A recent regulatory action by FINRA reveals that even in the risky world of "penny" stocks, some investments are riskier than others. Among the riskiest of these stocks are those that are not registered.
FINRA fined Aegis Capital Corp. $950,000 for improperly selling unregistered penny stocks. Among other violations, FINRA found that from April 2009 to June 2011, the company liquidated nearly 3.9 billion shares of five penny stocks that were not registered with the Securities and Exchange Commission (SEC) and not subject to a registration exemption.
Microcap stocks historically
have been more volatile and
less liquid than the stock of
Registration is Key
Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or meet an exemption. Regulation D (or Reg D) contains a number of rules providing exemptions from the registration requirements, allowing some companies to offer and sell their securities without having to register them with the SEC. One of the most valuable aspects of registration is that it requires companies to file period reports with the SEC.
These reports contain a wealth of information about the company, its finances and management. By contrast, companies exempt from regulation need only provide a brief notice that includes the names and addresses of the company's promoters, executive officers and directors, and some details about the offering—but little else. And when it comes to unregistered companies that are not exempt—good luck getting any information. Investors are generally left with a gaping hole in the company details needed to make an informed investment decision.
Before you invest, use the SEC's EDGAR system to check if a company is registered and up to date on its filings. EDGAR is free and provides corporate information, including registration statements, and confirmation of whether a company is using a certain registration exemptions under Regulation D.
In some cases, SEC registration may not be required, but the company may have to register with your state. Especially if there are no SEC filings, it's important to contact your state securities regulator to find out what, if any, information it has on the company, and whether the company has a legal right to sell securities in your state.
In addition to providing limited information, penny stocks historically have been more volatile and less liquid than the stock of larger companies—all reasons to invest with extreme care and only with money you can afford to lose.
Another reason to proceed with caution is that, while many companies engage in legitimate unregistered offerings to raise funds from investors, fraudsters can and do exploit unregistered offerings.
If you are presented with an opportunity to invest in an unregistered offering, in addition to thoroughly researching an investment, look out for these red flags that can signal potential fraud:
- Claims of High Returns with Little or No Risk. Hints or promises of high returns, with little or no risk, are classic warning signs of fraud. Every investment carries some degree of risk, and the potential for greater returns almost always comes with greater risk.
- Solo Operation. Be cautious if one person seems to control the sales effort or company. In the case of the unregistered securities sold by Aegis, customers were referred to Aegis by a single former securities broker who was barred from the industry and who controlled the activity in several of the Aegis accounts.
- Involvement of Unregistered Investment Professionals. Check to see if the broker or brokerage firm associated with the sale of a penny stock is registered using FINRA's BrokerCheck. If the firm or individual is not registered—or if a registered firm or individual is trying to sell you an unregistered penny stock—contact FINRA.
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