Penny Stocks:A fool and his money are soon parted, pray, don’t be a fool

I wouldn’t put my hard earned money in penny stocks – never! The last thing a person ought to do is take a chance with penny stocks – do it only if you are suicidal, or have money to burn, or frankly, if the money is not your own.

I never listen to my broker when he recommends such stocks, even when he tries to put up a convincing argument about their top-line growth. The valuations are unreal and an inexperienced investor can really get taken in when for instance, he hears that a particular company has about 8 million market cap and more than 10 million in revenue (which is small according to me)

I am not a professional financial advisor, or professional of any sort, so what I am saying is just my own opinion. At the same time though, my thoughts are pretty much in line with the general consensus about penny stocks that they are extremely risky to invest in.. I have rather strong opinions about such stocks and get rather vociferous in an argument.

Whenever a discussion about penny stocks comes up, I only have one consistent thought – that given all the risk elements surrounding them, I think it is better to go to Las Vegas and gamble there instead. 

I just won’t touch them with a ten-foot pole. First of all, the information on penny stocks is difficult to obtain.  Price and volume data may not be easily or directly available to the public and may only be made accessible to you by your broker or brokerage firm.

Because they are so thinly traded, penny stocks are easily manipulated. I can write about several past experiences when a penny stock trading experiment failed and I lost almost all my money. Brokers often push penny stocks upon clients because they can charge more for such stocks. A client can never be too careful while dealing with a broker who imposes such charges.

Penny stocks are marketed very aggressively, and people give in to temptation. Not many people are active investors, and can never judge when to offload such stocks, people often hold on too long and miss a selling opportunity, or are indecisive in a falling stock market, and sell for huge loss.

At such times, the broker will never give correct advice from the investor’s point of view. HE will never be happy with your decision to sell, so many people, not wanting to antagonize the broker, hold such stocks and finally one day they are left holding trash.

You always have to be careful when discussing your sell decisions with your broker. Mostly, the broker will be less than supportive of your wishes to sell your stock, and will convince you to keep hanging on or trading these so-called “investments” for a long term horizon. 

About Settling Trades in Three Days: T+3

Investors must settle their security transactions in three business days. This settlement cycle is known as “T+3″ — shorthand for “trade date plus three days.”

This rule means that when you buy securities, the brokerage firm must receive your payment no later than three business days after the trade is executed. When you sell a security, you must deliver to your brokerage firm your securities certificate no later than three business days after the sale. How you hold your securities (either in physical certificates or in electronic accounts) can affect how quickly you are able to deliver them to your broker.  For more information, please read Holding Your Securities — Get the Facts. 

History of T+3

Unsettled trades pose risks to our financial markets, especially when market prices plunge and trading volumes soar. The longer the period from trade execution to settlement, the greater the risk that securities firms and investors hit by sizable losses would be unable to pay for their transactions.

For many years, our markets operated on a “T+5″ settlement cycle. But, nearly a decade ago, the SEC reduced the settlement cycle from five business days to three business days, which in turn lessened the amount of money that needs to be collected at any one time and strengthened our financial markets for times of stress.  

Here are the answers to some of the questions we’ve been asked about settling trades:

 ”What security transactions are covered?”

Most security transactions, including stocks, bonds, municipal securities, mutual funds traded through a broker, and limited partnerships that trade on an exchange, must settle in three days. Government securities and stock options settle on the next business day following the trade.

“How do I calculate when the three-day settlement cycle begins and ends?”

The first day of the three-day settlement cycle starts on the business day following the day you purchased or sold a security. For example, let’s say you bought a stock on Friday at anytime during the day. Saturday and Sunday are not considered business days, so the three-day clock doesn’t start running until Monday. Your payment or check must arrive at your broker’s office by the close of business on Wednesday.

Generally, those days when the stock exchanges are open are considered business days. Always check with your broker to make sure that you understand when your payment or securities are due.

“Will there be a penalty if my payment does not arrive at the brokerage firm within three days?”

Some brokerage firms may charge investors fees or interest if their payments or checks do not arrive by the third day. Since firms are responsible for settling transactions if their investors do not pay, firms may decide to sell a security, charging the investor for any losses caused by a drop in the stock market value of the security and additional fees.

