The U.S. Securities and Exchange Commission (SEC) defines grey market securities as "securities that trade over-the-counter," but they are securities for which quoted prices aren't available for buyers or published anywhere publicly. Whereas the cost of stocks listed on exchanges like the NASDAQ are publicly communicated and their sales heavily regulated by the SEC's disclosure requirements, grey market stocks are subject to minimal regulation. As such, they tend to be riskier investments, even in countries where they are legal, hence their categorization as being on the grey market.
Over the Counter Stocks
As noted above, grey market stocks are a subset of over-the-counter (OTC) equity securities, so we'll start by exploring the different tiers of OTC stocks and the organization of the stock exchange. Regulated by the OTC Markets Group, formerly known as Pink Sheets, these markets fall into various tiers based on the strictness of their financial standards and disclosure requirements.
Video of the Day
The SEC lays out the marketplace tiers for over-the-counter securities. At the highest level of transparency is the OTCQX Best Market, which tends to sell stock for well-established companies in the U.S. and internationally. Companies that qualify for this market must comply with U.S. securities laws and meet the most stringent reporting standards to the SEC or U.S. banks.
The next tier, for slightly less well-established companies, is the OTCQB Venture Market. To qualify for this tier, companies must have a minimum number of shareholders, meet slightly lower reporting standards than the OTCQX Market, not be in bankruptcy and have annually audited financials. Finally, the OTC Pink Market is a more open marketplace without set financial standards or reporting requirements.
Grey Market Stocks
According to the Financial Industry Regulatory Authority (FINRA), grey market stocks are those that are not sold on the OTC bulletin board (OTCBB) or OTC markets, but which still have trading symbols associated with them. Like other stocks sold via OTC markets, these stocks are not affiliated with NASDAQ or other major stock exchanges. By comparison with other OTC stocks, grey market stocks carry the highest risk to investors, because the market for them faces minimal government regulation and virtually no cost transparency.
The most common use of grey market trading is to purchase shares in a company in advance of its initial public offering (IPO), or the process by which a private company first sells its stock shares to the general public. This increases the risk to purchasers, who are trading in stocks that will be available for purchase soon but are not available yet. These securities are not registered with the SEC and rely mainly on trust between buyer and seller.
Grey Market Transactions
Grey market transactions can be a strong predictor of how a new company's IPO performance, because they gauge market confidence in that company. If a buyer estimates that a company will sell its shares for $40 per share, they might make advance purchases on the grey market at $38 per share, with the intention of selling those shares once trading begins on the NYSE or the NASDAQ.
If the company's stock goes higher than the buyer anticipated, they stand to make even more money. On the other hand, if the stock underperforms, grey market buyers lose out.
In advance of their IPOs, Facebook and Twitter each saw significant activity on the grey market. Whereas Facebook was widely considered to be a flop, with shares losing significant value over the course of the first day, Twitter shares on the grey market rose well above the company's initial valuation, then outperformed the grey market estimate by over $1 per share.
Consider also: What Does it Mean When the Stock Market Is Down?