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Investor Bulletin: Microcap Stock Basics (Part 3 of 3: Risk)

Oct. 21, 2016

The SEC’s Office of Investor Education and Advocacy is issuing a series of three Investor Bulletins to provide investors with important information to consider before investing in microcap stocks, often known as penny stocks.  The Bulletins provide a general overview of microcap stocks and their marketplaces, a list of sources to research microcap stocks, and a list of “red flags” of fraud and other important factors to consider before making an investment in microcap stocks.

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.  This bulletin will provide you with a list of risks and “red flags” to consider before investing in a microcap stock.

Risks You Should Consider Before Investing in Microcap Stocks

Lack of public information.  Often, the biggest difference between a microcap stock and other stocks is the amount of reliable 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 is easy to find their stock prices on the Internet or in newspapers and other publications.  In contrast, the same 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 will be based on full and accurate information about the company.

No minimum listing standards.  Companies that list 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 quoted on the OTC Bulletin Board (OTCBB)OTC Link LLC (OTC Link) or Global OTC do not have to meet any minimum listing standards, but are typically subject to some initial and ongoing requirements.  You can find the OTCBB’s eligibility requirements for stocks at and you can find additional information about OTC Link and Global OTC at and, respectively.

Lack of liquidity.  A stock’s liquidity generally refers to how rapidly a stock can be bought or sold without substantially impacting its price.  Stocks with low liquidity may be difficult to sell, increasing the possibility that you may sustain a more substantial loss if you cannot sell the shares when you want to.  Historically, microcap stocks have been less liquid than the stocks of larger companies.  Before investing in a microcap company, you should carefully consider that you may have difficulty later selling the stock or that the sale will have a noticeable impact on the stock’s selling price.

High volatility.  A stock’s volatility generally refers to how much its price may change in a short period time.  Stocks with high volatility generally experience large price changes in a very short period of time.  While all stocks experience volatility to some degree, microcap stocks have historically been more volatile than stocks of larger companies.  Before investing in microcap stocks, you should carefully consider the possibility that these stocks may be susceptible to sudden large price changes; particularly in light of the potential difficulty you may have selling these stocks, as noted above.

Fraud.  Reliable publicly-available information about microcap stocks is often limited.  Also, the stocks of microcap companies are historically less liquid and more thinly traded (lower volume) than the stocks of larger companies.  These factors make it easier for fraudsters to manipulate the stock price or trading volume of microcap stocks.

Microcap Company “Red Flags”

  • SEC Trading Suspensions.  The SEC has the power to suspend trading in any stock for up to 10 days if, in the SEC’s opinion, it is in the public interest and will protect investors.  This can occur if it appears to the SEC that there is a lack of current and accurate information concerning the company and its stock.  Before investing, determine whether a company’s stock has been the subject of a SEC trading suspension.  You can find information about trading suspensions on the SEC’s website.
  • Stock Promotions (including email, text messages, and social media sites recommending a stock).  Carefully consider whether a company’s stock seems to be more heavily promoted than its products or services.  Microcap stocks are particularly vulnerable to “pump-and-dump” schemes.  These can occur when paid promoters or company insiders make false and misleading statements to create a buying frenzy and then quickly sell their shares before the hype ends.  After the promoters profit from their sales, the stock price typically drops and investors lose money.
  • Unexplained increases or decreases in stock price or trading volume.  Carefully consider whether you should invest in a company’s stock if the historical price or trading volume of the stock shows dramatic increases or decreases for no apparent reason, as this may suggest manipulation.
  • No History of Operational Success.   Use caution before investing in a company’s stock if the company has no history of operational success; yet still projects large future revenues, especially if the projections appear based solely on information about the company’s industry rather than on the company itself.
  • Insiders Own Large Amounts of the Stock.  In many microcap 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 attempt to manipulate the stock’s price.  You can ask your broker or the company whether one person or group controls most of the company’s stock; however, accurate information may not be available.  You also should consider whether a company issues financial instruments that are convertible into equity/stock positions, as this could mask control over large portions of a company’s stock.
  • No real business operations.  Frequent or unexplained changes in company name or type of business, little or no assets, minimal revenues, or implausible press releases may suggest no real business operations. 

Other Considerations

  • Be aware that dormant shell companies that continue to trade may be aggressively promoted and are susceptible to market manipulation.
  • Look closely at a company that became public through a reverse merger.
  • Look closely at a company that has recently undergone a reverse stock split (reducing the number of shares and increasing the share price proportionately), particularly when the reverse stock split also accompanies a reverse merger in a short time frame.
  • Review independent information about the company’s management and its directors.  Consider whether these individuals have background or expertise in the business of the company. 
  • Cautiously examine any unsolicited (you didn’t ask for it and don’t know the sender) stock recommendation. 
  • Never deal with brokers who refuse to provide you with written information about the investments they’re promoting. 
  • Unless you are accessing an account that you established, do not provide bank or brokerage account numbers, passwords, PINs, credit card information, Social Security numbers, or other personally identifiable information online or over the phone. 

    Before investing your money, take these simple steps: 

    • Check the background and registration status of anyone recommending or selling an investment by using the SEC’s Investment Adviser Public Disclosure (IAPD) database, which is available on  
    • Find out whether the SEC has suspended public trading of the company’s stock by reviewing this list of recent trading suspensions.  Also, just because the SEC has not suspended trading a company’s stock does not mean that the investment is safe.
    • Determine whether the securities offering is registered with the SEC by using the SEC’s EDGAR database.  If an offering is not registered with the SEC, check if it is registered with your state securities regulator.  Registration has important legal consequences impacting your ability to purchase the stock or sell the stock after you have purchased it.

Make sure you understand the company’s business and its products or services.  Carefully review all materials you are given and verify every statement you are told about the investment.  Pay attention to the company’s financial statements, particularly if they are not audited by a certified public accountant (CPA).  If there are no financial statements or other company reports, ask your broker to provide any information they can about the company.   If your broker has solicited you to purchase this stock and cannot provide you basic information regarding the company (for example, the company’s financials), carefully consider whether this is an appropriate investment for you.

To report possible securities fraud to the SEC, submit a tip or complaint.

Additional Information

Investor Bulletin: Microcap Stock Basics (Part 1 of 3: General Information)

Investor Bulletin: Microcap Stock Basics (Part 2 of 3: Research)

Investor Publication: “Microcap Stock: A Guide for Investors”

For more information about microcap fraud please visit the Microcap Fraud webpage on 

The Office of Investor Education and Advocacy has provided this information as a service to investors.  It is neither a legal interpretation nor a statement of SEC policy.  If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.

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