OTC Markets Group Reflects on Amended Rule 15c2-11
The last week of September marked the one-year anniversary of the compliance date for the Securities and Exchange Commission (“SEC”) amendments to Securities and Exchange Act Rule 15c2-11, which regulates the quotation of over-the-counter securities. As we shall see, OTC Markets Group, whose issuer-clients are directly affected by the amended rule, decided to commemorate the occasion with a webinar called “One Year On: The Impact & Outcomes of SEC Rule 15c2-11.”
An overhaul was long overdue; the rule had last been altered in 1991, more than 30 years ago. Since then, the ways in which most people manage their investments have changed enormously. Now they can do research on the internet, and buy and sell through online brokers, many of whom will charge them charge them no SECs or fees. They can communicate with their fellow investors on a large number of social media forums. All of that made the need for amended Rule 15c2-11 urgent.
Amended SEC Rule 15c2-11 took quite a while to make it to prime time. First, a concept release titled “Publication or Submission of Quotations Without Specified Information” was published by the SEC on September 25, 2019. Concept releases are relatively rare—none has appeared since the one under discussion here—and their purpose is to “solicit the public’s views on securities issues so that we can better evaluate the need for future rulemaking.” The SEC got what it wanted: though the deadline for comment was December 30, 2019, members of the public, market participants, and even politicians continued to send letters until July 26, 2022.
Perhaps because of the considerable number of widely differing responses to the concept release, the SEC decided to proceed immediately to a final rule, which appeared on September 16, 2020. It was immediately clear that the changed proposed would make for radical changes to the world of issuers quoted on the OTC Markets. The SEC’s chief object was to reduce the number of securities trading on the OTC Markets without even the most basic financial information and other disclosures made available to the public.
When Rule 15c2-11 was originally introduced in 1971, and again when it was extensively modified in 1991, it provided that new issuers would need to demonstrate compliance before quotation of their securities began. A market maker would have to agree to submit a Form 211 to the National Association of Securities Dealers (NASD). The form would contain financial information about the company in question, its history and business, and its management. The market maker would need to assure himself that the company’s financial statements were in order, but there was no requirement that they be audited. Once received by the NASD, the form would be processed, and the NASD would issue a trading symbol to the stock. It would then begin to be quoted.
For the first 30 days after trading began, only the market maker who’d compiled and submitted the Form 211 could make a market for its securities. That was intended as a kind of courtesy to the sponsoring market maker, since he was not permitted to charge for any of the services he’d performed in connection with the Form 211. Back in the ‘70s, ‘80s, ‘90s, and even the early 2000s, that may have been considered a meaningful benefit. Until 2006, when the NASDAQ became a national stock exchange, securities listed on it needed a market maker to see to the filing of a Form 211, just as did stocks that traded over-the-counter. Having the exclusive right to trade a hot new NASDAQ stock for a month might have been worth good money. That changed years ago.
Once the sponsoring market maker’s 30 days were over, other market makers were permitted to “piggyback” on the information contained in the Form 211 he’d filed. They could then join in making a market in the stock. The problem was that they could continue trading the stock literally forever, as long as the issuer’s registration wasn’t revoked. That, however, could only happen to SEC registrant’s delinquent with their required financial reports. Even non-reporters whose management had disappeared years before traded on as what’s known in Pennyland as “zombie tickers.” Some of them eventually become targets of shell vendors who bring custodianship actions in local courts in the state where the issuer was incorporated; the shell is then sold by the new custodian to management of a private company wishing to go public in what it hopes will be a quick and easy way. Others will simply trade less and less, and after a few years the former NASD, now called the Financial Industry Regulatory Authority (FINRA) will declare them “inactive securities,” and delete their tickers.
As manipulation and fraud involving OTC Markets issuers increased, in good part thanks to the ease of trading, and to the ease of pumping them on the internet, the SEC and FINRA became concerned. The 1991 modification of Rule 15c2-11contained a stipulation requiring the stocks that traded pursuant to it to maintain “current information,” but it was unclear how that should be monitored or by whom.
The 2020 Rule Amending 15c-211
When the final rule was published in September 2020, like the concept release, it received a good deal of attention, though no further comments were solicited. It became effective 60 days after its publication in the Federal Register on October 27, 2020. Although effectiveness did indeed take place on December 28, 2020, for reasons explained in the rule, the compliance date was set for September 28, 2021.
