• At least $15 million of shareholders’ equity;
• At least $1 million income from continuing operations before income taxes in latest fiscal year or in two of the last three years;
• At least 1.1 million publicly held shares with a market value of $8 million or more;
• A minimum bid price of $5;
• At least three broker-dealers acting as market makers in the security; and
• At least 400 shareholders of record.

• At least $5 million shareholder equity; or, at least $50 million of market value; or, at least $750,000 of net income from continuing operations in latest fiscal year or two of the last three fiscal years;
• At least 1 million publicly held shares with a market value of $5 million or more;
• A minimum bid price of $4;
• At least three broker-dealers acting as market makers in the security;
• At least 300 shareholders of record.

In 1999, the SEC approved an NASD rule allowing the NASD to require that all OTCBB companies file updated financial reports with the SEC or with their banking or insurance regulators. Beginning in June 2000, the rule applied to all companies on the OTCBB. Since then, any companies that have refused to file timely reports with the SEC or their banking or insurance regulators have been removed from the OTCBB.

When an OTCBB company fails to file its reports on time, the NASD 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.

The Pink Sheets does not require companies whose securities are quoted upon its systems to meet any listing requirements. With the exception of a few foreign issuers, the companies quoted in the Pink Sheets tend to be closely held, extremely small and/or thinly traded. Most do not meet the minimum listing requirements for trading on a national securities exchange, such as the New York Stock Exchange or the Nasdaq stock market. And many of these companies do not file periodic reports or audited financial statements with the SEC, making it very difficult for investors to find reliable, unbiased information about them.

www.nasdaq.com
Quotes, data and information on all Nasdaq-traded companies.

www.nasdaqnews.com
Market news, statistics, recent additions and deletions.

www.nasdaqtrader.com
Market news, Nasdaq indexes, broker-dealer information.

www.otcbb.com
Quotes, data and information on Bulletin Board–traded companies.

www.pinksheets.com
Quotes, data and information on Pink Sheet–traded companies.

www.otcquote.com
Semi-current Level II quotes on Pink Sheet issues for a monthly fee.

www.walkersmanual.com
Information on Bulletin Board, Pink Sheet and thinly traded issues.

www.stockpatrol.com
Alerts investors to potential fraud in penny stocks.

Many micro-cap stocks trade in the over-the-counter market and are quoted on OTC systems, such as the OTC Bulletin Board (OTCBB) or the Pink Sheets.

But many micro-cap 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. And while many of the companies that don’t file reports with the SEC are legitimate businesses with real products or services, the lack of reliable, readily available information about these kinds of companies can open the door to fraud.

Spreading False Information

Micro-cap fraud depends on spreading false information. Here’s how this false information is often distributed:

• E-mail Spam: Fraudsters distribute junk E-mail or “spam” over the Internet to spread false information quickly and cheaply about a micro-cap company to thousands of potential investors. Spam allows the unscrupulous to target many more potential investors than cold calling or mass mailing.

• Internet Fraud: Fraudsters often use aliases on Internet bulletin boards and chat rooms to hide their identities and post messages urging investors to buy stock in micro-cap companies based on supposedly “inside” information about impending developments at the companies.

• Paid Promoters: Some micro-cap companies pay stock promoters to recommend or “tout” the micro-cap stock in supposedly independent and unbiased investment newsletters, research reports, or radio and television shows. Paid promoters are generally behind the unsolicited “junk” faxes you may receive that tout a micro-cap company. The federal securities laws require the newsletters to disclose who paid them, the amount, and the type of payment, but many fraudsters fail to do so and mislead investors into believing they are receiving independent advice.

• “Boiler Rooms” and Cold Calling: Dishonest brokers set up “boiler rooms” where a small army of high-pressure salespeople use banks of telephones to make cold calls to as many potential investors as possible. These strangers hound investors to buy “house stocks”—stocks that the firm buys or sells as a market maker or has in its inventory.

• Questionable Press Releases: Fraudsters often issue press releases that contain exaggerations or lies about the micro-cap company’s sales, acquisitions, revenue projections, or new products or services. These fraudulent press releases are then disseminated through legitimate financial news portals on the Internet.

Micro-cap fraud schemes can take a variety of forms. However, the two most common are the classic “pump and dump” scheme, and the off-shore scam.

Pump and Dump
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 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 micro-cap 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 micro-cap 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.

Red Flags

To avoid micro-cap fraud, the SEC recommends that investors watch out for these “red flags”:

• SEC Trading Suspensions: The SEC has the power to suspend trading in any stock for up to 10 days when it believes that information about the company is inaccurate or unreliable. Think twice before investing in a company that’s been the subject of an SEC trading suspension. You’ll find information about trading suspensions on the SEC’s Web site at www.sec.gov.

• Assets Are Large But Revenues Are Small: Micro-cap companies sometimes assign high values on their financial statements to assets that have nothing to do with their business. Find out whether there’s a valid explanation for low revenues, especially when the company claims to have large assets.

• Odd Items in the Footnotes to the Financial Statements: Many micro-cap fraud schemes involve unusual transactions among individuals connected to the company. These can be unusual loans or the exchange of questionable assets for company stock that may be discussed in the footnotes.

• Unusual Auditing Issues: Be wary when a company’s auditors have refused to certify the company’s financial statements or if they’ve stated that the company may not have enough money to continue operating. Also question any change of accountants.

• Insiders Own Large Amounts of the Stock: In many micro-cap fraud cases—especially “pump and dump” schemes—the company’s officers and promoters own significant amounts of the stock. When one person or group controls most of the stock, they can more easily manipulate the stock’s price at your expense. You can ask your broker or the company whether one person or group controls most of the company’s stock, but if the company is the subject of a scam, you may not get an honest answer.

High Pressure Sales Tactics: Beware of brokers who pressure you to buy before you have a chance to think about and investigate the “opportunity.” Dishonest brokers may try to tell you about a “once-in-a-lifetime” opportunity or one that’s based on “inside” or “confidential” information. Don’t fall for brokers who promise spectacular profits or “guaranteed” returns. These are the hallmarks of fraud.

No Written Information: 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.