Microcap Stock: A Guide for Investors
Information is the investor's best tool when it comes to investing wisely. But accurate information about "microcap stocks" - low-priced stocks issued by the smallest of companies - may be difficult to find. Many microcap 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. When publicly-available information is scarce, fraudsters can easily spread false information about microcap companies, making profits while creating losses for unsuspecting investors. Even in the absence of fraud, microcap stocks historically have been more volatile and less liquid than the stock of larger companies.
Before you consider investing in a microcap company, arm yourself first with information. This Guide tells you about microcap stocks, how to find information, what "red flags" to consider, and where to turn if you run into trouble.
What Is a Microcap Stock?
The term "microcap stock" applies to companies with low or "micro" capitalizations, meaning the total value of the company's stock. A typical definition would be companies with a market capitalization of less than $250 or $300 million. The smallest public companies, with market capitalization of less than $50 million, are sometimes referred to as 'nanocap stocks.' This guide will use the term 'microcap stock' to refer to both microcaps and nanocaps.
Microcap companies typically have limited assets and operations. Microcap stocks tend to be low priced and trade in low volumes.
Where Do Microcap Stocks Trade?
Many microcap stocks trade in the "over-the-counter" (OTC) market, rather than on a national securities exchange such as the New York Stock Exchange or NASDAQ. They are quoted on OTC systems, such as the OTC Bulletin Board (OTCBB) or OTC Link LLC (OTC Link).
How Are Microcap Stocks Different From Other Stocks?
Lack of Public Information Often, the biggest difference between a microcap stock and other stocks is the amount of publicly available information about the company. Most large public companies file reports with the SEC that any investor can get for free from the SEC's website. Professional stock analysts regularly research and write about larger public companies, and it's easy to find their stock prices on the Internet or in newspapers and other publications. In contrast, information about microcap companies can be extremely difficult to find, making them more vulnerable to investment fraud schemes and making it less likely that quoted prices in the market will be based on full and complete information about the company.
No Minimum Listing Standards Companies that trade their stocks on exchanges must meet minimum listing standards. For example, they must have minimum amounts of net assets and minimum numbers of shareholders. In contrast, companies on the OTCBB or OTC Link generally do not have to meet any minimum standards, although companies quoted in OTC Link’s OTCQX marketplace are subject to initial and ongoing requirements and companies quoted in the OTCQB marketplace must be SEC reporting companies.
Risk While all investments involve risk, microcap stocks are among the most risky. Many microcap companies are new and have no proven track record. Some of these companies have no assets, operations, or revenues. Others have products and services that are still in development or have yet to be tested in the market. Another risk that pertains to microcap stocks involves the low volumes of trades. Because many microcap stocks trade in low volumes, any size of trade can have a large percentage impact on the price of the stock.
Which Companies File Reports With the SEC?
In general, the federal securities laws require all but the smallest of public companies to file reports with the SEC. A company can become "public" in one of two ways - by issuing securities in an offering or transaction that's registered with the SEC or by registering a class of the company’s securities with the SEC. Both types of registration trigger ongoing reporting obligations, meaning the company must file periodic reports that disclose important information to investors about its business, financial condition, and management.
This information is a treasure trove for investors: it tells you whether a company is making money or losing money and why. You'll find this information in the company's quarterly reports on Form 10-Q, annual reports (with audited financial statements) on Form 10-K, and periodic reports of significant events on Form 8-K.
A company must file reports with the SEC if:
If you'd like to learn more about the SEC's registration and reporting requirements, read Small Business and the SEC.
All OTCBB and OTCQB companies must file updated financial reports with the SEC or with their banking or insurance regulator. Any company that does not file timely reports with the SEC or their banking or insurance regulator is removed from the OTCBB OTCQB.
Tip: Tip: When an OTCBB company fails to file its reports on time, filed an incomplete filing or for those companies that file with a banking or insurance regulator, has not provided FINRA a copy of the report, FINRA will add a fifth letter "E" to the OTCBB trading 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 http://www.otcbb.com/DailyListContent/delistings/OTCBBDelOpenReport.pdf.
OTC Markets require companies to be current in their SEC or other regulatory disclosure to be quoted in the OTCQB marketplace. Companies must also be current in providing disclosure to be quoted in the OTCQX marketplace, though that requirement can be met by providing information in accordance with OTC Link's proprietary Alternative Reporting Standard rather than through filing with the SEC or a banking or insurance regulator. Companies quoted in the OTC Pink tier are assigned different symbols by OTC Markets, depending on whether they have provided "current" information, "limited" information or "no information." You can find the symbol currently assigned to a stock by OTC Markets and read more about the OTC Market marketplaces at www.otcmarkets.com.
With few exceptions, companies that file reports with the SEC must do so electronically using the SEC's EDGAR system. EDGAR stands for electronic data gathering and retrieval. The EDGAR database is available on the SEC's website at www.sec.gov. You'll find many corporate filings in the EDGAR database, including annual and quarterly reports and registration statements. Any investor can access and download this information for free from the SEC's website. View Researching Public Companies Through EDGAR: A Guide for Investors.
