Summary

During the 1980s, the widespread peddling of low-priced securities known as penny stocks was fraught with fraud and abuse; investor losses due to unscrupulous sales of these stocks may have topped more than $2 billion annually. In response, Congress granted the Securities and Exchange Commission (SEC) additional authority to go after individuals involved in questionable sales of penny stocks. Broker-dealers that sell penny stocks and companies that issue penny stocks must now disclose information about the stocks and the companies before finalizing penny stock sales. Although SEC statistics show that the number of broker-dealers trading penny stocks and complaints involving penny stocks have decreased in recent years, continued complaints by investors and newly uncovered selling tactics suggest that the potential for fraud and abuse in penny stock sales remains high. This report presents information on the overall status of penny stock activity and the National Association of Securities Dealers' efforts to (1) increase its regulation of the market during recent years, (2) implement new information collection and dissemination systems, (3) coordinate enforcement with other federal and state authorities, and (4) examine penny stock broker-dealers' sales practices.

GAO found that: (1) although the total number of penny stock broker-dealers has decreased by 49 percent and complaints filed with the Securities and Exchange Commission (SEC) have decreased by 78 percent, new tactics to avoid detection of penny stock fraud still significantly threaten investors; (2) NASD efforts to improve its penny stock regulation and fraud prevention included increased staffing, fraud detection programs, and coordination with federal, state, and local law enforcement agencies, and have resulted in both informal and formal corrective actions; (3) NASD believed that keeping investors better informed about penny stocks was important to guard against penny stock fraud and abuse; (4) in 1993, NASD plans to implement an automated information system to provide immediate information on each new penny stock transaction, provide investors with better information on which to base transaction decisions, and enhance NASD ability to detect manipulative and abusive trading practices; (5) the NASD toll-free service provided information on broker-dealers' disciplinary histories, but failed to provide information on arbitration awards against broker-dealers which could be important to investors who are entering into broker-dealer business relationships; (6) NASD primarily used on-site examinations of broker-dealer sales practices to identify penny stock abuse but the number of examinations varied between districts; and (7) periodic on-site visits to branch offices could increase detection of sales practice violations, determine whether the branches have conducted business independent of the main office, and determine whether branch employees are properly registered with NASD and supervised by the broker-dealer.