How are OTC markets categorised?

What is an over-the-counter market?

An over-the-counter market is a decentralised network where financial instruments are traded without the supervision of a formal exchange. Unlike listed exchanges such as the NYSE or NASDAQ, prices don’t have a natural price discovery mechanism established from supply and demand of all market participants. Trades on OTC markets are facilitated by “broker-dealers” (known as market makers) who provide bid and offer prices on financial products, effectively setting the price of a security. Transactions can take place without others being aware of the price at which that transaction was completed.

How are OTC stocks categorised?

OTC securities are assigned to one of five tiers, with the bottom three falling under the “pink sheets” category. All tiers are assigned based on their level of transparency and the level of disclosure they are required to provide to the market. The tiers are as follows:

OTCQX (sorted into OTCQX International, OTCQX U.S & OTCQX U.S Banks)

• Companies must provide audited annual financials and meet one of the following reporting standards: International Reporting Standard, Securities & Exchange Commission (SEC) Reporting Standard, US Bank Reporting Standard, or Regulation A Reporting Standard.
• Every issuer must be sponsored by an approved investment bank or law firm.
• Must not be subject to any bankruptcy or reorganisation proceedings.
  
  

OTCQB

• Each company is verified by annual OTCQB certification to certify that company information is current and signed by the company CEO or CFO.
• Companies must provide timely disclosure of material news and meet one of the following reporting standards: International Reporting Standard, SEC Reporting Standard, US Bank Reporting Standard, Regulation A Reporting Standard, or Alternative Reporting Standard.
• Must not be subject to any bankruptcy or reorganisation proceedings.
   

Pink Sheets

• Pink Sheets have no financial standards or reporting requirements, and they’re not required to be registered with the SEC.
• Pink Sheets are categorised further into three tiers:
  

1. Pink Current Information
   • Current SEC reporting companies and non-US companies that are listed on a qualified foreign stock exchange automatically qualify for this tier.
   • Issuers not reporting with the SEC must subscribe to the OTC Markets Disclosure and News Service to be quoted on the OTC Pink Sheets Current tier. They must also publicly file an Initial Information and Disclosure Statement with an Attorney Letter Agreement signed by the issuer’s SEC attorney.
2. Pink Limited Information
   • Designed for companies with financial reporting problems, economic distress, or in bankruptcy, that only release limited information publicly.
3. Pink No Information
   • Indicates companies that are not able or willing to provide current disclosure to the public markets - either to a regulator, an exchange or OTC Markets Group.
      

OTCBB

You might have heard of stocks trading on the over-the-counter bulletin board (OTCBB). This means the security isn’t traded on a national securities exchange (non-NMS securities) but it does quote on the Financial Industry Regulatory Authority’s (FINRA) interdealer quotation service. Securities can quote on both the OTC market segments listed above and the OTCBB, provided the underlying company is up to date with required regulatory filings.

Trading OTC securities

If you’ve done your due diligence and you want to place your first OTC trade, what should you look out for?

• Many OTC securities are thinly traded. This can cause an increase in price volatility as it becomes more difficult to enter or exit a position without affecting the last traded price.
• Illiquid stocks may prove difficult to sell, and in some cases they might not trade for weeks at a time.
• Due to the illiquid nature of OTC stocks and the pricing regulations of market makers (who are allowed to execute orders at any price), it’s prudent to consider a limit price on all orders.
• Remember that you’re trading with a market maker who quotes both the bid and offer prices (with a spread). Orders might trade at your limit price, but this could be due to investors taking the market maker’s offer, rather than the market maker accepting an investor’s bid. Therefore, even if a stock trades at your price, this isn’t a clear indication that your order will execute.