OTC Stocks and the ‘Hotel California’ Problem

This is a reprint of my article originally published by equities.com.

Many smaller cap stocks are illiquid compared to their larger cap cousins. 40% of the ticker symbols traded on NASDAQ and NYSE have average daily trading (ADV) volumes of less than 50,000 shares per day, according to the SEC. The median ADV within this group is only 10,000 shares per day. 50% of these ticker symbols have ADV of less than 100,000 shares a day.

Adam Epstein, nationally recognized small-cap expert and author of the “Systemically Overlooked Anomalies of Governing Small-Cap Companies” chapter of the Handbook of Board Governance: A Comprehensive Guide for Public, Private and Not for Profit Board Members (Wiley, 2016), has said that investing in smaller-cap NMS companies with illiquid stock presents the “Hotel California” problem for investors: they can invest in the company, but because of the stock trading liquidity, it’s virtually impossible to exit their stock position: “You can you check out any time you like, but you can never leave.”1

The ability of smaller cap stocks with low trading volumes to attract non-toxic professional investment capital approaches ZERO for reasons illuminated in earlier articles of mine.

Stocks traded on OTC Markets—about three times the total number of companies listed on the NYSE and Nasdaq combined—have two Hotel California problems. The first is that for most OTC Markets traded issuers, their stocks are LESS liquid than NYSE/Nasdaq stocks. The daily trading volumes for many OTC Markets traded companies is in the HUNDREDS of shares a day, i.e., virtually ZERO trading volume. Increasing their companies’ stock trading liquidity was the #1 capital markets priority for 80% of the CEOs/CFOs of OTC Markets issuers in a 2017 survey.2

The second Hotel California problem presents itself in this circumstance: to sell one’s OTC stock (other than in a privately negotiated sale), it is necessary to deposit the paper certificates with a brokerage firm. It is very, very difficult to find a brokerage firm to take possession of paper stock certificates.

Consider this scenario. An OTC Markets issuer raises needed capital in a private placement and sells shares of stock at, say, $.50 per share. The investor receives a paper stock certificate for the shares it has acquired. The company’s business progresses over the next 12 months and its stock price increases to $2.00 per share on reasonable trading volumes. With the Rule 144 holding period having elapsed, the investor decides to sell the shares for what should be a nice 300% gain. The investor call its brokerage firm to sell the shares. Guess what?

The brokerage firm refuses to take custody of the shares, citing the firm’s compliance department as the reason. The investor calls a dozen other brokerage firms and cannot find any that is willing to take the shares.3 The investor is unable to sell its shares to monetize its gain.

This is a very, very serious problem for OTC Markets traded companies. In fact, if investors in OTC Markets traded companies actually knew how difficult it would be to sell their shares, it’s reasonable to think that many of them would not have invested in the first instance.

All is not lost. As noted in my earlier articles on Equities.com, there are lawful and effective strategies for increasing stock trading liquidity. Contact me through LinkedIn at linkedin.com/in/ronwoessner for more information on this topic.

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  1. Lyrics to “Hotel California” by the Eagles.
  2. Reported in the 2017 OTC Markets CEO/CFOs survey. The #2 priority was increasing the company share price, and the #3 priority was raising capital.
  3. I’ve been told there is at least one brokerage firm that will take possession of OTC Markets traded shares, and I’m told the sales transaction fees are very expensive.

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Author: Ron

Ron Woessner of Dallas, Texas is former Senior Counsel to the Financial Services Committee of the US House of Representatives where he was special advisor to the Chairman for capital markets and fintech matters. He founded Microcap Strategies building upon his 25+ years' legal and operational experience in the smaller-cap and startup company ecosphere in the capacity of General Counsel to two NASDAQ-listed companies and CEO of an OTC-traded company that he up-listed to NASDAQ.  Mr. Woessner, a certified Toastmaster, currently lectures and writes on the inhospitability of the US public markets to smaller cap companies and other capital markets topics. His articles are published by equities.com and elsewhere. He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities.