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Investors interested in over-the-counter (OTC) securities may be in for a variation, according to a new SEC proposed rule change.

The goal of the proposed rule change is to enhance investor protection and market information. Though many of the thoughts in the proposed rule address these issues, some market participants are concerned the proposal will have unintentional consequences.

The question comes down to a specific rule under the SEC’s Exchange Act: Rule 15c2-11. The rule, adopted in 1971 and last amended in 1991, governs whether a broker-dealer is legally allowed to publish a quote for a security that doesn’t trade on an exchange.

Under the current rule, broker-dealers must gather and review specified information about a company before they are allowed to quote the security. Once the broker-dealer has quoted the security for at least 30 days, other broker-dealers can “piggyback” in and begin quoting the security based on the first firm’s review of the company information.

In other words, under this piggyback exemption, some broker-dealers are exempt from having to verify a company’s information is current before quoting its security. The current rule also contains other exceptions to the information review requirement, such as customer orders submitted on an “unsolicited” basis.

The SEC’s proposed rule change would effectively do away with the “piggyback” exemption by requiring that current information be publicly available at all times for the security to be quoted. The SEC is also proposing recognizing the process developed by OTC Markets Group, the operator of OTC markets for over 10,000 U.S. and global securities, to determine whether companies have disclosed current information. Under the SEC’s proposal, broker-dealers would be able to rely on OTC Markets to determine that current information is publicly available. This recognition has support within the industry.

A Push For Protection

“The Commission should explicitly state…that broker dealers may quote securities traded on the OTCQX, OTCQB, and Pink-Current sections of the OTC market without any additional regulatory requirements or record-keeping burdens,” wrote Jim Angel, associate professor of capital markets at Georgetown. “These market segments already have explicit publicly-available information requirements. Broker-dealers should be able to rely on the listing status of such securities without any additional record keeping requirements.”

In the proposed rule filing released Sep. 25, 2019, the SEC wrote that “The Commission is proposing to provide greater transparency to investors and other market participants by requiring that information about the issuer and the security be current and publicly available…to provide greater protections to retail investors.”

The SEC has previously tried on multiple occasions to limit or eliminate the piggyback exemption. But the industry overwhelmingly took the position that this would severely limit liquidity, resulting in less competitive pricing and increased costs for market participants.

Many comments to the current proposal are from professional value investors expressing concern that the SEC’s proposal would erode shareholder value if these “No Information” companies became ineligible for public quoting. As noted in one letter, “[t]here are many thinly traded, OTC stocks of legitimate, profitable companies. These shares have grown in value over time and continue to be profitable for those who do their research and seek out value.”

In a comment letter submitted by OTC Markets Group, they argued the proposal would effectively eliminate quoting for many types of securities, which would make that much more difficult for informed investors.

“Bankruptcies, financial restructurings, dark companies, cash shells and liquidations can all offer compelling investment opportunities for savvy fundamental investors,” they wrote. “Without an alternate solution, investors in these securities would be relegated to the “Grey Market” – an opaque, disconnected market with sparse pricing information and no electronic mechanism to facilitate best execution.”

The company’s proposed solution is for the SEC to allow securities with no current information to still be quoted – but in an “Expert Market” limited to professional investors with the savvy to navigate them. This solution, they say, would protect investors while also providing a better trading experience than what the SEC is proposing.

“We’d like to see the SEC move forward with its proposal while continuing to keep in mind the value of those securities in the hands of professional investors,” said Dan Zinn, OTC Markets general counsel. “We support the message of the rule and we believe in the value of current information for all OTC-quoted companies. However, the rule needs to adequately address what’s going to happen to companies that no longer have current information.”

The SEC received 130 comment letters before the comment period ended Dec. 30. They have not yet said when a vote would take place.

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