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Common shares of small public companies that trade for less than one dollar per share

Penny stocks are common shares of small public companies that trade for less than one dollar per share. The U. S. Securities and Exchange Commission (SEC) uses the term "Penny stock" to refer to a security, a financial instrument which represents a given financial value, issued by small public companies that trade at less than $5 per share. Penny stocks are priced over the counter, rather than on the trading floor. The term "penny stock" refers to shares that, prior to the SEC's classification, traded for "pennies on the dollar". In 1934, when the United States government passed the Securities Exchange Act to regulate any and all transactions of securities between parties which are "not the original issuer", the SEC at the time disclosed that equity securities which trade for less than $5 per share could not be listed on any national stock exchange or index.

Over the counter exchanges that list penny stocks include the OTC Bulletin Board (which is a facility of FINRA) or OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.). Penny stocks can also trade on securities exchanges, including foreign securities exchanges. Penny stocks can include the securities of certain private companies with no active trading market.

When considering penny stocks, investors and experts in the field recognize the low market price of shares and its correlation to low market capitalization. Market capitalization or "market cap" is the total dollar market value of all of a company’s outstanding securities. Since penny stocks are inexpensive, investors often buy large quantities of shares without spending much money. This tendency makes the penny stock market volatile. Volatility is “a statistical measure of the dispersion of returns for a given security or market index. Typically, the higher the volatility, the greater the risk in investing in said securities. Conversely, the lower the volatility, the "safer" the investment is. Volatility can be also understood as the frequency of large changes in the value of a given security in either direction. This is directly correlated to the price action of a security which, when talking about penny stocks, can change more rapidly than that of a large cap stock.

Prosecutors and the Federal Bureau of Investigation say that fraud is widespread in the penny stock market. Potential fraud that involves even what are considered very small or micro market cap companies can still involve losses of tens of millions of dollars. However, academic research shows that the risk created by small market cap size and lower liquidity results in higher expected returns due to the size and liquidity premiums. In the United States, the SEC and the Financial Industry Regulatory Authority (FINRA) have specific rules to define and regulate the sale of penny stocks.

There are inherent concerns that individuals should be aware of when investing in penny stocks, namely the lack of information that often exists surrounding the companies offering said stocks. The lack of public reporting mixed with a thin market is often the perfect recipe for stock manipulation via stock promoters. A common practice is for these individuals to purchase large quantities of stock and then utilize promoters to artificially inflate the sub penny stock’s share price, through false and misleading information. When the liquidity and price increase, the manipulator will sell their known as a "pump and dump" which is a form of microcap stock fraud. On April 3, 2017, the Federal Bureau of Investigation (FBI) reported on a story in which penny stock fraud was the focal point of the piece. According to the article, California resident Zirk de Maison was found guilty of conducting a "pump and dump" scheme, during the course of which de Maison and his associates convinced large groups of investors to purchase shares of companies that he had set up as shell organizations. From 2008 to 2013, de Maison created five small public companies which, unbeknownst to the investing public, did no actual business and had no legitimate assets. Once he set these companies up, he offered public shares of the company’s penny stocks for investors to purchase. In more sophisticated versions of the fraud, individuals or organizations buy millions of shares, then use newsletter websites, chat rooms, stock message boards, fake press releases, or e mail blasts to drive up interest in the stock. Very often, the perpetrator will claim to have "inside" information about impending news to persuade the unwitting investor to quickly buy the shares. When buying pressure pushes the share price up, the rise in price entices more people to believe the hype and to buy shares as well. Eventually the manipulators doing the "pumping" end up "dumping," when they sell their holdings. The expanding use of the Internet and personal communication devices has made penny stock scams easier to perpetrate. Since the Securities & Exchange Commission allowed for the use of social media outlets like Twitter to disclose public information in lieu of press services, many fraudsters have set up accounts to take advantage of this higher level of traffic on social media, giving investors another thing to consider when searching for viable sources of information.

The Mafia had infiltrated Wall Street by the 1970s. In the 1980s Lorenzo Formato conducted penny stock manipulations. Formato testified in Congressional hearings that during the years he promoted and sold penny stocks, he was involved in organized crime, and testified to rampant penny stock manipulation by organized crime. Subsequently, the company did acquire lithium production/exploration properties, and addressed concerns raised in the press. The "pump and dump" tactic is also known as a supernova and, unlike regular stocks, penny stocks usually move on momentum of the price action. One of the biggest penny stock operators in the 1950s was Tellier & Co. In the 1980s, major penny stock brokerages included Blinder Robinson (nicknamed "Blind'em and Rob'em"), First Jersey Securities, Rooney Pace, and Stuart James. Major penny stock brokerages operating in the 1990s included Stratton Oakmont, Sterling Foster, A. S. Goldmen, and Hanover Sterling. since it is thought that exchange traded securities are less vulnerable to manipulation. Therefore, Citigroup (NYSE:C) and other NYSE listed securities which traded below $1.00 during the market downturn of 2008–09, while properly regarded as "low priced" securities, were not technically "penny stocks". Although penny stock trading in the United States is now primarily controlled through rules and regulations enforced by the SEC and FINRA, the genesis of this control is found in State securities law. The State of Georgia was the first state to codify a comprehensive penny stock securities law. Secretary of State Max Cleland, whose office enforced State securities laws, was a principal proponent of the legislation. Representative Chesley V. Morton, the only stockbroker in the Georgia General Assembly at the time, was principal sponsor of the bill in the House of Representatives. Georgia's penny stock law was subsequently challenged in court. However, the law was eventually upheld in U. S. District Court, and the statute became the template for laws enacted in other states. Shortly thereafter, both FINRA and the SEC enacted comprehensive revisions of their penny stock regulations. These regulations proved effective in closing or greatly restricting broker/dealers, such as Blinder, Robinson & Company, which specialized in the penny stocks sector. Meyer Blinder was jailed for securities fraud in 1992, after the collapse of his firm.