The penny stock market drops and no one is picking it up

The house of pennies has started to topple.

The penny stock market, the Rocky Mountain version of Wall Street, is undergoing a major shakeout.

So far this year at least five underwriters specializing in low-priced stocks in the Denver or Salt Lake regions have closed their doors, and Denver syndicate managers say privately there may be more.

The latest failure involved OTC Net Inc., the second largest penny stock underwriter in Denver.

According to Elizabeth Spayd, a staff writer with Penny Stock News, an industry newsletter published in Columbia, Md., OTC Net had 30,000 customers with some $27 million worth of stock deposited with the firm. At the height of the new issues market, OTC Net had 28 offices and 200 brokers. Since it was established, the firm had raised some $70 million in capital for 23 companies.

In 1981, according to Going Public: the IPO Reporter, a Philadelphia-based newsletter, OTC Net underwrote 15 new issues but only one in 1982 because the penny stock market had nearly evaporated. It had four new public offerings in registration when it went under. OTC Net was established in 1979 by Carlos Schidlowski, a Chilean-born entrepreneur who started the company with $60,000.

Other failures this year among low-priced stock underwriters have included Langheinrich & Fender in Salt Lake City; American Western Securities Inc. of Denver; International Securities Inc., also of Denver; Miyamoto Securities, which was merged into Wall Street West; and G.S. Omni, another Denver-area firm.

Jerome Wenger, publisher of Penny Stock News, says the problems for the brokerage houses came from overexpansion and undercapitalization. ''They were bringing out new issues faster than there was money in the financial arena,'' Mr. Wenger commented. He added that he thought the shakeout in the industry was good for it and hoped it would ''be a lesson'' to other brokerage houses not to bring out new issues at such a fast pace.

Overexpansion isn't the only problem facing the firms. Lower stock prices for the less speculative shares traded on Wall Street have kept investors away from the penny stock market which is composed of many speculative stocks. And when penny stock prices fell, the value of the stock held in underwriters' portfolios fell dramatically. As a result, the underwriters faced difficulties complying with federal rules on the amount of capital an underwriting firm must maintain.

Roger Lopata, editor of Going Public, says the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD), two regulatory bodies, sensed in March that there could be problems at some of the Denver firms. Thus, it began a series of unannounced examinations. ''That's when the real shock wave of this particular round started,'' commented Mr. Lopata. The SEC and NASD found that some firms had resorted to fraudulent bookeeping practices to maintain the required net capital.

John Pinto, vice-president for surveillance of the NASD, the industry's self regulatory body, says the main reasons the broker-dealers are having problems is their lack of diversification. ''In the middle of last year, the underwritings of low-priced stocks slowed up,'' he commented, ''and by this year almost came to a halt. And the aftermarket trading also dropped off considerably so firms that concentrated in that one part of the business solely had losses that led to financial problems.''

The Denver firms have also faced legal action from the Denver district attorney's office, which vowed to clean up some of the broker abuses. In fact, a Denver grand jury returned an indictment against OTC Net two weeks ago. The indictment alleged fraud in connection with a representation made about Elan Air Corporation, a Boston airline, which OTC Net underwrote. The indictment claimed that OTC Net had circulated misleading reports about the company and had tried to make it look better than it actually was. Mr. Schidlowski denied the charges and said OTC Net would contest the matter in court.

Mr. Schidlowski was somewhat controversial in the Denver markets because of his near evangelical approach to investment banking. He had what he himself called a nearly religious belief that he was in one of the last frontiers: the initial public offering market. In the three years OTC Net was in business he expanded it rapidly in his zeal to market new issues. It was ultimately this overexpansion when the market was contracting that did in OTC Net, observers say.

The company on Thursday, June 3, had a receiver appointed and said it would try to effect a self-liquidation--that is, liquidation without help from a federal insurance agency.

Assets of the nation's money market funds bounced over $200 billion last week as high interest rates continued to attract investors to the funds. The Investment Company Institute reported the funds had assets of $201 billion as of Wednesday, June 2. Assets have risen 70 percent in the last year, the ICI reports.

The stock market continued to drift lower last week as investors waited to see the results of the Versailles conference. The Dow Jones industrial average fell 14.56 points, closing at 804.98 for the week. Volume slipped, prompting some analysts to complain that the summer doldrums had already hit Wall Street. Cities Service and Mesa Petroleum remained the most actively traded stocks.