The Pros & Cons Of Buying Foreign Stocks OTC

Anyone who saw "The Wolf of Wall Street" is familiar with the shady reputation of over-the-counter (OTC) stock trading. The small size and lack of disclosure associated with many Pink Sheet companies exposes investors to the risk of deception and fraud.

However, stereotypical “penny stocks” are not the only companies that trade OTC in the U.S. Ever heard of Nintendo Co Ltd NTDOY? What about Samsung Electronics Co Ltd SSNLF? You won’t find either of these companies listed on the NYSE or the Nasdaq. For Americans that are unwilling or unable to trade these stocks in foreign markets, buying shares OTC might be the only option.

ADRs
Americans may be familiar with Nestle SA NSRGY’s delicious products, but the $200 billion company’s primary stock listing is on the Swiss market.

An American depository receipt (ADR) is a certificate issued by an American bank that represents shares of a foreign publicly-traded company. The ADRs of many foreign companies trade on major U.S. exchanges, including Baidu Inc BIDU, Vale SA VALE and Toyota Motor Corp TM. So why doesn’t Nestle’s ADR trade on a U.S. exchange?

SEC standards
In order for an ADR to list on an American exchange, the company it represents must meet all the typical NYSE or Nasdaq SEC disclosure requirements.
 

For a company the size of Nestle, costs associated with hiring a legal team specializing in U.S. market regulations would be quite large. However, since the company already meets the regulatory listings of the SIX Swiss Exchange, the Euronext, the Bombay Stock Exchange and the National Stock Exchange of India Limited, Nestle simply chooses not to officially list in the U.S. Instead, American investors must buy shares of its foreign stock OTC.

Pros of OTC
The biggest advantage of OTC trading is access. Nestle, Nintendo, Samsung, BMW BAMXY, Volkswagen AG VLKAY and Nissan Motor Co Ltd NSANY are all available to U.S. traders via OTC trading.
Timing is another advantage of OTC trading. Instead of the 24-hour schedule required to trade stocks listed in different markets all over the world, OTC trading allows U.S. traders to trade foreign stocks
during U.S. market hours.

Cons of OTC
Outside of the lack of SEC regulation, there are other disadvantages to trading OTC as well. OTC market makers frequently mark up the price of OTC stocks relative to their prices on foreign exchanges.

In addition, liquidity in the OTC market can be nearly nonexistent. For example, Samsung averages a daily OTC volume of around 37 shares. Lack of liquidity can also lead to extreme volatility, and OTC traders can see wild, costly swings in share prices.

Bottom line
While the typical concerns about OTC penny stock trading don’t apply to large foreign companies like Nestle, there are certainly risks involved in OTC trading. When considering OTC trades, traders should first make sure they understand exactly what they are getting themselves into.