SEC Seeks Tougher Rules to Protect Small Investors in Penny Stocks

WASHINGTON — The Securities and Exchange Commission on Wednesday proposed stiff new rules to protect small investors from high-pressure sales tactics often used in the sale of so-called penny stocks.

The commission voted 5-0 to propose requiring stockbrokers to obtain written customer agreement and make a documented “suitability” determination before completing the sale of such stocks in most cases.

Penny stocks are inexpensive issues sold over the counter. They are not listed on any major stock exchanges or quoted on the NASDAQ over-the-counter system.

SEC staff members said the rule was deliberately crafted in a narrow way to avoid hurting the ability of small companies to use the markets to raise capital.

The proposed rule “in no way is intended to target small issues or speculative investment decisions per se,” said Richard Ketchum, head of the SEC’s Division of Market Regulation. Rather, he said, it was designed to give investors a chance to make “careful and unhurried” decisions.

The price of penny stocks is prone to manipulation because they are thinly traded and subject to domination and control by a single market maker.

SEC Chairman David S. Ruder, who has vowed to step up the commission’s efforts to combat penny stock fraud, said his target was “boiler room” operations used to make hundreds or thousands of telephone pitches a day to relatively unsophisticated people unable to properly evaluate the risks. Such operations are called boiler rooms because of the high-pressure tactics used.

He said such operations had spread to many parts of the United States from Denver and Salt Lake City, their traditional bases.

Charles Harper, administrator of the SEC’s Miami regional office, described for the commission some of the techniques used by salespeople to clinch a sale.

To rush people into making a decision, he said, sales managers would sometimes rattle a stapler to simulate the clatter of a ticker tape as their salesmen spoke on the phone. The pitchman would then tell a prospective buyer: “You better hurry. There goes the ticker. Orders are coming from Japan and Germany, and we only have a limited amount to sell.”