FINRA Enforcement of Non-Members and Penny Stock Issuers

PennWest - Accounting FraudFINRA & Penny Stocks

When the subject of penny stock enforcement actions arises, most people think first of the Securities and Exchange Commission (SEC), or erroneously, of OTC Markets Group (OTCM). The SEC has ultimate authority to deal with violations of the securities laws.  It has jurisdiction of penny stocks that are SEC registrants that trade over-the-counter, and of non-registrant Pinks and Greys as well.  It does not, however, subject non-registrants to any kind of reporting regime, and many abuses go unnoticed by it.  It’s empowered to impose 10 day trading suspensions to protect potential investors from falling for blatant scams.  Generally speaking, OTC issuers may be suspended for three reasons:  suspected fraud, shell status that makes them vulnerable to corporate hijackers, and delinquent filings.  Needless to say, only registrants can be suspended for delinquency; when they are, the regulator initiates a simultaneous action to revoke registration.  When registration is revoked, the stock’s ticker is killed, and the company effectively becomes a private entity.  If it wishes to trade again, it must file an initial registration statement to become a registrant once more, and in the future keep current with its required periodic filings.

If a company or its management has engaged in fraud that’s particularly outrageous, or that resulted in massive losses to investors, the SEC may litigate.  Often the litigation follows a suspension, though by no means immediately.  The agency will extend the investigation it made to warrant the suspension, and when it’s satisfied it can make a case, it will file a civil complaint in federal district court.  The federal statute of limitations for fraud is five years; the regulator can, and often does, wait that long, or almost that long, to bring charges.  The SEC is not a criminal prosecutor; it can only bring civil actions.  But if a case is particularly serious, it may ask for assistance from the Department of Justice (DOJ).  Often the DOJ and the SEC will file against the company in question and/or its management at the same time.  The advantage of that approach is that the SEC, with its securities expertise, will conduct the investigation that ensures the DOJ can prove its charges beyond a reasonable doubt.

The SEC can also discipline others who work in the world of finance:  private companies, investment advisers, Ponzi schemers, affinity scammers, and more.  The agency has jurisdiction of any individual or any entity that issues securities.

OTC Markets Group is not a regulator; it is a quotation service and trading platform—OTC Link—that also provides information about its client companies.  Many penny stock players mistakenly believe OTCM is a regulator like the SEC.  It’s not; it’s a private for-profit company.  Its “tier” system is its own invention. The SEC didn’t prescribe it, and pays no attention to it.  OTCM “filings,” as they’re often called by many investors, are more properly described as “disclosures.”  Companies are free to disclose as much or as little about their activities as they wish.  OTCM offers guidelines, but as long as the issuer pays the fees required to use the Disclosure and News Service, pretty much anything goes.

OTCM’s lower tiers—Pink Limited Information, which comes with a yield sign, and Pink No Information, which comes with a stop sign—do serve a purpose that was perhaps unanticipated by the SEC.  Many brokerages now refuse to accept stock in these companies for deposit, and clearing firms often refuse to clear them.  That’s made life more difficult for toxic funders and insiders wishing to dump large positions, but it isn’t a form of enforcement.

The Financial Industry Regulatory Authority (FINRA) is a regulator, though it is itself regulated by the SEC.  It is not a government agency, but a private not-for-profit organization whose membership is comprised of broker-dealers.  FINRA began life as the National Association of Securities Dealers (NASD).  The NASD was created in 1939, and much later, in 1971, it was the principal founder of the NASDAQ.  For decades, it oversaw market regulation for the NASDAQ and what was then called the American Stock Exchange (now the NYSE MKT).  In July 2007, it combined with the NYSE’s member regulation, enforcement, and arbitration operations to become the Financial Industry Regulatory Authority.

FINRA has jurisdiction of broker-dealer firms and individual registered representatives, commonly known as brokers.  It has its own enforcement division, which imposes monetary penalties for infractions, and can expel both firms and brokers from the organization.  It is also responsible for rule writing, firm examination, and arbitration and mediation between firms and investors who feel they were in some way wronged by their broker.  The organization believes that protecting investors is an important role, and to that end it provides copious information at its website.  The information includes warnings about investment fads like pot stocks and Initial Coin Offerings, and tools like BrokerCheck, which offers detailed disciplinary histories of broker-dealers and registered reps.

FINRA also has a fraud division, called the Office of Fraud Detection and Market Intelligence (OFDMI).  Created in 2009, OFDMI’s mission is to collect and review allegations of serious fraud and investor harm.  It consists of four units:  the Insider Trading Surveillance Group; the Fraud Surveillance Group; the Central Review Group, and the Office of the Whistleblower.  The first and last are self-explanatory.  The Fraud Surveillance Group’s job is to analyze equity trading, and to detect and investigate fraudulent or manipulative activity such as pump and dump schemes, issuer fraud, and more.  The Central Review Group performs preliminary investigations and analyzes regulatory filings, investor complaints, and other sources of regulatory intelligence.

Since FINRA has jurisdiction of broker-dealers and registered representatives only, it can’t deal with all the dirt OFDMI digs up on its own.  It makes many referrals to the SEC, other regulators like the U.S. Commodity Futures Trading Commission (CFTC) and state securities commissions, and to law enforcement.  In 2016, OFDMI made 785 referrals; there is no information available about how many were acted upon by the agencies contacted.  However, everyone who follows SEC enforcement actions knows FINRA is often thanked for its help in suspension and litigation notices.  Often,  those SEC enforcement actions involve OTC issuers.


In what other ways does FINRA deal with penny stocks?  Its role is larger than many suspect.  Ever since it was the NASD, it’s been charged with managing OTC issuers and facilitating trading in their stock.   That appears to have happened more or less by default.  Contrary to what many penny stock players believe, “the OTC” is not an exchange.  Some entity or entities must provide a trading platform, and trades executed on it must be reported to some central repository.

Decades ago, it was decided that FINRA—then the NASD—would create and maintain a trading platform.  It was called the OTCBB, for “Over-the-Counter Bulletin Board.”  In those pre-electronic days, all trades were executed and reported by telephone.  The system was slow and inefficient, but the OTC was largely a backwater of little interest to the vast majority of investors.  By the 1990s, that was about to change, and the agent of change would be the Internet.

Around 1995, online discount brokerages appeared on the scene.  They made it possible for retail investors to manage their own accounts and place their own orders.  Even more importantly, they slashed commission prices to the bone.  Some of their clients stuck with the exchange-listed issuers they’d always felt relatively safe with, but others discovered the excitement of the pennies.  As enthusiasm grew, it became clear to a group of New York investors that interest in OTC stocks was growing, and the OTCBB wasn’t doing the job it could be doing.  The group, headed by Cromwell Coulson, bought the National Quotation Bureau (NQB) in 1997.  The NQB, which had existed since 1913, did what its name suggests:  it published quotations for very cheap stocks.  It was informally called the Pink Sheets because the quotes were printed on pink paper.  Coulson introduced an electronic quotation service he called Pink Link in 1999, and changed the name of the NQB to Pink Sheets LLC in 2000.

Pink Link was an immediate success, because it simplified trade executions for OTC issues enormously.  As the new company picked up clients, the OTCBB took a course that would result in the loss of clients, though “clients” that were OTC issuers and market makers were never actively desired by the NASD.  In early January 1999 the organization announced that the SEC had approved the OTC Bulletin Board Eligibility Rule, which the NASD had proposed.  The rule required all OTCBB companies to be SEC registrants.  Enforcement would begin in July 1999, and would be phased in through June 2000 in “alphabetical increments based upon the company’s name as of January 4, 1999.”  No doubt the NASD believed if they didn’t make it absolutely clear, some issuers would change their names to avoid early compliance, and probably those doubts were warranted.  One non-filer unsuccessfully sued the regulator, accusing it of alphabetical discrimination.

Companies that failed to comply with the Eligibility Rule were given the boot by the OTCBB, and landed in the welcoming arms of Pink Sheets.  Not only did the OTCBB see a sharp decline in the number of companies quoted by it; it also saw many fewer market makers willing to use it to execute trades.  It made no effort to compete with the electronic platform Pink Link, and it charged market makers to use its services.  Pink Sheets did not.  Initially, many issuers were “dually quoted” by the OTCBB and Pink Sheets/OTC Markets.  But over the next eight years, their number declined precipitously.  In September 2009, FINRA announced it was interested in selling the OTCBB.  Negotiations with OTC Markets broke down, and in September 2010, FINRA announced the buyer would be investment bank Rodman & Renshaw.  But thanks to an accelerating exodus of issuers and market makers from the OTCBB, that deal fell apart as well.

