Keep a 10-Foot Pole's Distance

"Investors should be cautious when buying common stock of companies in Chapter 11 bankruptcy," the SEC warns. "It is extremely risky and is likely to lead to financial loss."

However, such warnings often go unheeded.

Kmart made retail history in 2002 when it became the largest merchant ever to seek bankruptcy protection. In its subsequent filings with the SEC and in news releases, the company made it clear that the old stock would be canceled and that buying it was highly risky. And yet the day Kmart and its U.S. subsidiaries and affiliates emerged from Chapter 11, 91 million shares of stock changed hands before trading in KMRTQ was canceled.

Kmart survived bankruptcy. The company issued millions of shares of new common stock, much of it to creditors. Individual investors holding the pre-bankruptcy stock felt cheated.

No question, companies can emerge from Chapter 11 and go on to operate successfully. However, if you are caught holding the old stock, you aren't likely to benefit from a rebound.

"Unsophisticated investors should stay away from stocks of companies that are in bankruptcy," Coulson said.

At some point, a company operating under bankruptcy protection will file a "plan of reorganization" outlining how assets will be distributed. The company also files its proposed plan with the SEC, attached to a Form 8-K, which is used to disclose material events or corporate changes. You can find the form by going to http://www.sec.gov and clicking on "Search for Company Filings." Then click on "Companies & Other Filers."

Once the company has filed its plan, look for the section that spells out what will happen to the common shares. And then wait until the company's final plan has been approved by the court to see whether the shares will be canceled.

But when a company says early in the process that it's extremely doubtful there will be any shareholder equity left if emerges from bankruptcy, take the company at its word.

· On the air: Michelle Singletary discusses personal finance Tuesdays on NPR's "Day to Day" program and online athttp://www.npr.org.

· By mail: Readers can write to her at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.

· By e-mail:singletarym@washpost.com.

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