Ask your broker or brokerage firm what they plan to do if your check or payment does not arrive within three days, and what fees or charges will apply.

“When I sell or buy a security, will I receive funds or my security certificate from my brokerage firm within three days?”

While brokerage firms are required to send funds or certificates “promptly” to customers following the settlement of a trade, there are no deadlines imposed by federal law or regulations.  Brokerage firms will credit your account with sale proceeds as soon as your trade settles. Some brokerage firms may immediately “sweep” your money into an account that earns interest. You should ask your broker about how you can assure that all funds and securities are delivered to you promptly.

If you purchase a security and would like to receive paper certificates, you should review your account agreement, as it may contain additional requirements and fees associated with ordering paper certificates.

Short Sale Restrictions

A short sale is generally a sale of a stock by an investor who does not actually own the stock. To deliver the stock to the purchaser, the short seller will borrow the stock. The short seller later closes out the position by returning the security to the lender, typically by purchasing securities on the open stock market. In general, short selling is utilized to profit from an expected downward price movement, to provide liquidity in response to buyer demand, or to hedge the risk of a long position in the same or a related security.

The SEC has traditionally held the belief that protections against abusive short selling are important for issuer and investor confidence and has enacted prophylactic rules designed to curb manipulative behavior. In addition, Rule 105 of Regulation M governs short sales immediately prior to offerings where the sales are covered with offering shares. Specifically, Rule 105 prevents persons from covering short sales with offering securities purchased from an underwriter, broker, or dealer participating in the offering if the short sale was effected during the Rule’s restricted period, which is typically five days prior to pricing and ending with pricing. Its aim is to promote offering prices that are based upon open market prices determined by supply and demand rather than artificial forces. In this way, the Rule safeguards the integrity of the capital raising process.

Direct Investment Plans: Buying Stock Directly from the Company

Many companies allow you to buy or sell shares directly through a direct stock plan (DSP). You can also have the cash dividends you receive from the company automatically reinvested into more shares through a dividend reinvestment plan (DRIP).

Here are descriptions of the two different types of plans:

Direct Stock Plans — Some companies allow you to purchase or sell stock directly through them without your having to use or pay commissions to a broker. But you may have to pay a fee for using the plan’s services. Some companies require that you already own growth stock in the company or are employed by the company before you may participate in their direct stock plans. You may be able to buy stock by investing a specific dollar amount rather than having to pay for an entire share. In that case, you could have your checking account debited on a regular basis to make investments in the plan. Some plans require a minimum amount of investment or require you to maintain specific minimums in your account.

DSPs usually will not allow you to buy or sell your securities at a specific market price or at a specific time. Rather, the company will purchase or sell shares for the plan at established times — for example, on a daily, weekly, or monthly basis — and at an average market price. You can find when the company will buy and sell shares and how it determines the price by reading the company’s disclosure documents. Depending on the plan, you may be able to have your shares transferred to your broker to have them sold, but the plan may charge you a fee to do so.

Dividend Reinvestment Plans — Dividend reinvestment plans let you take advantage of the power of compounding. Instead of receiving cash dividends from the company, you may purchase more of a company’s stock by having the dividends reinvested. You must sign an agreement with the company for this to be done. If you have a brokerage account or mutual fund, your firm may also have a dividend reinvestment plan. You should check with your firm or the company to see whether you will be charged for this service.

* * * *

The features and services offered in DSPs vary depending on the kind of plan and the company offering the plan. Before setting up a plan, read the company’s disclosure information to learn how its particular plan works. The plan will tell you how to enroll, the number of shares needed to open an account, any fees or charges that apply, the minimum or maximum you can buy or sell, the dates when you can invest, and how to withdraw, transfer, or sell your shares. Many large companies have Internet sites that can provide you with information about their plans or tell you who to contact for more information.

Convertible Securities

A “convertible security” is a security – usually a bond or a preferred stock – that can be converted into a different security – typically shares of the company’s common growth stock. In most cases, the holder of the convertible determines whether and when a conversion occurs. In other cases, the company may retain the right to determine when the conversion occurs.

