Nearly all penny stock promotions involve the use of convertible debt, or in some instances, preferred stock, which is then converted into the holy grail of penny stock promoters--free trading stock. The reason for this is based on an exemption from registration called Rule 144. Rule 144 states that before common stock can be resold into the public market, it has to have been fully paid for at least six months (12 months for a pink sheet reporting or a voluntary filer). But, the rule says that if you hold one security of an issuer, like a promissory note, or preferred stock, you can "tack" the holding period of that other security when you convert into the common stock. The "beauty" of convertibles for a penny stock company is that they can convert the debt or preferred into any arbitrary number of common shares right at the point of issuance. Sometimes the old debt or preferred was really issued for cash, or it might have been issued for services or in an acquisition of a usually worthless asset. Even if it were issued for cash, debt becomes worthless if a company goes out of business, and the promoters buy up the debt or preferred for pennies on the dollar. Sometimes issuers back date the issuace of the debt or preferred.
All of this might be okay if there were "disclosure." Sadly, in pennyland, full and honest disclosure is rare. lets take the example of PXYN Corporation (PXYN), based on their last quarterly report for the September 30, 2014 quarter. These numbers give effect to a giveback by a former affiliate in 2015, by the way:
Series D Preferred, 333,336 shares outstanding, convertible into 333,336,000 shares of common stock
Series B Preferred, 66,808 shares outstanding, convertible into 668,808,000 common shares
Series C Preferred, 220 shares outstanding, convertible into 645,333 common shares
common stock, 376,308,000 approximately oustanding as per the 10-Q
total common equity shares excluding convertible notes, 1,378,452,000 approximately. There are also millions of dollares in convertible notes, but its pretty difficult to figure out how many they are converted into. But based on other statements by management, it looks like there are a total 1 1.6 billion common equivalents, putting the convertible notes as equivelent to about 220 million shares.The question is, who controls these shares? The publc disclosure states that the former control person owns 60 million shares, and directors Midei Evon has 19 million shares and Daniel Zagorin has 34 million. No one else is telling us what they own. We do not know how many shares any other officers or directors own. Out of 1.6 billion common shares and equivalents, we only know about ownership of 113 million shares, or 7% of the total. And these unknown shares heep hitting the market.