Subscribe to our Newsletter
We are 100% anti-spam.
Sign up for FREE
|SEC Investors Guide|
SEC Guide for Investors
Information is the investor's best tool when it comes to investing wisely. But accurate information about "microcap stocks" — low-priced stocks issued by the smallest of companies — may be difficult to find. Many microcap companies do not file financial reports with the SEC, so it's hard for investors to get the facts about the company's management, products, services, and finances. When reliable information is scarce, fraudsters can easily spread false information about microcap companies, making profits while creating losses for unsuspecting investors.
In the battle against microcap fraud, the SEC has toughened its rules and taken actions against wrongdoers, but we can't stop every microcap fraud. We need your help in winning the battle. Before you consider investing in a microcap company, arm yourself first with information. This alert tells you about microcap stocks, how to find information, what "red flags" to consider, and where to turn if you run into trouble.
What Are Microcap Stocks
So what exactly is a microcap stock? The term microcap stock (also micro-cap) is used to describe publicly traded companies which have a market capitalization of less than US$250M.
If you are familiar with stock trading and investment boards, forums and chat rooms, you know that investors there rarely define microcap through capitalization. Instead, they call any stock that trades for under $5 a “microcap” or penny stock.
But it’s not just market capitalization or share price that differentiates microcaps from large caps. There are several other aspects that are very important since they are tied directly to the risk factor of the stocks:
Where microcaps are traded - While some microcaps trade on the U.S. and foreign exchanges (NASDAQ, NYSE, etc), most microcaps are “over the counter” (OTC) stocks, traded either on either OTC Bulletin Board or Pink Sheets:
OTC Bulletin Board The OTCBB is an electronic quotation system that displays real-time quotes, last-sale prices, and volume information for many OTC securities that are not listed on the Nasdaq Stock Market or a national securities exchange. Brokers who subscribe to the system can use the OTCBB to look up prices or enter quotes for OTC securities. Although the FINRA oversees the OTCBB, the OTCBB is not part of the Nasdaq Stock Market. Fraudsters often claim that an OTCBB company is a Nasdaq company to mislead investors into thinking that the company is bigger than it is.
The "Pink Sheets" The Pink Sheets — named for the color of paper on which they've historically been printed — are listings of price quotes for companies that trade in the over-the-counter market (OTC market). "Market makers" — the brokers who commit to buying and selling the securities of OTC issuers-can use the pink sheets to publish bid and ask prices. A company named Pink Sheets LLC, formerly known as the National Quotation Bureau, publishes the pink sheets in both hard copy and electronic format. Pink Sheets LLC is not registered with the SEC as a stock exchange, nor does the SEC regulate its activities.
How Are Microcap Stocks Different From Other Stocks?
Lack of Public Information The biggest difference between a microcap stock and other stocks is the amount of reliable, publicly available information about the company. Larger public companies file reports with the SEC that any investor can get for free from the SEC's website. Professional stock analysts regularly research and write about larger public companies, and it's easy to find their stock prices in the newspaper. In contrast, information about microcap companies can be extremely difficult to find, making them more vulnerable to investment fraud schemes.
Reporting requirements - Microcap companies traded on Pink Sheets are not required by SEC to file financial reports, although some do it voluntarily, and are not required to meet minimum standards, such as minimum amounts of net assets and minimum number of shareholders.
Records and research - Microcap companies tend to be new, might lack proven track record, and/or are still developing or testing their products.
No Minimum Listing Standards Companies that trade their stocks on major exchanges and in the Nasdaq Stock Market must meet minimum listing standards. For example, they must have minimum amounts of net assets and minimum numbers of shareholders. In contrast, companies on the OTCBB or the Pink Sheets do not have to meet any minimum standards.
Trading volumes - Trading volume for microcaps is much lower than for large cap stocks so that even a small-size trade can make significant impact on stock’s price.
Risk While all investments involve risk, microcap stocks are among the most risky. Many microcap companies tend to be new and have no proven track record. Some of these companies have no assets or operations. Others have products and services that are still in development or have yet to be tested in the market. Another risk that pertains to microcap stocks involves the low volumes of trades. Because microcap stocks trade in low volumes, any size of trade can have a large percentage impact on the price of the stock.
Which Companies File Reports With the SEC?
In general, the federal securities laws require all but the smallest of public companies to file reports with the SEC. A company can become "public" in one of two ways — by issuing securities in an offering or transaction that's registered with the SEC or by registering the company and its outstanding securities with the SEC. Both types of registration trigger ongoing reporting obligations, meaning the company must file periodic reports that disclose important information to investors about its business, financial condition, and management.
This information is a treasure trove for investors: it tells you whether a company is making money or losing money and why. You'll find this information in the company's quarterly reports on Form 10-Q, annual reports (with audited financial statements) on Form 10-K, and periodic reports of significant events on Form 8-K.
A company must file reports with the SEC if:
If you'd like to learn more about the SEC's registration and reporting requirements, read Q&A: Small Business and the SEC.
All OTCBB companies must file updated financial reports with the SEC or with their banking or insurance regulators. Any company that does not file timely reports with the SEC or their banking or insurance regulators is removed from the OTCBB.
Tip: When an OTCBB company fails to file its reports on time, the FINRA will add a fifth letter "E" to its four-letter stock symbol. The company then has 30 days to file with the SEC or 60 days to file with its banking or insurance regulator. If it's still delinquent after the grace period, the company will be removed from the OTCBB. You'll find a list of securities that have been removed from the OTCBB at www.otcbb.com.
