The only time most investors hear about the "pink sheets" is when one of the penny stocks trading there is touted in a spam E-mail or the Securities and Exchange Commission snares another crook.
But R. Cromwell Coulson hopes to change that. He's already had some success. Ten years after he and a group of investors took over an aging stock listing publisher called the National Quotation Bureau, Coulson has turned the company-renamed Pink Sheets LLC after the color of the paper that was historically used-into the main electronic listing and quotation system for over-the-counter securities in America.
The Pink Sheets, of which some version has been around since 1904, exist as a sort of corporate United Nations, but without the clout or most of the "first world" membership. It is the last stop before circling the drain for many distressed companies, the first hop into legitimacy for many tiny start-ups, and the home to a slew of companies that either can't or won't list on a true exchange. In short, it is the good, the bad, and the ugly.
The trick now is for Coulson to show investors that there might be a few gems worth ferreting out of what is still-and often correctly-viewed as a perilous swamp. "Most people think 'pink sheets,' and they think crappy penny stocks," admits Coulson. "The value comes in separating out the companies that are worthy of investor consideration."
Taking a page from London's popular AIM stock market, Coulson in March created a new tier, called OTCQX, for Pink Sheets-traded companies that agree to file credible disclosures and appoint outside overseers-approved by Pink Sheets-to review them. Of the more than 8,000 companies listed on the Pink Sheets, only 11 have met the requirements and paid the fees to join the OTCQX ranks so far. But Coulson projects that more than 100 will do so by year-end.
Disclosure. In another move, all other Pink Sheet-listed companies are being shoehorned into new categories based on their level of disclosure to investors and the SEC. Companies that offer no disclosure will have a stop sign icon next to their symbols, while those believed to be sending out spam or engaging in other questionable promotions will have a skull and crossbones displayed next to theirs. It is a "buyer-beware flag," says Coulson.
Andrew Berger, who edits Walker's Manual of Unlisted Stocks and related publications, doesn't think Coulson's new rating system will keep investors safe from penny-stock scams. He says any investor who needs warning flags should probably not be investing in Pink Sheets-listed companies.
But some give Coulson high marks. "Coulson's done a great job of bringing the Pink Sheets into the modern era," says James Angel, a finance professor at Georgetown's business school. In the past, Angel notes, anyone wanting to trade a stock listed on the Pink Sheets would have to get a broker to find the best price from the few market makers who dealt in that security. By putting broker-deal quotes online, he says, Coulson has made the market "much more transparent and much more efficient."
Regulators are also generally pleased. "It's yet to be seen how effective these steps will be in deterring the bad guys, but they are steps in the right direction," says Walter Ricciardi, the SEC's deputy director of enforcement.
Still, it's unlikely that Coulson can tame the over-the-counter market or that all investors will heed the warnings he hopes to provide. "If you think of the New York Stock Exchange as the Cadillac of the markets and the Nasdaq as the Lexus, the Pink Sheets is the stuff that's left out on the street for people to pick up for free," explains Angel. "And in much the same way you can see somebody throw out something perfectly good on the street, you will also find a lot of junk out there as well."
Spamalot. The junk attracts the most attention. In March, the SEC moved to suspend trading in 35 Pink Sheets-listed companies whose stock price appeared to have been manipulated by touts sending out millions of E-mails with stock tips. Called Operation Spamalot, it reflects a new focus on stock spammers in the over-the-counter market, one that SEC officials say will continue.
The rise of the Internet means that stock touts no longer need a boiler room and cold calls. Stock spam can pump a stock faster and more cheaply, with one recent study noting that target stocks purchased before the spam started and sold during it averaged a nearly 6 percent return, often in just a few days. The investors who bought into the E-mail hype generally lost about that much. That doesn't stop them from sometimes trying to beat the scam. "But it's like playing against the house in the casino," says the SEC's John Polise, who specializes in micro-cap fraud. "You will lose."
The problem for Coulson is that well-publicized stock manipulations on the Pink Sheets obscure the fact that there are well-run and profitable companies listed there, often trading at large discounts to exchange-listed rivals. There are solid community banks that already follow stringent federal reporting requirements, large overseas companies like Nestlé and Wal-Mart de México that are comfortable with just being listed on their home exchanges, and promising small companies with real revenues that can't justify the regulatory costs of listing on a true exchange.
Yet such promising companies often trade next to OTC issues with less than $100,000 in annual sales, "zombie companies" that remain listed even though they aren't going concerns anymore, and shells that seem to be there only to lure unsuspecting investors.
The trick for investors is to be patient and do some sleuthing, says Berger of Walker's Manual. "There are many companies here that are as legitimate as they can be," he says, noting, for instance, that the 99-year-old maker of the Etch A Sketch, the Ohio Art Co., trades on the Pink Sheets. "You can sometimes find these companies trading at much more attractive valuations."
Not all investors think before they leap, of course. The lure of quick gains on a long shot is what will always attract many small investors to the Pink Sheets. It's "like the kiddie pool at the swim club," Angel says. "It's too small for the adults, but the little people have a great time."
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