Inside the Office > Legal Services Division > Securities > Investor Education and Outreach

Fraudulent Penny Stocks/Microcap Stocks

State securities regulators and the Securities and Exchange Commission have received many complaints from investors who have lost money by purchasing microcap stocks. This brochure is intended to alert investors to the types of telephone sales tactics used in connection with fraudulent sales, and to suggest steps investors should consider before investing. While South Carolina can bring enforcement actions against the sellers to prohibit further violations of the law, money lost to micro-cap fraud is unlikely to be recovered. Your best protection is to INVESTIGATE BEFORE INVESTING!

What Are Microcap Stocks?

Formerly known as “penny stocks,” microcap stocks are small, relatively new companies, untested or offering one product or perhaps having only one market and are usually traded at less than $8 per share. While some microcap stocks may be legitimate investment opportunities, these stocks are by nature very risky business. In order to protect yourself, learn the warning signs of microcap stock fraud, and investigate before you invest. Remember, not all low priced stocks are a bargain!

How Are Microcap Stocks Traded?

Microcap stocks are generally traded in the over-the-counter (OTC) market rather than on an exchange. With exchange listed or NASDAQ quoted stocks, volume and price information is collected electronically and made available to the public so investors can determine recent volume and price movement. Not true with microcap stocks! Brokerage firms trading a microcap stock can usually provide information only about trades they make, not about the stock price.

How Can I Obtain Information About Current Microcap Stock Prices?

It can be difficult or impossible. One private company prints a daily list of firms trading particular over the counter stocks. This list, known as “pink sheets”, is available through brokerage firms and includes some prices. Additionally, some newspapers publish microcap stock prices. However, no prices are published for many microcap stocks. And by the way, the published prices are not necessarily the price for which you can sell your stock.

What Are The Risks Of Microcap Stock Investments?

Microcap stocks may provide investors with genuine investment opportunities. Investors should be aware, however, that many microcap stocks are the subject of fraudulent, manipulative, and abusive sales practices. The following risks are particularly great with microcap stocks:

  1. Risks Of Price Manipulation
    Many microcap stocks are traded by one or just a few brokerage firms. Because of this, the broker may control most of the market. This makes it very easy to take unfair advantage of investors by manipulating market prices through aggressively marketing the stock.
  2. Risks Of Being Over-Charged
    Brokerage firms selling microcap stocks generally earn their profits on these sales by charging a mark-up above the price the firm is paying for the stock, rather than through commissions. Undisclosed, excessive mark-ups are illegal; however because of the limited number of firms trading anyone microcap stock and the limited availability of current price information, excessive markups of 100% or more do occur.
  3. Risks Of Substantial Loss
    All investments involve risks. Microcap stock investments, however, can be highly speculative and involve the risk of losing your entire investment. There is often a large difference between the price the investor paid for the stock from the brokerage firm and the price at which the stock can be sold by the investor.
  4. Lack Of Information About The Investment
    Most microcap stock companies do not issue quarterly and annual reports available to the public as is done by companies traded on an exchange or quoted on NASDAQ. Thus, the investor has no information about the financial position or operating history of the company, which greatly increases the risk to the investor.
  5. Difficult To Sell Stocks
    Manipulative sales and hidden mark-ups result in artificially inflated stock prices. However, when the manipulation ends, the stock prices often plummet. Some microcap stock brokerage firms discourage the investor from selling or refuse to execute your sell order unless you agree to invest the proceeds in other microcap stocks.

Guidelines for Investors

If you receive an unsolicited phone call from a salesperson you don’t know who wants to sell you a microcap stock, here are some steps you should take before you invest. These guidelines will help you minimize the potential for investing in a fraudulent microcap stock deal.

  1. Be wary of promises of quick profits, offers to share inside information, and pressures to invest before you have had an opportunity to investigate. Brokerage firms offer all of the hot initial public offerings to the big institutional clients – NOT to randomly selected individuals.
  2. Remember, high rates of return on an investment often are accompanied by high risk. If a voice on the phone claims that you can get into a hot stock, you can be 100% certain that the voice is less than honest. If it sounds too good to be true, it probably is.
  3. If you cannot afford to lose your investment, don’t invest in high-risk investments.
  4. Keep personal information regarding your bank, credit union, or savings and loan references, social security number, your financial condition and your past investment history private. Ask yourself, “WHY does this caller want all this very personal information about me?”
  5. If you are told the investment opportunity won’t be there tomorrow, think twice. Your investment might disappear just as quickly.
  6. Don’t let a salesperson make you feel guilty, silly, or stupid for taking time to investigate before you buy.
  7. Ask for a prospectus on the company whose shares are being offered. Read it before you invest. The prospectus will highlight risks and give you background information on the company, its management, and its promoters. Additionally, ask your broker to send you written copies of any predictions about the price of the stock or the prospects for the company–and keep these records and notes of what the broker tells you.
  8. Use the same diligence in buying a microcap stock that you would use in buying a car or major household appliance. Research your investment product.
  9. Ask the salesperson what price you would receive if you wanted to sell the stock instead of buy it. Then check buy and sell prices with another broker.
  10. There are plenty of good brokers and also plenty with impressive names who are dishonest. Consult with someone knowledgeable before you buy. Check the broker and salesperson with the Securities Division of the S.C. Attorney General’s Office.
  11. If you are subject to undue sales pressure during an unsolicited phone call – Hang up! It’s OK to be rude in this instance.
  12. Pass the word! Tell your friends and retired parents to be careful. The less they know about investing the more vulnerable they are.
  13. You can help! If you are the victim of improper activities or suspect fraud, please report it immediately to the Securities Division of the S. C. Attorney General’s Office. Your prompt action may keep other people from losing money, help protect your legal rights, and assist securities regulators in prosecuting those responsible.

Where To Complain

To check on an offering being made to you, to check on a broker, or to report any suspected fraud or improper activities, please do not hesitate to contact us.