Companies generally issue convertible securities to raise money. Companies that have access to conventional means of raising capital (such as public offerings and bank financings) might offer convertible securities for particular business reasons. Companies that may be unable to tap conventional sources of funding sometimes offer convertible securities as a way to raise money more quickly. In a conventional convertible security financing, the conversion formula is generally fixed – meaning that the convertible security converts into common stock based on a fixed price. The convertible security financing arrangements might also include caps or other provisions to limit dilution (the reduction in earnings per share and proportional ownership that occurs when, for example, holders of convertible securities convert those securities into common stock).

By contrast, in less conventional convertible security financings, the conversion ratio may be based on fluctuating market prices to determine the number of shares of common stock to be issued on conversion. A stock market price based conversion formula protects the holders of the convertibles against price declines, while subjecting both the company and the holders of its common stock to certain risks. Because a stock market price based conversion formula can lead to dramatic stock price reductions and corresponding negative effects on both the company and its shareholders, convertible security financings with market price based conversion ratios have colloquially been called “floorless”, “toxic,” “death spiral,” and “ratchet” convertibles.

Both investors and companies should understand that market price based convertible security deals can affect the company and possibly lower the value of its securities. Here’s how these deals tend to work and the risks they pose:

	The company issues convertible securities that allow the holders to convert their securities to common stock at a discount to the market price at the time of conversion. That means that the lower the stock price, the more shares the company must issue on conversion.
	The more shares the company issues on conversion, the greater the dilution to the company’s shareholders will be. The company will have more shares outstanding after the conversion, revenues per share will be lower, and individual investors will own proportionally less of the company. While dilution can occur with either fixed or market price based conversion formulas, the risk of potential adverse effects increases with a market price based conversion formula.
	The greater the dilution, the greater the potential that the stock price per share will fall. The more the stock price falls, the greater the number of shares the company may have to issue in future conversions and the harder it might be for the company to obtain other financing.

Before you decide to invest in a company, you should find out what types of financings the company has engaged in – including convertible security deals – and make sure that you understand the effects those financings might have on the company and the value of its securities. You can do this by researching the company in the SEC’s EDGAR database and looking at the company’s registration statements and other filings. Even if the company sells convertible securities in a private, unregistered transaction (or “private placement”), the company and the purchaser normally agree that the company will register the underlying common stock for the purchaser’s resale prior to conversion. You’ll also find disclosures about these and other financings in the company’s annual and quarterly reports on Forms 10-K and 10-Q, respectively, and in any interim reports on Form 8-K that announce the financing transaction.

If the company has engaged in convertible security financings, be sure to ascertain the nature of the convertible financing arrangement – fixed versus market price based conversion ratios. Be sure you fully understand the terms of the convertible security financing arrangement, including the circumstances of its issuance and how the conversion formula works. You should also understand the risks and the possible effects on the company and its outstanding securities arising from the below market price conversions and potentially significant additional share issuances and sales, including dilution to shareholders. You should be aware of the risks arising from the effects of the purchasers and other parties trading strategies, such as short selling activities, on the market price for the company’s securities, which may affect the amount of shares issued on future conversions.

Companies should also understand the terms and risks of convertible security arrangements so that they can appropriately evaluate the issues that arise. Companies entering into these types of convertible securities transactions should understand fully the effects that the market price based conversion ratio may have on the company and the market for its securities. Companies should also consider the effect that significant share issuances and below market conversions have on a company’s ability to obtain other financing.

Broken Promises: Promissory Note Fraud

A promissory note is a form of debt – similar to a loan or an IOU – that a company may issue to raise money. Typically, an investor agrees to loan money to the company for a set period of time. In exchange, the company promises to pay the investor a fixed return on his or her investment, typically principal plus annual interest.

While promissory notes can be legitimate investments, those that are marketed broadly to individual investors often turn out to be scams. The SEC and state securities regulators across the nation have joined forces to combat the fraudulent sale of promissory notes to investors. But we can’t stop every fraud.

That’s why you should ask tough questions – and demand answers – before you consider investing in a promissory note. Be sure you understand how they work and what risks they pose. These tips will explain how promissory note fraud can occur and will help you to spot the scams.

