'Taken from Motley Fool'
Penny Stocks and Root Canals
Norman is my dental hygienist. He cleans my teeth. But last week, before
he got down to the business of scraping off the plaque and adding a
revivifying sheen, we talked shop. Some vague mention six months ago
about a possible root canal had given me intimations of mortality and thus
inspired me to start flossing daily. But in checking my gums, Norman noticed
some trauma. In my vigorous effort to ensure my teeth a brighter future, I
was actually tearing into my gum line, worsening some receding that it was
my goal to prevent. Somehow, it had never exactly occurred to me that I
might not know what I was doing. How complicated can flossing be, right?
Happily, I found I could return the favor. Norman's about 30 years old, with
a wife and two children. He works six days a week cleaning teeth. He has
also started his own modest used car business, fixing up European imports.
He's a likeable guy who clearly enjoys working, but he's started to think
about ensuring his family a brighter financial future and himself some more
leisure. He pulled out the local stock pages and told me he wanted to start
investing. His first question was about how to decipher those abbreviated
company names printed in the paper. The second question was about penny
stocks. Some of his buddies seemed to think you could make huge profits on
these things.
As one of the writers of the Fool's Daily Double/Trouble, I frequently
receive e-mails from readers suggesting I look into some terrific growth
story, say EZ Environment, a small company with a cure for America's
waste disposal problems. I check the quote on AOL and see that it trades
for $1.25 per share on the "OTC," which means the Over-the-Counter
Bulletin Board quote system run through Nasdaq's computer systems. From
there, I look for a recent filing with the Securities and Exchange Commission
(SEC). Nada. At that point, I write the reader back asking how he can feel
comfortable investing in a penny stock that provides no basic information to
the public about its business. I ask if he realizes how easy it is to manipulate
these stocks. I ask whether he'd really rather be a speculator than a Fool
and whether he's prepared to lose all his money. I'm tough.
Educating people about how to invest, as the Fool attempts to do, is no doubt
the best way to prevent Norman, his buddies, my correspondents, and the
widow next door from recklessly or naively throwing away their money. But
it's not enough. Just as I expect my dental hygienist to keep me from
screwing up my gums if he wants my business, so too should individual
investors expect the stock exchanges to prevent the neophyte flossers of the
investment world from tearing into the root of their financial future.
Sometimes we all need to be saved from ourselves. And sometimes that's
simply good business for everyone involved.
Safeguarding investors from seriously dubious companies is indeed good for
the exchanges and good for American business. It ensures that companies
that can meet at least some basic quality requirements and that are in need
of capital won't find that that capital has been squandered by investors on
crappy outfits being promoted by suspect brokers using cold-calling hype. As
a result, good companies will be around longer, paying fees to the exchanges
and attracting new investors. That in turn will attract more companies to the
markets, which will generate more listing fees. Thankfully, Nasdaq has
finally come to understand this virtuous circle.
According to a report Tuesday in The Wall Street Journal, this would-be
"market for the next 100 years" may cut its ties to some 3,400 of the 6,800
microcap companies that now trade on the OTC Bulletin Board. This is
excellent news. Though associated with Nasdaq, the Bulletin Board (BB) is
really just an electronic link allowing professional dealers to share quotes and
trading data on microcap stocks. These are not "Nasdaq stocks."
Both the Nasdaq National Market System, home to the likes of Intel and
Microsoft, and the Nasdaq SmallCap market have newly beefed up listing
requirements that include stronger minimum price, capitalization, and net
tangible asset standards, as well as some basic corporate governance
strictures. Companies listed on these two Nasdaq markets are not
necessarily good investments, but for the most part, they do meet some bare
bones standards that every investor should demand. For example, they all file
regular quarterly and annual reports with the SEC, which are available online
through the SEC's Edgar database or one of the commercial Edgar vendors.
By contrast, Bulletin Board issues currently don't need to meet any
significant requirements. Indeed, the firms that might be ousted don't make
regular filings with the SEC, meaning an investor may not be able to find out
diddley about the business. As might be expected, the Bulletin Board is the
cesspool of American finance, rife with scams and charlatans, as a recent
Business Week cover story reminds us. That's why the Fool will not open
message boards for BB companies. To put it bluntly, these firms are so small
and so risky that one could make a strong case for why they should not be
permitted to trade publicly at all. At the minimum, it's proper to make it
difficult for investors to find and invest in these companies, to educate
investors about the risks involved, and to ensure that the brokers who deal in
these securities have some integrity.
According to the Journal, that's what's in the works. Led by chair Frank
Zarb, the board of Nasdaq's parent, the National Association of Securities
Dealer (NASD), is reportedly planning on Thursday to approve a proposal
that would require companies to file regular financial statements with the
SEC in order to remain on the BB. Companies that don't meet this new
standard would not stop trading, but they would no longer do so over
Nasdaq's computer systems. These stocks would become significantly less
accessible to investors as all trades would be handled through phone calls
with brokers, with prices reported in the so-called "Pink Sheets" owned by
the National Quotation Bureau.
The proposal would also place some new burdens on broker-dealers. First,
brokerage firms couldn't quote a price on a security unless they had reliable
financial information on the company. Second, brokers who recommended
BB stocks to clients would be required to review the financial statements
before doing so, something that might make it easier for swindled customers
to come back later and sue their brokers. Third, brokers would have to send
investors a detailed statement disclosing differences between the Bulletin
Board and other markets. Though it's safe to say the latter will stop short of
saying the obvious -- that BB companies are high-risk rubbish that investors
should avoid -- at least it's a start.
Since the Justice Department brought its collusion case against Nasdaq's
market makers two years ago, the NASD and Nasdaq have made a number
of moves to scrape off the plaque and present a respectable face to the
world. These moves are necessary for Nasdaq to remain competitive,
particularly with the New York Stock Exchange, which has successfully
stolen away some prize Nasdaq jewels in the last year or so. One could still
argue that companies that can't make the Nasdaq SmallCap market's
minimum requirements (as most BB companies cannot) don't even deserve
the exposure afforded them by the OTC Bulletin Board. Nonetheless, itv is
smart for Nasdaq to clean up its ties to these speculative microcaps. And
any step that makes it tougher for novice investors like Norman to
inadvertently screw up their financial dentin should be applauded. |
