April 13, 1999

Jonathan G. Katz, Secretary

Securities and Exchange Commission

450 Fifth Street, Northwest

Washington, D.C. 20549

Re: File No. S7-5-99

Dear Mr. Katz:

We submit this letter in response to the request of the Securities and Exchange Commission (the "Commission" or the "SEC") for comments on Release No. 41110 regarding certain proposed amendments to Rule 15c2-11 (the "Proposed Amendments") under the Securities Exchange Act of 1934 (the "Exchange Act"). We understand that the Proposed Amendments are part of the SECís overall effort to reduce fraud in the microcap market and we support that goal and all efforts by the Commission to uncover, catch, and punish the participants in such fraud. However, we vigorously oppose substantial parts of the Proposed Amendments that focus on legitimate market makers. The theory that imposing an increased duty on market makers to review issuer disclosure will reduce fraud is unsupported.

Contrary to the stated goals of Congress, the Proposed Amendment will materially curtail valid investment options for legitimate start-up and other microcap companies. The Proposed Amendments will inappropriately punish an entire class of securities that include ten thousand companies and several million shareholders for no valid reason. As more fully discussed below, the regulatory scheme as proposed by the Proposed Amendments will more likely have the detrimental effect of curtailing transparency and liquidity in the market for microcap stocks making it more difficult and expensive for valid companies to obtain financing, without effectively reducing microcap fraud.

  1. Background
  2. Before discussing what we believe are the underlying defects of the Proposed Amendments, this section provides a brief background regarding microcap securities and participants in the microcap market. We also include some relevant analysis of the importance of this market sector.

    1. Microcap Securities
    2. The term "microcap security" is not defined in the federal securities laws. Microcap securities generally include low-priced securities with limited liquidity. A significant percentage of microcap securities are not required to file financial information with the SEC or any other regulatory body. Prices of microcap securities are typically quoted on the NASD over-the-counter (OTC) Bulletin Board or in the National Quotation Bureauís Pink Sheets.

      Public information on microcap securities is often limited, and a small number of broker-dealers may dominate trading, admittedly making the securities more susceptible to fraud or manipulation. However, historically microcap fraud has been associated with "pump and dump" schemes involving high pressure sales tactics conducted by retail brokers designed to induce investors to purchase relatively worthless stocks in which the firm or other insiders hold a large inventory. When successful, these high pressure sales tactics result in an increase in the price of the targeted stock (pump). Insiders then sell (dump) their shares, sometimes realizing large profits at the expense of public investors. A variety of other fraudulent practices are also used as part of these schemes, including "bait and switch" tactics, unauthorized trading, failure to execute sell orders, and excessive markups or price increases. More recently, unregulated internet chat rooms have become a convenient and powerful tool of stock manipulation where rumors and hype, anonymously planted, can fuel frenzied buying by day traders and speculators. But the key culprit in the scheme is usually the retail broker that inappropriately and illegally hypes the stock to gullible investors that believe the promises of a quick score. Those brokers are clearly violating several provisions of the Federal Securities laws as well as state criminal statutes. We wholeheartedly support all efforts aimed at eradicating such activity.

    3. Description of Microcap Issuers

    There are several types of microcap issuers, each with its own reasons why their securities are traded in the microcap market and differing kinds of relationships with their public shareholders.

    Infrequently Traded Issuers. Infrequently traded issuers are typically closely-held companies that have a minority of public shareholders. The public shareholders are often the residue of a public offering conducted many years prior, or due to the sale of stock by a disgruntled shareholder. Another example would be required businesses, such as community banks that offer issue shares to local investors, but never gain a significant shareholder base or market liquidity. The lack of a significant shareholder base, combined with little outstanding public float, means that there is no consistent daily trading volume in the securities of these issuers. These companies are typically not reporting companies and do not publicly disseminate financial information. As many of these companies do not view their stock price as significant, many such issuers are inclined to keep their stock prices artificially low, so they can attempt to buy back outstanding shares held by public investors and re-consolidate complete ownership in the hands of insiders. Without market makers, the company may be the only source of liquidity for outside shareholders, in which case, the price is arbitrarily set by the company.