Anatomy of a Promissory Note Fraud

Fraudsters across the nation have recently begun to use promissory notes as vehicles to defraud investors out of hundreds of millions of dollars. Most promissory note scams follow predictable, fraudulent fact patterns:

 
• The fraudsters – who may or may not be affiliated with the company – persuade independent life insurance agents to sell promissory notes, luring them with lucrative commissions of up to twenty or even thirty percent. These agents often do not have a license to sell securities. And in selling the notes, they frequently rely solely on the information the company gives them – which later proves to be false or misleading.

 

• Investors purchase the promissory notes, enticed by the promise of a high, fixed-rate return – up to fifteen or twenty percent – with a very low level of risk. The promissory notes may appear all the more attractive because the seller falsely claims that they’re “guaranteed” or insured. And few investors ask tough questions about these investments because they know and trust the sellers, insurance agents with whom they’ve done business in the past.

 

• The fraudsters use a portion of the money they collect from investors to pay the sellers their commissions. But they typically abscond with the rest, squandering it on personal expenses or high-flying life styles.

 

• They may also use some of the proceeds to support an elaborate “Ponzi” scheme in which money coming in from the sale of new notes pays the interest on older notes. Some fraudsters try to avoid repaying investors’ principal by convincing investors to “roll-over” their promissory notes upon maturity. These investors may, for at least a time, continue to receive interest payments – but they rarely get their principal back.

Promissory note scams often target the elderly, bilking them of their retirement savings at a time when they can least afford to lose it. But no one is immune. Fraudsters rarely discriminate when it comes to separating investors from their money. And most investors don’t even realize their investment dollars are at risk until it’s far too late.

Tips To Avoid Promissory Note Scams

Here’s how you can avoid the costly mistake of investing in a sham promissory note:

  
• Bear in mind that legitimate corporate promissory notes are not usually sold to the general public. Instead, they tend to be sold privately to sophisticated buyers who do their own “due diligence” or research on the company. If someone calls you up or knocks on your door trying to sell you a promissory note, chances are you’re dealing with a scam.

 

• Find out whether the investment is registered with the SEC or your state securities regulator – or whether it’s exempt from registration. Most legitimate promissory notes can easily be verified by checking the SEC’s EDGAR database or by calling your state securities regulator, which you can find at the website of the North American Securities Administrators Association. If the promissory note is not registered, you’ll have to do your own thorough investigation to confirm whether the company has the ability to pay its debt.

 

• Be skeptical if the seller tells you that the promissory note is not a security. The types of promissory notes involved in promissory note scams usually are securities and must be registered with either the SEC or your state securities regulator – or they must meet an exemption.

 

• Make sure the seller is properly licensed. Insurance agents can’t sell securities – including promissory notes – without a securities license. Call your state securities regulator, and ask whether the person or firm is licensed to sell securities in your state and whether they have a record of complaints or fraud. You can also get this information by calling NASD’s public disclosure hotline at (800) 289-9999 or by visiting their website.

 

• Beware of promises of “risk free” returns. These claims are usually the bait con artists use to lure their victims. Always remember that if it sounds too good to be true, it probably is.

 

• Watch out for promissory notes that are supposedly “insured” or “guaranteed,” especially if a foreign insurance company is involved. Be sure to call your state insurance commissioner to find out whether the foreign insurance company can legally do business in the United States.

 

• Compare the rate of return on the promissory note with current market rates for similar fixed-rate investments, long-term Treasury bonds, or FDIC-insured certificates of deposit. If the seller promises an above-market rate on a short-term note, proceed with caution.

What To Do If You Run into Trouble

If you believe you’ve invested in a promissory note scam, act promptly. By law, you only have a limited time to take legal action.

Contact the SEC’s Office of Investor Education and Advocacy. You can send us your complaint by using our online complaint form. Or you can reach us as follows:

 

U.S. Securities & Exchange Commission
Office of Investor Education and Advocacy
100 F Street, N.E.
Washington, D.C. 20549-0213
Fax: (202) 772-9295

You should also contact your state securities regulator and, if an insurance agent sold you the promissory note, your state insurance commissioner.

Closing Price

Many investors use closing prices reported in the newspapers to monitor their holdings. But not all closing prices are the same, and the differences may be important to you. Here’s what you should know about closing prices:

“Closing price” generally refers to the last price at which a stock trades during a regular trading session. For many market centers, including the New York Stock Exchange, the American Stock Exchange, and the Nasdaq Stock Market, regular trading sessions run from 9:30 a.m. to 4:00 p.m. Eastern Time.

