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Table of Contents


SECTION A - WHAT ARE Penny Stocks?

What is a Penny Stock?

The term 'Penny Stock' is used to refer to stocks that are low priced. Low priced, in this case, refers to stocks that sell at, or less than, five dollars. Penny Stocks generally trade in what is referred to as the Over-the-Counter (OTC) market, which would include the OTC Bulletin Board or the Pink Sheets. Penny Stocks that we feature, generally, do not trade on the national exchanges.

Penny Stocks are also referred to as Microcap Stocks.

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What is a Microcap Stock?

A Microcap Stock is also known as a Penny Stock. The term "microcap" is an abbreviation of the phrase "micro capitalization", or a company with a "micro" or low capitalization. Capitalization refers to the total value of a company.

Microcap Stocks or, if you prefer the term Penny Stocks, tend to trade in low volumes and their stock is relatively inexpensive.

Where do Penny Stocks trade?

Penny Stocks generally trade in the Over-The-Counter market, more specifically, the OTC Bulletin Board, or OTCBB or another electronic quotation system, the Pink Sheets. Penny Stocks generally do not trade on the National Stock Exchanges, such as NASDAQ or the NYSE.

How are Penny Stocks different from other Stocks?

The biggest differences between Penny Stocks and other stocks relate to a lack of public information, listing reguirements and investment risk.

Penny Stocks do not have as onerous reporting requirements vis a vis the SEC and so one cannot always get information directly from the SEC's website.

Companies on the OTCBB or the Pink Sheets do not have to meet any minimum listing requirements, whereas companies that trade their stocks on major exchanges have requirements relating to amongst other things, a minimum amount of net assets and a minimum number of shareholders.

Penny Stock investments tend to be risky because the companies tend to be new and have little or no proven track record. This is also why investors can make serious money when they come upon a good Penny Stock investment.

Are Penny Stock Investments risky?

All stock investments are risky. There are no guarantees in stock investment.

Penny Stock investments are often classified as very risky investments. Penny Stocks are low-priced shares of small companies not traded on any National Exchange or quoted on NASDAQ. Quoted prices for Penny Stocks are often unavailable because the shares tend to trade in low volumes.

The over-the-counter market is less liquid that national stock exchanges and so Penny Stock investors are often unable to sell their stock back to the dealer who sold the stock, since there may not be any willing buyers for that Penny Stock. While Penny Stock investments can be very lucrative, investors should understand the risks involved in investing in small, new companies.

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SECTION B - LISTING Penny Stocks

What is the "Over-the-Counter" (OTC) market?

Stocks that do not trade on recognized national stock exchanges, such as the New York Stock exchange or the NASDAQ, trade rather in markets described as "over-the-counter" (OTC).

The OTC market is less formal than the national exchanges when it comes to matters such as listing requirements and investor information and exists primarily to give relatively new and small companies access to public investor funding. The OTC market is, in essence a collection of broker-dealers, market makers, Penny Stock companies and investors from the public that generally interact with each other through the OTCBB or the Pink Sheets.

What is the OTC Bulletin Board?

The OTCBB is an acronym for the Over-the-Counter Bulletin Board. This OTC bulletin Board is described as such basically because it is an electronic quotation system. The number of shares traded (volume) and the price information on exchange-listed stocks are all displayed on the OTCBB.

Subscribing brokers find the OTCBB useful to look up prices or enter quotes for the OTC securities. The OTCC is overseen rather than managed or owned by the NASD.

Is the OTCBB part of the NASDAQ Stock market?

Although many people incorrectly assume that that the Over-the-Counter Bulletin Board (OTCBB) is associated with the NASDAQ Stock market, the OTCBB is not at all a part of the NASDAQ.

What are the Pink Sheets?

The "Pink Sheets", like the Over-the-Counter-Bulletin Board (OTCBB), is an electronic quotation system. The Pink sheets present quotes from broker dealers for many over-the-counter (OTC) securities. The Pink sheets are useful for brokers to publish their purchase and selling quotation prices.

The "Pink sheets" are named as such because pink was the original color of the page that this type of information was traditionally printed on.

A privately owned company, Pink Sheets LLC, publish the Pink Sheets. The Pink Sheets electronic quotation system is not registered with the Securities Exchange Commission (SEC) and neither is the company a broker-dealer of the National Association of Securities Dealers (NASD).

The Pink sheets are updated electronically on a daily basis and can be a useful source of information on public companies offering their shares in the OTC market.

What is the NASD?

The NASD is the National Association of Securities Dealers, and is an association of brokers and dealers in the securities business.