In 2014, FINRA tried to throw in the towel on the trading platform, at least.  (It was never entirely clear what it meant when it said it would be “selling the OTCBB.”  On July 9, 2014, it filed with its regulator, the SEC, proposing “amendments regarding quotation requirements for unlisted equity securities and deleting the rules related to the OTC Bulletin Board Service… and ceasing its operation.”  It appears FINRA’s intention was to abandon the trading platform altogether.  The regulator intended some sweeping changes:

Finally, FINRA is proposing to delete the FINRA Rule 6500 Series, which governs the operation of the OTC Bulletin Board Service and cease operation of the OTCBB. FINRA previously proposed to delete the OTCBB rules and discontinue operation of the Service as part of a separate rule filing, the “QCF Proposal.” As discussed in the QCF Proposal, the level of transparency in OTC equity securities facilitated by the operation of the OTCBB has been declining significantly for years as other quotation venues have emerged. In fact, since the filing of the QCF Proposal on November 6, 2009, the amount of quotation information widely available to investors relying on OTCBB BBO data has further declined and has become negligible. Thus, FINRA believes that the remaining OTCBB information being disseminated to investors is so incomplete as to be potentially misleading with respect to the current pricing in these securities.

Turning to statistics, the organization pointed out that:

In addition, less than twelve securities out of the 10,000 OTC equity securities are quoted solely on OTCBB. Furthermore, based upon a sample of 20 days in 2013, the OTCBB only disseminated an average of 27 computed BBOs, which means that OTCBB BBO quotation information was available through Level 1 on less than 0.3% of the 10,000 OTC equity security symbols.

The “QCF Proposal, advanced in 2009, was denounced by the then-Pink OTC Markets in several comments filed with the SEC.  The most comprehensive submission cites what OTCM saw as serious constitutional issues.

What happened to the rule change proposed in 2014?  It went through several SEC public comment periods.  And then on March 3, 2015, FINRA quietly withdrew it, offering no explanation.

FINRA did take down the OTCBB website in late 2014.  Presumably the OTCBB trading platform soldiers on in a basement somewhere, staffed by snoozing elves with phones that never ring.

The Rule 6500 Series, which FINRA wanted to kill in 2014, is still in place.  Even so, FINRA’s penny stock responsibilities go far beyond managing a trading platform.  They’re multiple and diverse, and most are part of what FINRA calls the “6400 Series” of internal rules.

Most of these rules are directed at broker-dealers, and have no enforcement or disciplinary implications for issuers.  Rules 6430-6431 and 6433-6438 have to do with quotation requirements, for example.   Rule 6450 has to do with access fees that may be charged by market makers; 6460 governs the display of customer limit orders; and 6480 is directed at members who wish to use more than one Market Participant Symbol (MPID) to quote and trade securities or to report trades.

Several other rules in the 6400 Series, however, may affect issuers in important ways.

SEC Rule 15c2-11 (FINRA Rule 6432)

FINRA deals with every OTC issuer at least twice:  when the company’s sponsoring market maker submits a Form 211 so that the stock may be publicly quoted, and when the company requests a ticker symbol.  Issuers that are not compliant with SEC Rule 15c2-11 can trade only on the so-called Grey Market, where no quotations are published and liquidity is minimal.

Rule 15c2-11 compliance for the OTC is managed by FINRA.  The process is straightforward.  The company locates a willing sponsor, and provides it with financial and other information.  Financial statements need not be audited, but needless to say, they must be accurate.  Since the market maker may be exposed to some liability should the information provided turn out to be fraudulent, he’ll proceed with reasonable caution.  He then compiles a Form 211 and submits it to FINRA.  The 211 was once a paper form, but since late October 2017 an electronic filing has been required.

FINRA then assesses the filing, making sure all the necessary information is included.  It may request clarification of some points, or ask that additional information be provided where needed.  Forms 211 for new issuers are usually processed fairly quickly, as are ticker requests, and the stock begins trading within a month or so.  Initially, only the sponsoring market maker can make a market in the stock of the new public company, but after 30 days, others may “piggyback” on his Form 211.

Compliance with Rule 15c2-11 isn’t necessarily forever.  If a security isn’t quoted by any market maker for more than four business days, it loses compliance and will be delisted to the Grey Market.  In that event, the issuer will need to find a sponsoring market maker willing to file a 211 once again.  Compliance will also be lost if a stock is suspended by the SEC.  Every suspension notice warns:

Brokers and dealers should be alert to the fact that, pursuant to Exchange Act Rule 15c2-11, at the termination of the trading suspension, no quotation may be entered relating to the securities of the subject companies unless and until the broker or dealer has strictly complied with all of the provisions of the rule.

