Penny Stock Supervision
Quick Answer
A "penny stock" is generally an equity security priced under $5 that is not listed on a national exchange and not issued by a sufficiently large issuer. The SEC penny-stock rules require, before any non-exempt customer transaction, delivery of Schedule 15G (the standardized risk disclosure document), inside bid/ask quotation disclosure, aggregate broker-dealer compensation disclosure, associated-person compensation disclosure, monthly account statements, and written account approval, suitability statement, and signed customer agreement. Established customers and excepted securities are exempt.
Penny stocks are reported through the ORF (covered earlier in this unit), but the supervisory regime around them is its own reporting-adjacent topic. The Series 24 tests penny stocks as a books-and-records and customer-disclosure topic, with the principal responsible for ensuring every non-exempt customer transaction satisfies the penny-stock disclosure regime.
Penny Stock Definition
A "penny stock" is generally an equity security that is NOT:
- Listed on a national securities exchange, OR
- An NMS security with a price of $5 or more, OR
- Issued by a registered investment company, OR
- Issued by an issuer with net tangible assets > $5 million (in business 3+ years) or > $2 million (newer issuer), OR
- Issued by an issuer with average revenue ≥ $6 million for the last 3 years
Most low-priced (under $5) OTC equities meet the definition.
| Test | Threshold for NOT Being a Penny Stock |
|---|---|
| Price | $5 or more (NMS securities) |
| Listing | On a national securities exchange |
| Issuer net tangible assets | > $5 million (3+ years in business) or > $2 million (newer issuer) |
| Issuer average revenue | ≥ $6 million over the last 3 years |
A security that fails all of these tests is a penny stock and is subject to the penny-stock disclosure regime.
Think of it this way: "Penny stock" is a regulatory category, not a price label. A $7 OTC equity issued by a tiny company is a penny stock; a $0.50 equity listed on a national exchange is not. The price is one test among several; listing and issuer size matter equally.
Exam Tip: Gotchas
- A security can be priced under $5 and NOT be a penny stock if it is listed on a national exchange. Listing alone is enough to take it out of the regime. Conversely, a $7 OTC security can be a penny stock if the issuer is too small.
- The issuer-size tests are alternatives to price/listing, not requirements on top of them. Meeting any one of the tests (listing, NMS price, registered IC, large issuer by assets, large issuer by revenue) takes the security out of the regime.
- Most low-priced OTC equities are penny stocks. The combination of "under $5" and "OTC" usually fails all the alternative tests.
Exempt Transactions
The penny stock disclosure regime does NOT apply to:
- Transactions where the customer is an established customer of the broker-dealer
- Transactions in excepted securities
An "established customer" is one who satisfies either:
- Account opened more than 1 year ago AND has had prior penny-stock activity, OR
- Three different prior penny-stock buys on three different days from at least three different issuers
"Excepted securities" include most exchange-listed securities, large-issuer securities, and certain institutional sales. The exception scope mirrors the conditions in the penny-stock definition (the security is excepted because it would not be a penny stock anyway).
Exam Tip: Gotchas
- An established customer is defined by SPECIFIC criteria, not by relationship length alone. A customer with the firm for 5 years but zero prior penny-stock activity is NOT established for penny-stock disclosure purposes. The specific test (1 year + prior activity, OR 3 buys / 3 days / 3 issuers) controls.
- The established-customer exemption is per-CUSTOMER, not per-FIRM. A new account at the firm is not established even if the customer has decades of penny-stock experience elsewhere.
- Excepted securities are exempt because they are not penny stocks in the first place. The two carve-outs (established customer, excepted security) operate on different theories: the customer is sophisticated enough, or the security is not a penny stock.
Disclosure Document: Schedule 15G
Before a non-exempt penny stock transaction, the broker-dealer must deliver Schedule 15G: the standardized risk disclosure document describing penny-stock market risks. The customer must:
- Sign and return an acknowledgment of receipt
- The firm must retain the signed acknowledgment
| Requirement | What It Requires |
|---|---|
| Pre-transaction delivery | Delivery of Schedule 15G before the first non-exempt penny stock transaction |
| Schedule 15G content | The standardized risk disclosure form |
Exam Tip: Gotchas
- Schedule 15G must be delivered BEFORE the transaction, not at confirmation or settlement. A firm that ships the document with the trade confirm has violated the disclosure rule even if the customer later signs and returns it.