With few exceptions, companies that file reports with the SEC must do so electronically using the SEC's EDGAR system. EDGAR stands for electronic data gathering and retrieval. The EDGAR database is available on the SEC's website at www.sec.gov. You'll find many corporate filings in the EDGAR database, including annual and quarterly reports and registration statements. Any investor can access and download this information for free from the SEC's website. Click here if you want to view detailed instructions on how to use EDGAR.
Caution: By law, the reports that companies file with the SEC must be truthful and complete, presenting the facts investors find important in making decisions to buy, hold, or sell a security. But the SEC cannot guarantee the accuracy of the reports companies file. Some dishonest companies break the law and file false reports. Every year, the SEC brings enforcement actions against companies who've "cooked their books" or failed to provide important information to investors. Read SEC filings — and all other information — with a questioning and critical mind.
Which Companies Don't Have to File Reports With the SEC?
Smaller companies — those with less than $10 million in assets — generally do not have to file reports with the SEC. But some smaller companies, including microcap companies, may choose voluntarily to register their securities with the SEC. As described above, companies that register with the SEC must also file quarterly, annual, and other reports.
A Word About Offering Requirements
Any company that wants to offer or sell securities to the public must either register with the SEC or meet an exemption. Here are two of the most common exemptions that many microcap companies use:
Unless they otherwise file reports with the SEC, companies that are exempt from registration under Reg A, Reg D, or another offering exemption do not have to file reports with the SEC. For more information about the registration requirements and offering exemptions, read Q&A: Small Business and the SEC.
What's So Important About Public Information?
Many of the microcap companies that don't file reports with the SEC are legitimate businesses with real products or services. But the lack of reliable, readily available information about some microcap companies can open the door to fraud. It's easier for fraudsters to manipulate a stock when there's little or no information available about the company.
Microcap fraud depends on spreading false information. Here's how some fraudsters carry out their scams:
Microcap fraud schemes can take a variety of forms. Here's a description of the most common schemes:
The Classic "Pump and Dump" Scheme It's common to see messages posted on the Internet that urge readers to buy a stock quickly or to sell before the price goes down, or a telemarketer will call using the same sort of pitch. Often the promoters will claim to have "inside" information about an impending development or to use an "infallible" combination of economic and stock market data to pick stocks. In reality, they may be company insiders or paid promoters who stand to gain by selling their shares after the stock price is pumped up by the buying frenzy they create. Once these fraudsters sell their shares and stop hyping the stock, the price typically falls, and investors lose their money.
The Latest Variation of the "Pump and Dump" Scheme
Some people are finding that they have received a "misdialed" call from a stranger, leaving a "hot" investment tip for a friend. The message is designed to sound as if the speaker didn't realize that he or she was leaving the hot tip on the wrong answering machine. If you get a message like this, it's not a wrong number at all. Instead, it is from someone who is being paid to leave these messages on a whole lot of answering machines. Check out "Wrong Numbers" and Stock Tips on Your Answering Machine for more information and to hear one of these scams.
The Off-Shore Scam Under a rule known as "Regulation S," companies do not have to register stock they sell outside the United States to foreign or "off-shore" investors. In the typical off-shore scam, an unscrupulous microcap company sells unregistered Reg S stock at a deep discount to fraudsters posing as foreign investors. These fraudsters then sell the stock to U.S. investors at inflated prices, pocketing huge profits that they share with the microcap company insiders. The flood of unregistered stock into the U.S. eventually causes the price to plummet, leaving unsuspecting U.S. investors with enormous losses.
How Do I Get Information About Microcap Companies?
If you're working with a broker or an investment adviser, you can ask your investment professional if the company files reports with the SEC and to get you written information about the company and its business, finances, and management. Be sure to carefully read the prospectus and the company's latest financial reports. Remember that unsolicited e-mails, message board postings and company news releases should never be used as the sole basis for your investment decisions. You can also get information on your own from these sources:
Caution If you've been asked to invest in a company but you can't find any record that the company has registered its securities with the SEC or your state, or that it's exempt from registration, call or write your state's securities regulator or the SEC immediately with all the details. You may have come face to face with a scam.
What if I Want to Invest in Microcap Stocks?
To invest wisely and avoid investment scams, research each investment opportunity thoroughly and ask questions. These simple steps can make the difference between profits and losses:
In addition to asking your broker or investment advisor, you can get information from:
We've spelled out the questions you'll need to ask in the following publications: Internet Fraud and Ask Questions. When you ask these questions, write down the answers you received and what you decided to do. If something goes wrong, your notes can help to establish what was said. Let your broker or investment adviser know you're taking notes. They'll know you're a serious investor and may tell you more — or give up trying to scam you. We've developed a Form for Taking Notes to help you. You'll find these and other useful publications on the Investor Information section of the SEC's website or from our toll-free publications line at (800) SEC-0330.
Also, watch out for these "red flags":
Additional Red Flags Don't deal with brokers who refuse to provide you with written information about the investments they're promoting. Never tell a cold caller your social security number or numbers for your banking and securities accounts. And be extra wary if someone you don't know and trust recommends foreign investments. For more tips on avoiding danger, be sure to read Cold Calling and The Fleecing of Foreign
What If I Run Into Trouble?
Act promptly! By law, you only have a limited time to take legal action. Follow these steps to solve your problem: