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 Pennystocks
are common stocks that trade for less than $5 a share and are
traded over the counter (OTC) through quotation services such the OTCBB or
the Pink Sheets. Although penny stocks are said to be "thinly traded," share
volumes traded daily can be in the hundreds of millions for sub-penny
stocks. Legitimate information on penny stock companies can be difficult to
find and stocks can be easily manipulated.
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 percent
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.
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. 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.
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.
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 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." |