A quirky corner of the U.S. stock market home to cannabis sellers, cryptocurrency trusts and other speculative investments is seeing record levels of activity.
Trading volume in over-the-counter stocks, which aren’t listed on exchanges, has surpassed $548 billion so far this year. That is already more than the total volume for all 2020, according to OTC Markets Group, OTCM 0.90% the company that operates the main marketplace for such securities.
A big factor behind the surge is the bull market for digital currencies. The most popular OTC security this year in terms of value traded has been the Grayscale Bitcoin Trust, GBTC 9.87% which trades under the ticker GBTC. The trust is a popular way for investors to bet on the price of bitcoin without holding actual units of the cryptocurrency.
Like the conventional stock market, the OTC markets have seen an influx of individual investors since the start of the Covid-19 pandemic. Such investors are often drawn to penny stocks, or cheap shares of companies too small to list on an exchange. One forum devoted to penny stocks on Reddit has 1.8 million members.
Penny stocks are risky and have a history of being prone to manipulation schemes. But enthusiasts say they can pay off for investors willing to do research and find opportunities in undervalued companies.
Doug Bober, a 57-year-old store manager in Los Angeles, began trading stocks two years ago to build up his retirement savings. Most of his portfolio is now in penny stocks, such as Solar Integrated Roofing Corp. SIRC 0.97% , a California-based company that installs solar panels on the rooftops of homes and businesses.
“Sure, I can play a blue chip. But if I buy a blue chip, I have to put down a lot of money and wait for a long time” to get a substantial return, Mr. Bober said. “With a penny, if you find a good, solid company, the upside is phenomenal.”
Mr. Bober says his penny-stock investing has been profitable, but he adds that people who can’t stomach the risk should stay away. “It’s not much different from going to Las Vegas,” he said. “You could lose a lot of money.”
Several studies have found that investors tend to lose money on penny stocks. From July 2011 to October 2020, the average annualized return of OTC shares of U.S. companies was -44%, according to calculations by Sihan Zhang, a doctoral student at the University of Alberta.
Such figures exclude the largest chunk of today’s OTC securities: international stocks. Many foreign companies have shares or American depositary receipts that trade over the counter, including reputable firms such as Tencent Holdings Ltd. TCEHY -1.59% , Nestlé SA, NSRGY 0.23% Nintendo Co. and Roche Holding AG RHHBY 2.60% .
The OTC markets are also home to the securities of some riskier foreign companies, such as indebted property developer China Evergrande Group and Luckin Coffee Inc., LKNCY 1.50% the Chinese coffee chain delisted by Nasdaq last year in the wake of an accounting-fraud scandal.
Foreign companies can use the OTC markets to gain access to U.S. investors without needing to comply with American accounting and financial-reporting rules that may be redundant with the regulations in their home countries. They also save money on exchange listing fees. In all, of the roughly 11,500 securities traded over the counter, about three-quarters are from international companies.
“We’ve created a market in the U.S. to trade global securities,” said Cromwell Coulson, chief executive of OTC Markets Group. “It’s mainly international securities that are driving our dollar volumes.”
The Securities and Exchange Commission has sought to clean up abuses of penny stocks. Last week, an SEC rule change took effect that largely prohibits brokerage firms from quoting prices for OTC stocks unless the companies issuing those shares publish up-to-date financial information.
As a result of the rule change, brokerages such as Fidelity Investments and Charles Schwab Corp. imposed restrictions on buying such stocks. Close to 1,400 securities were affected at Fidelity, according to a company spokeswoman.
The SEC’s move was aimed at fighting fraudulent schemes involving the shares of companies that have gone “dark,” or become delinquent in reporting their financials. In some cases, such companies effectively became empty shells whose shares were hijacked by swindlers that attempted to manipulate the price of the stock.
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