What are Penny Stocks?
Penny stocks are common shares of small public companies that trade at low prices per share. In the United States, the SEC defines a penny stock as a security that trades below $5 per share and is not listed on a national exchange. In the United Kingdom, stocks priced under £1 are called penny shares. These types of stocks are generally considered to be highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure. Trades are often done through the counter through the OTCBB and pink sheets.
Generally, it is hard to define a penny stock since the term is a misnomer but some consider it to be any stock that trades for pennies or those that trade for under $5, while others consider any stock trading off of the major market exchanges as a penny stock. However, there may be some confusion as there are some large companies, based on market capitalization, that trade below $5 per share, while there are many very small companies that trade for $5 or more.
The typical penny stock is a very small company with highly illiquid and speculative shares. The company will also generally be subject to limited listing requirements along with fewer filing and regulatory standards.Many penny stocks, especially those that trade for as little as fractions of a cent, are thinly traded. They become vulnerable to stock promoters and manipulators.These manipulators initially purchase large quantities of stock, then inflate the share price through false and misleading statements. This is commonly known as a “pump and dump” scheme. In more complicated version of the fraud, individuals or organizations buy millions of shares, then use newsletter websites, chat rooms, stock message boards, fake press releases, or e-mail blasts to drive up interest in the stock.
Because of this, there have been regulatory laws to avoid scams and frauds. In the United States, regulators have defined a penny stock as a security that must meet a number of specific standards. The criteria include price, market capitalization, and minimum shareholder equity. Securities traded on a national stock exchange, regardless of price, are exempt from regulatory designation as a penny stock, since it is thought that exchange traded securities are less vulnerable to manipulation. Therefore NYSE listed securities which traded below $1.00 during the market downturn of 2008-2009, 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 Securities and Exchange Commission and FINRA, the genesis of this control is found in State securities law. Shortly thereafter, both FINRA and the SEC enacted comprehensive revisions of their penny stock regulations. These regulations proved effective in either closing or greatly restricting broker/dealers, such as Blinder, Robinson & Company, which specialized in the penny stocks sector. Even with SEC halt, the stock can still move up or down trend and the people who invest in it would have no control over their shares until the company is released to the public again by the SEC.