SEC Adopts Amendments to Enhance Retail Investor Protections, Modernize Rule Governing Quotations for Over-the-Counter Securities

On September 16, 2020, the U.S. Securities and Exchange Commission (SEC or Commission) adopted amendments to Rule 15c2-11 under the Securities Exchange Act of 1934 (Final Rule).¹ Rule 15c2-11 (Rule) governs the publication or submission of quotations by broker-dealers in a quotation medium other than a national securities exchange, that is, the over-the-counter (OTC) market. Before a broker-dealer may initiate or resume quotations for a security in a quotation medium, the broker-dealer must review key, basic information about the issuer of the security. The Rule allows any qualified interdealer quotation system (IDQS) to conduct the required information review as well. The OTC market consists mostly of newer companies whose finances often are less transparent. In addition, the investing market in large part is made up of retail investors. In this regard, the Rule endeavors to create added investor protections by placing a “gatekeeper” function on broker-dealers or IDQSs that wish to quote OTC securities.

The Amended Rule: The amendments are designed to modernize the Rule and to enhance investor protection by requiring that current and publicly available issuer information be accessible to investors. The Commission stated that the intent of the amendments is to (1) provide greater transparency to retail investors and other market participants regarding issuers of quoted OTC securities, (2) limit the use of certain exceptions under the Rule to better protect retail investors from fraud and manipulation, and (3) add new exceptions to reduce unnecessary burdens on broker-dealers and to enhance the efficiency of the OTC market.

The amendments provide greater transparency to the investing public by requiring information about the issuer and its securities to be current and publicly available before a broker-dealer can begin quoting that security. The amended Rule continues to require a broker-dealer to obtain and review basic information about an issuer of an OTC security before initiating or resuming a quoted market in the issuer’s security. The amended Rule also continues to require the broker-dealer to have a reasonable basis for believing that the information about the issuer, when considered along with any supplemental information, is accurate and from a reliable source. In addition to broker-dealers, under the amended Rule, qualified interdealer quotation systems are permitted to comply with the information review requirement, and broker-dealers may rely on a qualified IDQS’s publicly available determination that it has complied with the information review requirement for the broker-dealer to publish or submit a quotation to initiate or resume a quoted market in an issuer’s security.

The information review requirement in the amended Rule includes additional provisions that are designed to enhance transparency of issuer information and help to foster the integrity of the OTC market. Importantly, the amended Rule requires that the documents and information that a broker-dealer or qualified IDQS reviews generally must be current and publicly available. The amended Rule specifies under paragraph (b) the documents and information that must be reviewed with respect to issuers, including a new provision to recognize companies that issue securities in reliance on Regulation Crowdfunding and expands the list of documents and information that must be reviewed for certain other types of issuers. In addition, the amended Rule requires that a broker-dealer or qualified IDQS identify whether the quotation is published on behalf of the issuer or a company insider and also expands the list of market participants that must review supplemental information to comply with the information review requirement to include qualified IDQSs.

Narrower Exception for Unsolicited Orders: The amended Rule contains several exceptions to the information review requirement. The amended Rule continues to provide an exception that permits broker-dealers to publish a quotation for unsolicited customer orders without complying with the information review requirement. However, the amendments to the Rule prohibit broker-dealers from relying on this exception for an affiliate of the issuer or a company insider unless information about the issuer also is current and publicly available. This exception, as amended, permits a broker-dealer to rely on a representation from the customer’s broker that such customer is not an affiliate of the issuer or a company insider.

Additional Exceptions Where Transparency Exists: The amended Rule also adds three new exceptions:

• Highly Liquid Securities: First, the amended Rule adds an exception to permit a broker-dealer or qualified IDQS to publish or submit quotations for highly liquid securities of well-capitalized issuers without complying with the information review requirement where (1) a security has a reported worldwide average daily trading volume value (the ADTV value) of at least $100,000 during the 60 calendar days immediately before the publication of a quotation for such security, and (2) the issuer of such security has at least $50 million in total assets and $10 million in unaffiliated shareholders’ equity as reflected in the issuer’s publicly available audited balance sheet issued within six months after the end of its most recent fiscal year. This amendment was adopted in order to offer price transparency to retail investors where issuer securities currently meet the exception, but are not quoted, so that they may develop a quoted market.
• Underwritten Offerings: Second, the amended Rule excepts quotations for a security in an underwritten offering by a broker-dealer that is named as an underwriter in the registration statement or offering statement for such security. In those instances, the Commission reasoned that an underwriter’s due diligence is a reasonable substitute for the rule’s information requirements.
• IDQS: Finally, the amended Rule adds an exception to permit broker-dealers to rely on publicly available determinations by a qualified IDQS or a registered national securities association that the requirements of certain other exceptions are met. The qualified IDQS or registered national securities association must establish, maintain, and enforce reasonably designed written policies and procedures with respect to making such determinations.

Modified Piggyback: The amended Rule modifies the “piggyback” exception, which allows a broker-dealer to rely on the quotations of another broker-dealer that initially complied with the information review requirement. The amended Rule permits broker-dealers to rely on the piggyback exception based on at least a one-sided priced quotation, so long as there are no more than four business days in succession without a quotation, and prohibits reliance on the exception if the issuer of the security is a shell company after a certain prescribed period or was the subject of a trading suspension order issued by the Commission until 60 calendar days after the expiration of such order. The exception also now requires issuer information to be, depending on the regulatory status of the issuer, one of the following: (1) current and publicly available, as defined by the amended Rule; (2) timely filed (i.e., filed by the prescribed due date for a report or statement as required by an Exchange Act or Securities Act of 1933 reporting obligation); or (3) filed within 180 calendar days from a specified period. The exception also now includes a grace period that permits broker-dealers to continue quoting the securities for a limited period of up to 15 calendar days once a qualified IDQS or registered national securities association makes a publicly available determination that issuer information is no longer current and publicly available, timely filed, or filed within 180 calendar days from the applicable specified time frame. The piggyback exception no longer requires that there be quotations on each of at least 12 days within the previous 30 calendar days to establish piggyback eligibility.

Compliance Period

The SEC’s Amendments to Rule 15c2-11 will become effective 60 days following publication of the Final Rule in the Federal Register. The Final Rule will have a general compliance date that is nine months after the effective date as well as a compliance date that is two years after the effective date regarding provisions to require an issuer’s financial information for the last two fiscal years to be current and publicly available.

Conclusion

The amendments to Rule 15c2-11 both reduce the scope of the rule through significant exemptions and provide some additional investor protections. The amendments are intended to and will remove from the markets a large number of “zombie” companies that have long failed to file financial statements. However, the amendments may also affect some widely held companies, with real operations and businesses, that are unable to file financial statements, for example because of an auditor’s resignation or a pending financial statement restatement. Broker-dealers should be very careful to comply with the amendments, because the SEC views them as “gatekeepers” for unlisted companies, and the amendments remove many of the “piggyback” provisions on which broker-dealers have relied. We anticipate that the amendments may lead some broker-dealers to stop quoting unlisted securities entirely. This result may reduce liquidity for some investors and legitimate small businesses that already have difficulty accessing the capital markets. The Commission has concluded, however, that risk is outweighed by the undoubted benefits from the removal of the “zombie” companies outweigh these possible costs.