SEC Revises Exchange Act Rule 15c2-11; Key Changes to Retail Investor Protections and Quotations for Over-the-Counter SecuritiesOctober 15, 2020
On September 16, 2020, the Securities and Exchange Commission (“SEC”) adopted amendments to Rule 15c2-11 (the “Rule”) under the Securities Exchange Act of 1934 (the “Exchange Act”), an important component of the over-the-counter (“OTC”) regulatory structure. The full amendment is available here.
The amendments are intended to modernize the Rule, which was last substantively amended almost thirty years ago. In the SEC press release announcing the amendments, available here, SEC Chairman Jay Clayton called the changes “long overdue.” Clayton explained, “[t]he technological advancements that have taken place since the rule was last amended enable us to require that information in the OTC market be more timely, enabling investors to make better informed investment decisions, and reducing fraud in these markets where retail presence is significant and, unfortunately, pump-and-dump and other frauds are too common.”
Broker-dealers serve as important gatekeepers to the OTC market by facilitating investor access to OTC securities, better known as “penny stocks.” The current Rule provides that before quotations can be initiated for an OTC issuer, the issuer must find a sponsoring market maker who would, relying on “current information” provided by the issuer, compile and submit a Form 211 to the Financial Industry Regulatory Authority (“FINRA”). FINRA would process the form, and the stock could then begin to trade. For one month, it would only be quoted by the sponsoring market maker; subsequently, other market makers could “piggyback” on the Form 211 and publish their own quotes. Unfortunately, this “piggyback” exception has contributed to the mushrooming fraud in the OTC market, since once a sponsoring market maker’s Form 211 for an issuer has been processed by FINRA, and other market makers have piggybacked on it, the securities might continue to trade with published quotations literally forever, even if the company itself had ceased to exist.
While many issuers of quoted OTC securities provide and maintain public disclosures of information about themselves, for some issuers, there is little or no current publicly available information, which can limit investors’ ability to make informed investment decisions and leave them vulnerable to incidents of fraud and manipulation. In fact, the SEC reports that a majority of enforcement cases stem from a lack of current, accurate or adequate information about an issuer.
When the SEC last substantively amended the Rule in 1991, it was significantly more difficult to obtain information about issuers of OTC securities and to continuously update and widely disseminate quotations for OTC securities. Investors could obtain information about OTC issuers only by contacting a broker or subscribing to the daily “Pink Sheets.” Recognizing this burden, the current Rule contains exceptions to the information requirements – including the piggyback exception discussed above – that have resulted in quoted markets for issuers lacking any current, publicly available information, including, in some cases, a continued quoted market, even when issuers have ceased operations.
Over the past several decades, the widespread use of the Internet and other forms of electronic communication have greatly increased investor access to such information and decreased the cost and burden to issuers and brokers associated with accessing, updating, and disseminating this information.
Recognizing the increased efficiency of information flow in today’s markets, the amendments generally prohibit broker-dealers from publishing quotations for an issuer’s security when issuer information is not current and publicly available, subject to certain exceptions. The amendments impose the following new requirements on broker-dealers:
- A broker-dealer or qualified interdealer quotations system (“IDQS”) must obtain and review certain current and publicly available specified documents and information regarding OTC issuers before commencing a quoted market in an OTC issuer’s security (“information review requirement”). Depending on the issuer, these documents may include:
- a prospectus as required by 10(a) of the Securities Act of 1993 that became effective less than 90 days prior to the day a broker publishes or submits the quotation (the “quotation submission”);
- an offering circular provided for under Regulation A, that was qualified less than 40 calendar days prior to the quotation submission;
- an annual report (together with any periodic reports and any current reports filed at least three business days prior to the quotation submission, as applicable) filed pursuant to various sections of the Exchange Act, Regulation A or Regulation Crowdfunding; or
- certain information specified in the Rule for “catch-all” issuers (e.g., OTC issuers that are not SEC registrants, and not otherwise required to file reports or make disclosures).
- A broker-dealer or qualified IDQS must identify whether the quotation is published on behalf of the issuer or a company insider and the amendments add qualified IDQSs to the list of market participants that must review supplemental information to comply with the information review requirement.
- Issuer information must be current and publicly available for a broker-dealer to rely on the “unsolicited quotation” exception to publish quotations on behalf of company insiders and affiliates of the issuer.
- Broker-dealers may initiate a quoted market for a security if a qualified IDQS complies with the information review requirement and makes a publicly available determination of such compliance.
The SEC considered eliminating the “piggyback” exception. Instead, the Rule amends the exception to provide greater investor protections when broker-dealers rely on the piggyback exception, while avoiding undue burden on broker-dealers. The amended Rule:
- Allows broker-dealers to rely on the quotations of another broker-dealer that initially complied with the information review requirement, provided that (depending on the issuer’s regulatory status) issuer information be current and publicly available, timely filed, or filed within 180 calendar days from a specified period.
