OTC Overview

OTC stands for over-the-counter, a method of trading stocks before they are listed on formal exchanges. These transactions can occur directly with company owners or through brokers. In the United States, listed companies trade on either the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (NASDAQ).

Companies not listed on the NYSE or NASDAQ can sell equity in their businesses over-the-counter. Other financial securities traded off-exchange, such as bonds, derivatives, currencies, and other complex instruments, are also considered OTC.

What are the different OTC markets?

There are primarily two types of over-the-counter stock quoting services, through which companies and investors can submit offers to buy or sell stocks via brokers.

OTC Market Group Overview

OTC Markets Group is a company that provides over-the-counter stock quoting services. It was initially established in 1913 as the National Quotation Bureau, providing brokers with lists of stocks and bonds available for quantified purchases. Stocks were listed on pink sheets of paper, and traders referred to these available OTC stock lists as "pink sheets," which became the company's name in 2000.

The company was renamed OTC Markets Group in 2010, providing the highest electronic quoting platform for brokers in the network, currently with three quoting tiers. OTCQX is reserved for established companies with significant financial disclosure requirements; OTCQB is designed for smaller companies but still with no bankruptcies. Currently, the pink tier is an open market with no disclosure or reporting requirements.

Over-the-Counter Bulletin Board

The Over-the-Counter Bulletin Board (OTCBB) is a quoting service hosted by the Financial Industry Regulatory Authority (FINRA), a non-profit, non-governmental regulatory body created by legislative authority from the Securities and Exchange Commission (SEC). OTCBB is a venue for trading securities of companies not listed on exchanges, where trades are reported to the SEC and can be listed on both OTCBB and OTC Markets Group.

Grey Market

Not all OTC securities are listed on OTCBB or OTC Markets Group. Many trades are conducted or have never been publicly listed.

These securities are understood to trade on the "grey market."

How does the OTC market work?

The OTC securities market operates much like any other product. Interested buyers seek products and propose the highest price they are willing to pay, while product owners have a minimum amount they are willing to accept; if the received price meets the minimum, a trade can occur.

OTC quoting services continually update the price buyers are willing to pay (bid) and the price sellers are willing to accept (ask). When bids reach the asking price, market makers intervene to facilitate the trade—they purchase the product from the seller and then resell it to the buyer.

Brokers often present buy or sell prices on behalf of clients. Alternatively, in some cases, brokers may also act as investment firms trading securities for themselves. In these instances, the firm is referred to as the broker.

Some traders also act as market makers, purchasing directly from sellers. Sometimes, OTC trades may occur without being published by quoting services. These so-called "grey market" trades may be facilitated through brokers who directly know buyers and sellers, and if buyers and sellers are in contact, they may strike a deal. Alternatively, OTC trades may occur directly between business owners and investors.

How to buy OTC stocks?

The most common way for retail clients to purchase over-the-counter stocks is by opening an account with a broker. Many companies that allow you to trade on stock markets also permit over-the-counter trading.

Over-the-counter trades cannot be directly purchased from OTCBB or OTC Markets Group; all trades go through market makers except for individual investors.

It's important to note that all investments involve risks, and investors should carefully consider their investment objectives before investing.

Can stocks move from OTC to NYSE?

Yes. Companies not listed on exchanges like the New York Stock Exchange (NYSE) trade over-the-counter. Typically, companies are too small to go public, or sometimes they cannot afford the listing costs. When companies grow large enough and meet listing requirements for exchanges, they can choose to "go public." Through an Initial Public Offering (IPO), companies can transition from the over-the-counter market to Wall Street.

While many companies trading over-the-counter have stock prices below $5 (referred to as penny stocks), this isn't always the case. Companies may be unable to meet exchange requirements for various other reasons, with the most common being failure to submit financial reports to the U.S. Securities and Exchange Commission (SEC); or the company recently faced bankruptcy. In such cases, once the issues are resolved, companies can list on one of the exchanges.

What's the difference between over-the-counter and exchange trading?

Centralized exchanges like the New York Stock Exchange (NYSE) or NASDAQ have specific listing requirements and are tightly regulated by the U.S. Securities and Exchange Commission (SEC). In contrast, over-the-counter stock trading between investors lacks strict disclosure requirements or direct government oversight.

For example, to list on the New York Stock Exchange, a U.S. company must have:

• At least 1.1 million shares of publicly traded stock
• 400 unique shareholders
• A market value of at least $40 million
• A stock price of at least $4.00

Companies must pass an earnings test, demonstrating at least $10 million in accounting profits over the past three fiscal years, with at least $2 million annually in the first two years and no net losses over the three years.

In addition to these standards, listed companies must meet certain governance requirements, provide audited financial records, and comply with SEC regulations.

OTC stocks do not have the same level of regulation, thus carrying greater risks compared to listed companies. Many are traded on open markets with little to no oversight.

Is the OTC market safe?

Every investment carries a degree of risk. Therefore, any investment can lose some or all of its value. However, when investors have reliable information, they can better understand the risks they are undertaking.

That's why companies listed on exchanges must provide extensive detailed information about their finances, activities, and management, which must be audited and accurate, or they may face criminal charges.

Securities traded in over-the-counter markets do not require this level of data. Therefore, understanding the level of risk associated with the investment itself may be more daunting. Additionally, companies traded over-the-counter are typically in the early stages of their lifecycles, making them more prone to failure as they are not yet fully established.

Advantages and Disadvantages of the OTC Market

Through the OTC market, you can own a stake in a company before it goes public.

Advantages

Through the OTC market, you can get in on the ground floor of a company before it becomes big. As the company grows, the value of your stocks increases exponentially. Imagine buying into a company like Amazon when it was just starting out, for a few cents per share. As the company grows, the value of your stocks grows along with other buyers.

Disadvantages

Most companies trading over-the-counter are not listed on exchanges for a reason. Some investments may have no chance of making money at all. Additionally, you may not have access to accurate information or may have no financial statements at all.