OTC Brokers

OTC refers to over-the-counter, thus OTC brokers are over-the-counter brokers. But, what exactly is OTC and what is the function of OTC brokers? Broadly speaking, OTC brokers might trade in unlisted stocks, bonds, and derivatives. Financial instruments classified as over-the-counter are categorized so because they are not traded on a formal exchange, such as a stock exchange. Unlisted stocks are one example. Bonds, which are examples of debt securities, are OTC because they are generally sold by a network such as banks and other financial institutes. And, derivatives are contracts involving two entities, which are not sold through exchanges, but rather OTC brokers.

Often, investors are confused by the term unlisted stock. They do not understand why it is not bought and sold on any of the stock exchanges. The answer to this is simple. The company that has issued the stock does not meet the criteria of any exchange. Therefore, they cannot sell the stock in that manner. They must find other ways to create interest, and ultimately sell the stock to investors. This is done through OTC brokers who negotiate the deals. Frequently, people are also confused about the role of NASDAQ. Many believe that because NASDAQ has its own dealer network, that the stocks listed there are considered OTC. This is not true. NASDAQ is a stock exchange, and those stocks are not OTC.

In 1990, the OTC Bulletin Board (OTCBB) was created as a result of the The Penny Stock Reform Act which required the SEC to develop an electronic system to publish quotation and last-sale information. The OTCBB is basically a way for subscribers to view real-time quotations, and know what trade activity has transpired in terms of volume and price. It may include regional, national or foreign securities. Two complaints about these OTC stocks, however, are apparent. First, sometimes companies who have tried to get their stocks listed were denied due to credit issues or some other misconduct. The same due diligence that goes into accepting a company's stock to the exchange is not existent here. Second, there are many penny stocks.

Another method of discovering OTC trades is through "pink sheets". Stock symbols from companies trading in this manner end in the letters "PK", derived from the fact that the sheets were originally made from pink paper. Again, the companies who sell their stocks on the pink sheets generally cannot be listed on any stock exchange, for various reasons (and not always negative reasons). Bonds were published on "yellow sheets". Now, due to the electronic distribution of information, the color of the sheets is non-existent, but the names are still used. In fact, the names are quite old dating back to 1913 when the National Quotation Bureau (NQB) started with the purpose of supplying information to investors and traders about OTC stocks and bonds. The company's name was eventually changed to Pink Sheets LLC, then to Pink OTC Markets Inc, and now, its legal name is OTC Markets Group, Inc. The service provided is called OTC Link.

Additionally, the Pink Sheets, or OTC Markets Group, Inc has established tiers for OTC stocks which include OTCQX (the cream of the crop), OTCQB (companies that report to either the SEC or a US banking regulator), OTC Pink (no reporting standards), Grey Market, and Caveat Emptor (obviously the most risky level of OTC trading).