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SEC Proposes Amending Rule Governing Quotations in OTC Securities

Steven.Lofchie@cwt.com's picture
Commentary by Steven Lofchie

The SEC proposed amendments to SEA rules that would tighten the requirements that broker-dealers must meet before being permitted to post public quotations on OTC securities.

Currently, in order to post such quotations, a broker-dealer must either (i) have access to specified information regarding the issuer or (ii) be able to rely on the fact that at least one other broker-dealer has been posting quotations (the "piggybacking exemption").

Under the Rule 15c2-11 (Initiation or resumption of quotations without specific information) amendments, the piggybacking exemption would be significantly reduced, and would be eliminated in the case of shell companies. It would not be sufficient for the broker-dealer to have the relevant information; the necessary information would have to be current and "publicly available." The SEC said it had found widespread fraud in connection with the sale of securities and that issuers were delinquent in their public filings; i.e., the relevant information was not current.

The proposing release poses additional questions as to how the SEC should regulate the OTC market. Comments on the proposal must be submitted within 60 days of its publication in the Federal Register.

Commentary

While this rule proposal will likely not attract nearly the same degree of attention as the ETF Rule amendments, it is very significant and deserves careful review. The SEC has the difficult problem of (i) allowing for market trading of companies that are too small to be listed on an exchange, while (ii) discouraging fraudulent activity in the securities of these companies. The greater the restrictions that the SEC imposes on trading to prevent fraud, the more that the SEC raises the costs of trading. Higher trading cost results in a lessening of liquidity and makes it less attractive to hold shares in small companies, which, in turn, discourages investment in such companies.

Rule 15c2-11 is the principal requirement, or one of them, by which the SEC attempts to balance these opposing interests. Given the difficulty of such balancing, it behooves market participants, issuers, investors, and other regulators to weigh in.

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