Risk and Penny Stocks
vancouverprovince.com
Risk and penny stocks
The Province
Brian Lewis The Province
Ric Ernst, The Province / B.C. Securities Commission executive director Stephen Wilson has warnings about workings of penny stocks.
Whenever you get the urge to splurge on a penny stock, what you're really contemplating, in many cases. is buying shares in Caveat Emptor Inc.
"It's a caveat emptor market where the buyer really does have to beware," says B.C. Securities Commission executive director Stephen Wilson.
The provincial regulator is concerned that increasing numbers of individual investors are investing in penny stocks on so-called Over the Counter (OTC) markets without understanding the added risks they're buying.
In fact, several weeks ago the BCSC issued a major bulletin warning B.C. investors about the risks associated with trading on the U.S.-based Nasdaq bulletin board which, like all OTC markets, has limited regulation.
The warning stems from recent news of the FBI alleging that organized crime has become involved in this market.
Penny stocks, also known as micro-caps, always have been much higher risk than small or large-cap stocks.
But when they trade on an OTC bulletin board -- also known as the "unlisted" or "street" or "curb" market -- with little or no regulation, they become even more of a risk.
Even the term "penny stock" is a misnomer because now it refers to any stock trading up to $5.
It also can refer to any low-priced stock which a brokerage refuses to sell to an investor on margin.
But a $3 stock trading on the Toronto Stock Exchange or the Canadian Venture Exchange is an animal very different from one trading on an OTC market.
Technically, both are penny stocks because of their price but, unlike those trading on conventional exchanges, the stocks trading on the OTC market do not come under the extensive regulatory scrutiny intended to protect investors.
That's because an OTC market basically is a network of brokers linked to one another via their computers.
In other words, where investing on a conventional exchange compares with shopping at a department store, the OTC market is more like a garage sale.
"The OTC market does not have the controls and safeguards with respect to information available to investors or the authenticity of that information," says Wilson.
"These are normal things you take for granted when trading on a fully-regulated exchange."
However, regulation only protects investors from being treated unfairly or being conned or scammed by unscrupulous promoters.
It is in no way intended to protect investors from losing money on a legitimate investment.
We also have an OTC market in Canada. It's called the Canadian Dealer Network (CDN) and Wilson says that, while it's not quite as bad as the Nasdaq bulletin board, it has less regulation than conventional exchanges.
"Fortunately, there are plans in the works to roll the CDN under the CDNX's umbrella, but I have to say in all honesty that each time you bring an OTC exchange under regulation, another OTC market springs up," he warns.
Most penny stocks are from small companies, either in the mining business attempting to raise funds for exploration or in technology companies looking for financing for product development.
However, a legitimate penny stock will have some sound business fundamentals behind it such as cash flow, assets, a business plan and prospectus, and so on, even though the venture holds investor risk and increased price volatility.
The kind of penny stock you should avoid is the one that's being promoted using false or incomplete information. This kind of information often is floated on Internet chat rooms by the promoter or others attempting to "push" the stock.
Many of these stocks are promoted by boiler-room operations where promoters use high-pressure selling techniques to solicit investors over the telephone, Wilson says.
In fact, this year Hollywood released a movie called Boiler Room, starring Giovanni Ribisi, which Wilson says gives an excellent insight into how these stock scams work.
"Penny stock promotions often revolve around stories being told about them and hype rather than actual value of the business," says Rick Sales, an equity analyst with Vancouver-based Odlum Brown Limited.
"They're all about pizzazz."
Sales advises investors to steer clear of penny stocks for a portfolio being used to save for retirement.
"I don't think they belong in a serious portfolio.
"If you want to play with penny stocks you'd be better doing it in a separate side-portfolio."
But Sales and other analysts also point out that, once in a while, a penny stock comes out of nowhere and pays off investors with major profits.
"Penny stocks are not all bad news," Wilson says.
"This market does serve a purpose of providing seed capital for start-up companies that otherwise would have extreme difficulty in raising money." |
