Some debate will be enlightening:
Penny Stock Investor Alert
So-called "Penny Stocks", which are generally traded at very low prices and promote new untested products such as
electronic asparagus cutters or gold mining operations, have been a growing problem for investors. The penny stock game has
the same allure to speculative investors as casino gambling. But sometimes the penny stock game is fixed. It is filled with
unproven or nonexistent products, novice management and investors who don't seem to know or care that a "gold mining
property" is under a lake, as long as they are told that their nickel stock in it will go to three dollars a share.
Penny stock losses have mounted to hundreds of millions of dollars in recent years. State securities regulators have taken
scores of actions against dealers for violations of state and provincial securities laws. Forty five percent of 78 new penny stock
issues surveyed by "Venture" magazine had participants who were convicted felons, securities violators, targets of securities
investigations, reputed crime figures or principals who faced serious charges of insider financial misdealing.
A June 1984 Survey by the North American Securities Administrators Association, Inc. and the Council of Better Business
Bureaus revealed these penny stock problems:
In Colorado, the 1982 collapse of the Denver penny stock market resulted in thousands of Coloradans losing hundreds
of millions of dollars.
One penny stock company's prospectus revealed it "has engaged in no business whatsoever and has no operating
history." It disclosed also that "it would not start business until the offering was completed and that it could "provide the
investor with no information whatsoever as to intentions."
The president of one computer firm was revealed to be a 15-year-old high school freshman. The vice president was 16;
his father had been convicted on two counts of perjury in connection with an earlier SEC investigation.
These are just a few of the hundreds of documented instances of questionable practices on file with securities regulators.
How Penny Stock Frauds Operate
In the classic penny stock fraud, promoters assign themselves millions of shares of stock at a fraction of a cent per share, or no
cost to them at all. Next a prospectus is prepared disclosing that the product has little or no chance of success and the stock is
offered at five or ten cents a share. The market is then artificially inflated through demand created by the controlling broker
who uses pushy, high-pressure tactics to lure investors.
A broker may not allow an investor "in" unless there is a promise to buy more shares later in order to keep the price up. After
the share prices reach several dollars the "smart money" gets out and the stock plummets. Novices often don't realize what is
happening and cannot sell in time. After the stock plunges, the development of the "moose pasture" dies and the company goes
out of business with promoters lining their pockets with the stock proceeds in the company treasury. In this situation, most of
the investors will lose a substantial portion, if not all, of their money.
This classic example is not true in all cases of low priced stocks, but is has been seen numerous times. There are, of course,
legitimate companies whose securities are traded at low prices, but discriminating between a legitimate offer and the penny
stock fraud can sometimes be difficult.
How To Protect Yourself In The Penny Stock Game
The following suggestions may be of help to anyone who decides to play the high-risk penny stock game:
Beware of high pressure, unsolicited telephone calls.
The fraudulent penny stock broker has a "boiler room", a bank of telephones manned by high pressure salespersons who tout
stocks with outrageous promises. Beware of claims that the stock will double soon, and demands that you make an
on-the-spot decision and pay immediately. Suggestions that the broker has inside information or that manipulative techniques
are being used to raise the stock's price should be viewed very suspiciously. They are danger signs of the penny stock game in
which many buyers are the losers.
Check out the broker-dealer.
Phone the Pennsylvania Securities Commission (in PA, call 800/600-0007) to learn if the salesperson is registered and
whether any legal actions have been filed against him/her.
The Prospectus
No matter what the salesperson tells you, get a prospectus and read it. The prospectus is the document containing full
disclosure of all the facts about the offering. It must be filed with the Pennsylvania Securities Commission. (In a private deal the
document is sometimes called an offering circular or offering memorandum and contains much the same information as in a
prospectus.) Anything a salesperson says that contradicts disclosures in the prospectus should be a red flag, warning one off
the offer. Following are some sections of the prospectus that disclose risks involved in a penny stock offering:
Management - This section tells the experience and background of management. Check to make sure, for example, that
someone, whose sole experience was as a railroad engineer, is not at the helm of a biomedical research company.
Company Financial Health - If they are not already deeply in debt, many penny stock companies have little or no capital to
work with. They will be using investors' money simply to keep the doors open. Read the financial statement and accountant's
report in the prospectus and, if you don't understand them, find someone who does and can explain it all to you.
Dilution - Promoters often obtain huge numbers of shares free. When the public's money is invested it is immediately watered
down by the absence of cash investment by the promoters. The prospectus will have charts of information showing how much
investors' dollars have been eroded by the "cheap stock" in the hands of promoters. For example, 75% dilution or more should
be a cause for concern.
Use of Proceeds - This section tells how much money will be used for the mineral exploration or whatever the purpose is, and
how much will be used for suspect, unproductive purposes such as loans to officers and directors, back taxes or unmet
payroll. This is the key to the legitimacy of the operation.
Product - Here the prospectus will tell if the electronic asparagus cutter has been tested and proven. Often this section will
contain double-talk indicating that the product is "about to be tested", "may be tested", or that money is being raised that will
allow testing. Read this part carefully to learn the stage of development--if any--of the "new invention".
Transactions with Management/Conflicts of Interest - Watch out for interest-free loans to principals, transaction where
the officers, directors, and promoters sell property to the company at inflated prices. This could indicate that the company is
giving its money to the promoters in less than arms-length transactions and that there won't be much left to develop the
property or product.
Litigation and Investigations - The prospectus will disclose lawsuits filed against the corporation and promoters and, often,
government investigations. Investors can get information on civil and criminal securities fraud actions, including the names of
defendants and companies, by calling the Pennsylvania Securities Commission.
Finally, find out if the securities are registered with the Securities Commission or the federal Securities and Exchange
Commission. Even if they are, investors should not rely on government registration of the offering as an indication of
government approval of the soundness of the company or the advisability of the investment. All that is required to register a
security in many jurisdictions is full disclosure of relevant facts. It is up to the individual to judge from the prospectus
disclosures and other reliable sources whether or not to invest in the securities.
(Original release date of the Investor Alert: 8/84)
Additional quantities of this document are available at no cost by calling The Pennsylvania Securities Commission's Harrisburg
Office: 800/600-0007
TDD Users via AT&T Relay Center: 800/654-5984. Or write: The Pennsylvania Securities Commission, 1010 N. 7th Street,
Harrisburg, PA 17102-1410 |