What is the SEC?

The acronym SEC stands for the United States Securities and Exchange Commission.

This Commission aims to protect investors and ensure that all investors, whether they invest on behalf of giant corporations or make up the individual investor on the street, should have access to certain basic information about an investment before they buy it. It is for this reason that the SEC necessitates the disclosure of financial and other information by public companies to the general public itself.

The SEC operates on the premise that it is only through the steady and comprehensive stream of accurate and reliable information that can people make investment choices of a sound and effective nature. The SEC exists primarily to devise rules and regulations that protect potential investors.

Are there any listing requirements to list a share in the OTC market?

No, neither the Pink sheets nor the OTCBB require Penny Stock companies to meet any listing requirements before their share is quoted on their systems.

Are there any minimum listing standards that must be met in order to list a share in the OTC market?

Companies that trade their stocks on the major national exchanges such as NASDAQ or the NYSE are required to meet minimum listing standards. There are no minimum listing standard that must be adhered to before Penny Stock shares can be listed on the OTCBB or the Pink Sheets and traded in the over-the-counter (OTC) market.

Can Private Companies be listed in the OTC Market?

Yes, any private company, provided they subscribe to the Over-the-Counter Bulletin Board (OTCBB) or the Pink sheets, can sell their shares in the OTC market.

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How does a Penny Stock Company become a public company?

A Public company is a company that sells shares of its stock to the public. The Securities and Exchange Commission (SEC) regulates all public companies. If a Penny Stock company wanted to become a publicly held company, it could do so by following one of two methods.

  • Either the Penny Stock company can issue stock in a transaction that is registered with the SEC or;
  • register the company and its outstanding stock with the SEC.

Both methods of registration stimulate ongoing reporting duties. This means that the company must file periodic reports disclosing vital information to investors about its business, management methods and financial state.

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SECTION C - Penny Stock REPORTING REQUIREMENTS

Do Penny Stock companies have to file reports with the SEC?

In general, a company (including Penny Stock companies) must file reports with the SEC if it has 500 or more investors and $10 million or more in assets; or it lists its securities on any one of the American, Boston, Cincinnati, Chicago, Nasdaq, New York, Pacific or Philadelphia stock exchanges.

If a Penny Stock company has voluntarily chosen to register their stock and file their reports, then this Penny Stock company will required to file the same quarterly, annual and other regular reports.

Some Penny Stock companies voluntarily register their reports with the SEC.

What is EDGAR?

EDGAR, or the Electronic Data Gathering And Retrieval system of the SEC allows companies to both file their own Financial Reports and access the corporate filings of other companies. The EDGAR system can be accessed from the Security Exchange Commission's (SEC) website.

Where do Penny Stock companies file financial reports with the SEC?

Penny Stock companies can file their financial reports with the Security Exchange Commission (SEC) electronically by using the SEC's EDGAR system. The EDGAR database is available on the SEC website and includes a variety of annual quarterly reports and other such corporate filing information.

How do I get information about Penny Stock Companies?

Your broker or investment adviser can provide you with information about the Penny Stock company and its disclosure documents.

One could contact the company and ask them whether they are registered with the SEC and files reports with the SEC.

Financial reports for Penny Stock Companies can be found at the Security Exchange Commission's (SEC) EDGAR system. This system is available on the SEC's website.

If you cannot find the company on EDGAR, you should contact your state securities regulator, which should give you access to the most recent reports the company has filed with its regulators.

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SECTION D - Penny Stock SHARE OFFERS

Do Penny Stock companies have to register with the SEC in order to offer or sell securities to the public?

Any company that desires to offer or put up shares for sale to the public at large must either register with the SEC or fulfill an exemption, in a general either under SEC Regulation A or D

What is a Regulation D offering?

Smaller companies that offer and sell stocks without registering with the SEC can do so under an exemption which is termed Regulation D. Regulation D exempts companies that look to raise less than 12 million dollars per annum from registration.

Companies looking to raise up to five million dollars are also exempted by Regulation D provided that the companies sell to thirty-five or less individuals, or to any number of investors deemed "accredited", (these are investors required to meet standards of high net worth or income).

Although companies declaring an exemption under Regulation D are not required to register or file reports with the Securities Exchange Commission (SEC) these companies must however file a "Form D" within three days after the sale their stocks. A "Form D" is a document that details the names and addresses of stock promoters and owners.

What is a Regulation A offering?

Regulation A exempts companies that raise less than five million dollars per annum from registering their shares. Rather than file their securities through the electronic data and gathering retrieval system more commonly known as (EDGAR), these companies are only required to file with the SEC a printed copy of an "offering circular".

