Penny Stock Disclosures

The final topic in this unit covers the special disclosure rules that apply to low-priced OTC securities. Because penny stocks carry elevated risks of fraud and manipulation, the SEC requires additional protections before a firm can trade them for customers.

What Are Penny Stocks?

  • Equity securities priced below $5 per share
  • Do not trade on a national exchange
  • Do not meet certain exemptions (e.g., established Exchange Act reporting, adequate net tangible assets)
  • Considered speculative and high-risk

Think of it this way: Not every cheap stock is a penny stock. A $3 stock listed on the NYSE is not a penny stock because it trades on a national exchange. Penny stock rules target low-priced OTC securities that lack the transparency and oversight of exchange-listed companies.

Exam Tip: Gotchas

  • Penny stock rules apply to equity securities below $5 that trade OTC and do not meet exemptions. A stock priced below $5 on a national exchange is not a penny stock.

SEC Rule 15c2-11 - Initiation or Resumption of Quotations

  • Before a broker-dealer can publish quotations for an OTC security, the firm must review specified current information about the issuer
  • Required information includes: financial statements, business description, and other material details
  • Ensures a minimum level of issuer information is publicly available before quotes are circulated

Exemptions exist for:

  • Securities with current Exchange Act reporting
  • Securities with an established quotation history
  • Unsolicited customer orders

Exam Tip: Gotchas

  • Rule 15c2-11 must be satisfied before a firm can even publish quotes, not just before trading. The information review happens at the quotation stage, before any customer transaction takes place.

SEC Rule 15g-3 - Penny Stock Quotation and Compensation Disclosure

Before executing a penny stock transaction, the broker-dealer must provide the customer with:

  • The current inside bid and ask quotations (or the dealer's own bid/offer if no inside market exists)
  • The number of shares to which the bid and offer apply
  • Compensation information for both the broker-dealer and the salesperson

This information must also appear on the customer's confirmation.

Exam Tip: Gotchas

  • Rule 15g-3 requires BOTH quotation disclosure AND compensation disclosure before executing. Missing either one violates the rule.
  • The compensation disclosure must cover both the firm's and the salesperson's compensation. Disclosing only the firm's share is not sufficient.

SEC Rule 15g-4 - Penny Stock Compensation Disclosure

  • Requires disclosure of the broker-dealer's aggregate compensation in connection with the penny stock transaction
  • Ensures the customer knows exactly how much the firm is earning from the trade

SEC Rule 15c2-7 - Identification of Quotations

  • Quotations in OTC securities must identify the broker-dealer responsible for the quotation
  • Prevents anonymous or misleading quotation practices
  • Ensures accountability for published prices

Think of it this way: The penny stock rules follow a logical sequence. First, a firm must verify issuer information before it can even quote the stock (Rule 15c2-11). Then, before executing a trade, it must disclose pricing and compensation details to the customer (Rules 15g-3 and 15g-4). And every quotation must identify which dealer is behind it (Rule 15c2-7). Each step adds a layer of transparency to protect investors in a market prone to manipulation.