OTC Equity Securities: Understanding the Risk

What is OTC Equity?

While world-famous stock exchanges like the Nasdaq and the New York Stock Exchange (NYSE) remain the focus of the investing world, there is a secondary option that eschews regulated national exchanges. Over-the-counter equity, more commonly known as OTC equity, is traded on a dealer network. The result? OTC equity can be fraught with risk and is not suitable for all investors. Those who have sustained losses through fraud, which runs rampant on the OTC market, often find themselves in need of a securities attorney.

Also known as “unlisted stocks” or “microcap stocks,” OTC equity is ostensibly designed to allow investors to invest in smaller companies. After all, the high fees to join the NYSE and Nasdaq can prove prohibitive to some startup companies. Investors looking for the next big thing don’t want to be limited. While this sentiment is understandable, investors should be aware of the risks of trading on the OTC market. It is worth noting that shares of foreign companies, derivatives, and bonds are also traded over the counter, but OTC equity is the category that carries the most risk.

This risk comes from the fact that fraudsters may use the OTC equity market to defraud investors. For example, an SEC press release dated October 23, 2018, describes how John Madsen issued phony press releases to generate hype about a penny stock and concealed his “secret control of the company.” He appointed a CEO, Bernard Fried, who was merely a figurehead, to conceal the fact that he had previously pled guilty to mail fraud. Ultimately, John Madsen was fined $80,000 and barred from acting as an officer of any public company. The OTC market allows investors to invest in smaller companies and potentially reap huge returns — but this speculation comes at a cost.

What are the Risks Involved in Investing in OTC Equity?

Why is investing in OTC equity considered to be inherently speculative? The ubiquity of so-called “Pink Sheets” makes the OTC equity market a breeding ground for fraud, market manipulation, and deceit. The SEC warns:

OTC Link does not require companies whose securities are quoted on its system to meet any eligibility requirements. With the exception of some foreign issuers, the companies quoted on OTC Link tend to be closely held, very small and/or thinly traded. Most issuers do not meet the minimum listing requirements for trading on a national securities exchange. Many of these companies do not file periodic reports or audited financial statements with the SEC, making it difficult for the public to find current, reliable information about those companies.

OTC equity allows investors to trade shares of companies not listed on a national exchange. 10,000 companies trade on the OTC Bulletin Board (OTCBB) and OTC Markets Group, Inc. While it can be exciting to trade shares of emerging companies, the SEC has spotlighted “Microcap Fraud,” warning investors:

While companies that trade their stocks on major exchanges undergo a formal application process and must meet minimum listing standards, companies quoted on the OTCBB or the OTC Markets do not have to apply for listing or meet any minimum financial standards.

The SEC goes on to warn investors about potential red flags to watch out for when investing in OTC equity. Investors should proceed with caution if a company traded on the OTC market:

• Has been suspended by the SEC
• Sends out spam
• Has considerable assets but little revenue
• Has unusual footnotes in its financial statements
• Is largely owned by insiders

If a company has any of those red flags, what could that mean? The company could be engaging in any number of securities violations, including using a shell company to lure investors, manipulating the market, or engaging in insider trading. n an effort to combat fraud, FINRA maintains a daily Eligibility Status Report, listing issuers who have been delinquent in filing required regulatory filings. FINRA oversees this as part of its commitment to enforcing FINRA Rule 6530(e), which stipulates that a company with multiple late filings will be ineligible for quotation on the OTCBB for one year.[1] Despite these protections, however, those with nefarious intentions still use the OTC network to manipulate the markets and deceive ambitious investors.

Choosing a Securities Attorney Familiar with OTC Equity

Not all securities attorneys are created equal. If you’ve been a victim of OTC equity fraud, you should seek the counsel of a securities attorney who fights for the rights of defrauded investors. At Fitapelli Kurta, we bring years of experience working for broker-dealers, but now we only fight for the interests of investors. Our exclusive, laser-sharp focus on investor advocacy sets us apart from the pack. Call (877) 238–4175, email info@fkesq.com, or visit www.stopbrokerfraud.com for your free case consultation.

[1] https://www.finra.org/sites/default/files/OTCBB%20Redacted%20Decision%202009_0_0_0.pdf