Be Wary of Penny Stocks

March 9, 2008
| By Pete Daly |
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GRAND RAPIDS — Philip J. Streng has heard it before. He's talking to someone who is getting a late start on investing for retirement, or for a son’s or daughter's college education, and he would like to make some money fast. A friend has told him about this penny stock that keeps going up.

At this point, Streng can almost hear the sound of someone yanking the lever on a slot machine.

Streng, a financial advisor at the Edward Jones office in Kentwood, said Edward Jones does not recommend penny stock investments to its clients.

"Penny stocks are like gambling at a casino," said Streng. "Although a few people can win big, chances are the odds are with the house. The biggest concern I have when it comes to clients wanting to invest in penny stocks is — is this their retirement money? Or is this their kids’ college education money?"

Streng said his company urges investors to do three things. First, he said, "Buy quality investments, the type (of companies) that are going to outlive both you and me." Second, diversify your investments. Third, focus on the long term.

Adopting a long-term view is a hard thing for people to do because, Streng said, “People want to get rich. What we try to focus on is helping people build wealth, and wealth doesn't happen overnight."

There is a practical reason for being wary of penny stocks: "Generally, we wouldn't recommend them because there is limited information available," he said.

"Penny stocks" is an informal term referring to low-priced stocks, many with a share price of less than a dollar, traded in the over-the-counter markets, which include the OTC Bulletin Board and the Pink Sheets.

The OTC Bulletin Board, according to its Web site, is "an informational Web site maintained by the Nasdaq Stock Market Inc. for investors and traders." The OTCBB site carries a warning, stating that the OTCBB "does NOT under any circumstances" send unsolicited e-mails, pop-up ads or faxes, nor does it advertise or promote any individual stocks. It also notes that the "OTCBB is unable to prevent third parties from referring people to the OTCBB Web site."

The Pink Sheets, according to the United States Securities and Exchange Commission, is an electronic inter-dealer system that displays quotes and last-sale information for many OTC securities. The name is a reference to the color of paper used when the quotes and information was formerly circulated in hard copy. The Pink Sheets are published by Pink Sheets LLC, a privately held company that is not registered with the SEC.

According to the SEC Web site (, Pink Sheets does not require companies whose securities it quotes on its systems to meet any listing requirements.

This disclaimer also appears on the SEC Web site: "With the exception of a few foreign issuers, the companies quoted in the Pink Sheets tend to be closely held, extremely small and/or thinly traded. Most do not meet the minimum listing requirements for trading on a national securities exchange. Many of these companies do not file periodic reports or audited financial statements with the SEC. As such, it may be difficult for the public to find current, reliable information about companies quoted through the Pink Sheets."

Penny stocks have been the focal point of a number of investigations by the SEC. Last year, the SEC issued press releases announcing "SEC Charges Securities Attorneys in Penny Stock Scam" (June 14); "SEC Charges Two Texas Swindlers in Penny Stock Spam Scam Involving Computer Botnets" (July 9);  and "SEC and U.S. Attorney Charge Repeat Stock Promoter and Penny Stock Trader With Illegal IPOs and Pump-and-Dump Manipulation Schemes" (Sept. 6).

The June 14 case involved attorneys from Arizona and Texas who helped AVL Global Inc., a penny stock company based in Port Huron, Mich., "in a scheme to dump millions of shares of AVL Global Stock into the marketplace without any public disclosure of the company's failing operations." AVL Global was secretly controlled by an Ontario resident with a criminal record, according to the SEC.

The July 9 case reveals how Internet spam has been used to pump up the alleged value of a penny stock, which is then "dumped" by its owners onto buyers who expect to make a fast profit when they sell it. The case involved two Texas men who bought shares of at least 13 penny stock companies. They then used "botnets" or "proxy bot networks" to send millions of spam e-mails that created an artificially active market in those stocks. Botnets are networks of personal computers that have been infected with viruses that forward spam or viruses to other computers via the Internet, which then infect still more computers.  The two men "scalped" investors out of more than $4.6 million, according to the SEC. "Scalping" is defined by the SEC as recommending that others purchase a security while secretly selling that security at the same time.

The SEC reported that the botnet penny stock scam "began to unravel … when (an SEC) enforcement attorney received one of the spam e-mails at work."

Streng said Edward Jones, one of the five largest securities firms in the U.S., also does not offer online trading. Online trading was heavily hyped during the dot-com craze of a few years ago as a way to get rich while sitting in your boxer shorts and T-shirt in front of your home computer, according to Streng.

Some large brokerage firms did offer online trading, said Streng, but "within five years, they abandoned them all."

Edward Jones only serves individual investors, and it recommends that its clients look at "quality management" and "quality dividends" before deciding which companies to invest in.

"If that's serious money, we should not be doing penny stocks," said Streng. "Maybe it's play money for you, though. But if it is, why don't we buy a really good company that's got a long track record, whose stock price is relatively cheap," compared to its historic prices. Right now, he said, a number of major financial companies fall into that category because of the ripple effect of the sub-prime mortgage problems. 

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