Buying OTC stock in small firm is risky

On Money

June 23, 1996|By Susan Bondy | Susan Bondy,Creators Syndicate

In February, my broker recommended that I invest in a small company that makes a line of men's toiletries. On Feb. 21, I bought 1,000 shares for approximately $15,000. The stock, which traded in the over-the-counter market, was not listed in my newspaper.

On April 18, my financial consultant called to tell me that my stock, which now amounted to 2,000 shares due to a stock split, was worth only about $4.50 per share and falling. I told him to sell. It was sold for $4.375 (really, this is $4 3/8 since stocks trade in eighths), so I received $8,750 for my $15,000 investment.

I noticed that my confirmation slip bore a statement, "Smith Barney is a market maker in this stock." It sounded like a scam to me. I called the office manager to register a complaint, and, of course, he denied any wrongdoing. I told him that at best, he had a very poor and unethical research department, but I got no sympathy.

What do you think?

I can find no wrongdoing, either. Your letter was too lengthy to print in its entirety, but you start off by relating two positive experiences with the same "consultant." (Whether he calls himself a consultant, account executive or financial planner, he is really a stock broker.) The first two investments were of a conservative nature; the third, the small men's toiletries company, was riskier.

Small, risky stocks tend to move up more and down much more than large, stable stocks. You knew it was a small company by the very fact that it was OTC and not listed in your paper.

I think you have a fairly responsible broker. At least he called when the stock was going down. Many brokers don't do that much.

There are many market makers dealing in OTC stocks -- your brokerage firm is one. The trader had an option to sell it to another market maker for a commission or buy it himself as a principal and take 1/8 of a point (worth 12.5 cents).

You got $4.375 ($4.50 minus 1/8 ), so I assume this order was executed as a principal trade. Had the broker sold it to another market maker (an agency trade), the commission would have been about $350 rather than the $250 you were charged (12.5 cents times 2,000 shares). You ended up $100 ahead.

As for the ethics of the recommendation, brokerage-firm research departments are not infallible. I have found that most security analysts are correct about 50 percent of the time. I'm sure your broker truly believed this stock would go up. It didn't work out. But you made the final decision to buy.

You have no legitimate complaint against the broker or his firm -- unless you specifically stated you did not want risky investments and could not afford to lose any money.

Your letter didn't mention your age, but your case would be further strengthened if you are retired or can prove you are an unsophisticated investor. In that event, you might have grounds for arbitration by arguing that these risks were unsuitable for you.

I say once again: All OTC stocks are risky by my definition since you cannot place stop orders on them. If you decide you can afford the increased risk for the possibility of a higher return, you must monitor that investment yourself. If it's not in your paper, call the broker once a week.

If you have a helpful broker, you can ask him or her to notify you if the price drops by 10 percent. When you buy a New York Stock Exchange or American Stock Exchange stock, you can limit loss by using a stop order, but if you buy an OTC stock and ignore it, you could be in for a rude awakening.

Pub Date: 6/23/96

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