A “penny stock” is defined by the Securities and Exchange Commission (SEC) as a security issued by a very small company, micro-cap or less than $100 million in market capitalization, and trades at less than $5 per share. Penny stocks generally are quoted over-the-counter, such as on the OTC Bulletin Board or OTC Link LLC. However, not all penny stocks trade over-the-counter and many trade on securities exchanges, including foreign securities exchanges. In addition, the definition of penny stock can also include private companies with no active trading market.
Penny stocks are inherently risky due to several contributing factors. First, penny stocks may trade infrequently, meaning that it may become difficult to liquidate penny stock holdings once acquired. Second, it may be difficult to find accurate quotes for certain penny stocks. Therefore, it may be difficult or even impossible to accurately price certain penny stocks. Due to these risks, penny stock investors may lose their whole investment. When penny stock investing is combined with margin borrowing the results can be catastrophic for the investor.
If the inherent risks of penny stocks were not great enough, penny stocks are often used and manipulated for fraudulent purposes. One common scheme is the “pump and dump” scheme. The idea behind a pump and dump scheme is to create unfounded hype for a penny stock the pumper already owns. As the pumper’s victims buy into the hype additional purchases drive up the price of the stock artificially. The pumper then sells his shares for a large profit while those the pumper recommended the penny stock to quickly lose their money as the stock’s value decreases precipitously.
Because of the speculative nature of penny stocks, Congress required broker-dealers to comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934. These SEC rules provide that a broker-dealer must: (1) approve the customer for the specific penny stock transaction and receive from the customer a written agreement authorizing the transaction; (2) provide the customer with a disclosure document describing the risks of investing in penny stocks; (3) disclose to the customer the current market quotation for the penny stock; and (4) disclose to the customer the amount of compensation the firm and its broker receives. In addition, the broker-dealer must monthly account statements to the customer showing the market value of each penny stock held in the account.
Recently, Richard R. Miller (Miller), a securities broker, was terminated by LPL Financial Corp. (LPL) on October 6, 2011, for soliciting low-priced securities in violation of firm policy. Miller was accused of soliciting two low-priced, or penny stock securities, to customers and wrongfully filled out non-solicitation letters in connection with the transactions.
From October 2009 through May 2010, FINRA alleged that Miller solicited purchases in two low-priced securities to 15 customers resulting in 31 transactions. LPL’s compliance procedures prohibited the solicitation of low-priced securities and required brokers to obtain a non-solicitation letter for each low-priced securities transaction. According to the complaint, Miller had the customers fill out non-solicitation letters and improperly marked 29 transactions as unsolicited, when, in fact, they were solicited.
The attorneys at Gana LLP are experienced in investigating claims involving the sale of penny stocks and financial fraud. Our attorneys can help you detect and uncover suspicious activity in your accounts. Our consultations are free of charge and the firm is only compensated if you recover.