Investors roll out the red carpet for pink-sheet stocks

Pink-sheet stocks, which represent thousands of public companies not listed on any U.S. stock exchange, are gaining appeal among some investors, thanks to increased efforts to hold the companies more accountable to shareholders.

In a little more than a year, the total OTCQX market capitalization has ballooned to nearly $400 billion, up from $486 million in March 2007, according to Pink OTC Markets Inc., a New York-based platform linked to 260 broker-dealer firms responsible for the trading of more than 5,000 pink-sheet stocks.

Total pink-sheet dollar trading volume hit a record $163 billion last year, which was up 44% from $113 billion in 2006 and up 919% from $16 billion in 2001.

Much of the recent growth on the pink-sheet markets has been driven by an influx of foreign companies taking advantage of a Securities and Exchange Commission rule change last year that allows companies to de-list from U.S. exchanges as long as less than 5% of their worldwide trading volume takes place in this country over the previous 12 months.

Trading pink-sheet companies is still not for everyone and is even compared to casino gambling by some financial advisers. But the increased trading volume among such companies is considered a sign that the market is emerging from the shadows.

Much of the newfound credibility of pink-sheet stocks has been tied to the effect of such international heavyweights as athletic-goods manufacturer Adidas AG; Air France-KLM SA; British Airways PLC; the world’s No. 1 food company, Nestlé SA; pharmaceutical giant Roche Holding Ltd.; and AB Volvo.

“Some of these large companies were spending over $10 million a year to be compliant on U.S. exchanges,” said Andrew Kyzyk, director of business development, working primarily with foreign companies at Pink OTC Markets.

Of the roughly 5,000 pink-sheet companies, 400 are based outside the United States, he said.

In stride with the de-listing trend among foreign companies, Pink OTC Markets has ramped up its coverage of all pink-sheet stocks in an effort to increase transparency, and pressure companies to be more shareholder-friendly.

RANKING SYSTEM

The seven-tier ranking system, which rates companies from “premier” to “toxic,” was enough to light a fire under management this year at White Mountain Titanium Corp.

The Vancouver, British Columbia-based mining company was moved into the “toxic” category in December after missing one filing on the Vancouver Stock Exchange.

The company responded by updating the filing and was eventually moved up seven tiers to the “transparent” category.

“Whether these companies like it or not, they’re on the pink sheets, and we’re just trying to give them the highest possible visibility,” Mr. Kyzyk said.

Pink sheets, so named because such companies were originally listed 80 years ago in binders printed on pink paper, are different from stocks listed on U.S. exchanges and the over-the-counter bulletin board in that they aren’t required to make public filings to the SEC.

Companies are often forced off exchanges and onto the pink sheets for not meeting various exchange requirements related to issues such as minimum market capitalization.

The cost of listing on an exchange, filing SEC documents and paying for regular audits is also driving a lot of smaller U.S. companies to the pink sheets, according to Jim Kennedy, president of Marathon Capital Management LLC in Hunt Valley, Md.

“With the advent of Sarbanes-Oxley and all the increased cost of being public, a lot of companies are choosing to go dark or de-list,” said Mr. Kennedy, who manages $175 million in mostly smaller-cap-stock portfolios for clients.

EXTREME CAUTION

He added that he won’t buy pink-sheet stocks for clients, but he does own some in his personal portfolio.

Failing to file certain public documents, regardless of where a company is based, might get a company downgraded by Pink OTC Markets, but there are no requirements for companies to react, which is why advisers often approach pink sheets with extreme caution.

“Pink sheets have always been the hunting ground for scallywags,” Mr. Kennedy said. “As an investor, you’re betting on management’s honesty and integrity.”

The biggest challenge is often sifting through the wreckage of the various companies that end up on the pink sheets, according to Jeffrey Camarda, owner of Camarda Financial Advisors Inc. in Fleming Island, Fla.

“We’ve dabbled in the pink sheets, and there are good companies there, but it’s so much harder to separate the gold from the garbage,” said Mr. Camarda, who manages $250 million for clients. “We have a lot of analytical power here, and we have a hard enough time getting information on real companies.”

Beyond whatever level of transparency a company is willing to provide, there are also the matters of liquidity and often wide bid and ask spreads.

“As an investor, you need a lot of patience to be able to weather what could happen, because this is much more difficult than trying to buy and sell on the New York Stock Exchange,” said Suzanne Stepan, a portfolio manager with Utopia Funds in Traverse City, Mich. “We try to keep our minds open to all areas of the market, but right now, it doesn’t make sense to look at pink sheets when you’ve got stocks on sale all over the market.”

E-mail Jeff Benjamin at [email protected].