In a press release announcing the final rule, the SEC observed:
Prior to today’s amendments, certain of the rule’s previous exceptions permitted broker-dealers to maintain a quoted market for an issuer’s security in perpetuity, in the absence of current and publicly available information about the issuer, and even when the issuer no longer exists. Recognizing the ease with which information sharing takes place today, 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. Investors who have access to current and publicly available issuer information are better equipped to make informed decisions about how to allocate their capital and to counteract misinformation that can proliferate through promotions and other channels.
That is the meat of the new Rule 15c2-11: issuers that want to be quoted must update their financial and other disclosures continuously. To a considerable extent, they’ll be watched by OTC Markets Group, which runs OTC Link, an electronic trading platform, and offers its clients—who consist of the issuers of most OTC stocks trading in the U.S.—a Disclosure & News Service at which they can present the materials that must be offered to the public in order for them to be compliant with the rule, and so eligible for quotation.
The revised rule contains an important new provision. In the past, the only actors involved in the Form 211 process were market makers. It was they who dealt with FINRA, and who, with information provided by the company, compiled and submitted the form. Now, “any qualified interdealer quotation system (‘qualified IDQS’) [can] conduct the required information review as well.” Needless to say, the qualified IDQS that immediately jumps to mind is OTC Markets. In fact, until the spring of 2021, OTC Markets appeared to believe it could simply cut to the chase and qualify issuers for quotation without any intervention from FINRA. It also believed it could charge for any work it did in that connection.
On May 28, 2021, FINRA, which had said nothing throughout the comment period for the amended rule, presented its own proposals in the form of changed to its Rule 6432 (Compliance with the Information Requirements of SEA Rule 15c2-11). Three points apply to OTC Markets. The first two concern its own obligations to FINRA, which are to: “(i) require that any Qualified IDQS making a publicly available determination regarding an initial information review submit a modified Form 211 filing to FINRA by 6:30:00 p.m. Eastern Time (ET) on the following business day; [and] (ii) require that any Qualified IDQS making a publicly available determination pursuant to SEC Rule 15c2-11 on a given day, including regarding the availability of an SEC Rule 15c2-11 exception, submit a daily security file to FINRA containing summary information for all securities quoted on its system on that day by 6:30:00 p.m. ET on the following business day.” In addition, as part of the modified Form 211, a principal of the IDQS must certify that “neither the firm nor its associated persons have accepted or will accept any payment or other consideration for filing Form 211.”
On July 6, 2021, Dan Zinn, OTC Markets’ General Counsel, and Associate General Counsel Cass Sanford submitted a comment letter on the FINRA proposed amendments to Rule 6432. In it, they immediately note that “[a]s the operator of a Qualified IDQS directly impacted by the Rule Proposal, our comments are narrowly focused on the application of FINRA’s existing Rule 5250 (Payments for Market Making) (‘Rule 5250’) to the activities of a Qualified IDQS as outlined in the Rule Proposal.” The thrust of their argument is that IDQSs don’t publish quotations, nor are they market makers. They add that Rule 5250 does allow for payment for “other services.” They lost their argument.
The OTC Markets Webinar
The compliance date for the new rule came and went a year ago. Some questions still linger, and a thoughtful assessment of its effect on the OTC market, and on market participants generally, would be welcome. But that is not really what the webinar offered. A video of the event is available at YouTube.
The participants were Bob Power, Senior Vice President, Client Relations; Jason Paltrowitz, Executive Vice President, Corporate Services; Dr. Rory Knight, Chairman of Oxford Metrica; Chris King, Senior Vice President, Corporate Services International; and Joe Oltmanns, Senior Vice President, Corporate Services, U.S. Power handled introductions and transitions. The presentation lasted for about half an hour, followed by a 15-minute question and answer session.
Paltrowitz got things started by declaring, fairly enough, that the new Rule 15c2-11 is all about disclosure. He applauded OTC Markets’ efforts to nudge issuers toward better and more complete disclosure for more than 15 years, and said he believes the SEC “modeled” the rule on those established by OTC MARKETS for its own OTCQX and OTCQB markets. He then gamely pointed out that removing bad companies from the market is a good thing:
The SEC was right to act. They were right to update what was an old rule, to bring it into the 21st century and to make sure that there were investor protections in the market in line with what you would find on the national exchanges.
