Brian E. Morrissey
82 Norristown Rd.
Blue Bell, PA 19422
Securities and Exchange Commission
450 Fifth Street, NW
Mail Stop 6-9
Washington, DC 20549
U.S. SECURITIES AND EXCHANGE COMMISSION,
Washington, DC 20549
|In the Matter of||)|
|PUBLICATION OR SUBMISSION OF||)||
File No. S7-5-99
|QUOTATIONS WITHOUT SPECIFIED||)|
Comments of Brian E. Morrissey(1)
Brian E. Morrissey
82 Norristown Rd.
Blue Bell, PA 19422
April 7, 1999
Microcap securities are particularly vulnerable to manipulation by brokers. The SEC
characterizes microcap securities as securities having "low share prices and little or no analyst
coverage."(5) Such securities are usually thinly traded through either the OTCBB or the "pink
sheets", or quoted in alternative trading systems.(6) Microcap securities can also be listed on
securities exchanges or Nasdaq.(7) A major problem with microcap securities is the lack of
information available. This can be the case, for example, when a company is not subject to the
SEC's periodic disclosure requirements. Because the securities are thinly traded and there is not
much information available to investors, microcap securities are more easily manipulated by
unscrupulous brokers. Such brokers will push certain securities to investors in order to generate
interest and drive up the price. When the broker finally cashes out their own shares at the inflated
price, the hapless investors are left holding the shares which have plummeted back to reality.
In addition, Rule 15c2-11 is one of the favorite tools used by microcap con-artists. When hyping
a microcap stock, con-artists like to have quotes from several market makers, implying that the
stock is well followed. The problem is that many market makers do not research the companies
whose quotes they publish. This is a result of the low standards currently in place under Rule
15c2-11. As Rule 15c2-11 stands now, market makers in bulletin board or pink sheet securities
have to look over the basics of the company at least once a year-- a fairly low standard.
Furthermore, once a quote has been out for 30 days, other market makers can "piggyback" -- by
publishing the same number even if they don't know anything about the company. The SEC
wants to make subsequent market makers review certain information before they offer quotes.
Under the current Rule 15c2-11, the first broker-dealer to publish a priced quotation must obtain and review the Rule's required information. The scope of the current rule is limited to apply only to the first market maker publishing a quotation. This is a result of the statutory scheme in which the piggyback exception basically swallows the rule. Under the current Rule's piggyback exception, a broker dealer may publish quotations of covered OTC securities without reviewing current issuer information if the security is already the subject of frequent quotations in the same interdealer quotation system. The piggyback exception is broad, allowing any subsequent market maker to publish quotations in the security indefinitely, unless there is a "significant lapse in quotation activity."
The reproposed amendments will require market makers to review issuer information before
initiating priced quotes for unlisted securities. The practice of "piggybacking" will be eliminated.
In short, they will have to "stop, look and listen" before starting to place priced quotes for an
unlisted security in a quotation system. Of course, as under the current rule, the first market
maker to publish a quote, priced or unpriced, will still be required to review the specified issuer
Under the current rule, the first broker quoting a microcap security can be characterized as an
underwriter. Thus, the first broker assumes a fair degree of culpability in these situations if he is
not carefully in his choice of companies. Under the reproposed amendments, subsequent brokers
in will be as equally exposed to liability as the first broker.
|1||Review||The broker-dealer must review the Rule's specified information|
|2||Determine||The broker-dealer must determine that it has a reasonable basis for believing that the information is accurate in all material respects and was obtained from reliable sources.|
|3||Record||The broker-dealer must record the following-- (1) the date the information was reviewed, (2) the sources of the information, and (3) the name of the person responsible for the firm's compliance with the Rule.|
|4||Preserve||The broker-dealer must preserve the Rule's specified information in accordance with Rule 17a-4.|
While this may seem rather burdensome, the Internet will help to facilitate the duties. For reporting issuers, broker-dealers can consult on-line databases such as EDGAR. In addition broker-dealers may consult federal or state databases for information about issuers of covered OTC securities. Broker-dealers publishing quotes for securities of exempt financial institutions may contact their primary bank regulatory agency to obtain the financial institution's regulatory reports. Internet sites exist for the Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation.
For non-reporting issuers of covered OTC securities, the SEC has noted the desirability of having
a database containing Rule 15c2-11 information. Such a database would be an efficient source of
information regarding issuers that do not follow a policy of public disclosure. While the SEC and
the NASD are unable to take responsibility for creating and maintaining a Rule 15c2-11
repository, the SEC has encouraged private sector initiatives to address the issue.
III. Effects of the Reproposed Amendments
In response to submitted comments, the SEC has limited the scope of the Rule to:
1. priced quotations (exception: If a broker-dealer is giving the first quotation for a covered OTC security, the Rule applies to unpriced quotations as well).
2. those securities that the Commission believes are more likely to be the subject of improper activities (the Rule no longer applies to securities that have a substantial trading price or that meet a minimum dollar value of average daily trading volume).
Another area which the reproposed amendments differ from the original proposed amendments is
in the entities to which a broker-dealer must provide information. Under the original proposal,
broker-dealers were obligated to provide the Rule 15c2-11 information to anyone making such a
request. Under the reproposed amendments, broker-dealers must provide such information only
to requests made by:
|1||A current customer|
|2||A prospective customer|
|3||An information repository|
The current Rule does not specify the status of the person who must conduct the review on the broker-dealer's behalf. The reproposed Rule requires the broker-dealer to make a record of the person at the firm who is responsible for the broker-dealer's compliance with the Rule's provisions.
The final difference is that the amendments do not require broker-dealers to provide information that is accessible through EDGAR, any other federal or state electronic information system, or an information repository.
In general, the effects of the amendments are:
|1||Elimination of the piggyback exception.|
|2||Expansion of the information required for issuers that do not file periodic reports with the Commission (e.g., non-reporting issuers).|
|3||Broker-dealers are required to make the issuer information available to anyone who requests it.|
|1||Volume of security||Any securities that have a worldwide average trading volume of at least $100,000 during each month of the six full calendar months immediately preceding the date of publication of a quotation. A convertible security can meet this threshold on the basis of its underlying security.|
|2||Price of security||Any securities with a bid price of at least $50 per share.|
|3||Assets of Issuer||Any securities of issuers with net tangible assets in excess of $10,000,000 (demonstrated by audited financial statements)|
|4||Category Exemptions||a) Any non-convertible debt or non-participatory preferred stock
b) Any asset-backed securities that are rated as investment grade by at least one nationally recognized statistical rating organization.
In addition, the SEC has provided broker-dealers with a great deal of guidance for the review
process. For example, the SEC has declared a number of situations "red flags" for which broker-dealers should not publish quotes without addressing. One such "red flag" is a commission
trading suspension.(11) Broker-dealers publishing quotes once a trading suspension terminated
must satisfy the requirements of Rule 15c2-11.(12)
1. The author is a third-year law student at Villanova University School of Law.
2. See Securities Exchange Act Release No. 34-41110 (March 2, 1999), 64 FR 11124 (Reproposed Rule: Publication or Submission of Quotations Without Specified Information), available through the SEC website at <http://www.sec.gov/rules/proposed/34-41110.htm>.
3. 17 CFR 240.15c2-11.
4. Id. See also, 17 CFR 240.10b-5 (exemplifying another antifraud provision under which broker-dealers may be subject to liability).
5. See supra note 1, Release No. 34-41110 at 11125 n.1 (noting that the term "microcap securities" is not defined under the federal securities laws or regulations).
6. OTCBB refers to the over the counter bulletin board operated by the National Association of Securities Dealers (NASD). "Pink sheets" are referred to as such because of the color of the pages used to list them by the National Quotation Bureau (NQB).
7. However, Rule 15c2-11 does not apply to securities listed on a national exchange or Nasdaq.
8. See Michael Brush, "Turning Up the Heat on Scamsters" Money.com Thursday, February 26, 1998 <http://pathfinder.com/money/moneydaily/1998/980226.moneyonline.html> ("The SEC originally created "S-8" forms to give companies a quick way to register shares used to compensate employees."). The SEC figures that because employees already know about their company, no prospectus is needed. Id. In 1990, the SEC decided to let companies use S-8s to register shares meant for paying consultants also. Id. This created a loophole. Id. Manipulators quickly figured out that Form S-8 could be used to register shares for "consultants" whose only real "service" was to turn around and sell those shares to the public. Id. In other words, they found a way to get new shares in the market without having to file a prospectus. Id. The SEC has adopted amendments to Form S-8 that restrict the use of Form S-8 for the sale of securities to consultants and advisors. See Securities Act Release No. 33-7646 (February 19, 1999), available through the SEC's website at <http://www.sec.gov/rules/final/33-7646.txt>.
9. See supra, note 8, "Turning Up the Heat on Scamsters." Regulation S (Reg. S) lets companies avoid registering shares with the SEC, as long as those shares are to be sold offshore. Id. The SEC's reasoning is that if the stock is going to another country, let that country worry about it. Id. However, some brokers have been abusing this rule by bringing shares sold offshore back into the U.S. markets. Id. Therefore, the SEC want to make "Reg. S" securities like any other restricted securities, meaning that they can't be resold in the U.S. without having been registered. Id.
10. See The Bond Market Association, Legal & Regulatory Issues: Corporate Bond Division, SEC Rule 15c2-11 <http://www.bondmarkets.com/regulatory/corp.shtml> ("The Association submitted a comment letter which strongly opposed the Rule's application to debt securities."). This outcome reflects a widely held view, among market participants as well as regulators, that the Rule is unnecessary for, and was not intended to apply to, debt market transactions. Id.
11. Information regarding recent trading suspensions orders can be obtained either by telephone at 800-SEC-0330 or through the SEC website at <http://www.sec.gov/enforce/tsuspend.htm>.
12. NASD Marketplace Rule 6740 works in conjunction with Rule 15c2-11. See NASD Regulation, "Trading & Market Making: Compliance With SEC Rule 15c2-11 And NASD Marketplace Rule 6740 Following An SEC Trading Suspension" <http://www.nasdr.com/3070_9903.htm> ("It has come to the attention of NASD Regulation that following recent trading suspensions some members have been entering quotations into quotation mediums without complying with SEC Rule 15c2-11 and NASD Marketplace Rule 6740."). In this article, the NASD reminded its members of their obligations under SEC Rule 15c2-11 and NASD Marketplace Rule 6740 following trading suspensions imposed by the SEC. Id. In particular, the NASD stated that members must fully comply with the requirements of those rules before entering quotations into any "quotation medium". Id. The NASD explained that SEC Rule 15c2-11 establishes requirements for the publication and submission of quotations for certain over-the-counter securities on a "quotation medium" (as defined below). Id. Therefore, unless a member can rely upon an exception to 15c2-11, NASD Marketplace Rule 6740(a) prevents members from initiating or resuming the quotation of a non-Nasdaq OTC security without first demonstrating compliance with the information maintenance requirements of Rule 15c2-11. Id.