The majority of larger companies that trade publicly choose to list their stocks on one of the major exchanges - the NYSE or Nasdaq. However, many companies are unable to meet the financial or other listing requirements for the exchanges, or choose not to subject themselves to the regulatory requirements that come with an exchange listing, and therefore trade instead in the over-the-counter (OTC) market. OTC Markets Group is the largest operator in this market, although quotes are also available through FINRA’s OTC Bulletin Board (OTCBB). Recent changes and innovations have also caused the OTC market to become more attractive to large foreign firms that use it as a means to access U.S. investors without the cost and duplicative regulatory burden of a U.S. stock exchange listing.
While NYSE functions as auction markets, the OTC market is dealer-driven. The OTCBB and OTC Markets Group’s OTCQX, OTCQB and OTC Pink marketplaces fall into the latter category, and all stocks trade there as a result of broker-dealers quoting a company’s stock. This compares to the exchanges, where companies must apply and qualify to be listed with the exception of OTCQX, OTC Markets Group's highest marketplace, for which there are qualification requirements.
The Penny Stock Reform Act of 1990 mandated that the SEC create a uniform electronic quotation system for OTC stocks. The OTCBB was created to provide this and now provides real-time securities data for 1,000 securities and is used by 80 market makers. Although FINRA is responsible for overseeing its daily operations, the OTCBB is regulated by the SEC.
The stock market segment that was traditionally referred to as the “Pink Sheets” has undergone many changes over the years. It began with the National Quotation Bureau (NQB) in 1913 and chiefly comprised penny stocks and high-risk offerings that were listed on sheets of pink paper (or yellow paper for bonds), which were distributed to brokers and investors. This continued for decades until the internet boom in the 1990s facilitated widespread electronic dispersion of quotes. NQB introduced its real-time electronic quotation service in 1999 and changed its name to Pink Sheets the following year. Electronic messaging was introduced in 2003. It was then renamed Pink OTC Markets in 2008 and took its present name of OTC Markets Group in 2010. In 2007, it reorganized all stocks previously traded in the Pink Sheets into three separate marketplaces. These marketplaces are based on the quality of the companies’ disclosure, so that investors can more easily access and analyze companies and make informed trading decisions:
- OTCQX® – The top marketplace where many of the biggest and best OTC companies trade. All issuers are required to meet both financial and reporting criteria and undergo a management review. They must also be sponsored by an accredited third-party investment bank or attorney adviser. Approximately 370 securities trade on this marketplace.
- OTCQB® - The middle marketplace is referred to as the Venture Stage Marketplace. Companies that trade on this marketplace file reports with the SEC or other U.S. regulator on a regular basis. However, there are no financial requirements for listing. Over 3,000 companies trade on this marketplace.
- OTC Pink® – Most companies from the old Pink Sheets® landed in this marketplace. This is referred to as the Open Marketplace, and there are no filing or financial requirements for companies that trade here. Companies may file reports to the SEC or other agency at their choosing. OTC Pink securities are further categorized into three segments:
2. OTC Pink Limited Information – Companies that have filed a quarterly or annual report within the past six months via the OTC Disclosure & News Service fall into this marketplace. Those that fall into this category are often experiencing financial problems or insolvency.
3. OTC Pink No Information – This is for companies that have not submitted information of any kind to OTC Markets Group or the regulatory agencies within the past six months. OTC Markets Group also classifies some companies as “Caveat Emptor” and includes a skull and crossbones icon next to the company’s ticker symbol. Caveat Emptor companies often engage in questionable business practices and shady dealings, and are generally considered to be the riskiest segment of the entire stock market.
Electronic Trading Capability
OTC Markets can now facilitate electronic trading with its SEC-registered Alternative Trading System known as OTC Link® ATS. This system is owned by OTC Link®, a subsidiary company of OTC Markets Group that is a registered broker-dealer and member of FINRA. The system traded $135 billion of transactions in 2012 with an average daily dollar volume of $600 million. The three marketplaces combined feature a total of 10,000 securities including 650 U.S. banks, 2,300 companies that report to the SEC, 1,600 companies that pay dividends, 1,400 ADRs and 1,400 foreign ordinaries. Together these companies boast an aggregate market capitalization of about $11.6 trillion.
OTC Link® ATS has provided OTC Markets Group with a substantial advantage over the OTCBB, because its real-time quotes are now coupled with electronic trading capability, which its rival cannot facilitate. OTCBB still does not offer any messaging functionality. There is also a Grey Market for securities that are not quoted or traded on OTCQX, OTCQB, OTC Pink or the OTCBB. All transactions in this market are unsolicited and are reported on an individual basis by broker-dealers to an SRO such as FINRA.
Who Trades on OTC Markets and Why
As mentioned previously, many companies that do not trade on either Nasdaq or NYSE trade on OTC Markets Group’s OTCQX, OTCQB or OTC Pink marketplaces. These marketplaces are also attractive to large foreign firms such as Roche, Nestle and Adidas that only file with the securities regulators in their own countries and are not inclined to file periodically with U.S. regulators. These firms can penetrate the American markets by having their ADR traded on the OTCQX, OTCQB and OTC Pink marketplaces, which now provide electronic trading functionality that rivals that of the exchanges.
The process for a company to have its shares traded on these marketplaces is relatively simple; a registered broker-dealer must file a Form 211 with FINRA requesting permission to quote the company’s securities. Once the Form 211 is approved, the company will be assigned a ticker symbol and begin trading on the appropriate marketplace. Over 130 broker-dealers currently use OTC Markets Group’s OTC Link® ATS to quote and trade securities.
The Bottom Line
The preeminence of OTC Markets Group has substantially streamlined and improved the transparency and liquidity of the OTC market. OTC Markets Group’s marketplaces and its OTC Link ATS have attracted nearly all quotes away from the OTCBB, which may result in the OTCBB’s eventual obsolescence. For more information on quotes and trading in the OTC market, consult your broker or visit www.otcmarkets.com and www.otcbb.com.
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