    Accordingly, the existing microcap market makers are the only way for public investors to realize any value from their holdings other than through infrequent and inconsistent company buy-back programs. Professional market makers often recognize the intrinsic value of such companies and by creating a shareholdersí market and accumulating shares until there is a company transaction at a higher price they provide a valuable liquidity service to the otherwise starved shareholders.

    Emerging Issuers. A large percentage of non-NASDAQ OTC issuers are legitimate startup companies using the market to raise capital and therefore expand the market visibility of their businesses. The existence of a liquid microcap market is key to the survival and development of these issuers. An efficient microcap market ensures potential investors that their shares will be readily tradable regardless of an issuerís size. The liquidity and price transparency provided by market makers in these issues lowers overall risk to investors, which consequently lowers the cost of raising investor capital. Without a market maker presence, prices and spreads sometimes can fluctuate wildly. Availability of capital is important to all companies, but critically so to startup/growing ventures. We believe that the Proposed Amendment will fundamentally hurt the ability of smaller and riskier companies to raise initial tranches of capital, and many of them will likely not survive and grow into viable businesses if the proposal is adopted. Contrary to the stated intent of Congress, this market sector is particularly vulnerable to the likely negative effects of the Proposed Amendment.

    Fallen Angels. Successful companies that have fallen on hard times and have lost their investor base often find it difficult to keep analysts and the market interested in their securities. These companies may be in the wrong technology, may have a dominant industry player as competition, may be subject to a prolonged down cycle, or otherwise just lost their way and fell out of favor with the investing public. The high-flyer of yesterday may be the fallen angel tomorrow. There are thousands of legitimate companies that have fallen out of favor and market makers serve as their only meaningful source of liquidity.

    Special Situations. This category includes numerous companies that have limited marketability because of special circumstances. Examples include:

    ▪ In an acquisition transaction, the selling company receives an "earn out" based on the earnings of the sold assets over an agreed to period of time. The shares of the selling company represent the economic right to the earn-out proceeds, if any.

    ▪ On liquidation, a reserve is established for contingent liabilities, which may or may not have value based on future events related to such contingencies.

    ▪ The future right to the residue of the reserve, if any, will be followed and quoted by market makers.

    ▪ A companyís only assets is a lawsuit against a competitor for antitrust and patent infringement damages. The timing and result of the litigation is highly speculative, but a market maker will often buy and/or sell the potential that such suits may result in a future benefit to the plaintiff company.

    ▪ The residue of numerous tax partnerships that flourished in the 1970s are quoted by market makers today in the Pink Sheets. Oil and Gas or Real Estate residuals are not everybodyís cup-of-tea, but at least today a market maker will provide a quote for holders who need to sell in order to establish a tax position or otherwise.

    The foregoing are just a few of the special situations that legitimate market makers are actively quoting.

    Scam companies. Scam companies are a small, yet highly visible minority of the microcap issuers. They typically work in conjunction with fraudulent retail brokers, who manufacture trading volume and inflate prices in "pump and dump" schemes. These securities are characterized by unauthorized large excessive spreads between the bid and ask prices, false and misleading representations about the stock, retail broker and Internet hype, and dumping of the stock at an inflated price by the insiders and others involved in the scheme. Such schemes often involve an initial public offering and therefore many of these issuers are reporting companies, though such reports may contain false and/or misleading statements. Such issuers have incentive to keep stock prices artificially high so that profits may be realized upon the sale of the stock to unwitting investors. Although professional market makers may recognize and avoid such schemes, they are also occasionally caught in the frauds. However, having been involved in this industry for more than 30 years, I sense that the level of fraudulent securities is still very low relative to the approximate 10,000 securities that would be caught in the cross-fire of the Proposed Amendments. The degree of fraud in this sector is not a significant market factor, as is evidenced by the limited regulated activity over the years. We are aware of only 39 issuers with shares quoted on the Bulletin Board or Pink sheets penalized with trading suspensions in the last five years.

    With respect to all of microcap issuers, a viable community of market makers serves a benefit to the legitimate investor.

