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Avoid Fraud

Low-Priced Stocks Can Spell Big Problems

Low-Priced Stocks istockimage

Are you considering investing in low-priced securities? You might have heard that they’re a good way to make a profit without spending much. But how much do you know about these securities?

Low-priced securities are often known as “microcap stocks” or “penny stocks.” Generally, microcap stocks are stocks issued by companies with market capitalization of less than $250 to $300 million. Penny stocks are typically stocks issued by very small companies that trade at less than $5 per share. While the two categories overlap, not all penny stocks are microcap stocks.

Many low-priced securities trade in the over-the-counter (OTC) market rather than on an exchange such as the New York Stock Exchange or Nasdaq. This means they aren’t required to meet the listing standards imposed by exchanges, such as a minimum total market value or number of shareholders. While these securities can be legitimate investments, they’re also high-risk, so approach them with caution.

A Risky Proposition

Low-priced securities often are considered speculative investments, which you should only make with money that you can afford to lose. They tend to be volatile, and they trade in low volumes, which means they’re subject to price fluctuations from even relatively small trades. The low trading volume of these securities also can make them hard to sell due to a potential lack of buyers.

A major risk for low-priced securities is the limited amount of publicly available information. Many of these securities are issued by small or emerging companies, which can make it difficult to find comprehensive information about the company’s finances or business model. Without this information, it can be hard to judge whether a company might be a reasonable investment.

In addition, some low-priced securities aren’t registered with the Securities and Exchange Commission (SEC). Companies that don’t register their securities have fewer filing and disclosure requirements, meaning that there’s even less public information available for—and therefore even greater risk with—these investments.

Potential for Fraud

Unfortunately, low-priced securities also can be more susceptible to fraud. Scammers might take advantage of some of the lesser listing and disclosure standards to misrepresent key facts about the company. They might exaggerate—or even invent—its products or capabilities, perhaps capitalizing on current events or market trends to appeal to investors.

The potential combination of minimal information and low trading volume can also make it easier for bad actors to manipulate a stock’s price to their advantage. Low-priced securities can be a target for pump and dump and similar schemes in which fraudsters artificially inflate the price of a security and then quickly sell their shares, leaving investors facing losses.

This price inflation often depends on the spread of false information promoting the stock to lure in new investors, such as through social media or mass email campaigns. More sophisticated scammers might even issue fraudulent press releases or reports about the stock or the company and engage in trading to support their manipulative schemes. When there’s little other information available about the company, these fakes become harder to catch.

If you’re considering investing in low-priced securities, look out for these red flags that can signify fraud:

  • claims of guaranteed returns or that the investment is “no risk”;
  • overly optimistic performance projections for a new or untested company, especially in a sector with stiff competition, or unsupported claims regarding partnerships or joint ventures;
  • aggressive social media, email or press release campaigns, particularly of information that can’t be reliably confirmed; 
  • unsolicited social media messages, emails, texts or phone calls promoting specific stocks;
  • a lack of current publicly available financial information in SEC filings; and
  • frequent changes of company name, ticker symbol or business model, or abrupt expansion of an existing business model, often to benefit from the latest trend.

Proceed with Caution

In addition to checking for signs of fraud or manipulation, ask questions. Make sure you understand the company’s business and the terms of your investment. Rather than relying on unsolicited marketing or promotional materials or on commentary from stock-focused social threads, look for or request written information from the company, including a prospectus, financial reports and business documentation—and read these materials carefully. Some companies have been known to state outright in disclosure documents that they have no operations or revenue sources even as social media posts paint a rosier picture.

Find out whether the company issuing the securities you’re considering is registered with the SEC and if it files reports. To do this, check the SEC’s EDGAR database or contact your state securities regulator to see if the securities are registered.

You can also check the OTC Markets website to see which market the stock trades in and what the reporting standards are for those companies. Companies listed in the gray market or in the pink market with limited information are the riskiest. OTC Markets Group also uses different designations and compliance flags to provide additional information to investors about a company’s profile and risk factors. 

If you’re working with a registered financial professional, they should be able to help you get all this information.

If you receive an unsolicited pitch to buy or sell a penny stock, use FINRA’s BrokerCheck to find out whether the person or firm is registered and if they have any complaints against them. 

Remember: Low-priced securities might sound like a steal. But too often, FINRA has seen retail investors lose money to frauds in this space. Even a web search for the name of the company or person and the word “scam” or “fraud” can be helpful. If you suspect a penny stock scam, contact FINRA.