This "offering circular" contains financial statements and other corporate information relating to the company.

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SECTION E - Penny Stock BROKERS

Who can sell Penny Stocks to me?

A broker-dealer or a market maker can sell Penny Stocks to the public. Etrade or Scottrade are examples of reputable online brokerages that can and do sell Penny Stocks.

What are market makers?

In the context of Penny Stock investments, market makers are firms that remain prepared to buy and sell a specific stock on a frequent and continuous basis at a price that is publicly quoted.

Market makers are in constant competition with one another for orders to buy or sell at prices publicly quoted. Market makers must, on the whole, be prepared to buy and sell at least one hundred shares of a stock they develop a market in.

Resultantly, a substantial order requested by an investor could possibly have to be filled by numerous market makers at potentially different prices. If, for example, a broker seeks to buy a stock but there are no offers to sell it, the marker maker will fill the order himself by selling shares from his own account. This works in reverse too where, if a broker desires to sell but there is no buyer; the market maker then buys the shares.

Market makers have an important role to play in providing liquidity in the Over-the-counter (OTC) market, where Penny Stocks tend to trade.

Who are the market makers?

In the Over-The-Counter (OTC) market, a market maker is the broker or trader responsible for maintaining a functioning market in an individual stock by standing ready to buy or sell shares. The market maker can be an individual or a firm.

What questions should I ask the broker who sells the Penny Stocks?

  1. Is the brokerage registered with a state securities regulator? Have they ever been investigated or disciplined by a state regulator, the Securities Exchange Commission (SEC) or any other organization, such as NASD or one of the stock exchanges?
  • How long has the brokerage firm been in business? How many arbitration awards have been filed against the firm?
  • Have you personally been involved in any arbitration cases? What happened?
  • Please describe your personal investment philosophy.
  • Describe your typical client. Please let me have the names and telephone numbers of some of your long-term clients.
  • How do you get paid? By commission? Amount of assets they manage? Another method?
  • Do I have any choices on how to pay you? Should I pay you by the transaction? Or a flat fee regardless of the number of transactions?
  • Do you make more money if I buy this stock rather than another? If you weren't making extra money, would your recommendation be the same?
  • Are you participating in a sales contest? Is this purchase really in my best interest, or are you trying to win a prize?
  • How much will I receive if I sell the stock again today?
  • Where do you send my order to be executed? Can we get a better price if we send it to another market?
  • How do I find out more about the stock broker who is trying to sell me Penny Stocks?
  • By contacting the state securities regulator you will be in a position to access information detailing whether or not the stock broker and his or her firm are registered, if they are in a possession of a business license, and if the broker or firm has been the subject of complaint or disciplinary action.
  • Under federal law, what information does my broker have to give me before I buy a Penny Stock?
  • Your broker must reveal to you the bid and offer price quotes for the Penny Stock, as well as the number of share to which the quoted prices apply.
  • You must be informed of the brokerage firm's compensation for facilitating the trade and the compensation amount allocated to the firm's salesperson.
  • You must be given monthly account statements giving an estimate of the value of each Penny Stock owned by you.
  • Your broker must send you a written statement for you to sign that accurately describes your financial situation, your investment experience and your investment goals. This document should also contain a statement of why your firm decided that Penny Stocks are a suitable investment for you.

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SECTION F - ASSESSING Penny Stock INVESTMENTS

What should I do if I want to make a Penny Stock investment?

Before making a Penny Stock investment, a potential investor should research each investment opportunity thoroughly and ask questions. Find out whether the Penny Stock company has registered its securities with the SEC or the state's securities regulators.

Make sure that you understand the company's business and its products or services. Be wary of companies that have no operating history, few assets, or no defined business purpose.

Is the company making money? How they rank in relation to their competitors?

Read carefully the most recent reports the company has filed with its regulators and pay attention to the Penny Stock company's financial statements, particularly if they are not audited or not certified by an accountant. If the company does not file reports with the SEC, ask your broker for the Rule 15c2-11 file on the company.

This file contains important information on the company. What are the specific risks associated with this Penny Stock investment? What is the maximum I could lose? Perform a background check on the management of the company with your state securities regulator, and find out whether they have ever made money for investors before this venture.

You should also find out whether the management of the company have ever run into trouble with the regulators or other investors.

