Trading the Pink Sheets: Bold Move or Ill-Advised?
Public companies sell shares of stock to investors, giving them partial ownership in exchange for money used for capital investment purposes. These stocks trade on an exchange where investors can freely buy and sell shares. While most investors are familiar with the NYSE and NASDAQ exchanges, there’s another type of exchange that doesn’t receive the same amount of Wall Street coverage – the Pink Sheets.
In order for a company to list stock on an exchange like the NYSE or NASDAQ, the company must comply with extensive financial reporting requirements intended to make information as transparent as possible for investors to reduce fraudulent activity. These requirements come with other restrictions, such as a minimum market capitalization and minimum stock price. The pink sheets, or over-the-counter exchanges on the other hand, don’t have the same amount of regulations in place, allowing companies to list stock without complying with financial reporting requirements.
The lack of coverage means investors can buy stocks at just pennies per share, giving stocks that trade on the pink sheets the nickname “penny stocks.” Because these companies don’t have to report to the SEC, risk is much higher than normal, but so is the potential for profit.
Pink Sheet Trades
Penny stocks don’t have to submit to the same reporting requirements that stocks on the NYSE or NASDAQ do, making them highly risky trades. But it also gives investors an opportunity to take advantage of market inefficiencies that can’t exist in other, more reputable exchanges.
The pink sheets contain roughly 15,000 companies that range from small speculative stocks to large foreign companies. These companies trade on the pink sheets for a number of different reasons. It could be because the company doesn’t meet listing requirements or because the stock isn’t priced high enough. Often, companies that trade on the larger exchanges find themselves downgraded to the pink sheets as their stock price falls below the threshold value. Foreign companies might not have the ability or resources to meet certain listing requirements and choose to trade on the pink sheets instead.
Just because a stock trades on the pink sheets doesn’t mean it’s fraudulent or a poor investment choice. Many name-brand foreign companies like Nintendo and Volkswagen trade on the pink sheets. Other types of companies, like those that deal in Marijuana, don’t meet Federal regulations and can’t be listed anywhere else.
Investing in over-the-counter stocks comes with a high degree of risk and exposure to fraudulent trading activity. One of the most common, known as a pump and dump scheme, operates best with penny stocks. False recommendations or statements about a company is disseminated to investors with the intention of boosting interest in the stock and raising its value, so sellers can sell their shares at inflated prices.
Investors interested in trading penny stocks should use extreme caution and perform due diligence above and beyond what they would normally do in order to ascertain a stock’s true value. While higher profits can be made, investors shouldn’t make pink sheet companies a large part of any investment portfolio.