Theoretically, the issuer is free to try to find a sponsoring market maker who’ll help it return to the OTCBB or the Pinks, but in reality, it will probably be stuck on the Greys forever.  Any market maker approached about a 211 will be aware that the stock and the company are problematic enough to have warranted a suspension; the form itself asks whether the stock has been “subject to a trading suspension order issued by the SEC during the past 12 months.”  If the answer is “yes,” the market maker will probably not take the job.  Success is unlikely, and he isn’t allowed to accept compensation for the assignment.  In the rare event that the issuer does find a willing market maker, FINRA will almost certainly decline to process the 211.  In the past 15 years or so, only a handful of previously suspended stocks have returned to “normal” trading, and most of those have been delinquent filers who accepted revocation of registration and then began the registration process anew.

Rule 6490:  Processing of Company-Related Actions

Rule 6490 was introduced by FINRA in 2010.  Unlike most FINRA rules, it affects issuers only, and most OTC companies will find themselves dealing with it sooner or later.  As the regulator says:

Historically, FINRA has performed certain limited functions relating to the processing of non-exchange-listed issuer company actions in the over-the-counter (OTC) securities market. Specifically, FINRA reviews and processes documents related to announcements for company-related actions pursuant to SEC Rule 10b-17 (Untimely Announcements of Record Dates), and other company actions, including the issuance of or change to a trading symbol or company name, mergers, acquisition, dissolutions or other company control transactions, bankruptcy or liquidations.

Before the new rule was put in place, FINRA could only hope issuers informed it of corporate actions in a timely manner; the old rules had no teeth.  Rule 6490 made clear what corporate actions needed to be sent to FINRA for processing, and provided for a fee schedule that included penalties for late submissions.

The actions that must be reported include dividends or other distributions in cash or kind, stock splits or reverse stock splits, rights or other subscription offerings, name or symbol changes, mergers, acquisitions, dissolutions, bankruptcy or liquidations.

Most importantly, the Rule gives FINRA the power to decline to process a corporate action if the issuer’s submission is deemed to be “deficient.”  Actions may only be denied for a few very specific reasons:

The Department of Market Operations shall make such deficiency determinations solely on the basis of one or more of the following factors:

(1) FINRA staff reasonably believes the forms and all supporting documentation, in whole or in part, may not be complete, accurate or with proper authority;

(2) the issuer is not current in its reporting requirements, if applicable, to the SEC or other regulatory authority;

(3) FINRA has actual knowledge that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected to the issuer or the SEC Rule 10b-17 Action or Other Company-Related Action are the subject of a pending, adjudicated or settled regulatory action or investigation by a federal, state or foreign regulatory agency, or a self-regulatory organization; or a civil or criminal action related to fraud or securities laws violations;

(4) a state, federal or foreign authority or self-regulatory organization has provided information to FINRA, or FINRA otherwise has actual knowledge indicating that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected with the issuer or the SEC Rule 10b-17 Action or Other Company-Related Action may be potentially involved in fraudulent activities related to the securities markets and/or pose a threat to public investors; and/or

(5) there is significant uncertainty in the settlement and clearance process for the security.

That list ought to give FINRA considerable leeway to reject unsuitable corporate action requests, yet since 2010, the number of submissions deemed deficient has remained relatively small.  To some extent, the mere existence of the rule may have a deterrent effect. While FINRA can refuse to process actions like a stock split, other corporate changes such as name changes, reverse mergers and changes of control can occur without FINRA processing. This has resulted in an increasing number of issuers ignoring Rule 6490. Unfortunately, FINRA takes no action against the issuers.

On September 16, 2014, Ecolocap Solutions, Inc. (ECOS) announced in a Form 8-K that FINRA had declined to process a 1:2,000 reverse stock split.  The ECOS CEO, Michael Siegel, fulminated that:

FINRA has predicted  its unwillingness to process the reverse stock split based upon Rule 6490(d)(3) of the FINRA Manual which provides that FINRA does not have to process the reverse stock split because FINRA has actual knowledge that we, persons associated with us, our officers, our directors, our transfer agent, our legal advisor, our promoters or other persons connected to us were the subject of a settled regulatory action by a federal (SEC) agency.  FINRA goes on to describe the actions of one Kurt Krammer [sic: Curt Kramer] and his corporations, Mazuma Corporation, Mazuma Funding Corporation, and Mazuma Holding Corporation which were the subject matter of an SEC cease and desist order and fine.  Our officers, directors, transfer agent, legal advisor, our promoters are not subject to the foregoing sanctions or determination.

Siegel went on to admit that ECOS had indeed borrowed money from toxic funder Curt Kramer’s Asher Enterprises, but claimed that “as a matter of law,” Kramer and Asher were not “connected” to Ecolocap.

FINRA’s letter to Ecolocap is more temperate.  It details the offenses for which Curt Kramer was sanctioned, adding that “The above activity involving Curt Kramer as convertible note holder of ECOS shares in the name of Asher Enterprises, has raised concerns for FINRA regarding the protection of investors and the transparency to the marketplace as it relates to the proposed corporate action request. As such, the Department has deemed ECOS’s corporate action submission to be deficient under FINRA Rule 6490(d)(3)(3).”

Siegel vowed to appeal this “arbitrary and capricious action.”  Rule 6490 makes provision for appeals of deficiency determinations.  The appellant must notify members of FINRA’s Uniform Practice Code Committee within seven days of receipt of a letter like the one received by ECOS.  Siegel did file a notice of appeal with FINRA on September 23, 2014, but failed to pay the $4,000 filing fee.  And so FINRA’s decision became final.

Siegel gave the matter some thought, and arranged for Kramer to sell his promissory note to Proteus Capital, LLC.  He then informed FINRA that ECOS no longer had any relationship with Kramer or Asher Enterprises.  FINRA agreed to review the matter.  Ecolocap submitted a new corporate action request.  This one was processed, and the reverse split became effective on February 18, 2015.

Issuers whose corporate action requests have been denied, and have appealed to FINRA and lost, have one last chance:  they’re entitled to an SEC review.  A company called AutoChina International Limited filed such an action in 2016.  The Commission weighed the information presented by both sides and delivered an interesting opinion.

AutoChina was not like most penny companies.  It had once traded on the NASDAQ, from which it was delisted on September 19, 2011.  In April 2012, the SEC sued AutoChina, a senior executive of the company, a director and several key investors for participating in a market manipulation scheme.  The SEC prevailed in the action in 2014.  Unlike many of its fellow “Chinese reverse merger companies,” AutoChina did not fade away.  It was still trading on the OTCQB, and still an SEC registrant current with its filings, in 2015, when it decided to change its name to “Fincera, Inc.”  FINRA denied its corporate action request, in part on the grounds that, it claimed, some of the defendants in the SEC civil action were “apparently still employed by or affiliated with AutoChina.”

In its appeal, AutoChina did not dispute FINRA’s contention that the request was deficient; it objected that the defendants in the SEC suit referenced by FINRA were no longer associated with the company.  The Commission’s review “identified no evidence to support FINRA’s finding.”  So in the end, the SEC remanded the proceeding to FINRA to determine the status of the individuals in question, and to determine whether denying the name change was necessary for the “protection of investors and the public interest.”  The company now trades as Fincera, Inc (YUANF).

Most of the time, appeals to FINRA or the SEC by issuers whose corporate action requests have been denied go in FINRA’s favor.  In early 2015, attorney Jehu Hand, a sometime shell peddler, applied for custodianship of a Nevada public shell called Mabcure, Inc (MBCI).  On May 28 of that year, he reinstated the company’s corporate charter.  On the same date, he incorporated a new Nevada entity called Shika Dam, and on 9 June, he merged Mabcure into Shika Dam.  Mabcure, like many dormant public shells, was a delinquent SEC registrant.  On 25 June, Hand filed a Form 15 to terminate the company’s registration.

Hand was evidently planning a complex merger transaction that is explained in a Form 10 for Shika Dam companies filed with the SEC on 30 September 2015.  (Curiously, the document’s Edgar caption is “Another EDGAR filing by Jehu Hand.”)  According to the Form 10, Mabcure/Shika Dam was to have served as a sort of holding company for the other Shika Dam entities.