Caution: By law, the reports that companies file with the SEC must be truthful and complete, presenting the facts investors find important in making decisions to buy, hold, or sell a security. But the SEC cannot guarantee the accuracy of the reports companies file. Some dishonest companies break the law and file false reports. Every year, the SEC brings enforcement actions against companies who've "cooked their books" or failed to provide important information to investors. Read SEC filings - and all other information - with a questioning and critical mind.
Which Companies Don't Have to File Reports With the SEC?
Smaller companies - those with less than $10 million in assets, or fewer than 2,000 shareholders of record - generally do not have to file reports with the SEC. But some smaller companies, including microcap companies, may choose voluntarily to file reports with the SEC. As described above, companies that register with the SEC must also file quarterly, annual, and other reports.
A Word About Offering Requirements
Any company that wants to offer or sell securities to the public must either register with the SEC or meet an exemption. Here are two of the most common exemptions that many microcap companies use:
Unless they otherwise file reports with the SEC, companies that are exempt from registration under Reg A, Reg D, or another offering exemption do not have to file reports with the SEC. For more information about the registration requirements and offering exemptions, read Small Business and the SEC.
What's So Important About Public Information?
Many of the microcap companies that don't file reports with the SEC are legitimate businesses with real products or services. Even in the absence of fraud, a lack of public information about a company can make investing in its stock more risky because the prices that are quoted for the stock are less likely to accurately reflect the risks and opportunities associated with the company and its business. In addition, stocks of such companies may trade only in small volumes.
Of potentially greater concern is that the lack of reliable, readily available information about some microcap companies can open the door to fraud. It's easier for fraudsters to manipulate a stock when there's little or no information available about the company.
Fraud involving microcap stocks often depends on spreading false information. Here's how some fraudsters carry out their scams:
Microcap fraud schemes can take a variety of forms. Here's a description of the most common schemes:
The Classic "Pump and Dump" Scheme 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 interest they create. Once these fraudsters sell their shares and stop hyping the stock, the price typically falls, and investors lose moneyThe Latest Variation of the "Pump and Dump" Scheme
Some people are finding that they have received a "misdialed" call from a stranger, leaving a "hot" investment tip for a friend. The message is designed to sound as if the speaker didn't realize that he or she was leaving the hot tip on the wrong answering machine. If you get a message like this, it's not a wrong number at all. Instead, it is from someone who is being paid to leave these messages on a whole lot of answering machines. Check out "Wrong Numbers" and Stock Tips on Your Answering Machine for more information and to hear one of these scams.
The OffShore 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 microcap 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 and share the resulting profits with company insiders. The flow of unregistered stock into the U.S. eventually causes the price to drop, leaving unsuspecting U.S. investors with losses.
How Do I Get Information About Microcap Companies?
If you're working with a broker or an investment adviser, you can ask your investment professional if the company files reports with the SEC and to provide you written information about the company and its business, finances, and management. Be sure to carefully read any prospectus and the company's latest financial reports. Remember that unsolicited e-mails, message board postings and company news releases should never be used as the sole basis for your investment decisions. You can also get information on your own from these sources:
Caution If you've been asked to invest in a company but you can't find any record that the company has registered its securities with the SEC or your state, or that it's exempt from registration, call or write your state's securities regulator or submit a complaint to the SEC at http://www.sec.gov/complaint/select.shtml immediately with all the details. You may have come face-to-face with a scam.
What if I Want to Invest in Microcap Stocks?
To invest wisely and avoid investment scams, research each investment opportunity thoroughly and ask questions. These simple steps can make the difference between profits and losses:
We've spelled out the questions you'll need to ask in the following publications: Internet Fraud and Ask Questions. When you ask these questions, write down the answers you received and what you decided to do. Let your broker or investment adviser know you're taking notes. They'll know you're a serious investor and may tell you more - or give up trying to scam you. We've developed a form for taking notes at http://www.sec.gov/complaint/callform.htm to help you. You'll find these and other useful publications on the Office of Investor Education and Advocacy section of the SEC's website or from our toll-free publications line at (800) SEC-0330.
Also, watch out for these "red flags":
Additional Red Flags 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. For more tips on avoiding danger, be sure to read Cold Calling - Know Your Rights and The Fleecing of Foreign Investors: Avoid Getting Burned by "Hot" U.S. Stocks..
What If I Run Into Trouble?
Act promptly! By law, you only have a limited time to take legal action. Follow these steps to solve your problem:
We will forward your complaint to the firm's compliance department and ask that they look into the problem and respond to you in writing.
Please note that sometimes a complaint can be successfully resolved. But in many cases, the firm denies wrongdoing, and it comes down to one person's word against another's. In that case, we cannot do anything more to help resolve the complaint. We cannot act as a judge or an arbitrator to establish wrongdoing and force the firm to satisfy your claim. And we cannot act as your lawyer.