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MARKETS - Prettier than Pink

Cromwell Coulson is trying to bring some order to the Wild West of the equity markets.

WHEN R. CROMWELL Coulson bought an over-the-counter stock quotation service called the Pink Sheets with a group of investors in 1997, he knew that it wasn't exactly the New York Stock Exchange. The platform, tracing its roots to 1904 and named for the color of the paper on which its bids and offers circulated, had long been a loitering ground for unremarkable, bankrupt and often fraudulent companies that couldn't meet the listings standards of proper exchanges.

"Stocks not listed on exchanges range from the good to the ugly to the bad," admits Coulson.

Even today, eight years after Coulson ditched the pink paper for an electronic quoting system, his market has a dubious reputation. In April the Securities and Exchange Commission charged seven people with operating a pump-and-dump operation out of boiler rooms in Barcelona, Spain, and Santa Ana, California, that allegedly inflated the share price of a Pink Sheets­quoted shell company, Nu Star Holdings, bilking investors of $4 million.

But plenty of legitimate concerns also trade on the New York­based market, including emerging-growth companies that don't meet exchange listing standards, as well as 372 American depositary receipts, including those of such big overseas companies as Heineken and Volkswagen. Brokerage houses like Citigroup and UBS make markets in these shares.

To create a more attractive platform for these companies, Coulson has developed a new listings tier, called OTCQX, that is essentially a segregated and sanitized version of the Pink Sheets market. To qualify for OTCQX, operating companies must disclose audited financial statements -- something not required of other Pink Sheets denizens. An ultraexclusive tier, Premier QX, is open to big companies that have annual shareholder meetings and minimum share prices of $1.

"Investors want to put money into emerging growth and reputable foreign companies, but in Pink Sheets, fraud risk has been the primary risk rather than investment risk," says Coulson. "We want people to be focused on investment risk."

To that end, OTCQX-listed companies must have a designated adviser for disclosure, or DAD, typically a regulated investment bank or law firm that vouches for the issuer and participates in the preparation of investor releases. ADR issuers must appoint a principal American liaison, or PAL, which performs a similar function. This structure takes a page from the London Stock Exchange's popular AIM market, which requires so-called nominated advisers, or Nomads, to chaperone its emerging-growth companies.

"Some international companies, such as Heineken, are best in breed, but they are lumped in with the pump-and-dump stocks," says Jason Paltrowitz, vice president in global capital markets at Bank of New York Mellon, which is a PAL on the Pink Sheets. "OTCQX provides investors with a means to differentiate, which should boost liquidity."

So far 15 issuers have joined OTCQX, including Computer Services, a Paducah, Kentucky, software company that was the first U.S. issuer to rise from the main market to the premium tier. "It has separated us from some of the dodgier companies on the Pink Sheets," says David Simon, the company's CFO. Coulson believes 20 percent of the Pink Sheets' roughly 5,000 companies could qualify for the higher tier and expects 100 issuers within the year.

The Pink Sheets' main source of revenue is per-transaction fees charged to the brokerage firms that use the quotation system, so Coulson isn't about to turn his back on the more marginal companies that call the market home. Still, he's making sure investors know what they're getting into when buying these shares. Last month the Pink Sheets introduced a labeling system designed to alert market participants about the riskiest companies. Those that don't disclose their financials will have a stop sign next to their price quotes; companies deemed to be subject to manipulation by unscrupulous brokerages will carry a skull-and-crossbones symbol.

Coulson is as unapologetic about his market's wares today as he was a decade ago. "Our business is to make trading more efficient for brokers," he says. "And brokers are like supermarkets. They need to sell everything -- including cigarettes, beer and girlie magazines."