Hand commenced his effort persuade FINRA to grant a name change from Mabcure to Shika Dam in June.  FINRA denied the action quickly.  Hand requested the intervention of the Ombudsman.  FINRA agreed to review the request, and on November 5, 2015, FINRA sent Hand a deficiency notice. FINRA’s grounds for denial are interesting.  Despite the fact that Hand had filed a Form 15 to terminate Mabcure’s registration, FINRA objected that MBCI was nonetheless delinquent, “having failed to file a complete Form 10-K for the fiscal year ending December 31, 2011…”

When Hand submitted his corporate action request for the second time, FINRA informed him that Mabcure might be delinquent in its reporting obligations.  Hand requested a waiver from the SEC’s Chief Accountant.  And then…

On August 26, 2015 the Office of Chief Accountant for the SEC responded in writing to the Issuer, stating that they will not be granting a waiver and further noted that “The Commission believes that the proposed factors are reasonably designed to allow FINRA to deny a request to process a Company Related Action based on the above-noted objective criteria… The Commission believes that the proposal furthers FINRA’s goal to assure that documents supporting a request to process a Company Related Action are complete and correct and that its facilities are not misused in furtherance of fraudulent or manipulative acts and practices.”

On November 10, 2015, Hand sent a notice of appeal to FINRA’s Uniform Practice Code Committee.  Hand had five objections to FINRA’s assessment:

First, the Department of Market Operations (the “Department”) failed to follow the procedures of Rule 6490 in evaluating the corporate action. Second, the deficiency determination letter is based in part on the Department’s false and misleading statement.  Third, the phrase in Rule 6490(d)(3)(2) “the issuer is not current in its reporting requirements, if applicable, to the SEC or other regulatory authority” should be interpreted, not as requiring an issuer to never having  missed a required report in all its reporting history, but only the recent, relevant history. Fourth, the Department’s deficiency determination letter of November 5, 2015 is “arbitrary and capricious” and is therefore invalid. Finally, had the Department followed the procedures of Rule 6490, it would have been required to approve the corporate action under the balancing test implicit in the Rule.

Hand seems to have believed that by filing a Form 15 to terminate registration before he filed his corporate action request, he’d relieved the company of any obligation to become current with its filings.  FINRA disagreed, and apparently the SEC’s chief accountant did as well.  Hand explained that he’d filed the Form 10 for Shika Dam (which by 30 September, the date of the filing, had already been merged in Nevada with Mabcure) to provide the current financial disclosure FINRA evidently sought.

FINRA did not relent.  In January 2016, Hand pulled the plug on Shika Dam’s relationship with the SEC, terminating its registration.  Mabcure received no name change, and continued to trade as MBCI.  It is currently a “dark or defunct” Pink.  Under its new name—Shika Dam—its corporate charter is once again revoked in Nevada.  It stands ready to be hijacked once again.

Did Hand suspect FINRA was just toying with him?  He’d have had reason to do so.  There are a great many OTC companies that have terminated their SEC registration while delinquent in their required periodic filings.  It’s quite rare for the SEC, or for FINRA, to raise objections.  And yet both regulators did that with Hand.  While one possible reason for FINRA to decline to process a corporate action is a failure on the part of the issuer to be current with its reporting requirements, another is “actual knowledge” that an officer, director, or associate of the issuer is the subject of an investigation by a federal… regulatory agency… or a civil or criminal action related to fraud or securities laws violations.”

Hand most certainly fits that description.  He’d been under investigation by the SEC and the DOJ for several years, in connection with a pump and dump scheme that used a company called Greenway Technology as its vehicle.  It seems unlikely the SEC failed to share that information with FINRA.  On December 11, 2015, only a month after the lawyer had sent in his notice of appeal, he was sued by the SEC and indicted by the DOJ.  On June 6, 2018, he was convicted by a Massachusetts jury of securities fraud, wire fraud, and conspiracy to commit those offenses.

The corporate actions addressed by Rule 6490 are reported by FINRA on the Daily List once effectiveness is imminent.  The Daily List is a useful tool for OTC investors.  Not only does it report corporate actions; it also provides OTC market statistics, FINRA’s bi-monthly Equity Short Interest reports, a list of trading halts, the Reg SHO OTC Threshold list, and more.

Rule 6440:  Trading and Quotation Halt in OTC Equity Securities

Rule 6440, like Rule 6490, gives FINRA limited regulatory power over issuers.  First promulgated in 2000 as Rule 6660, it derives some of its authority from SEC Rule 10b-17.  As noted above, Rule 10b-17 has to do with “untimely announcements of record dates,” and establishes that for an issuer to fail to give notice of corporate events may constitute a “manipulative or deceptive device or contrivance.”  It granted what was then the NASD, and is now FINRA, the job of seeing to it the Rule was not violated.

