By: Janet Whitman

As U.S. lawmakers mull a crackdown on murky trading activities such as dark pools and high-frequency trading, another unregulated sector of the market known as the Wild West of stock trading is cleaning up its own act.

The Pink Sheets has long been the home for stocks too thinly traded, too tiny or too financially ailing to list on a senior stock exchange. But since it started introducing new transparency initiatives, including a trading risk-ranking system a couple of years ago, the over-the-counter venue has attracted a growing list of big names, from German sportswear maker Adidas AG to Swiss drug maker Roche Holding Ltd.

The new OTCQX trading platform for premium listings being offered by Pink OTC Markets Inc., as the company is formally known, is expected to double its listings of Canadian companies by the end of this year.

“We have taken great strides to make the OTC market more friendly to investors,” says Tim Ryan, managing director of sales and business development for New York City-based Pink OTC Markets. “Stocks that trade on the pink sheets are categorized by their amount of disclosure. For a company that doesn’t provide disclosure, we flag it with a stop sign [icon]. We don’t stop trading in it, but we say investors should look both ways.”

For even shadier listings, including possible “pump-and-dump” stock promotion scams among the 5,000 or so stocks it quotes, the Pink Sheets slaps them with a black skull-and-crossbones warning label.

At the opposite end of the spectrum is the OTCQX listing service, set up to highlight reputable companies.

The QX, which stands for quality and excellence, doesn’t require foreign companies to make filings with the U.S. Securities and Exchange Commission nor do they need comply with burdensome accounting regulations that are part of the Sarbanes Oxley Act, a huge cost savings.

Instead, Canadian companies can use the filings they make with the Toronto Stock Exchange.

“The OTCQX opens the door for these companies to the vast U.S. retail market,” says Mr. Ryan.

It can also help improve demand in the companies’ home market.

Beyond a 373% surge in trading in the United States within three months of joining the OTCQX, Canadian companies have seen their trading volumes jump 54% on the Toronto Stock Exchange, according to data from Pink OTC Markets.

Avalon Rare Metals Inc., Globex Mining Enterprises Inc., Azure Dynamics Corp., China Education Resources Inc. and Alter NRG Inc. are among the Canadian companies that make up about 10% of the OTCQX’s 74 listings.

Officials at Pink OTC Markets, which debuted in 2007, say they’re getting a flurry of applications from Canadian companies this year.

Even with the improved disclosure efforts, industry observers doubt the Pink Sheets will eradicate fully its Wild West mentality.

“The Pink Sheets still has a whole realm of penny stocks that has always given the SEC problems,” says James Angel, a professor at Georgetown University in Washington D.C. who specializes in the structure and regulation of financial markets around the world. “A lot of little companies there are scams waiting to happen, so the SEC has a real enforcement nightmare.”

Nevertheless, the agency isn’t likely to come down on the Pink Sheets. Regulators recognize that small companies need a place to raise capital without the burden of registering and filing financial reports with the SEC. Perhaps more significantly, the SEC and U.S. Congress are much more preoccupied with other concerns, such as tightening up regulations on high-frequency trading, dark pools of capital and short-selling.

“The pink sheets are a small niche representing a very tiny slice of overall U.S. equity market value and a very small slice of trade volume,” says Prof. Angel. “The complaints the SEC gets in that space are usually about an individual company that’s fraudulent. They’re not getting a huge number of complaints about trading practices.” For savvy traders, the

Pink Sheets can offer a good opportunity to clean up.

Anthony Marchese, general partner at Insiders Trend Fund, a New York hedge fund that has a portfolio built around insider-trading activity, says he often prefers to buy stocks on the Pink Sheets rather than on more reputable, regulated exchanges.

“A lot of people aren’t able to buy those stocks, so there’s less competition,” he says. “There is still a heavy bias in general against purchasing micro-cap stocks.”

Mr. Marchese adds that the skull-and-crossbones warnings sometimes offer good buying prospects, including his purchase earlier this year of shares in Colorado-based mining company Golden Minerals Co.

“They came out of bankruptcy back in March and insiders were buying the stock,” he says. “When we bought it, it was trading below cash. It’s a situation where the skull-and-crossbones [warning] let me buy it for much less than it was worth.”

Buying such stocks isn’t always easy for retail investors.

“My brother bought some of this and his online brokerage called him twice,” says Mr. Marchese. “Discount brokerage accounts either won’t let you buy some of these stocks or if you do they put the fear of god in you.”

Link to Original Article: http://www.financialpost.com/news-sectors/story.html?id=2204249

If you intend to invest in penny stocks you should know the differences between penny stocks and other stocks, such as blue chips and mid-caps. While the performance of mid-cap and large-cap stocks is driven primarily by fundamentals, several analysts believe that the performance of penny stocks is driven primarily by investor speculations. If you analyze the fundamentals of 100 penny stocks, perhaps only two or three would be generating superior returns.

Despite the issues associated with penny stocks, several investors intend to invest in penny stocks, since they believe many of today’s blue-chip stocks, such as, Microsoft (Nasdaq: MSFT) and Wal Mart (NYSE: WMT) were once penny stocks. However, the share prices of these companies were almost never trading for pennies, however it appears that way when one looks at the price adjusted for stock splits. Many investors ignore this fact.

Since many penny stocks are traded on the pink sheets and are not scrutinized by the SEC, you will find it more difficult to find credible information about them.

Penny stocks often lack liquidity, which means investors would find it difficult to buy or sell. A lack of liquidity often helps fraudulent investors to manipulate the share prices. The SEC itself in Schedule 15G states “Investors in penny stock should be prepared for the possibility that they may lose their whole investment”.

A penny stock traded on the over-the-counter exchange has a higher chance of being delisted for lack of compliance. If the particular company is unable to list its stock on another exchange or become re-instated, you may lose 100% of your investment. You should consider this seriously, if you intend to take long positions in a penny stock.

Several new investors are attracted to penny stocks, given their low price and potential for substantial gains. There have been instances where penny stocks rose more than 1000% in a few days in the past, but this is extremely rare and often the price is not sustained. There are historical evidences that most penny stocks lose their entire value. If you are a new investor, you need to be aware of the risks involved.

If you still want to invest in penny stocks, do the relevant research into the company’s fundamentals and ignore the pre-conceived theories about the successes of the penny stocks in the past.

By: Joel Arberman

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