- The signed acknowledgment is a record under SEC books-and-records rules. A firm that delivered Schedule 15G but did not retain the signed return has a separate recordkeeping problem.
Quotation, Compensation, and Statement Disclosures
A second set of disclosures applies to specific dimensions of the transaction:
| Disclosure | What Is Disclosed |
|---|---|
| Inside-quote disclosure | Inside bid/ask (or notice that no quotations are available) before the transaction |
| Firm-compensation disclosure | Aggregate compensation received by the broker-dealer in the transaction |
| Associated-person compensation disclosure | Compensation of the associated person (registered rep) for the transaction |
| Monthly account statement | Shows market value (or "no value available") for each penny stock held |
Exam Tip: Gotchas
- Each disclosure is independent. A firm may satisfy the inside-quote disclosure but fail the rep-compensation disclosure; the two disclosures are separate documents and separate signed records.
- Monthly statements continue indefinitely while the penny stock is held. The disclosure is not a one-time event at purchase; the firm must keep showing market value (or "no value available") on every monthly statement.
- The firm-compensation disclosure covers the FIRM'S compensation; the AP-compensation disclosure covers the AP'S compensation. The exam will sometimes try to merge them; they are separate disclosures.
Sales Practice Requirement
For non-exempt transactions, the broker-dealer must:
- Approve the customer's account for penny-stock transactions in writing
- Obtain a suitability statement from the customer (financial situation, investment objectives, prior experience)
- Obtain a signed and dated customer agreement specifying the identity and quantity of the penny stock to be purchased before executing the trade
| Step | What It Requires |
|---|---|
| Account approval | Written principal approval for penny-stock activity in the customer's account |
| Suitability statement | Customer-provided information on finances, objectives, and experience |
| Signed agreement | Per-trade customer agreement specifying identity and quantity of the penny stock |
The signed agreement is per-trade, not a blanket pre-authorization. A customer who buys five different penny stocks signs five different agreements.
Think of it this way: The penny-stock sales-practice regime is a deliberate friction layer. Each step adds documentation and the chance for the customer (or the principal) to think twice. Penny stocks are dangerous enough that the SEC built the friction in by design.
Exam Tip: Gotchas
- The signed agreement is REQUIRED PER-TRADE, not as a blanket account authorization. A customer who buys five penny stocks signs five agreements. A "I authorize penny-stock trading generally" form does not satisfy the sales-practice rule.
- Account approval is in writing by a principal, not by the registered rep. The rep cannot self-approve a customer's account for penny-stock activity.
- Penny stock rules apply at the BROKER-DEALER level, not just the registered rep. The principal's WSPs must require written account approval, signed agreement, and Schedule 15G delivery for every non-exempt customer before a buy is executed.
How the Penny-Stock Regime Stacks for a Single Trade
A new customer's first non-exempt penny-stock buy requires the firm to satisfy multiple requirements in sequence:
| Step | Action |
|---|---|
| 1. Account opening | Principal approval of account for penny stocks (written) |
| 2. Customer suitability | Customer suitability statement collected |
| 3. Pre-trade disclosure | Deliver Schedule 15G; retain signed acknowledgment |
| 4. Pre-trade quote | Disclose inside bid/ask (or absence of quotes) |
| 5. Per-trade agreement | Customer signs agreement specifying identity and quantity |
| 6. Compensation disclosure | Disclose firm and AP compensation |
| 7. Trade execution | Execute and report through the ORF |
| 8. Monthly statements | Show market value (or "no value available") on each monthly statement until the position closes |
A breakdown at any step is a separate violation. The principal must ensure the WSPs build all eight steps into the workflow and that supervisors can produce evidence of each step on FINRA request.
Exam Tip: Gotchas
- Each requirement in the penny-stock regime is a separate violation. The exam will sometimes describe a fact pattern with multiple breakdowns and ask which step was violated; usually more than one is.
- Established customers and excepted securities short-circuit the regime. A trade that meets the exemption carve-outs does not require Schedule 15G, the per-trade agreement, or the customer suitability statement. But the broker-dealer still has to make the determination and document the basis for the carve-out.