06 May Understanding pennystocks and OTCMarkets Group
Understanding pennystocks and OTCMarkets Group
Penny stocks are defined—for purposes of marginability—as non-exchange listed stocks trading under $5. They may file periodic financial reports and other materials with the Securities and Exchange Commission (SEC) or not. In the former case, they're generally called “OTCBB” stocks, for “Over-the-Counter Bulletin Board.” In the latter, they're Pink Sheet issues. Originally, OTCBB stocks were traded on a platform developed and operated by the Financial Industry Regulatory Authority (FINRA; formerly known as NASD). Both are considered to be “OTC” securities, because they do not trade on national exchanges.
In 1997, Cromwell Coulson, who began his career as a broker, bought the National Quotation Bureau (NQB), which oversaw trading in Pinks. He officially changed its name to Pink Sheets, LLC. At that time, Pink Sheet stocks were much scorned. Very thinly traded, information and quotes were generally only available on flimsy sheaves of pink paper that was circulated to brokers and other interested parties. But Coulson saw potential. There was no electronic trading on the OTCBB platform. Once the internet and discount brokerages were up and running, players could enter trades on their computers, but MMs could only complete these transactions by telephone. Coulson got to work designing an electronic platform, which when finished would be called Pink Link (now OTC Link).
In the early 2000s, Coulson got lucky. The SEC decided to crack down on OTCBB stocks that were technically SEC filers, but in reality were delinquent. They set dates by which groups of stocks had to become compliant, or suffer delisting. The deadlines were assigned according to alphabetical order. Comically, one ghastly little company whose name began with “A” sued the SEC, complaining of discrimination and general unfairness. The suit did not last long in court. As a result of the SEC crackdown, thousands of former OTCBBs became Pinks.
Coulson worked hard to make the Pink Sheets website use-friendly, and to present the information contained therein in a clear and understandable way. To that end, he conceived the idea of ranking stocks in tiers, dependent on the amount of disclosure each was willing to make. In the meanwhile, FINRA had tired of operating the OTCBB platform, and attempted to sell it. Initially, Rodman & Renshaw showed interest, and a deal seemed close at hand. In the end, though, it was never consummated. Perhaps that had to do with the fact that OTCBB still did not allow for electronic trading, and continued to charge market makers fees to use its platform. It costs nothing for MMs to use the OTCMarkets platform. The choice was obvious, and MMs left OTCBB in droves. Today, only a handful of stocks still trade there.
Coulson, moving forward, changed the name of his company once again, to OTCMarkets Group.
Two kinds of stocks trade on OTCMarkets: fully-reporting issues, and stocks that do not report to the SEC at all. There are two tiers for reporting stocks; five for non-reporting stocks.
The OTCQX is the most prestigious tier; it's called the “Intelligent Marketplace.” To qualify, companies must be “credible;” even OTCMarkets notes that they're unlike the “large number of economically distressed and questionable companies that trade OTC.” They're divided into several sub-categories: OTCQX U.S., OTCQX U.S. Premier, OTCQX International, and OTCQX International.
There are qualifying standards. Premier U.S. must have assets greater than $2 million, and must keep stock price above $1. Certain revenue targets must be met as well. Ordinary U.S. must have the same $2 million in assets, but its share price may be as low as $0.10. OTCQX International is similar, though designed for companies that have foreign exchanges as their principal trading venues. Criteria for International are similar to those for OTCQX U.S., but International Premier demands a higher market cap and significant revenues, and incorporates a portion of the NYSE Worldwide Financial Listing Standards.
OTCQB stocks must be fully-reporting issuers. There are no asset, revenue, or stock price qualifications. They can be entirely worthless, and trade at no bid by $0.0001, but as long as they don't fall behind with their filings, they'll continue as OTCQB stocks. If they become delinquent, they'll be dropped to the Pinks, but will still be considered to be SEC filers. That will be noted on their company info page at OTCMarkets, under “reporting status.” Delinquent filers run the risk of having their registration revoked by the SEC. That means, effectively, that in worst case their tickers will be killed and the stocks will never trade again.