As Rule 6440 was originally conceived, the NASD would halt trading in OTCBB issues for only three reasons:  the security is a foreign issue whose primary trading venue is not in the U.S., and the stock has been halted by the regulatory authority for that venue; the security is a derivative of an exchange-listed U.S. issue, and the exchange has halted trading in it; or the “OTCBB issuer does not timely provide the NASD with information provided by SEC Rule 10b-17.”

In other words, the NASD could have imposed a halt on penny stocks that failed to comply with Rule 6490, had Rule 6490 existed at the time.  In 2007, Rule 6660 was modified, and that third reason to impose a halt was the most significantly altered part of the new version:

Further, Rule 6660 expands NASD’s existing trading halt authority to provide more general trading and quotation halt authority beyond halts related to non-compliance with SEC Rule 10b-17, while limiting such authority to only those extraordinary events that have a material effect on the market for the OTC Equity Security and have the potential to cause major disruption to the marketplace and/or significant uncertainty in the settlement and clearance process. Specifically, under Rule 6660(a)(3), NASD has the authority to impose a trading and quotation halt for material events, where NASD determines, at its discretion, based on the facts and circumstances of the particular event, that halting trading in the security is the appropriate mechanism to protect investors and ensure a fair and orderly marketplace.

The notice applies the brakes a few paragraphs later, adding that “NASD does not favor imposing a trading halt and thus expects to exercise this authority in very limited circumstances.”  The NASD would base its decision on a number of factors, “including but not limited to”:

(1) the material nature of the event;

(2) the material facts surrounding the event are undisputed and not in conflict;

(3) the event has caused widespread confusion in the trading of the security;

(4) there has been a material negative effect on the market for the subject security;

(5) the potential exists for a major disruption to the marketplace;

(6) there is significant uncertainty in the settlement and clearance process for the security; and/or

(7) such other factors as NASD deems relevant in making its determination.

Originally, halts imposed by the NASD had a maximum duration of 5 trading days, but in 2007 that was changed to 10 trading days.

A notice from later in 2007 introduced new trading halt codes, and christened the type of halt discussed above—the U3—as an “Extraordinary Events” halt.  It also attached the very brief definition used today:  “Trading is halted because NASD has determined that an extraordinary event has occurred or is ongoing that has had a material effect on the market for the OTC Equity Security or has caused or has the potential to cause major disruption to the marketplace and/or significant uncertainty in the settlement and clearance process.”

Since then, FINRA has made no significant changes to its rules regarding trading halts, except to change the rule number from 6660 to 6440.  The only additional information offered about U3 halts has to do with their duration:  “After FINRA initiates a halt in an OTC Equity Security as a result of an Extraordinary Event Halt, trading and quotations in the OTC market for the OTC Equity Security may resume when FINRA determines that the basis for the halt no longer exists, or when ten business days have elapsed from the date FINRA initiated the trading and quotation halt in the security, whichever occurs first.”  It is later explained that U3s may be extended, if an extension appears to be in the public interest.

So far, FINRA has stood by its word, and kept U3 halts rare.  In the past five years, FINRA has halted Eco-Trade Corporation (BOPT), Cynk Tech Corp (CYNK), Riviera Tool Company (RIVT), Calissio Resources Group (CRGP), SWK Holdings (SWKH), and Jetcom Inc. (JTCMF).  The halts were imposed for mostly different reasons.  BOPT and CYNK were relatively low-volume pump and dump operations, with insiders who controlled the float and manipulated it to provoke short squeezes.  The SEC brought no enforcement actions against BOPT, but it and the DOJ threw the book at the CYNK insiders and a number of Caribbean and Central American brokers and brokerages.  Nearly all the perpetrators agreed to plead guilty to somewhat reduced charges, and settled with the SEC.  Those who went to prison are still incarcerated.  RIVT was an unusual case of mistaken identity.  Early on the day it was halted, some traders wrongly believed the company had been acquired by Tesla.  They bought with enthusiasm, driving the stock price into the dollars.  Other traders, realizing that information was incorrect, and that RIVT was a long-dormant shell with no value, shorted.  Chaos ensued, triggering “major disruption to the marketplace and/or significant uncertainty in the settlement and clearance process.”  FINRA halted.  Similar uncertainly was created by a bungled special dividend declared and distributed by CRGP, a study in greed and incompetence we last wrote about a few months ago.  The SEC only began to bring related enforcement actions nearly three years after the offenses occurred.

