How is a Penny Stock Created?
A penny stock, like any other publicly traded stock, is created through
a process called an initial public offering, or IPO. First, a company must
file a registration statement with the Securities and Exchange Commission
or file stating the offering qualifies for an exemption from registration. It must
also check state securities laws in the locations it plans to sell the stock.
Then, upon approval, the company may begin the process of soliciting orders
from investors. Finally, the company can apply to have the stock listed on an
exchange, or it can trade on the over-the-counter market, or OTC.
Small companies and start-ups typically issue stock as a means of raising
capital to grow the business. Though the process is lengthy, involves
mountains of paperwork and can be quite costly, issuing stock is often one of
the most efficient ways for a start-up company to obtain necessary capital.
Penny stocks are often the result of such ventures and can make for profitable
but precarious plays for investors.
As with other new offerings, the first step is hiring an underwriter, usually
an attorney or investment bank specializing in securities offerings. The
company's offering either needs to be registered with the SEC according
to Regulation A of the Securities Act of 1933 or file under Regulation D if
exempt. If the company is required to register, Form 1-A, which is the
registration statement, must be filed with the SEC and is accompanied
by the company's financial statements and proposed sales materials.
These financial statements need to remain available to the public for review,
and timely reports must be filed with the SEC to maintain the public offering.
Once approved by the SEC, orders for shares may be solicited from the public
by accompanying sales materials and disclosures, such as a prospectus.
After initial orders are collected and stock is sold to investors, a registered
offering can begin trading in the secondary market via listing on an exchange
like NYSE or Nasdaq or trade over-the-counter. Many penny stocks end up
trading in OTC markets due to the strict requirements for listing on the bigger
exchanges. The majority of penny stocks do not meet such requirements, and
the companies cannot typically afford the hefty cost and regulations involved.
Sometimes companies make an additional secondary market offering after the
IPO. This dilutes the existing shares but gives the company access to more
investors and increased capital. It is important that companies issuing penny
stock keep this in mind and work to gain value in the shares as they trade in
the open market. Furthermore, it is mandatory that the companies continue to
publicly provide updated financial statements to keep investors informed and
maintain the ability for quoting on the over-the-counter bulletin board, or OTCBB.
The SEC's Rules for Penny Stocks
Penny stocks are considered highly speculative investments. In order to
protect the investor’s interest, the SEC and the Financial Industry Regulatory
Authority (FINRA) have specific rules to regulate the sale of penny stocks. All
broker-dealers need to comply with the requirements of Section 15(h) of the
Securities Exchange Act of 1934 and the accompanying rules to be eligible to
effect any transactions in penny stocks.
(1) Sales Practice Requirements §240.15g-9
Before effecting any transaction, a broker-dealer must approve the
investor's transaction (of specific penny stocks); meanwhile, the customer
must give a written agreement to the broker-dealer for the same transaction.
This measure has been taken to prevent manipulative, fraudulent practices in
such investments. “Approving” the customer basically means checking his
suitability for such investments. Approval should be given only after the broker
-dealer has assessed the customer's investment experience and objectives
along with his or her financial position.
(2) Disclosure Document §240.15g-2
A broker-dealer must provide a standardized disclosure document to
the customer. The documents explain the risk factor associated with
investing in penny stocks, concepts related to the penny-stock market,
customer rights, broker-dealers' duties towards the customers, remedies
in case of fraud and other important information which can be handy for an
investor. The investor would be well-advised to go through this document so
as to take informed decisions.
(3) Bid-Offer Quotations Disclosure §240.15g-3
It is mandatory for a broker-dealer to disclose and later confirm the
current quotation prices and related information to the customer before
effecting a transaction. If a broker-dealer doesn’t follow the same, it is
considered unlawful. This helps the investor to keep a track of the price
movement in the marketplace.
(4) Compensation Disclosure §240.15g-4
This rule makes the investor aware of the money being earned by the
broker-dealer from a certain transaction. This can help the customer to
judge if the broker-dealer has a selfish motive in trying to push a certain
transaction.
(5) Monthly Accounts Statements §240.15g-6
A broker-dealer must send to its clients a monthly account statement
which discloses details such as: the number and identity of each penny
stock in the customer’s account; the dates of transaction; purchase price;
and the estimated market value of the security (based on recent bids and
purchase prices). Such statements must also explain the limited market
for the securities and the nature of an estimated price in such a limited market.
In cases where there have been no transactions effected in the customer’s
account for a period of six months, the broker-dealer shall not be required to
provide monthly statements. However, broker-dealers should send written
statements on a quarterly basis.
