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In the Pink: OTC Stocks Offer Peril Along With Potential Profit


Among the illiquid microcaps sit some of the biggest and most prestigious companies on earth, including Rolls Royce.

MINYANVILLE ORIGINAL The unlikeliest characters, it appears, can resist everything except the temptation provided by pink sheets, that often seedy underbelly of investing. It's a corner of the Over the Counter (or OTC) market that compelled Larry Wilcox, none other than Erik Estrada's upstanding law-enforcement sidekick in the hit '70s TV show CHiPs, to commit a crime. Meanwhile, one Michael O'Brien Pickens was earlier arrested for pilfering some $300,000 of ill-gotten gains from a similar securities fraud, never mind that -- as his father is a billionaire -- he surely didn't need the money.

If pink sheet stocks and their ilk often conjure up images of unscrupulous snake oil salesmen peddling worthless "pump and dump" issues to unsuspecting widows and orphans in shady back-office boiler rooms, the reputation is not entirely undeserved. Many of these equities are indeed illiquid micro caps whose financials are at best an educated guess and often downright deceptive. They are very much buyer beware and at your own risk, and any get-rich-quick delusions are quickly disabused.

Strange Bedfellows

Yet the OTC market is also home to some of the biggest and most prestigious companies on earth. These include Rolls Royce (RYCEY), that byword for luxury that last month reported a profit of almost $1 billion. Riding right alongside it in the fast lane is Bentley and Lamborghini owner Volkswagen (VLKAY), having just announced its own 18% profit increase. Even before bidding goodbye to the Bs, we encounter British Sky Broadcasting (BSYBY), France's BNP Paribas (BNPQY), and German car giant BMW, formally known as Bayerische Motoren Werke Aktiengesellschaft (BAMXY). (Any headache arising from trying to spell that one can be quickly alleviated with an aspirin by Bayer (BAYRY), itself also quite literally available over the counter.) Deutsche Telekom (DTEGY), Nintendo (NTDOY), Nestlé (NSRGY), and Roche (RHHBY) are among many other major market caps to trade OTC while often eschewing formal American Depository Receipts (ADRs).

As this list illustrates, firmly established foreign firms often find themselves strange bedfellows under the pink sheets with financially troubled domestic companies. Taken together, these two groups combine for the overwhelming majority of the segment's top trading volume. Overseas outfits invariably opt to list OTC rather than on large exchanges including the NYSE (^NYA) as a way to cut operating expenses. An annual Over the Counter listing is typically obtainable for only about $15,000, as opposed the Big Board's six figure sum. Along with enticing American investors, another key OTC attraction for an international organization is being able to avoid the sort of stringent red tape required by exchanges, regulations made increasingly onerous in the wake of Sarbanes-Oxley laws enacted after Enron's collapse a decade ago.

Important Distinction

Neither broad Over the Counter bulletin board shares nor pure pink sheets trade on a formal exchange, and many constituents of the former can also be found on the latter's quotation system. Yet while the terms are often tossed around interchangeably, invariably seen as a distinction without a difference, there is an important contrast to draw between these two investment Rodney Dangerfields. OTC stocks must comply with certain minimal listing requirements and file assorted financial forms with entities including the Securities and Exchange Commission (SEC), although these stipulations are certainly less stringent than those enforced on either the Nasdaq (^IXIC) or NYSE.

By contrast, pinks often operate in an environment akin to the Wild West, where anything goes and oversight and corporate governance are negligible. Such securities need do little more than file a perfunctory Form 211, safe in the knowledge that they remain largely under the radar of the SEC, whose already-stretched resources are focused almost exclusively on entities with more than $10 million in assets and over 300 shareholders. On a single day this May, the agency did, however, suspend trading in a record 379 shell companies it found ripe for fraud, suggesting a longstanding "too small to jail" attitude from the Feds may be about to end.

Of course, not all companies on the pink sheets are fly-by-night penny stocks, generally defined as anything under $5 per share. Some are eminently trustworthy, but too tiny to trade elsewhere, or demoted by famous firms, temporarily or otherwise, after falling from favor. Iconic American outfits that have been booted from major exchanges to pink sheets purgatory after dropping below minimum listing requirements include post-bankruptcy incarnations of Eastman Kodak (EKDKQ) and General Motors (GM), which in 2009 traded as Motors Liquidation Company under ticker (MTLQQ.PK). (Any stock symbol ending in ".PK" serves as a scarlet letter indicating it's a pink.)

Born 99 years ago in 1913

The pink sheets began life in 1913 as a daily price and information directory published, as the name implies on pink paper, by the National Quotation Bureau. Each page contained scores of stocks in alphabetical order, with the publication eventually running to more than 300 pages. It was basically a book where many stories abruptly ended in Chapter 11, such was the dire financial predicament of many protagonists on its pages. Each morning, over 2,000 financial professionals received the latest edition, a Herculean undertaking in a pre-Internet era. Indeed, until Nasdaq arrived on the scene in the early 1970s, the periodical was the only reliable resource for OTC equities.

A century later, approximately 10,000 stocks continue to trade on the pink sheets, although the process is, of course, now unrecognizably automated -- and its corporate parent embarked upon a major re-branding effort last year. In an effort to remove any taint of pink slime and aim for at least the appearance of increased exclusivity, privately held Pink OTC Markets morphed into OTC Markets Group in early 2011. The company is presided over by one Cromwell Coulson, a distinctly blue-blood-sounding CEO and onetime trader for Carr Securities who purchased it fifteen years ago.

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