Investors Be Alert—“Penny Stocks” Can also Trade on Exchanges

In my most recent blog post, Capital Raising During Times of Uncertainty—Issuers Beware!, I discussed the issues facing small and micro-cap companies as they confront critical funding issues and the heightened need to secure growth capital. The companies that do all the right things and provide quality disclosure deserve a public market that provides a mechanism for investment funding to keep their businesses going.  However, some may still fall victim to bad actors. We cautioned issuers to beware of “too good to be true” financings with terms that dump shares, dilute shareholder value and destroy companies.

While we focused on OTC-traded companies during these turbulent times, there are exchange-listed small and micro-cap companies facing the same challenges.  They too will be fighting for their survival and will find themselves doing whatever it takes to access funding and maintain their listings.

My latest piece touches on key points investors should research when looking for new opportunities and assessing risks for investing in publicly traded small and micro-cap companies.

Did you Know that Over 200 “Penny Stocks” are Listed on the Exchanges?

Because of recent market volatility and economic distress, there are currently over 200 exchange-listed companies that fall under the financial standards of minimum revenue, net tangible assets or stock price that define “Penny Stocks” under SEC Rules.  Investors often operate under the presumption that any company or fund that is publicly traded on a national exchange such as Nasdaq or NYSE is inherently a ‘safe’ investment and relatively free from risk.  Were it not for a National Securities Exchange listing exemption, which is predicated on companies meeting other listing standards, these securities would be subject to the Penny Stock resale restrictions. Our OTCQB Venture Market can play an important role in giving these companies a way to continue providing disclosure to investors as they address their current financial or economic challenges in a cost effective and time efficient manner.

The continuing listing standards that usually remove most penny stock-type securities from exchanges may soon no longer be in place.  In a recent filing with the SEC, Nasdaq proposed to grant companies whose shares have fallen below $1 an additional grace period to raise their stock prices before the threat of being de-listed, and to provide companies with market values that fall below Nasdaq’s required minimum pricing additional time to cure.  If approved, this will only increase the number of securities that would be considered penny stocks were it not for the fact that they are listed on an exchange.

From the standpoint of a market operator that provides established public markets for thousands of early stage and growth companies, we understand the funding challenges and the broader systemic issues small and micro-cap companies face. These companies have always had to work harder to secure growth capital.  In the wake of unprecedented economic uncertainty, and in this same vein, earlier this month, OTC Markets announced it was providing relief to the companies trading on our OTCQX and OTQCB Markets.  However, we are not relaxing our prohibition against penny stocks trading on our OTCQX market.

Small and Micro-cap Companies Face Similar Challenges When Trading on an Exchange

Many of the challenges that advisors deem to be most problematic for small and micro-cap issuers trading on OTC Markets are the same as those for companies trading on an exchange.  Private placements, convertible debt, toxic and death spiral financing unfortunately become all too familiar

“solutions” for smaller companies regardless of where they are traded.  These challenges and corresponding actions are exacerbated by the current Covid-19 pandemic and its effect on the health of companies given the global economy.

However, there is a far greater danger that exists to the investing public in allowing such struggling companies to retain their listing on an exchange.  Why is that?  Because investors may be unaware that  the cache and prestige of national exchange does not insulate the public from risk.  It is important to understand that it is not the markets job to remove risk, instead it is to fairly price a security based on investor perceptions of future value, risks, supply and demand.

Investors Always Need to Carefully Read Financial Disclosures and Conduct Background Research

The fact is, independent financial analysis is how investors make superior returns and generate long term profits trading small and micro-cap stocks, whether they are listed on a national exchange or on the OTC market.  Investors meeting in an efficient and transparent public market is what creates efficient pricing.   Blindly buying a security harms both investor returns and market efficiency.

Quite often, investors may be lulled into a false sense of security simply because a stock is traded on an exchange or is actively traded.   All markets need public and investor scrutiny to operate effectively.  Although companies,  ETFs or other complex financial instruments may be traded on a national exchange, investors need to operate with caution and conduct their own research to independently ascertain the opportunity and potential risk.

Investors should be aware

Small and micro-cap companies’ trading prices and volumes can be distorted by stock promotion.  Digital platforms, social media and online investment newsletters provide public companies and investor relations professionals more immediate access to engage with a broader universe of potential investors. In this technology-driven environment, anonymous market manipulators will offer seemingly independent commentary on investment research websites that may in fact be part of paid stock promotion.

Promotion, misinformation, or fake news can affect securities across all markets.  In the past year, dollar volume in promoted securities listed on a national exchange was $105 billion. Over the same period, promoted securities on the OTC market traded $547 million in dollar volume.[1]

From an investor protection standpoint, and often less understood by issuers and investors alike, is that companies that traditionally could not meet the Nasdaq $1.00 minimum standard would remain freely tradable even after being delisted.  Those companies would move to one of the markets operated by OTC Markets Group, where they would still be traded electronically by the same market makers who traded those securities on the exchange(s).  Investors would thus benefit from the same price discovery and trading experience.

What Happens if Companies are Delisted from an Exchange?

Our most recent comment letter to the SEC on Rule 15c2-11 includes our proposal that exchange delists should have a 90-day exemption under which they should be able to be quoted on our markets so that investors have continuity.  It would provide an easy-on, easy-off access point for those companies and their investors tailored to these specific situations.  Companies not able to publish current information in the 90-day grace period would move to an Expert Market for sophisticated investors.  This would  make for a softer landing spot for a lot of companies, including those that may find themselves struggling in a time of crisis.

If those same companies were to be delisted from an exchange, allowing them to then trade on OTC Markets, several things might occur:

1) They would be appropriately classified and identified as “penny-stocks” making it easier for investors to research and analyze risk 2) Investors would have access to the promotion tracking and risk flags that OTC Markets makes publicly available for the securities traded on our markets 3) Companies may find a more appropriate home on our markets, where they will not be subject to the higher fees and costs necessary to maintain an exchange listing  4) If a company chooses to do so, it can take some time to focus on its business versus worrying about meeting an artificial exchange standard.  Then, when the timing is appropriate, that same company can reapply to Nasdaq when ready.

Now more than ever, we are empathetic to these companies but also want to caution investors to do their own analysis when evaluating a company.  Investors need to look at the fundamentals of the company instead of focusing on where they are traded.  There are still red flags to look out for, regardless of the market on which a company chooses to trade.  Make sure you are looking to a source that requires specific disclosure.

Not all small cap and micro-caps are created equal, nor should they be perceived to be “Blue Chip” simply because they trade on a larger exchange.  Responsible investors should scrutinize every potential investment before they click buy, regardless of the market.  Most importantly, we encourage all investors to remain vigilant.  Market volatility creates many opportunities: smart investors win, and speculators lose.

[1] Based on dollar volume in securities while promoted between April 1, 2019 and March 31, 2020.



Jason Paltrowitz is Executive Vice President, Corporate Services at OTC Markets Group, where he is responsible for managing the firm’s international and domestic Corporate Services business. Drawing upon his expertise in cross-border trading and as a recognized proponent of Reg A+ and small company capital raising, Jason is an advocate for small cap issuers, start-ups, and entrepreneurial innovators working to alleviate the cost, time and complexity associated with being a public company. Prior to joining OTC Markets in October 2013, Jason was Managing Director and Segment Head at JP Morgan Chase responsible for the custody, clearing and collateral management business in the Corporate and Investment Bank division. Jason also held multiple senior management positions at BNY Mellon, most notably, as Head of M&A for the Financial Markets and Treasury Services Sector and 11 years as the Head of the Global Capital Markets Group in the Depositary Receipt Division. Jason currently serves on the Board of Directors of the Crowdfunding Professional Association (CfPA) and also served as a member of the Board of Directors at OTC Markets Group from 2008 – 2011. Jason holds a Bachelor's degree in International Relations from Boston University and received his MBA from the NYU Stern School of Business.

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