  3. Comments
    1. Generally
    2. In spite of the fact that the Commission in the Proposed Amendment has more clearly defined the securities covered by Rule 15c2-11 (the "Rule") since its initial February 1998 proposing release (File S7-3-98) (the "Original Proposal"), most of the concerns voiced in earlier comment letters remain because the Commission has apparently failed to recognize the fundamental flaws in the proposed changes to the Rule as expressed in numerous letters objecting to the Original Proposal. Legitimate market makers dominate the OTC market, including the Microcap segment, and their benefit far outweighs the burden of the few fraudsters that will invariably exist. We therefore take this opportunity to reiterate a number of the industry concerns.

      Our primary concerns are summarized below:

      ▪ We believe that the Proposed Amendment would have an adverse impact on market efficiency, competition, and capital formation for small businesses and no significant benefit in the area of fraud reduction.

      ▪ The Commission has provided no reliable evidence that adoption of the Proposed Amendments would reduce the incidence of fraud in any meaningful way. Substantial regulatory costs for market makers will be passed on to investors in the form of wider spreads and less liquidity.

      ▪ Competition will diminish, as fewer reputable firms will be willing to trade microcap securities. Transparency will decrease as fewer market makers are willing to publish prices.

      ▪ Legitimate capital sources for small or troubled companies will be difficult to find. The cost of capital will rise if there is not an efficient secondary market for small or troubled companies.

      ▪ Market makers will be less inclined to quote new securities. The good companies will be forced to pay for othersí misdeeds.

      Fundamental to our concerns is the realty that potential civil liability will be drastically increased for legitimate market makers if they are now forced to police the securities they trade. In eliminating the "piggyback" provisions, the Commissionís proposed amendments to Rule 15c2-11 would require all subsequent market makers "to review fundamental information about the issuer and have a reasonable basis for believing that the information is accurate, current, and from reliable sources." Market makers would have to annually repeat the review process if they submitted priced quotations. As such, all market makers will be subject to greater obligations, expenses and potential liabilities.

      It is also not insignificant that requiring the compilation of a Rule 15c2-11 file for every quoted security, with annual updates, would impose significant compliance costs and potential liabilities on broker-dealers which would likely lead to a decrease in microcap market-making. For reporting companies, the required information would be easily accessible through EDGAR, but the process of reviewing the information and documenting such review would be time consuming. For non-reporting companies, obtaining the required information would be quite difficult and in many cases impossible. Accessing such information through non-electronic means for literally thousands of issuers would be painstakingly slow. This process would involve thousands of man-hours and, combined with the overhead costs of storing the information, may be cost-prohibitive to wholesale market makers in microcap securities. We strongly believe that the SECís estimated cost analysis grossly understates the real imputed hard dollar expenses and man-hour cost of the Proposed Amendments.

      Further, the Commission has failed to offer evidence that rogue issuers, broker-dealers and promoters use independent quotations of other market makers as a basis for a stockís value as part of their attempts to force securities on unsuspecting investors. This is a fundamental assumption of the Commissionís approach to solving Microcap fraud. An issue so critical to the proposed solutions, in fairness to the securities industry, requires more support than the Proposed Amendment provides. To the contrary, the quotations and trading activity of legitimate broker-dealers provide investors with the only pricing information available independent of the rogue market participants. Legitimate firms serve as a "reality check" when a stockís price has reached unrealistic price levels, by selling short and lowering their ask quotations. Rather than abetting fraudulent schemes, legitimate quotation activity serves to frustrate attempts to keep prices artificially high. The Commission should not believe that by restricting the quotation activity of legitimate market makers that fraud will be any less prevalent, but left to themselves, fraudsters will be more efficient in their manipulation activity.

    3. Need For a Competitive and Transparent Market
    4. The success of the small business community has been a hallmark of our free enterprise system, helping to drive the engine of Americaís economy as we compete in the global marketplace. Various SEC and congressional initiatives have been directed at small businesses with the intent to keep them competitive and viable in the marketplace. This is because small businesses have traditionally been at a competitive disadvantage due to a variety of factors that have limited their access to the capital markets. Such factors, among other things, have included the difficulties potential investors have faced in obtaining adequate information about small business investment opportunities and to add liquidity to any anticipated exit strategy.

      Potential investors have relied on multiple market makers competing in a transparent medium to learn of small business investment opportunities. Quotations of microcap stocks by the market makers at competitive prices have been an effective way of making small business equity available to investors. The market maker quotes, more than anything, have provided more competitive, transparent and efficient prices.

      If the Commission adopts the Proposed Amendments, its enactment would be contrary to the rationale of ongoing regulatory and congressional efforts to promote capital formation and reduce regulatory burdens on small businesses. The new Rule would diminish competition as fewer reputable market makers will be willing to trade microcap securities, deterred by the Proposed Amendmentsí increased costs and expanded potential liabilities. As a result, the market liquidity and transparency would be reduced, stock prices would be more volatile, the value of legitimate securities affected by the Proposed Amendment would be substantially reduced and the ability of small businesses to raise capital would be hurt and consequently a number of legitimate fledgling companies would not survive. Virtually every industry participant that commented on the original Proposal echoed the foregoing analysis. The SEC, based on numerous unsubstantiated assumptions has chosen to ignore the overwhelming industry concern with these issues.

      In its current form, the Proposed Amendments to the Rule prohibits a broker-dealer from publishing (or submitting for publication) a quotation for a covered OTC security in a quotation medium unless it has obtained and reviewed current information about the respective issuer. The Ruleís "piggyback" exception (discussed in greater detail below) has been crucial to increasing the number of legitimate market makers dealing in microcap stocks. Under the piggyback exception, such market makers have been able to offer a meaningful market for investors and liquidity for small businesses, because they are not confined by the Ruleís due diligence constraints when a previous broker-dealer has reviewed a microcap issuerís financial information.

      The Proposed Amendments eliminate the Ruleís piggyback provision and require all broker-dealers to review current issuer information that has been filed on EDGAR before publishing a price quotation for a security. The Proposed Amendments also burden broker-dealers by expanding the information required for certain non-reporting issuers; requiring documentation of the broker-dealerís compliance with the Rule; and requiring annual reviews of specified information.

      In eliminating the piggyback exception and imposing additional burdens, the Commission is effectively shifting its statutory mandate to police fraud and manipulation in the microcap arena to the market makers. As stated above, the Commission, however, has failed to offer concrete evidence that the proposed shift would actually reduce the fraud and manipulation it targets. To the contrary, the Proposed Amendmentsí only deterring effect will be to discourage Carr Securities and other legitimate market makers from publishing and dealing in microcap stocks. Avoiding the new Ruleís excessive burdens, such as the annual review requirement, will be a significant disincentive for legitimate market makers, inevitably leading to less competitive pricing for microcap stocks, and a less liquid marketplace for the small businesses that the SEC and Congress have a national economic interest in assisting and maintaining.

    5. The SEC Cannot Regulate Against "Smart" Investments, But It Can Warn Against "Dumb" Ones
    6. Our society is marked by, and sometimes even defined by, the high-risk/high-reward adventurers. Bungee-jumping, laying a bet on the roll of the dice, buying a lottery ticket, or smoking a pack of cigarettes per day are far from being rational personal or economic decisions in a society generally concerned with the well-being of its citizens. However, subject to the duty to warn the unwary of the risk involved, government should not regulate free choice. The right to choose to engage in a legal investment activity, so long as the risks are apparent or disclosed, is fundamental to the U.S. capital markets. Targeting the elimination of fraud in the securities markets is obviously an important function of our securities laws. However, when those efforts substantially hurt numerous legitimate companies and investors, the Commission must weigh the impact of the proposal in light of the damage it will do to a valid capital market interest. That weighing process requires far more critical, quantitative analysis than is evidenced in the Proposed Amendments.

      The Proposed Amendments have effectively mandated that the way to stop fraud in the microcap stocks is to regulate such companies out of existence as potential investments. As described by the Commission in the Release, the typical microcap fraud involves "pump and dump" schemes in which unscrupulous brokers will sell securities to retail customers, using high pressure sales tactics and the dissemination of false and misleading information. Obviously, sufficient legal basis presently exists for the SEC to curtail such fraudulent activity to the extent the SEC can detect it. In addition to SEC and NASD enforcement action, the securities laws provide meaningful civil remedies for injured parties in the case of fraudulent and manipulative schemes. The SEC, however, asserts that the fraud is then furthered by legitimate market makers quoting prices, thereby validating the worth of the security. The Commission provides no support for this assumption, which is the central theme of the entire Proposed Amendments.

      We believe the foregoing assertion is unsupported and fundamentally incorrect. Legitimate market makers typically balance the forces of supply and demand Ö excess buy-side demand being created by fraudulent pumping should be offset by market makers selling activity. If a market maker believes stocks are being sold above their intrinsic value, the natural market reaction is to short the stock providing a natural downward pressure and quite frankly making it more difficult for fraudsters to "dump" the stock on unsuspecting investors. Unchecked and without legitimate selling pressure by market makers, the fraudster would have unfettered control of the market, which would create far more price inefficiency.

      The concept of eliminating fraud by making market makers the "gatekeeper" to insure that securities are appropriately priced is impractical and inappropriate. Carr Securities, a relatively small market maker, provides quotes for approximately 1800 securities at any given time. The Proposed Amendments provide no safe-harbor with respect to the information review and analysis requirements and consequently will merely serve as a bullís eye for investors that lose money to shoot at. Counsel has advised us that the Proposed Amendments will substantially increase the firmís exposure with respect to many of the securities we make a market in, and the cost of compliance will be substantial. Investors that lose money will intuitively focus on the fact that the disclosures failed to accurately reflect the Companyís intrinsic value and the market maker quote therefor furthered the fraud. Whether such claim can be proved or whether the market makers price quote was the proximate cause of the loss are immaterial. There is no way to escape the allegations and the cost of defending frivolous suits Ė other than not making a market. Clearly this is not in the best interest of the market place or current shareholders of thousands of microcap securities.

      A particularly disturbing characteristic of the Proposed Amendment is the notable lack of support for the Commissionís underlying position and proposed remedies. We are troubled by the broad assumption used throughout the Proposed Amendment and the lack of any quantitative or even anecdotal support for the Commissionís approach. By quick count, the Proposed Amendment contains more than 50 assumptions and speculations. The Securitiesí Industry, the affected companies and the shareholders that will be impaired by this approach deserve more consideration than evidenced in the proposal. There are more surgical, and we suggest effective, ways of dealing with Microcap fraud which needs to be thoroughly explored.

    7. Piggyback Exception/Annual Review
    8. We believe that the Proposed Amendments elimination of the "piggyback" exemption and institution of an annual review represent excessive regulatory burdens, the costs of which will far outweigh any benefits gained. the Rule currently requires the first broker-dealer quoting a security in a quotation medium to gather, review, and preserve the issuerís information. The amendments will require the first broker-dealer initiating any quotation and all broker-dealers initiating priced quotations thereafter to review current issuer information for accuracy and reliability before quoting a security. In addition, the amendments would require broker-dealers to update and review issuer information annually and would expand the need for information about issuers that do not file periodic reports with the Commission.

      The Commission professes that these amendments "will serve an important surveillance function," while readily admitting that it "[does] not have the data to quantify the value of [these] benefitsÖ." The Commission also admits the elimination of the piggyback rule will create significant costs, including costs (i) to update that information annually; (ii) to publish initial priced quotation; (iii) in conducting the required annual review; and (iv) in creating the records required by the Rule and retaining the Ruleís required information for the specified period of time.