- Requires at least a one-way priced quotation, so long as there are no more than 4 business days in succession without a quotation.
- Prohibits reliance on the exception during the first 60 calendar days following the termination of an SEC trading suspension under Section 12(k) of the Exchange Act.
- Provides an 18-month window following the initial publication or submission of a priced bid or offer quotation in an IDQS, during which broker-dealers may quote the securities of “shell companies,” assuming all other requirements of the piggyback exception are met; trading may continue after the 18-month period only if the information review requirement is satisfied.
- Provides a grace period of up to 15 calendar days that permits broker-dealers to continue quoting the securities once a qualified IDQS or register national securities association makes a publicly available determination that issuer information is no longer current and publicly available, timely filed, or filed within 180 calendar days from the applicable specified timeframe.
- Deletes the previous requirement that there be quotations on each of at least 12 days within the previous 30 calendar days to establish piggyback eligibility.
The changes to the “piggyback exception” will make the greatest difference to shell companies and “catch-all” issuers. Those companies will now be required to make some form of disclosure. The Rule governs broker-dealer publications or submissions of quotations for OTC securities in a quotation medium; it does not govern trading in OTC securities altogether. Securities of an OTC issuer that fails to comply with Rule 15c2-11 will be delisted to the so-called “Grey Market,” where they can trade, but published quotes cannot be offered. This will occur automatically if there are no published quotations for a stock for four consecutive trading sessions.
The Rule amendments also add several new exceptions to the information review requirement, where the SEC has deemed the risks of fraud and manipulation to be lower due to the circumstances:
- Exception for highly-liquid securities of well-capitalized issuers, if the security meets a multi-prong test based on the securities worldwide average daily trading volume value and the issuer’s total assets and shareholders’ equity.
- Exception for security quotations by a broker-dealer acting as an underwriter named in the registration statement or offering statement for such security.
- Exception to permit broker-dealers to rely on publicly available determinations by a qualified IDQS or a registered national securities association, provided that the requirements of certain other exceptions are met. To rely on this exception, the qualified IDQS or registered national securities association must establish, maintain and enforce reasonably designed written policies and procedures with respect to making the determinations.
The Rule amendments also modify certain document retention requirements for broker-dealers and others. Broker-dealers, qualified IDQSs, and national securities associations must preserve the applicable documents and information they reviewed to demonstrate reliance on an exception and in relation to publicly available determinations, for at least three years; the first two years in an easily accessible place.
The amendments also add new definitions for the terms “company insider,” “current,” “publicly available,” “qualified interdealer quotation system,” and “shell company.” Of note, the definition of “current” varies depending on the document at issue, but generally refers to the most recent version of a particular document, report or filing. Additionally, “publicly available” is defined to include: (i) available on EDGAR, (ii) available on the website of a state or federal agency, a qualified IDQS, a registered national securities association, an issuer, or a registered broker-dealer, or (iii) available through an electronic information delivery system generally available to the public in the primary trading market of a foreign private issuer. However, access to the information cannot be restricted by a user name, password, fees or other restraints.
The SEC has stated the goals of the amendments are to: (1) promote investor protection by providing greater transparency to the investing public regarding issuers of OTC securities, (2) facilitate capital formation for issuers for which information is current and publicly available, and (3) reduce unnecessary burdens on broker-dealers and enhance the efficiency of the OTC market. In light of these goals and the amendments aimed at achieving them, issuers seeking to maximize access to capital through the OTC securities market should prioritize maintaining current, publicly available information. Broker-dealers and qualified IDQSs should review their changing obligations under the Rule, and allocate their resources accordingly.
The Rule, as amended, becomes effective 60 days after publication in the Federal Register (the “Effective Date”). In order to provide sufficient time for effected individuals and entities to prepare to comply with the new requirements, the SEC has provided for a transition period following the Effective Date. Accordingly, compliance with the amendments must be achieved within nine months following the Effective Date, except the requirement in the piggyback exception that a “catch-all” issuer’s information (as specified in paragraph (b)(5)(i)(M)) be current and publicly available, for which compliance must be achieved within two years following the Effective Date. SEC staff will be available to offer assistance and support to covered entities during the transition period and afterwards, to ensure efficient and effective implementation of the amendments. The SEC is also encouraging those market participants wishing to seek relief from the provisions of the amended Rule to submit such requests expeditiously within the nine-month transition period. Lastly, the SEC will be issuing additional guidance that provides basic principles and examples of red flags to facilitate compliance with the information review requirement.
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