SEC Proposes Revisions to OTC Quotation Rule to Limit Application to Equity Securities
Commentary by Steven Lofchie
The SEC proposed amendments to SEA Rule 15c2-11 ("Initiation or Resumption of Quotations Without Specific Information") that would limit the rule’s information-gathering and review requirements to broker-dealers publishing or submitting quotations for "equity securities" in over-the-counter ("OTC") markets.
The proposed rulemaking would replace the terms "security" and "securities" throughout the rule with "equity security" or "equity securities," utilizing the specific definition provided in SEA Rule 3a11-1 ("Definition of the term 'equity security.'") The SEC said this approach provides clarity and relieves brokers and dealers from the burden of applying the rule to fixed-income and other non-equity securities. The SEC noted that the original regulatory concerns prompting the rule—namely manipulative trading schemes by shell corporations—were predominantly observed in the "OTC equity markets," and that applying the rule broadly to non-equities created unintended compliance hurdles.
The SEC highlighted the following conforming and technical reforms in the proposal: (i) amending the specified and supplemental information review requirements to apply strictly to equity securities, with the sole exception of retaining the requirement to review trading suspension orders for "any securities" of an issuer to ensure brokers remain alerted to potential red flags; (ii) narrowing the conditional exceptions and corresponding record preservation requirements to cover only equity security quotations; (iii) "remov[ing] [the rule]'s existing exception for municipal securities, as it is expected to "no longer be needed" under the revised scope; and (iv) explicitly noting that the rule applies to "crypto assets" only to the extent that a specific crypto asset meets the definition of an equity security.
The SEC stated that the revisions are intended to address "potential operational and liquidity difficulties" stemming from the 2020 amendments, which required specified information to be current and publicly available. The SEC cited industry feedback that market participants did not view the rule as applying to non-equity securities, raising concerns that the requirements could reduce information availability and cause some fixed-income issuers to "go dark." The SEC also noted that, unlike equity markets, there is no centralized infrastructure for non-equity issuer information, making it difficult—or in some cases impossible—to obtain. The SEC emphasized that broker-dealers would remain subject to applicable registration and antifraud obligations, including the duty to make a "reasonable inquiry" with respect to non-equity securities.
Comments on the proposal must be submitted no later than 60 days after its publication in the Federal Register.
Commentary
This amendment would completely undo the first big mistake of former SEC Chair Gensler's tenure at the SEC, which was to proclaim that Rule 15c2-11, which had for half a century applied only to equities, applied equally to debt securities. The proclamation was issued without any consideration of whether the markets for debt securities and for equity securities might be quite different (they are) and thus a rule that worked in equities might not be appropriate, at least without revision, for the debt markets.
In fact, the misfit between the requirements of Rule 15c2-11 and the debt markets was so great that former Chair Gensler was forced to gradually issue "no-action" relief that carved back Rule 15c2-11's application to debt until all that was left was an obscure trap for the unwary (if that, given that no enforcement action was ever brought with respect to debt securities). Accordingly, we would expect that this rule change will go ahead, quickly and without meaningful opposition (if any).