Penny Stocks:

Regulatory Actions to Reduce Potential for Fraud and Abuse

GGD-93-59: Published: Feb 3, 1993. Publicly Released: Feb 3, 1993.

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GAO reviewed the National Association of Securities Dealers' (NASD) efforts to reduce fraud and abuse in the penny stock market, focusing on: (1) increased NASD market regulation; (2) NASD implementation of new information collection and dissemination systems; (3) NASD coordination of enforcement activities with other federal and state authorities; and (4) penny stock brokers' 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.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: On July 1, 1993, SEC adopted an NASD rule change to begin providing the expanded toll-free phone service and provide arbitration award information.

    Recommendation: The Chairman, SEC, should require NASD to provide public investors who request information via the NASD toll-free phone service with information on final arbitration awards.

    Agency Affected: United States Securities and Exchange Commission

  2. Status: Closed - Implemented

    Comments: NASD is preparing a branch office examination program to be submitted to SEC in late 1993 for review and comment. According to Ms. Judith Poppalardo, Assistant Director, SRO Inspections, SEC, the branch office examination criteria has been incorporated into NASD examination procedures.

    Recommendation: The Chairman, SEC, should require NASD to develop a plan for examining the branch offices of penny stock broker-dealers in all NASD districts that includes a sampling plan to identify high-risk branches, establishes the frequency of examinations, and determines the number of employees required to examine branches.

    Agency Affected: United States Securities and Exchange Commission

 

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