Reconsidering Penny Stocks

by: Mick Weinstein

This is the first in what I hope will become a series of posts on the editorial process at Seeking Alpha - the opportunities, challenges and questions we confront on a daily basis. I hope this becomes interactive in comments, with my post just the beginning of the conversation.

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Are penny stocks still the primary domain of pump-and-dumpers and stock spammers? You know what I'm talking about:

We've had a longstanding, blanket policy at Seeking Alpha not to publish articles that focus on stocks trading under $1. The reason: Our primary editorial goal in our opinion and analysis section is to bring readers insightful writeups from hundreds of serious investors and sector experts, while filtering out (1) the junk and non-market content that gets through automated aggregators, and (2) charlatans who attempt to manipulate stock prices by spreading misinformation.

Our $1 rule has been a simple and effective way to block the overwhelming majority of the bad guys, who require thinly-traded stocks to perform their dirty deed. While there have always been legitimate writers and investors in microcap and smallcap equities (Microcap Speculator comes immediately to mind), our rule required us to exclude these authors when they addressed penny stocks, to maintain a broader community of credible authors.

And then the market collapsed.

We're now facing a situation where four US-traded stocks with market caps over $500 million trade under $1: Fannie Mae, Freddie Mac, Level 3 and Sirius XM. If you pull that market cap figure back to $250 million, the number jumps to ten, and includes household names and popular portfolio holdings such as Rite Aid (NYSE:RAD).

The sheer volume of stocks that recently fell under this threshold drove the Nasdaq to suspend its own delisting rule that previously banished stocks trading below $1 for more than 30 days to the over-the-counter exchanges:

By Nasdaq's count, the number of securities trading below $1 on the exchange rose from 64 to 227 in the 12-month period that ended Sept. 30. By Oct. 9, the number had risen to 344. In addition, another 300 Nasdaq-listed securities were trading between $1 and $2.

(The NYSE is still freezing trading in these stocks and then delisting - Thornburg Mortgage got this treatment today.)

Given this novel situation, our editorial team has been reassessing our rule and at times bending it. The risk of manipulation seems much lower on a stock like SIRI that has daily turnover of 50 million+ shares. So when we know and trust the author, we have been publishing on Sirius XM and the financials that dropped under a buck.

This applies to microcaps as well. We recently ran an article by longtime SA contributor Asif Suria on a portfolio holding of his that he finds to be trading below book value - at 73 cents. It's a solid writeup, and since we trust Asif fully, we wanted to make it available to our readers.

So while we're as diligent as ever in rejecting submissions that smell even faintly of stock manipulation (in any case, we accept only about 25% of submissions from new authors), we've opened the doors to trusted SA contributors who address penny stocks as investment opportunities in these extraordinary times.

What are your thoughts? Have we done the right thing, or should we have maintained the firm rule in any case?

Update 12/8/08: A case for the Nasdaq to eliminate its $1 rule entirely.

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