Markets

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

It's amazing how ridiculous the story of an over-the-counter stock has to get before it starts making headlines in the financial press. 

A couple of years ago it was Cynk Technology Corp., which swelled in value -- at least theoretically -- to more than $6 billion for about an hour. Not bad, considering the company had no assets, no revenue and one employee.  

This week it was Neuromama Ltd., whose shares were banished to the "grey market" after its market cap bloated to $35 billion on very thin (and suspected manipulative) trading. What exactly is Neuromama's business model? Well, the company hasn't reported its financials since 2013, so it's hard to know for sure. But there's a search engine and a variety of other endeavors that are sort of a moving target. Here, maybe the clown in this YouTube video will help explain it all. 

Oh, Mama!
Shares of Neuromama were suspended, then relegated to the "grey market," after surging in OTC trading
Source: Bloomberg

The funny thing (besides the clown) is that ridiculous stories are not a bug of penny-stock trading, but a feature. Authorities, like the financial press, have long been too outnumbered to track down every scam, especially those that don't rise to absurdist levels.

As a result, it's likely that the best strategies for these markets is either to be a pump-and-dumper yourself or, if the potential for prison does not fit into your risk tolerance profile, attempt to learn to recognize when a stock is being pumped and when it's about to be dumped. Take it from the poster boy of penny-stock trading himself, self-described "rich douche bag" Tim Sykes, who writes

The key to successful trading is just to accept that fraud is rampant in penny stocks and use each stock/press release/pattern to try to grow your account and then move on.

To his credit, Cromwell Coulson, CEO of OTC Markets Group, has gone to great strides to polish the image of trading in stocks that don't meet the requirements, or don't have the desire, to list on Nasdaq or the New York Stock Exchange.

In an effort to separate the OTC wheat from the chaff,  it operates three different markets with varying degrees of financial-disclosure requirements for its stocks. It has created indexes to track OTC markets in general, highlight the blue-chip international companies traded on them as well as companies bigger than $1 billion in market cap and those paying dividends. OTC Markets also recently struck an interesting partnership with Morningstar, which will provide "quantitative equity ratings" for some OTC stocks. 

And, most important, the company cooperates with regulators in cases like Neuromama, while marking suspected scams with a skull-and-crossbones and blocking price quotes. 

Yet it's a tricky business because the chaff is arguably the bigger business opportunity based on the number of stocks listed on the three marketplaces and the dollar value of trading volume. The Pink market, or what the company calls "the Open Market," accounts for the vast majority of stocks on its markets.  

Proceed With Caution
The Pink market, which requires minimal disclosures to investors, dominates OTC trading
Source: OTC Markets

As OTC Markets describes the Pink market: 

With no minimum financial standards, this market includes foreign companies that limit their disclosure, penny stocks and shells, as well as distressed, delinquent, and dark companies not willing or able to provide adequate information to investors. As Pink requires the least in terms of company disclosure, investors are strongly advised to proceed with caution and thoroughly research companies before making any investment decisions.

Some may argue the best way to proceed with caution is to avoid this market altogether. Still, it's easy to see how this type of Wild West market could allure retail traders' inner gambler.   

And there's good reason to believe that the allure of the OTC markets could become even stronger, if Coulson's optimism is in the right ballpark. He has been promoting his markets as the place to go for small companies to seek liquidity for their shares after raising capital through Internet crowdfunding, which has become much easier thanks to what's known as Regulation A+ under the Jumpstart Our Business Startups (JOBS) Act.

OTC Markets has developed an "on-ramp" program for companies to have shares traded on the OTCQX and OTCQB markets, which are more stringent than OTCPink when it comes to financial and disclosure requirements. (The template is Elio Motors, the maker of three-wheeled cars, which began trading on OTCQX in February after raising money through crowdfunding.) Only time will tell how many companies take that on-ramp and how many end up taking the offramp onto the Pink market.

Like many financial stories of the day, this one may boil down to how millennials respond. Coulson envisions millennials flicking left or right to make decisions on what companies they would like to invest in, similar to how they would use a dating app like Tinder. 

If that's the case, they'd be wise to approach OTC Markets the same way they should approach Tinder (or a three-wheeled car, for that matter): With a great deal of skepticism.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net