Pink Current Information
Current Information is the highest Pink tier. By definition, Pinks are not registered with the SEC, and have no filing obligations, to the Commission or to anyone else. OTCMarkets encourages these issuers to make disclosure, however, in accordance with what they call the “alternative reporting standard.” This standard is their own invention. It is loosely based on SEC reporting standards, but much less rigorous.
In order to qualify as Pink Current, an issuer must file one (unaudited) annual report each year, three quarterly reports, and must also disclose a variety of material corporate events. A letter from an attorney who has met “face-to-face” with the company's officers and a majority of the board of directors must accompany the annual report. Until early this year, when OTCMarkets revised its requirements, attorney letters had to be provided with interim financial reports as well.
That may mean lower attorney fees for some, but the list of material events that must be disclosed has grown. Companies are now expected to give prompt notice—within four days—of entry into or termination of material agreements, acquisition or disposition of assets, creation of a financial obligation, or a change in an existing obligation, material impairments, sales of stock, non-reliance on previous financial statements, changes in control, and departures or appointment of new board members or officers, among other things.
The addition of stock sales to the list is particularly interesting. It means that Pink Current issuers should now inform OTCMarkets every time the outstanding is raised. That information is extremely valuable to anyone playing the stock. Historically, Pinks tend not to be upfront about it. It remains to be seen if most will now bite the bullet and report.
Pink Limited Information
The Pink Limited Information tier is, as OTCMarkets notes, for “companies with financial reporting problems, economic distress, or in bankruptcy.” Companies may post whatever information they have available, or wish to share. In order to maintain Limited Information status, an issuer must have posted an annual or interim report within the preceding six months. Failure to do so will result in a demotion to Pink No Information.
The financials offered by Limited Information companies is often sketchy at best; it can rarely be relied upon for accuracy or completeness.
Pink No Information
These companies either cannot or will not make any information available to anyone. They are sometimes defunct. Many continue to trade because they never had registered stock in the first place, and so their registration cannot be revoked; they are often referred to as “zombie tickers.” OTCMarkets warns that they “should be treated with suspicion and their securities should be considered highly risky.”
The Grey Market isn't really an OTCMarkets tier. It comprehends several types of stocks. Many promising issues spend a few weeks or months on the Greys before they move on to a listing on a national exchange, or at least to the OTCQB or Pinks. That is because first they need to become compliant with SEC Rule 15c2-11, which requires that they locate a market maker willing to sponsor them and file a Form 211. The Form 211 must be approved by FINRA. The approval process normally proceeds quickly, though occasionally FINRA has questions that need to be answered. Normally these stocks don't trade until their reach their final destination.
A second category of Greys consists of stocks so unexciting that they've been deserted by their MMs because of a general lack of interest. If an issue is not publicly quoted for four consecutive trading sessions, the MMs will be deemed to be gone, and the stock will lose Rule 15c2-11 compliance. To return to the Pinks, it will have to go through the Form 211 process once again.
The most notorious Greys are the stocks that were dumped there as a result of an SEC trading suspension. Since these are invariably suspended for two weeks, they, too, must once again become compliant with Rule 15c2-11 in order to trade normally. But since they're generally considered to be under SEC investigation, or are likely to have registration revoked in the very near future, market makers rarely agree to sponsor them. Those whose registration is not revoked trade on in limbo, with no bid or ask, subsiding stock price, and dwindling volume.
Caveat Emptor, like the Grey Market, is not a tier. Any OTC stock may find itself slapped with OTCMarkets' nasty skull and crossbones icon. A CE is intended as a strong warning, and will be applied when OTCMarkets decides that a spam campaign, questionable stock promotion, investigation of fraudulent or other criminal activity, regulatory suspension, or disruptive corporate actions are a problem.
OTCMarkets has put time and effort into persuading its client companies to make more and better disclosure. Along the way, of course, it's made more money for itself, adding new requirements here and “helpful” bells and whistles there. But at the end of the day, OTCMarkets is not a regulator. It can encourage, but not enforce. If issuers misrepresent material facts in their submissions, by omission or commission, it can't sue them for civil fraud; it can only demote them to a lower tier.
As OTCMarkets itself would say... Caveat emptor.