A penny stock, like any other publicly traded stock, is created through
a process called an initial public offering, or IPO. First, a company must
file a registration statement with the Securities and Exchange Commission
or file stating the offering qualifies for an exemption from registration. It must
also check state securities laws in the locations it plans to sell the stock.
Then, upon approval, the company may begin the process of soliciting orders
from investors. Finally, the company can apply to have the stock listed on an
exchange, or it can trade on the over-the-counter market, or OTC.
Small companies and start-ups typically issue stock as a means of raising
capital to grow the business. Though the process is lengthy, involves
mountains of paperwork and can be quite costly, issuing stock is often one of
the most efficient ways for a start-up company to obtain necessary capital.
Penny stocks are often the result of such ventures and can make for profitable
but precarious plays for investors.
As with other new offerings, the first step is hiring an underwriter, usually
an attorney or investment bank specializing in securities offerings. The
company's offering either needs to be registered with the SEC according
to Regulation A of the Securities Act of 1933 or file under Regulation D if
exempt. If the company is required to register, Form 1-A, which is the
registration statement, must be filed with the SEC and is accompanied
by the company's financial statements and proposed sales materials.
These financial statements need to remain available to the public for review,
and timely reports must be filed with the SEC to maintain the public offering.
Once approved by the SEC, orders for shares may be solicited from the public
by accompanying sales materials and disclosures, such as a prospectus.
After initial orders are collected and stock is sold to investors, a registered
offering can begin trading in the secondary market via listing on an exchange
like NYSE or Nasdaq or trade over-the-counter. Many penny stocks end up
trading in OTC markets due to the strict requirements for listing on the bigger
exchanges. The majority of penny stocks do not meet such requirements, and
the companies cannot typically afford the hefty cost and regulations involved.
Sometimes companies make an additional secondary market offering after the
IPO. This dilutes the existing shares but gives the company access to more
investors and increased capital. It is important that companies issuing penny
stock keep this in mind and work to gain value in the shares as they trade in
the open market. Furthermore, it is mandatory that the companies continue to
publicly provide updated financial statements to keep investors informed and
maintain the ability for quoting on the over-the-counter bulletin board, or OTCBB.
The SEC's Rules for Penny Stocks
Penny stocks are considered highly speculative investments. In order to
protect the investor’s interest, the SEC and the Financial Industry Regulatory
Authority (FINRA) have specific rules to regulate the sale of penny stocks. All
broker-dealers need to comply with the requirements of Section 15(h) of the
Securities Exchange Act of 1934 and the accompanying rules to be eligible to
effect any transactions in penny stocks.
(1) Sales Practice Requirements §240.15g-9
Before effecting any transaction, a broker-dealer must approve the
investor's transaction (of specific penny stocks); meanwhile, the customer
must give a written agreement to the broker-dealer for the same transaction.
This measure has been taken to prevent manipulative, fraudulent practices in
such investments. “Approving” the customer basically means checking his
suitability for such investments. Approval should be given only after the broker
-dealer has assessed the customer's investment experience and objectives
along with his or her financial position.
(2) Disclosure Document §240.15g-2
A broker-dealer must provide a standardized disclosure document to
the customer. The documents explain the risk factor associated with
investing in penny stocks, concepts related to the penny-stock market,
customer rights, broker-dealers' duties towards the customers, remedies
in case of fraud and other important information which can be handy for an
investor. The investor would be well-advised to go through this document so
as to take informed decisions.
(3) Bid-Offer Quotations Disclosure §240.15g-3
It is mandatory for a broker-dealer to disclose and later confirm the
current quotation prices and related information to the customer before
effecting a transaction. If a broker-dealer doesn’t follow the same, it is
considered unlawful. This helps the investor to keep a track of the price
movement in the marketplace.
(4) Compensation Disclosure §240.15g-4
This rule makes the investor aware of the money being earned by the
broker-dealer from a certain transaction. This can help the customer to
judge if the broker-dealer has a selfish motive in trying to push a certain
transaction.
(5) Monthly Accounts Statements §240.15g-6
A broker-dealer must send to its clients a monthly account statement
which discloses details such as: the number and identity of each penny
stock in the customer’s account; the dates of transaction; purchase price;
and the estimated market value of the security (based on recent bids and
purchase prices). Such statements must also explain the limited market
for the securities and the nature of an estimated price in such a limited market.
In cases where there have been no transactions effected in the customer’s
account for a period of six months, the broker-dealer shall not be required to
provide monthly statements. However, broker-dealers should send written
statements on a quarterly basis.
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