But a number of market centers offer after-hours trading. Some financial publications and market data vendors use the last trade in these after-hours markets as the closing price for the day. Others, however, publish the 4:00 p.m. price as the closing price and display prices for after-hours trading separately.

This discrepancy in the way the media and others report closing prices can cause confusion – especially when a single, low-volume after-hours trade occurs at a price that’s substantially different from the 4:00 p.m. closing price. For example, an investor might read on a company’s website that its stock closed at one price but then see a much different price on theconsolidated tape flashing across the bottom of her or his television screen. Or, the next day, the investor might hear that the stock opened “up” when, in fact, it opened “down” compared with the price at the 4:00 p.m. close.

To help clear up this confusion, the central distributor of transaction prices for exchange-traded securities – the Consolidated Tape Association – implemented a system designed to make closing prices uniform. Under this system, the regular session closing price for stocks will be the 4:00 p.m. price. Sometimes orders come in before 4:00 p.m., but they can’t be filled until after 4:00 p.m. Therefore, the CTA produces a 4:15 p.m. Stock Market Report for vendors and the media that includes regular session trades that are reported before 4:15 p.m. but should be included in regular session 4:00 p.m. prices. Any trades that take place during after-hours trading sessions will be “tagged” with the letter “T” on the consolidated tape and will not affect the regular session closing price (or the regular session high and low prices). The Nasdaq Stock Market, which operates a similar system for trades in its securities, uses similar conventions.

Because the closing price for the same stock may continue to be reported differently among various media and market data vendors, investors should try to understand what the reported price is based on. For example:

 
• Does the newspaper or vendor indicate that the closing price is based on the regular trading session price established on the security’s primary market, such as the New York Stock Exchange, the American Stock Exchange, or the Nasdaq Stock Market? 
• Does the closing price reflect the last trade reported over the consolidated tape as of the close of the regular trading session at 4:00 p.m. Eastern Time? 
• Does the closing price reflect the last trade reported over the consolidated tape in after-hours trading?

Investors may be able to find this information if their newspaper or vendor system describes how the closing price is being reported.

Bond Funds and Income Funds

“Bond funds” and “income funds” are terms used to describe a type of investment company (mutual fund, closed-end fund or unit investment trust (UIT)) that invest primarily in bonds or other types of debt securities. Depending on its investment objectives and policies, a bond fund may concentrate its investments in a particular type of bond or debt security—such as government bonds, municipal bonds, corporate bonds, convertible bonds, mortgage-backed securities, zero-coupon bonds—or a mixture of types. The securities that bond funds hold will vary in terms of risk, return, duration, volatility and other features.

A common misconception among some investors is that bonds and bond funds have little or no risk. Like any investment, bond funds are subject to a number of investment risks including:

1. “Credit risk”  This is the risk that the issuers of the bonds owned by a fund may default (fail to pay the debt that they owe on the bonds that they have issued). This risk may be minimal for funds that invest in insured or U.S. Government bonds.
2. “Prepayment risk”  This is the risk that the issuers of the bonds owned by a fund will prepay them at a time when interest rates have declined. Because interest rates have declined, the fund may have to reinvest the proceeds in bonds with lower interest rates, which can reduce the fund’s return. (Not all bonds, however, can be prepaid.)
3. “Interest rate risk”  This is the risk that the market value of the bonds owned by a fund will fluctuate as interest rates go up and down. Nearly all bond funds are subject to this type of risk, but funds holding bonds with longer maturities are more subject to this risk than funds holding bonds with shorter maturities. Because of this type of risk, you can lose money in a bond fund, including those that invest only in insured bonds or government bonds.

A bond fund’s prospectus should disclose these and any other risks.

Many bond funds invest in tax-exempt municipal bonds of a particular state. Depending upon your state of residence, the bonds of your state may be exempt from state as well as federal income tax. Not all of the income that you receive from a municipal bond fund, however, will necessarily be exempt from federal and state income tax. The fund’s prospectus will describe any of its tax-exempt features.

Before investing in a bond fund, you should carefully read all of the fund’s available information, including its prospectus and most recent stock market report.

