A Look at Over-the-Counter Equities Trading

When it comes to equities trading, movements of share prices on major stock exchanges like the New York Stock Exchange and Nasdaq tend to dominate headlines. But every day, millions of equity trades are made off the stock exchanges in what’s known as over-the-counter (OTC) trading.

What Is OTC Trading?

OTC trading generally refers to any trading that takes place off an exchange. A host of financial products trade OTC, including stocks, bonds, currencies and various derivatives. It’s a massive part of the global financial market, with OTC trading in certain types of financial products accounting for billions of dollars in trades daily.

OTC trading in equities can occur for:

• stocks that are listed on an exchange (generally referred to as “exchange-listed stocks”) and
• stocks that aren’t listed on any exchange (generally referred to as “unlisted equities” or “OTC equities”).

Exchange-listed stocks may be traded either on a stock exchange or OTC. In contrast, unlisted equities only trade OTC. OTC trading for both exchange-listed stocks and OTC equities can occur through a variety of off-exchange execution venues, including alternative trading systems (ATSs) and broker-dealers acting as wholesalers.

When Can Exchange-Listed Stocks Trade OTC?

Exchange-listed stocks trade in the OTC market for a variety of reasons. For example, when an institutional investor is making a large trade (think thousands of shares), they sometimes prefer to do so OTC for the pre-trade anonymity—and potentially price stability—that an OTC venue can provide. Institutions and broker-dealers don't necessarily want to publicize their trading strategies. If a large institution or brokerage firm attempted to make a block trade on an exchange, the market might react in such a way that pushes prices in a direction unfavorable to the institution or firm.

In other cases, even smaller trades in exchange-listed stocks might occur through ATSs, single-dealer platforms (SDPs) or wholesalers where the firm believes that it can obtain a better price through these OTC execution venues than on an exchange.

Why Are Certain Stocks Unlisted?

There are a number of reasons why a company’s stock might be unlisted. A company must meet exchange requirements for its stock to be traded on an exchange. A number of companies are traded as OTC equities because they’re unable to meet exchange listing requirements, such as the threshold for the number of publicly traded shares or the minimum price per share.

Other larger companies are traded OTC because they’ve been delisted from the exchanges for failing to continue to meet listing standards. This often includes companies seeking bankruptcy protection.

American Depositary Receipts (ADRs)—certificates representing a specified number of shares in a foreign stock—might also trade as OTC equities instead of on exchanges. That can include ADRs for large global companies that have determined not to list in the US.

Where Can I Find Information About OTC Trading?

OTC trades in exchange-listed stocks—whether occurring on an ATS or otherwise—must be reported to a FINRA Trade Reporting Facility (TRF). Along with trades that occur on the exchanges, OTC trades in exchange-listed stocks reported to a FINRA TRF are published on the consolidated tape, an electronic system that provides real-time data for listed securities.  

Transactions in OTC equities must be reported to the FINRA OTC Reporting Facility (ORF) for real-time public dissemination. 

FINRA also publishes aggregate information about OTC trading activity for both exchange-listed stocks and OTC equities, both for trades occurring through ATSs and outside of ATSs. Additionally, FINRA publishes a variety of information about OTC equity events, such as corporate actions, trading halts and UPC advisory notifications, among other things.  

What Are the Risks of Trading in OTC Equities?

All investing involves risk, but there are some risks specific to trading in OTC equities that investors should keep in mind. Compared to many exchange-listed stocks, OTC equities aren’t always liquid, meaning it isn’t always easy to buy or sell a particular security. If you’re seeking to sell your OTC equities, you might find yourself out of luck because you simply can't find a buyer. Additionally, because OTC equities can be more volatile than listed stocks, the price might vary significantly and more often. 

But perhaps the greater risk to OTC equity investors is that there are fewer disclosure requirements for many unlisted companies. A company that’s listed on a U.S. exchange must follow disclosure rules that require it to file regular reports and financial statements with the U.S. Securities and Exchange Commission (SEC). These materials, which are available to the public on the SEC's EDGAR database, are helpful for investors seeking to gain a thorough understanding of a company's performance and financial health.

By contrast, an OTC equity issuer may or may not be required to file these reports. Some OTC equity issuers do file regular reports with the SEC like listed companies, and some non-SEC reporting OTC equity issuers might make certain financial information publicly available through other avenues. However, not all do. This means information available to investors about the company could be limited or incomplete. A company might appear to be an attractive investment, but judging its performance and prospects can be difficult without seeing details about its earnings, debts, operating expenses and other critical financial information.

The adage “know before you invest” can be hard to live up to when it comes to non-reporting companies in the unlisted market. Before investing in OTC equities, research the company as much as possible and consult with your investment professional to make sure the investment is suitable for your financial profile.

Learn more about investing in stocks.