      Without adequate basis, the Commission estimates that it will take a broker-dealers a maximum of four hours to collect, review, record, retain, and supply to the NASD the information pertaining to a reporting issuer, and a maximum of eight hours to collect, review, record, retain, and supply to the NASD the information pertaining to a non-reporting issuer. Time commitments will far exceed such unfounded estimations. Lawyers and accountants will be required to evaluate disclosure in specific areas. Analysis of material contracts that are filed as exhibits will be undertaken to evaluate the disclosure. Litigation and lien searches may be necessary to ensure compliance with the "reasonable basis" requirement of the Proposed Amendment. We believe that professionals that have been involved in the securities industry for significant periods of time will virtually unanimously agree that a four-hour review (three of which the SEC suggests can be by a $35 per hour clerk) will be useless, other than for plaintiffís lawyers, who will point out in great detail how little substantive analysis was done.

      Our accountants are presently attempting to prepare a cost survey for us which will be submitted to the Commission upon completion. To date, they are finding it impossible to set a pricing schedule which would justify the liability we are asking them to assume.

      The Commission also maintains that "broker-dealers that collect, review, and retain the information currently required by Rule 15c2-11, would incur only marginal start-up, operating, and maintenance costs." We believe this statement is incorrect as most broker-dealers currently complying with Rule 15c2-11 do not need to collect, review and retain the total amount of information that the Proposed Rule would require with the elimination of the piggyback exception.

      The SEC should retain the "piggyback" exception without imposing additional unnecessary review requirements because the burdens associated with eliminating the piggyback rule far outweigh the likelihood of any material benefit of reducing instances of fraud or manipulation. If anything, the excessive new costs and the increased liability exposure imposed on market-makers providing quotations, and effectively vouching for accuracy and reliability, will only discourage legitimate market makers from quoting microcap stocks and leave fraudsters and manipulators behind to wreak havoc (thus countering the supposed benefits of the Proposed Amendments).

    9. Increased Liability

    Under the Proposed Amendments, broker-dealers are required to review current issuer information for "accuracy" and "reliability" before publishing a price for a security. By holding market makers responsible for assuring the accuracy and reliability of issuer information, the Proposed Amendments essentially require market makers to act as gatekeepers to screen out illegitimate microcap issues. This increased review obligation effectively exposes market makers to increased risk, creating ongoing liability for market makers in all microcap securities. The review obligation will make market makers the focus of legal actions brought by investors if there is any issuer fraud or manipulation in the securities they trade, even if the market maker had nothing to do with the fraud or manipulation. The Proposed Amendment will have the practical and inappropriate effect of redefining the well established "aid and abettor" theory of liability to include innocent market makers that could not meet an ill-defined and impossible to police standard. The implied duty to police the market place is a logical avenue for plaintiffís lawyers to explore for a deep pocket. The Rule fails to provide a bright line test or safe harbor for market maker activity and consequently market makers are likely to become innocent victims of the fraud along with the investors.

    The due diligence guidance provided by the Release is insufficient to protect or guide the market maker because it does not provide an explicit standard to be met by market makers and a safe harbor from civil liability. The various examples of "red flags" that broker-dealers should look for when reviewing issuer information will be expanded and manipulated by every investor that loses money, no matter how risky the investment obviously was. The SECís assertion that the Proposed Amendments do not require a broker-dealer to conduct an independent inquiry about the issuer of the security like an underwriter in a securities offering does nothing to quell liability concerns by securities law practitioners. What standard of care will be applied to the market makers obligations? Underwriters spend numerous hours and not infrequently a $100,000 or more on completing a full due diligence inquiry. Will a jury with perfect hindsight in light of investor losses conclude that a "red flag" required more in the way of effort by a market maker than four hours? Counsel to Carr Securities in unable to advise us as to where the bright line is.

    If the standard of review imposed by the Proposed Amendments do not establish a safe harbor that a market maker can clearly satisfy on a cost-effective basis, we believe numerous legitimate market makers will consider that it would not be worth the material risk for the market maker to establish a price quotation for a covered security. Without a safe harbor, plaintiffs will surely argue that the market maker failed in its review and analysis of underlying documents to find all the red flags or to establish the reasonable basis for believing in the reliability of such disclosure. Lacking such a safe harbor, potential liability under the Proposed Amendments will therefore be a significant deterrent for market makers that otherwise would have participated in the microcap market. The potential liability from an implied right of action by investors will drive legitimate firms from making markets in OTC securities and give an incentive for the remaining market makers to refrain from publishing prices.

