OTC Market Compliance
The Over The Counter Market for trading shares was the original way to transfer securities. In order to mitigate risks for investors, new authorities and regulatory documents were created to lower scams and fraudulent transactions. Today, the OTC market still exists, but has more regulation than its formation in the 1700s. There are thousands of securities that have been traded in the OTC Market, so there are some benefits to working within this pool of investors and traders.
History Of OTC Markets
Before formal exchanges were established, most shares and securities were traded over the counter and are known for some of the dodgiest deals. Although OTC securities have low liquidity a few trades could change their price rapidly. Later, the National Association of Securites Dealers (NASD) and the Financial Industry Regulatory Authority (FINRA) were established to help regulate pump-and-dump schemes in the OTC Market.
Trading was inefficient during this era so it was almost impossible to establish a fixed stock price. Pink Sheets was a paper-based system that was used for unlisted securities. Later, the Pink Sheets were transitioned to an electronic quotation system that operates on multiple platforms.
The Layout Of OTC Markets
Since the OTC comes with fewer barriers to participation in exchanges, some higher risks and challenges may limit the amount of reliable information that investors can access.
The three markets include:
- OTCQX: The top-tier market with the most requirements
- OTCQB: “Venture Market” that has fewer requirements than OTCQB, but more than the Pink Market
- OTC Pink Open Market: Formally “Pink Sheets” and has many small speculative companies and the lowest requirements.
The OTC divides issuers into three levels and has different financial statements and investors. The OTC Pink Open Market is the tier with the highest risk, so it is further divided into Current Information, Limited Information, and No Information. There is no central location for OTC trading and are no standardization.
How Is The Market Regulated?
In today’s market, the OTC market is regulated by the SEC and FINRA. SEC focuses on the regulatory framework while FIRNA focuses on the day-to-day operations. Regulations now require disclosure requirements, due diligence, and other specific information. Broker-dealers need to gather specific information about the issuer of the security. Checking that the information is up to date and is available to the public is typically a sign that the company is reliable.
FINRA’s responsibility is to monitor all trading activities and will also handle disputes. Broker-dealers need to submit specific forms before going through with a purchase in order to be compliant. If a company is not compliant, it will be bumped to a lower tier or moved to the Pink No Information category.
Benefits For Smaller Companies
The OTC market does not require companies to file with the SEC in order to be on the platform. While some companies still do, the OTC Markets have large companies and small businesses that are looking to trade securities. Because there are lower standards and fewer legal hoops to jump through, small businesses can gain capital without filing through major exchange markets. There are financial and suspension consequences for not meeting regulations which could reduce your trustworthiness as a company.
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Frequently Asked Questions (FAQs) on OTC Market Compliance
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What is the Over-the-Counter (OTC) Market, and how does it work?
The OTC Market is a decentralized market where securities are traded directly between parties without a centralized exchange. Historically, this was the original method for trading shares before formal exchanges existed. Today, the OTC Market offers different levels of participation, with varying regulatory requirements, allowing companies of all sizes, including smaller businesses, to trade securities.
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What are the different tiers within the OTC Market?
The OTC Market has three main tiers:
- OTCQX: The top tier with the highest requirements and most reliable companies. ● OTCQB: Known as the “Venture Market,” which has fewer requirements than OTCQX but more than the Pink Market.
- OTC Pink Open Market: Formerly known as Pink Sheets, this tier includes small, speculative companies and has the fewest requirements. It is subdivided into Current Information, Limited Information, and No Information based on the disclosure provided.
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How is the OTC Market regulated?
The OTC Market is regulated primarily by the SEC and FINRA. The SEC establishes the regulatory framework, while FINRA oversees daily operations, monitoring trades, and handling disputes. Broker-dealers in the OTC Market must follow specific disclosure and due diligence requirements to ensure transparency and protect investors.
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Why might smaller companies choose to trade on the OTC Market?
Smaller companies often trade on the OTC Market due to its lower regulatory requirements and reduced filing costs compared to major exchanges. This enables them to gain access to capital with fewer barriers. However, companies must still meet specific disclosure standards, as failure to comply can result in financial penalties or a downgrade to a lower OTC tier.
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What are the risks associated with trading on the OTC Market?
The OTC Market generally presents higher risks due to lower disclosure requirements and potential information gaps for investors. Some OTC tiers, such as the OTC Pink Open Market, have minimal requirements, increasing the risk for speculative investments. Investors should exercise caution and conduct thorough research when trading in the OTC Market.