You are right - a must to study the public filings.
In the Pink
Understanding the OTC Bulletin Board
by Elie Cassorla
March 26, 1999
One evening at dinner when we were kids, my brother excitedly described a new investment opportunity he had learned about from his high school science teacher. He was talking about buying stock in a small company called Haloid. My dad, who was known to speculate in penny stocks, came to a no-buy decision after a brief "fundamental analysis," taking note of such esoteric factors as the difference in age between himself and the speaker.
Years later, my brother would call our attention to the name change of that company from Haloid to Xerox Corp., which now trades on the NYSE under the ticker XRX.
It seems a lot of people have stories like that. And therein lies the appeal of so-called unlisted, or over the counter (OTC) stocks. Once you get away from the organized exchanges with trading floors (NYSE, AmEx, Chicago, etc.) and the Nasdaq Stock Market (National Market System and Small Cap Market), you enter the world of hopes and dreams.
And that world has been made more accessible over the last decade through major improvements in the availability of market and financial data.
Color of Choice
Prior to 1990, prices of unlisted stocks were printed at the end of the trading week on distinctive pink paper, and distributed to the trading community. The "pink sheets," which contained the names of dealers offering to make a market in each issue, and their self-reported trading activity, were the only source of information about the unlisted market.
But as we know today, the age of electronic markets depends on swift dissemination of market information. So it was that in 1990, the SEC called for the creation of an electronic reporting system for unlisted equities in the United States. They called it the Over the Counter Bulletin Board (OTCBB), and its purpose was to improve information flow about the thinly traded issues that comprise the list of OTCBB stocks.
On Jan. 4, 1999, the SEC approved the OTCBB Eligibility Rule. Under this rule, all newly listed securities must report their current financial information to the SEC, banking or insurance regulators. This is a major step forward, since today only about half of the 6,672 Bulletin Board securities are classified as "reporting companies."
Non-reporting companies whose securities are already quoted on the OTCBB have a phase-in grace period to meet the new rule. By June 2000, current financial information about all domestic companies quoted on the OTCBB will be publicly available.
Commissioned Offers
There is a major difference between OTC and exchange floor-based trading. OTC trading is based on a negotiation, quite different from the open outcry auction on exchanges. The parties to the negotiation are the securities dealers on both sides of the transaction, and the customer and the customer's dealer on each side of the transaction.
Some trades are executed either on a net price basis, which means that any commission is built into the price reported to the customer on each side of the trade (the bid and asked prices). Other times, a trade is executed on an agency basis, which means that the customer is charged a commission in addition to the price differential.
If the customer's dealer is acting as a principal or market maker in the trade, then the price is net, the mark-up or mark-down earned by having taken the inventory risk. If the customer's broker acts merely as the agent, a commission is added. In this case, the commission is earned by shopping the market makers for the best price.
Fast Market
Sources at the NASD tell us that once an issue is on the OTCBB, each of the 397 market makers have a responsibility to report trades within 90 seconds. Transactions then are reported out over the ITS (Intermarket Trading System), where they join the worldwide electronic river of market information flowing to investors.
The OTCBB considers it a matter of pride that there are an average of 6.2 market makers per listing. One of the leading market makers, Hill Thompson & Magid of Jersey City, N.J., has been in the business since 1932, and posts quotes for more than 5,000 issues.
The top five volume leaders on Mar. 16 among OTCBB stocks were Starnet Communications International Inc. (SNMM), GIC Global Entertainment Corp. (GGNC), LCS Golf Inc. (LCSG), Franklin Telecommunications Corp. (FTEL) and Topclick International Inc. (TOCK). FTEL graduated to the American Stock Exchange on Mar. 18, with ticker FCM.
Buy Low?
While the OTCBB is often thought of as the penny stock venue, some well-known companies are traded there because they simply do not have high floats, or large numbers of outside shareholders. For example, the venerable Kohler Co. of Wisconsin (KHCO), which trades very infrequently, posted a 52-week high of $200,000 (sic) and recently traded at $51,000.
Other companies get on a faster track to graduation from the Bulletin Board. A trader familiar with some of these stories tells of Quigley Corp. (QGLY), which he says began as a very obscure low-priced shell company that didn't have much in it. Suddenly, it became very active, but at first people just didn't believe what was happening.
Quigley's product is now one of the nationally advertised cold remedies, Cold-Eeze zinc lozenges. The company traded from obscurity to some very high prices (more than $20 in late 1997) before listing on the Nasdaq. It recently closed at $5 1/8, down from its 52-week high of $13 7/16.
Another example of a stock attracting the attention of market makers' traders is Carnegie International Corp. (CAGI), which started in November of 1997 as an obscure stock trading under $1 (trading in 256ths). Since that time, through mergers and acquisitions, our informant opines that "it appears they've built something." The stock climbed as high as $8 3/4 in January 1999, and closed at $6 1/4 on Mar. 16. The latest whisper is that they are applying for an AmEx listing.
Power of Suggestion
Whisper, rumor and story are the fuel for much of the OTC volume. In the online chat rooms, as well as in taxicabs and barber chairs, erstwhile risk takers swap and circulate the latest buzz.
Although there are no detailed profiles of OTC investors, the last major study of U.S. investors in general (which was completed in 1997, by Peter D. Hart Research Associates, for the Nasdaq Stock Market) found that one quarter of all investors describe themselves as aggressive in their investment risk-taking.
If you are one of those risk-takers, still hoping to get in on the next Xerox or Microsoft, allow me to pass on some advice I received from a friend who's a stockbroker for a major traditional firm: The odds are better in Las Vegas if you don't do your homework. |