He then showed pie charts showing how the proportional distribution of issuers trading on the various OTC MARKETS had changed:
As we see, OTC Markets believes this shows a “flight to quality.” But how so? While the text informs us QX securities have increased by 9 percent, and QB companies by 14 percent, those gains look less impressive on the pie charts, where they are respectively shown as green and orange slices. The OTC Pink Current Information sector (shown in pink) has taken quite a hit. It seems hard to understand why, since the companies trading on it should have been compliant, with nothing to worry about, when the compliance date arrived. Some may have upgraded to OTCQB, or even to QX, but not enough to have made the very visible difference manifested in the charts.
At first glance, it seems odd that there are now considerably more stocks trading as Pink Limited Information than there were a year ago. Chris King, who works with international issuers, explained later in the webinar that SEA Rule 12g3-2(b), which became effective in 2008, exempts many foreign private issuers (“private” rather than government-owned) from having to register a class of securities under the Securities Exchange Act, and so from compliance with the periodic filing requirements of the Exchange Act. They must, however, be listed on a foreign securities exchange and make regular disclosure to that exchange, and must further post English translations of important disclosures at their websites, or, perhaps more conveniently for investors, at OTC Markets’ Disclosure & News Service.
The current problem, King says, is due to the fact that compliance with Rule 12g3-2(b) was in the past not closely monitored, and so the appropriate reviews were never done. The result is that “[t]here are thousands of companies that now fall into this category.”
The virtual disappearance of Pink No Information issuers, of which there were once many, can be accounted for by the fact that 2,963 companies were downgraded to the Expert Market (once called the Grey Market), where they cannot be quoted. The OTC MARKETS webinar panelists claimed those Expert Market stocks do have quotes that can be seen by broker-dealers and accredited investors, but as far as we know, they are not available to the latter. In late 2020, OTC Markets was informed that it needed exemptive relief if it intended to operate its Expert Market in that way. It hastily applied for an exemption on December 22, 2020. As far as we’re aware, nothing has happened with the application since August 2, 2021, when the Division of Trading and Markets released a statement declaring that “[t]his proposed order is not on the Chair’s agenda in the short term.” To date, the SEC has not granted the exemption.
How Does the Processing of Forms 211 Work Now?
Over the past year, we’ve been wondering exactly how new OTC issuers get up and running. We know that as an IDQS, OTC Markets can perform initial reviews. It can also initiate quotations without notice from FINRA, though it must submit a modified Form 211 by 6:30 p.m. the following day. (Sponsoring market makers who submit Forms 211 for clients must wait until they hear from FINRA to begin publishing quotes.) At the webinar, the contrast between the new process and the old was summed up in a slide:
We don’t know what happens if, once quotations have appeared, FINRA sees a problem with the Form 211 provided by OTC MARKETS. We also don’t know how many initial reviews have progressed to the submission of a modified Form 211 to FINRA. In its annual report for the 2021 fiscal year, OTC MARKETS explains the necessity of complying with FINRA’s amended Rule 6432, which became effective the same day compliance with the amended Rule 15c2-11 was required, September 28, 2021. The company notes that it is now obliged to submit a modified Form 211 and a daily data file, and reports that:
OTC Link has commenced conducing Initial Reviews pursuant to Rule 6432. We do not expect the ongoing costs of compliance with Rule 6432 to have a material impact on our financial results.
That suggests they’re complying with FINRA’s requirements, and are submitting those Forms 211 and daily data files. But it lacks specificity. At the webinar, Jason Paltrowitz supplied what seems to be a more current, but also more puzzling, explanation:
If you’re a private company that needs to have a 211, the old 211 process, right, you want to be publicly quoted, that initial review process is something that we’ve incorporated as part of the OTCQX and QB onboarding. We can do that initial review.
However, what’s different in the new rule is that there’s an initial requirement and –remember what I mentioned—there’s an ongoing requirement. And part of the ongoing requirement, not just the filing of your financials and disclosure with us on an ongoing basis, but there is a requirement that a market maker is quoting the security. So while we can do the 211 review, and make the company ‘public quote eligible,’ those are the term[s], so you’re eligible to have a public quote, you still need to ensure that there is a market maker quoting your security, because if there isn’t a market maker quoting the security, then you fall out of compliance as well.
And so we help with that as part of the process. But there’s two things that need to be done there, right? There’s the review—are you publicly quote eligible?—and then there’s the ‘a market maker actually needs to quote the security’–so we can work on both of those fronts.
