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A few years ago, a reputable investment newsletter recommended a pink sheet stock. The writer briefly explained its riskiness for various reasons, including its lack of inclusion in the big leagues of major stock exchanges.
That mention prompted me to learn more about pink sheets, referencing the color of paper the stocks used to be listed on, and penny stocks, referencing a stock price of less than $5.00. I became intrigued with the concept and decided to learn the difference between equities traded on major exchanges and those traded over-the-counter (OTC).
Pink sheets and penny stocks, which are generally traded over the counter, are often touted as nontraditional ways of making lots of money. Just as growth in financial net worth can be a tool for thriving, losing money to worthless and misunderstood investments can thwart the achievement of my goals. So I did some research to determine how to best consider these investments and here's what I uncovered:
Technology has facilitated greater financial transparency and trading of over-the-counter stocks
When I started delving into this topic, I soon realized that pink sheets, penny stocks, and other over-the-counter (OTC) stocks could be more easily purchased today than in the past. Electronic systems developed and refined in the last ten years or so now provide real-time quotes and match buyers with sellers.
According to the International Monetary Fund, “Advances in electronic trading platforms have changed the trading process in many OTC markets, and this has sometimes blurred the distinction between traditional OTC markets and exchanges.”
Still, I need to be careful as ease of transactions doesn't take away risk. Just as in the past, pink sheets may still be pitched aggressively to investors, sometimes from smooth-talking sales reps like the The Wolf on Wall Street.
Companies on major exchanges have a ready market for shares (making ownership more liquid) and they're obligated to provide financial information on a regular basis
A big difference between OTC stocks (including pink sheets and penny stocks) and those traded on the NYSE (New York Stock Exchange) and NASDAQ are listing requirements. Companies on major national exchanges must meet certain criteria, which relate to the size of the company, number of outstanding shares, and stock price. They must comply with the U.S. Securities and Exchange Commission (SEC) regulations, which require these stock-issuing companies to publish audited financial reports on a quarterly and annual basis plus make certain disclosures about their business operations.
Note that companies like Enron and Tyco, which were listed on major exchanges, tricked the SEC and defrauded investors. So, it still makes sense to be cautious and consider long-term performance, even when buying stock on major exchanges from reputable brokers.
In general, though, the requirements of the major U.S. stock exchanges protect investors by 1) providing a ready marketplace for a company's stock whenever I want to buy or sell shares; and 2) ensuring access to information about the company's financial status, such as annual earnings or cash flow. Such measures don't guarantee I'll make money but they can help me make an informed investment decision.
Rules for pink sheets and penny stocks exist but are less stringent than those pertaining to stocks traded on major exchanges
The OTC Market Groups has organized various types of OTC stocks into three distinct marketplaces, which includes OTC Pink for pink sheets and OTCQB or venture stage companies that include penny stocks. These distinctions are useful in researching stocks and separating proverbial wheat from the chaff in terms of investment potential.
Stocks traded on the pink sheets and many penny stocks are not required to meet the same standards of U.S. stock exchanges and more stringent SEC regulations (though the SEC does provide some regulatory oversight for pink sheet and penny stocks).
Pink sheet and penny stock companies may not disclose relevant (also called “material”) facts about their businesses or they may erratically (or variably) publish financial statements. So, unlike NYSE and NASDAQ companies, for example, less is known about these stocks. As a result, establishing an appropriate price for the investment may be difficult. Sellers may claim to be insiders and promote a company's potential while buyers are still in the dark in terms of financial results and company valuations.
Pink sheets and penny stocks are OTC stocks but not all OTC stocks are pink sheets and penny stocks
Note that while pink sheets and penny stocks are OTC stocks and considered speculative, not all OTC stocks are considered speculative. Some companies with stocks that trade off exchanges file regular financial reports and adhere to strict regulations.
I won't say that I will never ever invest in pink sheets or penny stocks. But I can say that I will recognize the risk and the difference between a stock traded on a major exchange and one that is thinly traded off exchanges.
Do you buy and sell pink-sheet stocks? What has been your experience with these investments?