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Say "Pink Sheets" and most people think, "Stay away." Why is there a stigma attached to the stocks that trade on the Pink Sheets? Many people don't know much about them except that the SEC doesn't regulate them. Since many attractive Canadian mining companies' shares trade on the Pink Sheets, we thought it would be worthwhile to talk with Kevin Hudak, an investment advisor who specializes in helping his customers buy shares that trade on the Pink Sheets and educating them about the pros and cons. Kevin, with Financial Network Investment Corp. in Albuquerque, NM, specializes in energy, precious metals and uranium, and says he "can trade stock sold on any major exchange in the world."

Some Background on the Pink Sheets

The Pink Sheets — named for the color of paper the quotes were historically printed on prior to the electronic system — are secondary market sales of stocks that are available on the U. S. Over-the-Counter [OTC] market. "Market Makers" — the brokers who commit to buying and selling the securities of OTC issuers —use the Pink Sheets to publish bid and ask prices.

A company named Pink Sheets LLC, formerly known as the National Quotation Bureau, publishes the Pink Sheets in both hard copy and electronic format. Pink Sheets LLC is not registered with the SEC as a stock exchange, nor does the SEC regulate its activities.

We asked Kevin how a Pink Sheet is created. "Pink Sheets are created by market makers who handle individual stocks. These market makers are people who specialize in one or more individual stocks and their purpose is to help the market remain fluid. They will buy and sell out of their own account, depending on what individual investors want or need. That's the way it's supposed to work," he says.

"However," he adds, "this is one of the reasons why you have to be very careful when your broker places a market order - a market order can be anything the market maker wants it to be; whereas a limit order has very specific parameters. I use limit orders 99% of the time just for this reason - I don't want my client exposed to what a market maker thinks the market should be at that point in time. This is one reason why you don't want to be in a hurry buying companies on the Pink Sheets."

The fact that shares traded on Pink Sheets are unregulated makes some investors wary. And many Broker-Dealers steer unsophisticated investors away from them. In fact, under SEC regulations, brokers are not allowed to solicit the sale of the shares if they are under $5; they can only respond if asked about them.

Do Your Homework

We asked Kevin how he deals with the pitfalls of the unregulated aspect of the Pink Sheets. "They are definitely an unregulated secondary market," he responds, "although there is an inherent risk in all the stock markets. However, Pink Sheet securities carry more risk because they do not require the companies to register with the SEC or stay current in their financial statements. This is a case where an investor needs to know the company's management (extremely important), history, and future prospects."

He adds:

However, if you look at just Canadian public exploration and mining companies, there is a level of disclosure in that Canadian Securities Administrators have what is known as the NI 43-101. National Instrument 43-101 is a law that sets conditions under which public exploration and mining companies are required to publish technical reports. The content of the reports and the qualifications of their authors are specified by the Instrument. The purpose of the Instrument is to ensure that securities commissions and investors are informed on technical matters materially affecting the financial status of the listed companies.

The Instrument may be viewed here or here.

How does a company get traded on Pink Sheets? A market maker has to be willing to trade the stock. Says Kevin, "Many companies want to be traded in this secondary market for exposure to U.S. investors. This is beneficial to the company, since they are always looking for new money to expand their business. That's the only place in the U.S. market where they can be traded, owing to their size and/or nationality. The primary market covers larger companies with higher market caps, greater name recognition and stricter regulation. However, some companies don't realize they are on the Pink Sheets and I know of a few Canadian companies that do not want to be traded in the United States." He adds, "Reasons vary as to why this is so. Maybe it's national pride, desire to remain local, distrust of the U.S.? I really don't know why —I've asked and never really got an answer."

Easier than Buying through Canadian Exchange

We asked Kevin what advantages there are for U.S. investors if they buy shares of Canadian companies using the Pink Sheets instead of purchasing shares on the Toronto Stock Exchange [TSX] or the TSX/Venture Exchange.

For a U.S. investor, buying a Canadian company listed in the Pink Sheets means you don't have to open an account with a Canadian broker or find a broker who has Canadian access. Plus, you avoid the cost of currency exchange, both ways.

Pink sheet securities are OTC securities. They are not listed on exchanges, but are quoted in the daily publication issued by Pink Sheet LLC. They are all traded on-line; it's just a question of whether you use a broker or do it yourself. In the case of the Pink Sheets, the more eyes and ears you have, the better off you are because it is an unregulated secondary market. Read your newsletters, attend conferences and remain educated.

How liquid are pink sheet stocks? Kevin says occasionally he will run into one with no volume, but that's rare:

I assume all of us know that liquid means that we can buy and sell the stock in question in a specified period of time. The majority of the stocks traded on the Pink Sheets are traded every day, some are not. This is when a broker can be beneficial to the investor.

Would he say that Pink Sheets are hard to trade?

Saying they are hard to trade can be misleading. They can be time-consuming in reaching your goals using limit trading and watching market trends. The best way to invest in Pink Sheets is to know your market, the companies and the history of the stock market as a whole — the ups and downs that are temporary glitches and the long-term adjustments dictated by macro economic trends.

For more information, Kevin suggests visiting Pink Sheets and the SEC's information page on the Pink Sheets. Kevin can be reached at 505-980-2809.

Source: Understanding Pink Sheets Stocks