Penny stock rule

A penny stock is generally defined as an unlisted (over-the-counter) equity security trading for less than $5 per share. These stocks tend to be thinly traded, hard to price, and vulnerable to fraud and manipulation, so the SEC adopted special sales-practice rules under the Securities Exchange Act of 1934 to protect investors who are solicited to buy them.

Before executing a solicited penny stock trade for a new customer, a broker-dealer must determine that the investment is suitable for that person and obtain a written suitability statement signed by the customer. The firm must also provide a risk disclosure document describing the penny stock market, disclose the current quote and the compensation the firm and its representative earn on the trade, and send monthly account statements showing the market value of each penny stock held.

The rule targets solicited transactions — situations where the firm or its representatives recommend the purchase. Unsolicited trades, where the customer initiates the order on their own, are not subject to the suitability statement requirement. Established customers are also exempt from the signed suitability statement requirement, though disclosure obligations still apply. A customer qualifies as established by either transacting in or depositing into an account at the firm more than one year earlier, or by making three penny stock purchases on separate days involving different issuers.

The penny stock rule appears on the SIE exam within the broader coverage of the Securities Exchange Act of 1934. Know the $5 unlisted-security definition, the suitability statement requirement for solicited new customers, and which customers and transactions are exempt.