While would-be investors everywhere are drawn to the stock market hoping for huge returns, some may be considering investing in penny stocks. Penny stocks are stocks that trade for less than $5. Although there are stocks on the NASDAQ and NYSE that trade for less than the $5 mark, they aren’t considered penny stocks by the Securities and Exchange Commission (SEC).
Penny stocks are low-priced, small-cap stocks that are listed on the Over-the-Counter Bulletin Board (OTCBB) or in the Pink Sheets. That doesn’t mean that just anyone can purchase penny stocks, would-be investors would still have to go through a stockbroker to buy stock in these companies, but the bar to entry in the investment is significantly lower due to the lower cost per share for investors.
Those that remember the 2013 film, “The Wolf of Wall Street,” may have at least a passing familiarity with the Pink Sheets, but the movie may not have highlighted the financial loss that the individuals investing in penny stocks really suffered. The Pink Sheets have a much lower standard when it comes to listing stocks, in fact, Pink Sheets isn’t even registered with the SEC. That means that the rules that apply to exchanges don’t apply to Pink Sheets in the same way.
OTCBB & Pink Sheets
The OTCBB is slightly better than the Pink Sheets in that it does have some listing requirements, and it is registered with the SEC. The listing requirements still aren’t as stringent as those for listing a company on the NASDAQ or NYSE. Specifically, the financial reporting requirements for penny stocks simply aren’t regulated in the same way as standard stocks.
Financial reporting can easily be manipulated by companies that want to appear more financially stable than they actually are, and that’s happened more than once in the world of penny stocks. The lack of regulation also attracts a host of scammers, or otherwise dishonest people trying to profit off of unsuspecting investors. Penny stocks are also especially susceptible to pump & dump schemes.
Pump & Dump
Here’s what the SEC has to say about pump & dump schemes:
“One of the most common Internet frauds involves the classic "pump and dump" scheme. Here’s 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.”
A California man, Zirk de Maison, a self-described merchant banker, ran a pump & dump scheme from 2008 to 2013 that helped him take over $39 million in investor money. Although De Maison’s scam was found out and he has since pled guilty to related charges, the damage, for many has already been done.
Penny Stock Success
That’s not to say that there aren’t success stories when it comes to penny stocks. Tim Grittani, invested $1,500 in penny stocks and three years later had turned that initial investment into over $1,000,000. Grittani learned from and followed the advice of Tim Sykes, who made headlines when he turned $12,000 received for his bar mitzvah into millions. Sykes followed that success with various training and teaching which is how Grittani learned to navigate the volatile penny stock market.
While there are successes and failures in all of investing, trading in penny stocks increases the risk and the possible rewards. That means that individual investors will have to determine if the possible reward is worth the substantial risk that penny stocks represent.