What are Pink Sheet Stocks?
Equities listed and traded over-the-counter (OTC) markets rather than on major shares like NASDAQ or NYSE (New York Stock Exchange) are known as Pink sheet stocks. In the past, the price quotation for such stocks was printed on pink paper slips, which is how they came to be known as pink-sheet stocks.
What are Pink Sheet Stocks?
Pink sheet stocks are securities traded on over-the-counter platforms, also known as OTC Markets. On over-the-counter markets, transactions directly occur among dealers, usually referred to as dealers. OTC Markets thus also refer to an off-exchange. The OTCM- OTC Markets Group is an exchange with OTC listings, wherein frequently stocks traded on it are also referred to as pink sheets. Unlike other publicly traded companies trading on major exchanges, pink sheet stocks listed in Over-the-market places are not subject to financial reporting standards and are not required to find any kind of financial reporting with the Securities and Exchange Commission (SEC).
Pink sheet stocks are also known as OTC stocks, are traded directly and compiled electronically. As they are thinly traded, they can result in higher trading costs, with low liquidity, causing longer waiting periods to find buyers.
To list a Pink sheet stock in the pink sheet listing, small businesses are required to file Form 211, which discloses some financial information, in compliance with the OTC Unit. However, there is no obligation for such companies to disclose financial information or situation transparent to the brokers and dealers who may choose to market their securities.
Example of Pink Sheet Stocks
A common example of pink sheet stocks is some of the small-cap penny stocks that usually trade at very low prices. Penny stocks have share prices lower than $5. Small-cap stocks tend to have low market capitalizations and consequently low share prices, which also makes them very volatile and risky as a choice of investment.
While some companies may list their penny stocks to trade on an exchange like NYSE, mostly they are traded via OTC through pink sheet listing or on OTCBB. Companies that are usually keen on restricting the public disclosure of their financial and accounting information trade over the counter through pink sheet stocks. An example of this is Nestle SA (NSRGY)- the Swiss food and beverage brand and Bayer A.G (BAYRY) - a German healthcare company are companies listed via pink sheet stocks.
OTCM or the OTC Market Group lists the most actively traded pink sheet stocks. Large companies such as Nestle, Bayer, and Tencent Holding, a Chinese multimedia company tend to have a significantly higher trading volume than other smaller company penny stocks, which makes them highly liquid and thus readily tradable in the market. Monitoring the OTCM can conclude the large variation in volumes traded for large known companies and those of smaller businesses listed on the pink sheet listings.
How do Pink Sheet Stocks work?
Over-the-Counter is the process of trading securities of unlisted companies. OTC platforms that trade pink sheet stocks or penny stocks are an electronic decentralised network of dealers and brokers. These platforms do not fall under the same reporting standards as other major exchanges and are known to operate two tiers of trading marketplaces.
The first tier is OTCBB, which is operated by NASDAQ. OTCBB refers to an electronic system display, that showcases OTC securities against their real-time quotations and volume information. OTCBB stocks are represented by an OB suffix and are required to file financial reporting with the SEC (Securities and Exchange. The second is the pink sheets platform. Shares are further divided across OTCQX and OTCQB platforms.
A qualitative review is performed, as is a requisite of OTCQX, while OTCQB mandates the price of at least one penny stock while validating that the company’s information is complete and up to date with an annual certification.
A broker arranges the buying and selling of a pink sheet stock by locating interested sellers and buyers. As data is largely unavailable, complete research of the stock might take time. Due to infrequent trading, impacting their liquidity, and the difficulty encountered in their trading at an accurate price, brokers charge wide bid-ask spreads or price quotes between the sell-side and buy-side. As a result of their highly speculative nature, investors may be prone to losing a sizable amount or all of their investment.
While many brokers have shifted to a commission-free model of trading for stock trading on major exchanges, a fee is usually charged for OTC trades. Investors tend to lack the option to enter buy or sell market orders for pink sheet stocks, which implies that there are no scenarios of the investor’s choice of a bid being matched to the current asking price or vice versa. Instead, they may have to accept a limit order wherein the price desired is manually entered.
While Pink sheet stocks are OTC, they are not OTCBB, Over-the-Counter-Bulletin Board. Commission). Pink sheet stocks are represented by the PK suffix with no obligation to file financial reporting with the SEC, which is why they are also reviewed as high-risk investments.
Advantages and Disadvantages of Pink Sheet Stocks
Pink sheet stocks provide small companies with an approach to raising capital through a public sale of their shares. Considering the price of trading for small companies is usually low, it is relatively simpler for an investor to become a stakeholder while making significant returns on their investment, provided the company is successful.
Investors can capitalize on the growth trajectory of associated company stock which may eventually trade on the major exchange, in due course. Transaction costs associated with pink sheet transactions are usually lower as they do not carry the high listing fees of large exchanges, which also contributes significantly to their affordability.
Due to the lack of any regulatory requirement for disclosure of financial information, Pink sheet stocks are greatly prone to fraud and price manipulation. Thus, pink sheet listings can turn out to be shell companies. Lack of information by companies can also make it difficult for investors to do necessary due diligence before investing, making these an investment a risky choice.
Due to their infrequent and illiquid nature, it can be very difficult to find buyers or sellers in the market. Certain pink sheet stocks have also been known to be found as fraudulent shell companies and in certain situations, they are on the verge of insolvency.
SEC Regulation of Pink Sheet Stocks
The SEC regulation requirements on pink sheet stocks largely focus on consumer protection and education. Owing to the very speculative nature of the pink sheet penny stocks, several SEC restrictions, regulations, and requirements govern the guidelines for brokers who trade in these securities. In comparison to the stocks listed on major exchanges, pink sheet stocks are often associated with high risk.
Stocks that fail to meet the SEC requirement for the larger stock exchanges usually wind up on the pink sheet listings, as they might be lacking incomplete financial information as per SEC requirements or simply may have a stock price trading below one dollar. SEC is known to notify that OTC traded stocks tend to be extremely volatile and highly illiquid and require proper due diligence by investors. Risk outweighs rewards when trading small company penny stocks.