  • How liquid is this investment? How easy would it be to sell if I needed my money right away?
  • Does this investment match my investment goals?
  • Why is this investment suitable for me?
  • How will this investment make money? (Dividends? Interest? Capiutal Gains?)
  • What must happen for this investment to increase in value?
  • What are the total fees to purchase, maintain and sell this investment?
  • After all the fees are paid, how much does this investment have to increase in value before I break even?

Know the brokerage firm and the salespeople with whom you are dealing. The nature of the market for Penny Stock is such that you may have to rely on your original brokerage firm that sold you the stock to trading prices and to buy the stock back from you. Only use reputable brokerage firms such a Scottrade and Etrade where possible.

How do I find out more about the people running a Penny Stock company?

To discover information regarding a Penny Stock company's owners or the particular people running the company you should contact your state securities regulator.

How do I know that the Penny Stock that I am considering investing in is not fraudulent?

The lack of accurate and accessible information about some Penny Stocks means that they are made vulnerable to fraudulent activities. When there is no information available about Penny Stock companies fraudsters are given more leverage to manipulate a Penny Stock and spread false information.

The greater the volume of financial data and other information on a Penny Stock, accessible for the public consumption, the smaller the propensity for fraud taking place

How do I protect myself from Internet fraud?

Internet fraud, as it relates to Penny Stock investments, generally involves the distribution of e-mails more commonly known as spam or junk mail. This spam would advertise misleading or false information about a Penny Stock company in the hopes to attract more investors.

Fraudsters also use aliases or "false identities' on Internet bulletin boards and chat rooms to secure anonymity from which they are able to lure potential Penny Stock investors with false investment tips deemed as "inside information".

Being vigilant about internet fraud, understanding the methods used, and most importantly performing thorough research into the Penny Stock company or companies you choose to invest with, are all steps that can be taken to ensure that you do not fall prey to the pervasions of internet fraud

What are the typical Penny Stock scams?

Penny Stock scams are most predominately carried out in two ways, the "Pump and Dump" or the "Offshore" scams. The "Pump and Dump" scheme usually involves posted internet messages or telemarketers urge investors to speedily buy penny shares or sell before the price falls. The promoters will maintain that they possess "inside information" about a particular investment or business opportunity.

In reality the promoters may actually be company insiders or hired promoters who will themselves benefit after the sale of their own Penny Stocks once their "promotions" have cultivated an inflated stock price. Investors lose their money once the fraudulent party has sold their own penny shares, the generated hype has died down, and the price inevitably falls.

The Off-Shore Scam would normally be perpetrated by an unethical Penny Share company that sells unregistered Regulation S stock at a great discount to fraudsters posing as foreign investors. The fraudsters subsequently sell the stock to United States investors at elevated prices and the profit generated is shared by the Penny Stock company. The great volume of unregistered stock streaming into the US stimulates a price fall which, in turn, means the US investors suffer significant losses.

What is Regulation S?

SEC Regulation S is a Penny Stock share offer exemption that allows companies to sell stock outside of the United States to foreign or off-shore investors without registering the stock with the SEC.

What are the Penny Stock investment fraud 'red flags' to look out for?

The SEC suspends trading in a Penny Stock if it is under the impression that a company is distributing inaccurate, false or misleading information. If a Penny Stock's shares have been suspended, find out more information.

Be careful of Penny Stock investments where there exists no current financial information on the company but it is both widely recommended and advertised. High pressure sales tactics, where a salesperson speaks very emphatically about a "once in a life time opportunity, not to be missed" and you are being privilege to "confidential, inside information", are clear red flag signals of fraud. Be careful of Penny Stock companies that have large assets but small revenues.

This fraud involves attaching high values on the financial statements to assets completely unrelated to the company itself.

Strange items in the financial statements footnotes, an unusual loan for example, could be another indication that things may be amiss. Strange auditing issues such as a company's auditor's refusal to certify their financial statements or a change in accountants may also signal danger in the Penny Stock investment.

A Penny Stock investor should be careful of situations where insiders own large amounts of the stock in the company and are given the power to control most of the shares. In this situation, it may be easy to manipulate the Penny Stock share price to the detriment of a new investor.

A Penny Stock investor should be careful of investing in a Penny Stock when there is an unwillingness to provide access to written documentation about the Penny Stock investment, including information a potential investor is entitled to in terms of law or regulations.

Where can I turn to for help if I become the subject of a Penny Stock scam?

If you find that you have been targeted in a Penny Stock scam you should immediately contact your state's securities regulator and give them all information that you have at your disposal so that they could investigate the matter further.

You should also file a complaint through the Securities Exchange Commission's (SEC) website at their online complaint centre.