One significant difference between SEC suspensions and FINRA U3 trading halts is that by law, suspensions can last no longer than ten trading days.  U3 halts, however, may at FINRA’s discretion be rolled over indefinitely.  RIVT was halted in May 2015, and the halt was not lifted until early December of the same year.  Ironically, that punished the shorts who’d made the correct play:  they were forced to pay daily fees to their brokers or clearing firms until they were able to cover by negotiating private transactions with longs who were also stuck, though in a different way.  BOPT and CRGP were both halted for more than four trading sessions, and lost compliance with Rule 15c2-11.  They, along with CYNK and RIVT, still trade on the Grey Market.  SWKH does not.  Halted on September 16, 2015, a few weeks after CRGP had suffered the same fate, it returned to normal trading the next day.  FINRA released a Uniform Practice Advisory explaining that there’d been “issues related to perceived post-split trading and subsequent price adjustments.”  In other words, the company had given insufficient warning that its stock would be trading on a post-split basis on the morning of the 16th.  It had failed to submit a corporate action request to FINRA in compliance with Rule 6490.  JTCMF was halted in August 2016, and that action was also accompanied by a UPC Advisory.  FINRA believed that as with RIVT, “trading activity in JTCMF demonstrated investor confusion related to the acquisition of an unrelated private entity.”  The halt was lifted five days later, and trading resumed on the Grey Market.

Since then, FINRA has only employed U3 halts once, on April 28, 2017.  At the opening bell on that day, the regulator surprised market observers by pulling the plug on 271 OTC stocks.  Hours later, it explained that the halts were imposed “because technical issues experienced this morning with the FINRA BBDS (Bulletin Board Dissemination Service) data feed resulted in the dissemination of potentially inaccurate data to the marketplace.”  All of the halts had been lifted by 2:55 p.m. the same day.

FINRA and Penny Stock Enforcement

Although FINRA may regard OTC companies as their red-headed stepchild, it has responsibilities to them, and to members of the public who invest in them.  Among those responsibilities are limited enforcement obligations.  As we’ve seen, they police Forms 211 in an effort to ensure that issuers aren’t allowed to begin trading until, through their sponsoring market makers, they’ve produced information that demonstrates at least minimal bona fides.  If their disclosures fail to convince, FINRA will request additional data until it’s satisfied, or the issuer gives up.

It can scrutinize corporate action requests, and deny them in some circumstances.  Still, we have the feeling that in many cases, not all the questions that should be asked, are asked.  Worthless, and often mendacious, companies are sometimes permitted to perform actions that are likely to be detrimental to their investors, such as successive reverse splits.  As the wording of Rule 6490 suggests, it was originally contemplated that corporate actions would be processed within 10 days from the time the issuer’s request is submitted.  The issuer is in fact encouraged to propose a date of effectiveness.  But for the past several years, processing is in many cases taking longer and longer, as FINRA asks for more and more information.  Requests for name and ticker changes can drag on for six months or more, as FINRA seeks to persuade the applicant to ensure his request is “complete and accurate,” as mandated by the Rule.  In the end, however, the actions are almost always processed, even for companies that may seem problematic to outsiders.

We wonder how closely FINRA’s corporate actions staff coordinates with the SEC, and whether the SEC is willing to discuss ongoing investigations.  While the target of an investigation has not (yet) been found liable, much less guilty, Rule 6490 doesn’t require that:  it’s enough that an investigation exist.  It seems likely that in the case of Jehu Hand, FINRA staff was aware that the SEC was planning an action against the lawyer.  But that may have been an exception to the norm.  Perhaps better communication between the SEC and FINRA would help prevent suspect issuers from doing harm to their shareholders.

FINRA itself has indicated a preference for using U3 trading halts sparingly.  When they have been used, they’ve been triggered by events that had already begun to disrupt the marketplace; FINRA acted quickly to put a stop to that.  But Rule 6440 could be interpreted as offering FINRA a broader mandate to halt trading in the stock of problematic companies, should it wish to expand its role as a market cop.  For example, even relatively simple pump and dump schemes have potential to disrupt the market for the stocks being pumped.  In addition, wash trading, which FINRA can detect more easily than can the SEC, often plays a role.  Why shouldn’t FINRA stop that manipulation in its tracks?

OFDMI, as we’ve seen, investigates fraud in the market, and makes referrals to other regulators and to law enforcement.  Those referrals often result in SEC trading suspensions.  Perhaps FINRA should give some thought to cutting out the middleman, and dealing with some of the abuses it spots on its own, with a U3 halt.

For further information about FINRA listing requirements or this securities law blog, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit  This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates 
Brenda Hamilton, Going Public Lawyer
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956