For two years, a powerful belief in a type of alchemy had a grip on the Denver area. It promised to transform pennies into millions of dollars overnight and produced its own industry.

It was the "hot issues" market, a fast moving boom environment that produced batches of brokerage firms specializing in penny stocks, dozens of stories of instant millionaires and--ultimately--a bust.

Its focus was Denver, where small companies, primarily energy firms, sought to raise money through stock offerings. Hundreds of new issues floated onto the over-the-counter market on the crest of the oil and gas boom. Most of them were low-cost.

From January 1979 to the end of December 1981, some 492 new offerings went to market through Denver underwritings. Of that group, 397 sold for a dollar or less, which put them in the "penny stock" category (as slightly redefined by inflation). More than 300 of them were oil or mineral extraction firms.

Brokerage firms--62 new ones were organized in the Denver area in about two years--beat the bushes for investors willing to gamble on rapid growth.

That was then.

In the past year, as oil prices dropped and the energy boom faded, a cold wind blew across the hot issues market. In February, Robert H. Davenport, regional administrator of the Securities and Exchange Commission's Denver office, called in reinforcements from Washington to take a look at broker-dealers that the SEC believed were in financial difficulty.

At the same time, the National Association of Securities Dealers Inc., which monitors over-the-counter firms, also decided that a closer look at the finances and operations of several firms was warranted. NASD staff from Washington and several district offices swooped down on Denver.

Since then, 11 brokerage firms, including some of the largest penny-stock specialists, have closed either of their own volition or because of actions pending against them. Six others have reopened after correcting problems and with new infusions of capital, Davenport said.

What had made a high number of firms vulnerable, according to John Pinto, vice president for surveillance for the NASD, was their extreme concentration in penny stocks. When investor interest began to fade in late 1981 and early 1982, the brokers' business faded too, leaving them without adequate income in some cases to keep up with high fixed expenses.

Although SEC actions have focused on brokers, rather than the companies issuing stock, the chaos in the penny-stock market is making it difficult for small, speculative firms to raise capital.

"It's a real fine line," said Davenport. "The West has traditionally been the situs for young companies, for speculative companies. In the mid-1950s, in the uranium boom, hundreds and hundreds of companies were being formed. That faded." Davenport said that the recent boom-and-bust period was not very different.

"The abuses we found in the so-called hot issue market were not by issuers, they were by certain segments of the brokerage community," he said. But the issuers are paying in their inability to raise money.

"Small companies need to have access to capital markets," said Davenport. "The flip side is we really need to try to stimulate compliance with the law in the brokerage community."

The SEC has charged that a series of abuses occurred, including violation of SEC rules about how much capital brokers must maintain, falsification of books and records and manipulation of the price of stock.

"When a company is recently organized, with few assets and no track record and unproven management and heavily diluted by insider share holdings, the public takes the majority of the financial risk," Davenport said. "When such an issue sells out very quickly and jumps from cents a share for 20 million shares to 50 cents to $3, you have a $60 million company--and it hasn't done anything," he said. In those situations, the SEC will be keeping a careful eye on things, according to Davenport.

The most recent of the brokerage firms to liquidate was J. Daniel Bell & Co. Inc., which voluntarily chose to shut down its operations on June 28. Pinto said that several firms that had enough assets to cover their obligations had chosen self-liquidation under the NASD's supervision.

Being liquidated are OTC Net Inc., a large firm which is under a temporary restraining order because of charges that it violated federal securities laws and which is now under the direction of a court-appointed trustee; G.S. Omni Corp., also under a court-appointed trustee; International Securities Inc., which is being liquidated under supervision of a court-appointed trustee, and American Western Securities Inc., which decided to voluntarily liquidate after it was sued by the SEC.

First Colorado Investments and Securities Inc. is open with additional capital and with a court-appointed special officer in place to investigate allegations that stock certificates were forged and that books and records were not accurate. The Investment Bankers Inc., its president and other employes were charged by the SEC last year with securities fraud in connection with the market in stock of Chipola Oil Corp. The firm is being liquidated under a court order.

All of the firms being liquidated involuntarily have been taken over by Securities Investor Protection Corporation trustees appointed by the court to protect customer interests.

Under voluntary liquidation, along with Bell and American Western, are Miyamato Securites Inc., Morris Bridger Securities Inc., Security Traders Inc. and Townsend, Bauerle & Co.

Still another firm, Wall Street West Inc., was the subject of an administrative hearing last week on charges that it manipulated the price of stock of Lake City Mines Inc.