How, then, does that work? It’s clear that a market maker needs to be involved, because once the issuer is “public quote eligible,” someone needs to quote its stock. And that will not be OTC Markets. As Paltrowitz made a point of saying at another point in the presentation, no component of the company is a market maker, so OTC Link cannot publish quotes; it can only display them. Clearly OTC MARKETS can help its clients, and, presumably, introduce them to a market maker willing to begin quoting their stocks. He would, perhaps, be more agreeable to helping out, knowing he needn’t spend unpaid time preparing and submitting a Form 211 to FINRA.
How long does the process take? According to Joe Oltmanns, who was asked how much time would be needed for a stock that lost compliance with Rule 15c2-11 to recover that compliance and trade with published quotes once again:
To get off of Expert and back onto Pink, QB or OTCQX, there are two options, but both require the initial review, whether it’s us doing it here internally, or you would work with an outside broker-dealer on a 211 with FINRA. That process, though, will take a few weeks to get through. So companies that do move to Expert, to get back to QB or QX, it’s not going to be an overnight process, to be clear, it’s going to take a few weeks. But normally companies that fall into Expert, usually fall into to it due to being delinquent with their filings. And so that alone will take time just to catch up.
Oltmanns is saying that if an issuer that’s been dumped to the Expert Market can supply the necessary and complete “current information” required, it can be up and running with published quotes in practically no time. Once again, in order to get things moving even relatively fast, the help of a market maker willing to publish quotations would be needed. Paltrowitz commented on a similar question:
So to get out of Expert Market, it is that 211 process. Now again, the rule doesn’t say that OTC Markets owns this process. That [sic] a company can find a market maker or a broker-dealer that does that 211 process on their own, or that company can come through OTC Markets if they meet the OTCQB or QX standard and can join that market. I think Joe mentioned that we have a service for Pink companies that want to make their disclosure available, the DNS [Disclosure & News] service. It would require a 211 review and the ongoing requirements to meet the new rule.
He obviously wanted to make clear that companies wishing to go public on the OTC Market have a choice: they can take the traditional route and find a market maker willing to file a Form 211, or they can instead choose OTC Markets, which can perform a “211 review,” which he appears to see as the same thing as “filing a Form 211.”
As noted above, another member of the webinar panel was Rory Knight, Chairman of Oxford Metrica. Oxford Metrica describes itself as a “strategic advisory firm” whose services are “anchored on evidence-based research in risk and financial performance.” In July 2022, OTC Markets first presented work done for them by Oxford, a paper titled “OTC Markets Strengthened by Regulation Change.” Needless to say, the “regulation change” was the amended Rule 15c2-11.
For the webinar, a more up-to-date version was prepared. Called “Positive Market Reaction to SEC Rule Change,” it came to conclusions similar to those reached in its first examination of the subject. Like Paltrowitz, the Oxford people see the requirements of the new rule as “codifying” OTC Markets’ “best-practice disclosure standards” for the OTCQX and QB, and the “baseline disclosure standards” for the two Pink tiers. Not unexpectedly, they found higher quality stocks providing more extensive disclosure—the QX and QB issuers—did better than Pinks over the year following the compliance date for the amended rule.
Oxford also provides a number of charts illustrating the “value gap” between the QX and QB stocks and the lowly Pinks, the greater liquidity of the QX and QB stocks, and tighter spreads for them. The “interpretation of the results” is as follows:
The results provide strong evidence that the increased transparency and disclosure that attends graduating to OTCQX and OTCQB in the OTC Markets attracts investor interest, visibility and liquidity. Companies should aspire to trade on the highest market for which they qualify. Progressing through the tiers from Pink Limited through Pink Current to OTCQX/OTCQB adds value at each step. Companies should see the process of moving through the tiers as a maturing process to be a publicly owned company.
That is true, and also unsurprising. But it overlooks something known to everyone—market participant or mere observer—who keeps an eye on Pennyland: that most OTC players aren’t interested in the regional banks that pay dividends, or in the ADRs of big foreign issuers. They’re interested instead in the high flyers and fast movers. Yes, in the pump and dump operations and at times in outfits that are downright fraudulent.
From their perspective, the OTC market has become a ghost town over the past year. Former penny partisans have packed their bags and moved into crypto, SPACs, and meme stocks with options that pack a punch. The amended Rule 15c2-11 was a big win for the SEC, but a great disappointment for them.
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