.S. Securities and Exchange Commission.RetrievedNovember 21,2006.
  13. ^ab"Penny Stock Fraud Nets Millions".Federal Bureau of Investigation.RetrievedJune 3,2020.
  14. ^"Eight people sentenced to prison for penny-stock fraud that resulted in $39 million loss to investors".justice.gov.January 31, 2017.RetrievedJune 3,2020.
  15. ^Staff Writer (November 26, 2012)."The $400 million buyout hoax that fooled many".NBC News.RetrievedJanuary 4,2014.
  16. ^FINRA (2012)."Spams and Scams".Financial Industry Regulatory Authority.RetrievedJuly 29,2012.
  17. ^Harry Domash (June 12, 2000)."Internet Makes Scams Easy".San Francisco Chronicle.RetrievedJune 15,2006.
  18. ^"SEC Says Social Media OK for Company Announcements if Investors Are Alerted".SEC.gov.U.S. Securities & Exchange Commission.RetrievedDecember 16,2020.
  19. ^abcdefg"SEC Testimony: Organized Crime on Wall Street (R. Walker)".sec.gov.RetrievedNovember 14,2018.
  20. ^abc"Witness Tells of Mob Influence in Penny Stocks".Associated Press. September 8, 1989.RetrievedNovember 14,2018– via LA Times.
  21. ^"Lithium Exploration Group: Beware of Mailmen Bearing Gifts".Seeking Alpha. May 10, 2011.RetrievedMarch 30,2012.
  22. ^"Lithium Exploration Group Inc".New York Times.RetrievedJanuary 4,2014.
  23. ^"Con Artist Hall of Infamy: Walter Tellier".archive.pixelettestudios.RetrievedNovember 14,2018.
  24. ^"Great frauds in history: Meyer Blinder's Blind 'em & Rob 'em".December 2020.
  25. ^Douglas Martin (March 4, 2004)."Meyer Blinder, Penny Stock King, Dies at 82New York TimesMarch 4, 2004 ".The New York Times.RetrievedJanuary 15,2019.
  26. ^"SEC Settlement: Rooney Pace Halting Securities BusinessLos Angeles TimesNovember 17, 1987 ".Articles.latimes. November 17, 1987.RetrievedJanuary 15,2019.
  27. ^Penny Stock Dealer Stuart-James, Executives, Appeal SanctionsAssociated PressOctober 9, 1996
  28. ^Taylor, J. Lynn."SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240"(PDF).RetrievedJanuary 4,2014.
  29. ^"SEC Charges Eight Participants in Penny Stock Manipulation Ring".SEC.RetrievedJanuary 4,2014.
  30. ^Darden, Stan (March 20, 1990)."Georgia to OK Tough Law for Penny Stocks".LA Times.RetrievedJanuary 4,2014.
  31. ^"1/3/14: Commissioner enters Order in Georgia Commerce Bancshares, Inc.'s fairness proceeding under O.C.G.A. §10-5-11(9)".Ga. SoS.RetrievedJanuary 4,2014.
  32. ^"GEORGIA LAW WON'T HURT BROKERS, JUDGE RULES".Deseret News. July 11, 1990.RetrievedJanuary 4,2014.
  33. ^HENRIQUES, DIANA B (February 16, 2003)."Penny-Stock Fraud, From Both Sides Now".New York Times.RetrievedJanuary 4,2014.
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