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Pay Attention to These Stocks

The Sarbanes-Oxley Act of 2002 (SOX), signed into law after a rash of corporate malfeasance, was designed to protect U.S. investors. But it might be protecting us from investing in some great stocks.

The SOX effect
In response to the legislation, many international companies have opted to delist from a major exchange, moving to the Wild West-like over-the-counter market to avoid SOX regulations.

Clive Crook, writing in The Atlantic, summed it up beautifully: "'Sarbox' is only one aspect of a regime of corporate regulation that seems, by international standards, increasingly persnickety, complex, and hazard-prone."

And a University of Chicago study found that since SOX was passed, "The frequency of foreign listings on the NYSE and Nasdaq has fallen by nearly 63%." Furthermore, the study showed not just a decrease in new listings, but also an increase in delistings because SEC regulation is so costly.

Dutch giant Ahold, one such delister, said the "benefits of maintaining a U.S. registration and a NYSE listing have declined over time."

This migration has happened while international stocks have flat-out sizzled. In fact, the day SOX went into law, U.S. companies made up nine of the 10 largest companies on our domestic exchanges (BP (NYSE: BP  ) was the lone foreigner).

Today, that number is down to five: ExxonMobil (NYSE: XOM  ) , General Electric (NYSE: GE  ) , Microsoft (Nasdaq: MSFT  ) , Wal-Mart, and Procter & Gamble.

Now, you could have bought the remaining foreign companies and others like them easily. Some list directly on our exchanges, such as Canada's Research In Motion (Nasdaq: RIMM  ) , which has both Nasdaq and Toronto listings, while others, such as Mexico's America Movil (NYSE: AMX  ) and Finland's Nokia (NYSE: NOK  ) , offer American Depositary Receipts for U.S. investors.

But the trend of fewer foreign listings means we're likely to be locked out of some unbelievable stocks. According to data from Capital IQ (a division of Standard & Poor's), only 14.6% of companies listed on the NYSE, Nasdaq, or AMEX are headquartered outside the United States.

Enter the Pink Sheets
The answer here is straightforward: It's up to you to find promising stocks.

One place worth a look is the Pink Sheets. Yes, that Pink Sheets.

If you'd owned shares of Nintendo or Volkswagen in the past five years, you'd be up about 500% on each. But these companies aren't available on major U.S. exchanges -- they live alongside the dregs of the Pink Sheets and OTC markets.

Actually, the Pink Sheets, which carries a smattering of blue-chip companies amid distressed or fraudulent ones, is encouraging stratification among its ranks. Pink Sheets Chairman and CEO R. Cromwell Coulson told me he's trying to "change the OTC market from fraud risk to investment risk."

A clean, well-lighted place
To that end, he's launched a premium market tier called OTCQX, which, in Coulson's words, is meant to separate higher-quality companies "from the Pink Sheets stigma." (Last summer, that stigma led me to suggest that retail investors stay away from Pink Sheets stocks altogether. With caveats, I am retracting that conclusion.)

Built like the London Stock Exchange's AIM market, OTCQX requires listed companies to have reliable information and disclosure. As Coulson said, "Any company will be more efficiently valued if there's good information in the market." Amen.

OTCQX-qualifying stocks must have ongoing operations, audited financial statements, and a sponsor -- an investment bank or securities attorney that verifies that the company meets all listing requirements. The goal is to bring OTCQX disclosure levels to the same level as those on the NYSE or Nasdaq by creating "processes [that] put more information in the market."

Taming the Wild West
More information means better decisions. But don't jump into the Pinks headfirst. Retail investors would be wise to:

  • Only research companies that have up-to-date financial statements you trust. The "trust" part, incidentally, is a built-in advantage of searching only among OTCQX stocks.
  • Pay close attention to liquidity and bid/ask spreads.
  • Remember the normal due diligence required for foreign stocks: Look at political, national, and currency risks.

Our Global Gains newsletter service has recommended three companies listed on the Pink Sheets. Our latest issue ranks the team's top five international stocks for new money. If you're interested, we offer a free trial with no obligation to subscribe.

This article was first published Jan. 26, 2008. It has been updated.

Brian Richards owns shares of Microsoft, but no other companies mentioned. Microsoft and Wal-Mart are Motley Fool Inside Value recommendations. Nintendo is a Stock Advisor pick. The Motley Fool has a disclosure policy.

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