Wise investment always leads you to growth

The only thing that concerns a smart investor is ‘growth’. In the stock market, the share prices and the respective company’s worth are directly proportional to each other. The investor should therefore always go for companies that are constantly rising in worth. It is a stock market golden rule that the company which manifests persistent growth will automatically provide generous stock market returns.

But it is not always advisable to solely concentrate on the growth rate projections. This is because if due to any unforeseen circumstance, the stock market happens to lose faith in the prospects of the said company, it will be a disaster for the investor. But growth stock companies are generally found to possess a sound market reputation due to their persistent performance and they are further aided with a support of sizeable capital and are equipped with a strong and competent managerial team. A growth stock investor is therefore saved from the market fluctuations to a great extent.

An investor just has to look at three fundamental conditions before ascertaining the credibility of the growth stock:

A sound growth rate – if the growth rate of the company is fast it is even better. When the rest of the factors are equal, a slow growth rate does not really prove to be very impressive. In fact a minute relative change in the growth rate makes a whole lot of a difference to the investor in term of his estimated returns.

The sustainability factor – the investor will do better if he looks beyond the growth estimates. The sustainability factor should be of more concern than the appealing estimates because it is the determinant and logical factor which ensures great returns. The tech bubble has been the outcome of such myopic vision. However alluring the growth projections might be, it is very important to figure out if the company has any competitive advantages.  

The investor should also be careful from being too much obsessed with the growth factor. He must not end up paying a fortune for it. This has often been noticed and that is why the growth stocks are at times believed to be over-rated. Good research and logical calculations will enable a sensible investor to uphold even a marginal profit in a state where the growth is consistent. A smart investor will always select a growth stock which is undervalued or rather fairly priced. The equation of a Discounted Cash Flow can help the investor to the fair value of a growth company. 

Stock Market Circuit Breakers and Other Volatility Procedures

The major stock and commodities exchanges have instituted procedures to limit mass or panic selling in times of serious stock market declines and volatility. These mechanisms are known as Circuit Breakers, the Collar Rule, and Price Limits. Circuit Breakers establish whether trading will be halted temporarily or stopped entirely. The Collar Rule and Price Limits affect the way trading in the securities and futures markets takes place. Here’s a description of each one:

Circuit Breakers

The securities and futures markets have circuit breakers that provide for brief, coordinated, cross-market trading halts during a severe market decline as measured by a single day decrease in the Dow Jones Industrial Average (DJIA). There are three circuit breaker thresholds—10%, 20%, and 30%—set by the markets at point levels that are calculated at the beginning of each quarter. The formulas for these thresholds are set forth in the New York Stock Exchange (NYSE) Rule 80B.

For example, on April 1, 2007, the average value for the DJIA for the preceding month (March 2007) was used to calculate point levels (rounded to the nearest 50 points). This resulted in the Level One (10%) circuit breaker set at 1,250 points, Level Two (20%) circuit breaker set at 2,450 points, and the Level Three (30%) circuit breaker set at 3,700 points.

Collar Rule

Under NYSE Rule 80A, if the DJIA moves up or down two percent (2%) from the previous closing value, program trading orders to buy or sell the Standard & Poor’s 500 stocks as part of index arbitrage strategies must be entered with directions to have the order executions effected in a manner that stabilizes share prices. The collar restrictions are lifted if the DJIA returns to or within one percent (1%) of its previous closing value.

The 2% collar rule threshold is set by the NYSE at a point level that is calculated at the beginning of each quarter. For example, on April 1, 2007, the average value for the DJIA for the preceding month (March 2007) was used to calculate a point level (rounded to the nearest 10 points). This resulted in the 2% collar rule threshold being set at 180 points.

Price Limits

The futures exchanges set the price limits that aim to lessen sharp price swings in contracts, such as stock index futures. A price limit does not stop trading in the futures, but prohibits trading at prices below the pre-set limit during a price decline. Intra-day price limits are removed at pre-set times during the trading session, such as ten minutes after the thresholds are reached or at 3:30 p.m. (all times are Eastern), whichever is earlier. Daily price limits remain in effect for the entire trading session. Specific price limits are set by the exchanges for each stock index futures contract. There are no price limits for U.S. stock index options, equity options, or stocks.