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SECTION G - EXECUTING Penny Stock INVESTMENTS

What happens when I place an order to buy or sell a Penny Stock?

Online brokerage accounts are not connected directly to the securities markets. If you are trading in Penny Stock shares through an online brokerage account, your order to buy or sell it sent over the internet to your broker who then decides which market to send it to for execution. Your order to buy or sell stock is not instantaneous.

What options does my broker have for executing my trade?

If your stock is listed on an exchange your broker can direct your order to that particular exchange, or to another exchange in another area (regional exchange) or to a firm known as a "third market maker". A third market maker is a firm that is, at any time, ready to buy or sell shares listed on an exchange at prices that are publicly quoted. For shares trading in the over-the-counter (OTC) market, your broker can possibly send the order to a market maker in the stock.

Your broker can route your order to what is called an ECN (electronic communications network) which is a network that automatically matches buy and sell orders at specified prices. Your broker can also decide to send your order to another division of the broker's firm and your order is then filled out of the firm's own inventory. This is known as internalization and it allows your broker's firm to possible make money on the difference between the purchase and sale price (the spread).

What is "payment for order flow"?

Payment for order flow refers to the way in which regional exchanges or third market makers will pay your broker for directing your order to that specific exchange or market maker.

What is internalization?

Internalization describes the practice of brokers opting to send your order to another division of the broker firm so that your order can be filled out of the firm's own inventory, giving the firm the opportunity to make money on the spread.

What is a limit order?

A limit order is an order to sell or buy a stock at a particular price.

What is a market order?

A market order is an order to buy or sell a stock at the current market price and, unless you indicate to the contrary, your broker will enter your order as a market order.

What is a bid price?

This refers to the highest price that a market maker will pay at any specified time to buy a given number of shares in a Penny Stock.

What is the ask price?

The ask price is also referred to as the 'offer' price and refers to the lowest price at which a market maker will sell a specified number of shares of a Penny Stock.

What is the spread?

The spread is the difference between the bid price and ask (offer) price. There exists a difference between the two prices because the ask price is certainly always higher than the bid price. Market makers make money on the spread when Penny Stocks are traded

What is the broker's mark-up or mark-down?

The price that an investor pays for a Penny Stock includes the profits for the broker and the firm to which he is affiliated. Knowing what the mark-up or mark- down amounts are, will assist you to assess the overall value of the trade.

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SECTION H - MONITORING Penny Stock INVESTMENTS

Where can I find quoted prices for stocks I am trading in the OTC market? Quoted Prices for stocks traded in the Over-The-Counter (OTC) market can be found on the Over-the-Counter Bulletin Board (OTCBB) or at the Pink Sheets. If you are having any trouble in finding quoted prices for your Penny Stock investments, you should contact your broker / dealer, who will be able to help you.

Where can I check how my Penny Stocks are trading?

The Over-the-Counter Bulletin Board (OTCBB) and the Pink Sheets are both electronic quotation systems that allow one access to the most recent trading information on Penny Stocks.

What questions should I ask about the progress of my Penny Stock investments?

How frequently do I get statements? Do I understand what the statement tells me? Does the return on my investment satisfy my expectations and is this rate of return a good reflection of what I was originally told to expect? How much money will I get back if I sell the Penny Stocks today? How much am I paying in commission or fees? Have my investment goals changed and are Penny Stock investments still suitable? What criteria should I use to decide when to sell?

What do I do if I suspect that something is amiss after I have made a Penny Stock investment?

There is a limited time period during which you can take legal action.

You should immediately talk to your broker and explain your concerns. If you suspect that your broker is involved in fraudulent activity, document your complaint straightaway and send it to the firm. If a circumstance arises that your broker is unable to resolve proceed then to the broker's branch manager and re-explain your predicament.

Thereafter, if your problem remains unresolved, document your complaint in written form and send it to the compliance department at the firm's headquarters. If, after this, you are still not satisfied, send a letter to your state securities regulator and attach copies of all the documentation that you previously sent to the firm. You could also use the Security Exchange Commissions (SEC) online complaint form to lodge any complaints or problems that you may have encountered.

What happens to my Penny Stock shares if the company declares bankruptcy?

A Penny Stock investor should be careful when investing in common stock of companies in Chapter 11 bankruptcy. Some people look to purchase the low-priced shares of these Penny Stock companies in the hopes that the price of the shares will rise after the company surfaces from a bankrupt state.

In actual fact, creditors are paid from the company's liquidated assets before common stockholders and the holders of these Penny Stock shares stand a very good chance of losing their whole investment.

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