SEC Adopts Rule : New Buyers of Penny Stocks Must OK Deals in Writing

Stock brokers who deal in low-priced, often risky securities known as penny stocks must obtain a new customer’s written approval before completing a sale, under a rule adopted Wednesday by the Securities and Exchange Commission.

The new rule comes in response to a dramatic rise in the fraudulent sale of penny stocks, which are usually not traded on exchanges or quoted on the National Assn. of Securities Dealers Automated Quotations System, commonly known as the national over-the-counter market.

The rule is effective Jan. 1.

In other matters, the SEC voted to seek comment on two matters:

- Revised rule proposals for disclosure of securities trades by corporate officers and other insiders.

- A proposal to raise the minimum net capital required of registered broker dealers to as much as $250,000 depending on the method of computing net capital.

Fraudulent Claims

The SEC was also supposed to consider new rules on information to be disclosed during takeover battles, but those proposals have been shelved until early September to give the agency more time to consider the issue.

Because most penny stocks, usually selling for a few cents to a few dollars per share, are not listed nationally, information about them is hard to come by and fraudulent claims are difficult to dispute.

Before the commission voted 5-0 to approve the rule, SEC Chairman David S. Ruder said the problem was of “great concern” to the agency. But he and several other members of the commission also noted that most penny stocks and penny stock dealers are legitimate.

Commissioner Charles C. Cox said he was distressed that, because of bad publicity, “penny stock is almost becoming synonymous with fraud and manipulative practices.”

Two weeks ago, 14 people and two companies were charged in Chicago with an alleged $10-million penny stock scam in which the companies’ share prices were artificially raised and the shares then sold at large profits.

Last fall, Ruder created a Penny Stock Task Force that found a key element of penny stock fraud was high-pressure sales tactics--often over the telephone--on small, unsophisticated investors.

Industry officials say the problem lies with unscrupulous salesmen who pressure investors to buy the high-risk stocks of new or small companies or with crooks peddling the stocks of sham companies.

Numerous Complaints

The “rapidly rising tide of penny stock fraud and abuse” is “the No. 1 threat” facing small investors, according to the North American Securities Administrators Assn., a state-level investment regulators group.

In the first half of the current fiscal year, the SEC has received 2,462 complaints about penny stock fraud compared to 1,510 for all of last year.

“This will help us in our investigations,” James I. Goldstein, head of the task force, said of the new rule. “Here’s something that will require writings to be made,” said Goldstein, who is also an associate director of enforcement with the SEC.

The new rule, first proposed in February, will require brokers and dealers to obtain written purchase agreements from new customers before completing their first three transactions in stocks that are not traded on stock exchanges or through the NASDAQ system.

The rule would apply to stocks selling at $4.99 or less per share or to stocks issued by companies with less than $2 million in tangible assets.

Broker-dealers would also have to obtain financial information from the customer such as income, investment experience and investment objectives; determine whether the transaction is suitable for the customer’s needs, and write down the basis for that determination.

Securities issued by some companies and sales to certain investors would be exempt from the “put it in writing” requirements.

Those exceptions include initial public offerings that are scheduled to be listed with NASDAQ or a stock exchange and customers who have dealt with the broker previously.