3 Myths About Penny Stocks

“Penny stock” is one of those ubiquitous investing terms with slightly different definitions depending on who you ask.

Part of that confusion comes from the fact that the colloquial definition of the term differs from the legal definition contained in the Exchange Act. Let’s dispel some of that confusion right now.

Myth #1: Any stock that trades under $5 is a Penny Stock

This is often the first thing people assume when they hear the term penny stock.

While the SEC website says that “The term ‘penny stock’ generally refers to a security issued by a very small company that trades at less than $5 per share,” the penny stock rule includes
several other notable exemptions.

A security with a bid price less than $5 can still be exempt from “penny stock” status if it meets the Net Tangible Asset or the Average Revenue exemptions. The Net Tangible Asset exemption applies to companies who have been in operation for less than three years with at least $5 million in net tangible assets and companies in operation for more than three years with more than $2 million in net tangible assets.

The Average Revenue exemption removes the ‘Penny Stock’ label for companies with average revenue of $6 million over the past three years.

Even the SEC is sometimes misleading. In a recent case against clearing firm COR Clearing, the SEC defined penny stocks as “securities not listed on a national securities exchange and priced under $5 per share.”

For context, over 60 percent of stocks traded on the OTCQX and OTCQB Markets meet at least two of the exemptions noted above (bid price, net tangible assets, average revenue).

Myth #2: All OTC securities are Penny Stocks

First, the top tier of OTC Markets—the OTCQX Market— does not allow penny stocks.

Overall, there are approximately 3,400 securities traded OTC that are not penny stocks. This includes over 800 SEC-reporting securities, more than 400 banks, and over 1,900 international securities.

As of Nov 30, 81 securities traded on an Exchange would be considered Penny Stocks, two such examples being Synchronoss Technologies, Inc. SNCR and Livexlive Media Inc LIVX.

Myth #3: Institutions cannot trade penny stocks

Many people assume that the penny stock market is made up entirely of retail traders and that institutions are prohibited from participating in the market, but this is actually not the case. This myth may have gained credence based on historical restrictions or prohibitions on OTC stocks, but these are no longer true.

Institutions follow opportunity—be that in penny stocks or larger, more liquid securities. Importantly the majority of dollar volume traded occurs in the 3400+ OTC securities which meet the penny stock exemption, including ADR's, Banks, Fannie Mae and Freddie Mac.

Clarifying the misconceptions around what constitutes a penny stock and understanding the data is critical to helping retail investors and institutions make better-informed decisions.

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