Nasdaq is stuck with the Bulletin Board lease.
Nasdaq's Over-the-Counter Bulletin Board (OTCBB) – launched in 1990 after Congress hoped that Nasdaq and its parent, the NASD, could clean up the penny stock mess – is caught between a regulatory and market dilemma.
The OTCBB, which was designed to provide greater transparency and reassure investors that penny stocks were a legitimate form of trading, makes little or no money. That's even though the OTCBB, which is not a listing market, is in the midst of a small stock bonanza.
"This is a very important market. It is an incubator market for micro stocks. It is an important part of capital formation in the United States," said Nick Ponzio, chief executive of Hill, Thompson, Magid, a prominent OTC market maker.
One big Street player, Citigroup Global Markets, took the plunge when it embarked on plans to ratchet up the number of Bulletin Board names it trades.
Still, at the same time that Nasdaq is stuck with the OTCBB, today it has little ability to discipline sleazy companies. It presides over a marketplace that is an illustration of Gresham's Law (bad money drives out good money).
The problems for Nasdaq are regulatory and the nature of penny stocks. "A small minority of those stocks are questionable and many of the others are risky," according to another executive of an OTC firm.
But Nasdaq, which has an application pending with the Securities and Exchange Commission to become an exchange, would have some problems walking away from the OTCBB. How could it persuade regulators and dealers to accept it as an exchange when it ignores a very important part of the market?
A Nasdaq official dismissed this point, saying the exchange application had little to do with pulling out of the BBX plan last year. "It was merely an attempt to have a listing product that could be part of an exchange," he said. "Today, we operate it as part of the NASD, a registered securities association." Nevertheless, the official conceded that what happens to the OTCBB depends on the exchange application.
All parties agree that the OTCBB is serving a critical market. "Most of the companies in America are small companies. It is very important that the Bulletin Board is run well so companies will have access to capital," said Stephane Touizer, chief executive and founder of Microcap Feed, a market data and technology platform that covers the OTCBB.
But the dilemma for Nasdaq, in running the Bulletin Board, is the unique nature of its membership and the companies in the Bulletin Board. "You can't regulate the 3,500 stocks on the Bulletin Board the same way you regulate Microsoft and Intel," Ponzio said.
A Competitor
Many trading executives say that Nasdaq's structure puts it at a disadvantage. It is a quasi-government entity. However, it is competing with private firms for OTC business. Nasdaq must win the regulators approval to make basic changes by going through a rules amendment process. Nasdaq's private competitors – like FedEx competing against the U.S. Post Office – can be more flexible in changing business plans.
The previous Nasdaq regime thought it had the Bulletin Board figured out. That is, until a proposed rules change was delayed. That Nasdaq management, under chairman Hardwick Simmons, had been committed to a Bulletin Board Exchange (BBX), which had attempted to take this market a step further than the OTCBB by establishing a listing approval process. But the application for the BBX bogged down when it was pulled.
The BBX, had it ever been approved, might have solved many of Nasdaq's problems. BBX called for a new platform for companies not listing on the Nasdaq SmallCap market. It was going to be a way of taking the cream of small companies and introducing a method of charging them. That would have been more likely to put its Bulletin Board operations in the black.
Nasdaq officials won't comment on the profitability of the operation. However, one Nasdaq official, who wouldn't be quoted by name, said the application was yanked, in part, because the BBX would have led to some confusion. "We felt there would have been certain brand risk in listing these smaller companies when we had a very well established brand for Nasdaq listed companies," said the Nasdaq official. He said there also had been some complaints about the market structure of the proposal, which envisaged a limit order system.
The BBX also would have only accepted the strongest penny stock firms, and then closed down the OTCBB some six months after the new operation was running. The rejects might have ended up with private competitors such as the Pink Sheets. But this grand solution – the same as a number of other Nasdaq projects that failed such as Nasdaq Europe – was killed last year by the new leadership. It also announced that it was sticking with the OTCBB.
The Red Ink
The new Nasdaq leadership, facing red ink, looked at the BBX, and concluded: "Why build this when it is never going to make a lot of money and when your main business is in trouble," said an OTC executive who didn't want to be quoted by name. This source also noted that some Nasdaq dealers want the Bulletin Board to continue, but not as a hungry competitor. The pressure from dealers, he said, killed the BBX, because it threatened to take a good deal of business away from dealers.
Now Nasdaq is stuck with the OTCBB, a market place with plenty of garbage stocks and in which it has little power to clamp down on frauds. For example, a company can qualify for the OTCBB even if it has no assets, revenues or business, provided it files quarterly reports. If it suspects something is wrong, in most cases, it must ask the SEC to follow up on its suspicions. Maybe worst than that from Nasdaq's point of view, it has little ability to make this dicey service into a moneymaker. It receives no listing fees, which traditionally provide Nasdaq with its biggest profits.
Ponzio concedes that Nasdaq probably doesn't have fat profit margins, or maybe no margins, on the OTCBB. Still, he argues, "sometimes one has to have a loss leader to be successful in your main business."
Ponzio wants Nasdaq to continue with small stocks because Nasdaq is the best venue "to provide critical pools of liquidity for these overlooked stocks." Many of the latter, he insists, will be big companies in a few years, or are in the process of reorganizing and will return to profitability. Touizer disagrees with Ponzio.
"Nasdaq shouldn't continue with the OTCBB. It really doesn't have the driving desire to do this," Touizer added. Touizier's proposed solution is that Bulletin Board trading should be put in private hands. He says it should be run by a firm that exclusively operates Bulletin Board trading or has set up a subsidiary to do so.
Touizier's candidates would be a giant trading operation such as Instinet or Archipelago. Indeed, Instinet has INET, a venue for Bulletin Board trading. Then there is ArcaEdge, another Bulletin Board venue, which is run by Archipelago.
However, a Nasdaq OTC competitor had another suggestion. Nasdaq can stay in the small stocks game but on a nominal basis, according to Cromwell Coulson, chief executive of the Pink Sheets. He argues that its Bulletin Board operation should concentrate on trade reporting. "What they should do is keep the OTCBB designation, but just have it on the trade tape, SEC reported. Charge issuers to designate a symbol as SEC reported," Coulson said.
This downsizing strategy, he added, would allow Nasdaq to keep all the trade data. The latter could be resold, and would also permit Nasdaq to oversee all limit order rules, Coulson said. Also, he argues that this would move Nasdaq away from offering quotations for penny stocks. Doing that today, Coulson contends, "tarnishes the Nasdaq brand name."
Nevertheless, the Nasdaq official noted that the OTCBB is a unique trade reporting and quotation operation and it "can't just be sold to someone." In the short term, this official said that the OTCBB will continue to be run by Nasdaq. In the long term, much will depend on the SEC's Reg NMS proposal on market structure and on the exchange application.
"We will certainly continue to operate OTCBB if the SEC doesn't allow trade reporting to go through an exchange," the Nasdaq official added. "My prediction is that OTCBB will be improved over the next six to eight months and that the market center itself will remain the same other than in improved functionality."