  4. Suggestions/Alternatives
  5. We suggest several potential regulatory solutions that might effectively deter microcap fraud by targeting the purveyors of fraud and limiting their capacity to mislead investors with relative impunity.

    As the proposing release recommends, it would be most beneficial for the Commission to foster development of central repositories of information about issuers that are not participating in its public disclosure system. We urge the Commission to encourage the development of independent repositories, such as the centralized database proposed by Securities Industry Association and the National Securities Clearing Corp. Further, the Commission should require that all requisite materials must be available seven days a week, 24 hours a day at the independent repositoriesí web sites.

    Currently only the Commission has the power to suspend trading in non-NASDAQ securities. The NASD should be empowered to act when fraud is suspected in OTC Bulletin Board stocks. Often times the NASD suspends trading and eventually de-lists a security from NASDAQ, only to see trading volume for that security surge in the microcap market as rogue firms dump their inventories on unsuspecting investors. The Commission should work with the NASD to establish a framework where the NASD would be authorized to suspend member firms from facilitating trades in a non-NASDAQ stock temporarily, and then disclose its findings to the Commission so that a permanent resolution of the situation can be made.

    Efforts should specifically target broker-dealers that recommend microcap stocks to their customers, rather than firms that simply facilitate an efficient market in these securities. The NASD has recently proposed requiring member firms to review issuer financial information prior to recommending a non-NASDAQ OTC equity security and provide customers with risk disclosure statements prior to effecting a transaction in such securities. Firms could also be required to make pre and post-trade disclosure (e.g., on customer confirmations and account statements) that a recommended issuer does not file current financial information with the Commission. This would require rogue firms to put investors on notice regarding the type of securities being recommended, making the task of soliciting purchase orders that much more difficult.

    A warning system should be established whereby brokers are advised (i) whether or not current financial information is available and has been audited; (ii) if information is available, but not current; and (iii) no meaningful information is available and whether the SEC or NASD is reviewing trading data with respect to such securities. Retail broker dealers should be required to warn customers of the status of such disclosure and that category (iii) securities are highly risky because of the lack of valid information.

    At a time that public information is not readily available through EDGAR or other information repository, issuers, affiliates and other insiders should not be permitted to buy or sell securities.

    Take steps to educate the public against the inherent risk of fraud in the securities markets and steps that can be taken by investors to avoid the perpetration of such fraud. The government needs to undertake an extensive program of public education as to the inherent risk of investing in securities and the need to know and evaluate the issuers and the recommending brokers. Television advertising about securities fraud and the technique used to manipulate stock prices is essential. Information booklets should be provided to all investors explaining the risk of investment in companies with unjustified stock prices. However, investors should be allowed to invest after proper education and warning.

    Ultimately it may be old-fashioned law enforcement, not new regulatory requirements, that is most effective in the war against securities fraud. Therefore, we urge the Commission to focus more on investor education and to continue its vigorous use of current enforcement tools and resources to prosecute fraud in the microcap securities market.

  6. Conclusions

The Proposed Rule is fundamentally flawed because its adoption will fail to achieve its primary purpose of reducing fraud and manipulation in the microcap market. To the contrary, by eliminating the piggyback exception and imposing a slew of review requirements on market makers, the Rule would have the opposite effect of reducing transparency as legitimate market makers flee from the microcap market in order to avoid excessive regulation and potential liability.

While the Commission should not refrain from new regulation for the protection of investors, burdening legitimate market participants with difficult and costly compliance obligations as the price of participation in the microcap market would not only leave the capacity for fraud undiminished, but greater than ever as reduced competition leaves investors at the mercy of unscrupulous broker-dealers and non-responsive issuers. The Commissionís approach should instead be targeted at the perpetrators of fraud and their schemes, while strengthening the levels of competition and efficiency in the microcap market.

Carr appreciates the opportunity to comment on the Commissionís proposals and hopes that the Commission finds these comments helpful. Please feel free to contact the undersigned at (212) 760-0707 to discuss further any aspect of these comments.

Sincerely yours,

Walter Carucci, President