National Quotation Bureau, LLC

11 Penn Plaza, 15th Floor

New York, NY 10001

(212) 896-4476

April 27, 1998

Jonathon G. Katz


Securities and Exchange Commission

Mail Stop 6-9

450 Fifth Street NW

Washington, D.C. 20549

Re: File No. S7-3-98

Dear Mr. Katz,

As Chairman of the National Quotation Bureau, LLC (the "NQB"), I am pleased that the Securities and Exchange Commission (the "Commission") is taking an initiative to review their rules and regulations surrounding the over-the-counter ("OTC") markets. A competitive and transparent market should be available for all securities and regulators should be given the tools to punish any entity that attempts to manipulate that market or defraud investors. I would like to offer my comments, which represent the views of the NQB, on the proposed changes to the Rule 15c2-11 and the regulatory structure for secondary trading of OTC securities. I view the intentions and goals of the proposed rules favorably, although I think that, improperly implemented, they may cause terrible unintended consequences. The following comments relate to the proposed rule and its potential effects on the marketplace for securities covered by the proposed rule.

The NQB is a publisher of financial information for the securities market. Our core business has been publishing quotations of competitive market makers in OTC securities. The National Quotation Service (the "NQS") is a quotation medium composed of sections: the Pink Sheets_ the Yellow Sheets+ and the Partnership Sheets.

I have put substantial thought on how to identify and offer solutions to various regulatory concerns in the OTC markets. It has been an interesting learning experience as I have had the opportunity to discuss the issues with investors, issuers, market makers and regulators from the Commission, self regulatory organizations and state securities departments. The first part of this letter will be to seek to provide helpful information to the Commission about the OTC market and various regulatory approaches. Since the majority of the Commission's contact with participants in these markets is when the Commission brings enforcement actions against the bad guys, we fear that the staff and the Commission tend to see only the problems. I also think that is what the media tend to see and sensationalize. I hope that the Commission takes this opportunity to better understand the inner workings of and functions that this marketplace and brings forward some innovative solutions to its problems.

While "micro-cap stocks" are currently in the public spotlight, fraud occurs across all markets. Employee fraud at New York Stock Exchange listed Cendant Corporation cost investors over $14,000,000,000. Stratton Oakmont was lead managers in twenty-seven stock offerings according to Securities Data Company; all of which were listed on the Nasdaq Stock Market, Inc._ (the "Nasdaq"). On February 26th, an officer of A.R. Baron & Co. was convicted of twenty-five charges including enterprise corruption, scheming to defraud, falsifying business records, perjury, and manipulating prices of eight Nasdaq listed companies.

Forcing issuers to provide financial disclosure does not prevent fraud. Comparator Systems Corp. (IDID) and Systems of Excellence Inc. (SEXI) both filed with the Commission.

There are two primary routes that shady operators use to prey upon investors: (1) traditional hard sell boiler rooms and (2) fraudulent touts of securities through radio, television and print media and now the Internet or other "new" media. Investors will send their orders through legitimate brokers based on an Internet tout. The globalization of stock markets means that the stock touted may trade overseas. Thus, the first problem is long-standing and demands fine-tuning of existing rules and regulations. I was mildly surprised by my research on the well known boiler rooms, Stratton Oakmont, A.R. Baron & Co., Duke & Co., etc., that virtually all of the stocks they underwrote or were convicted of manipulating were listed on Nasdaq. I might venture to guess that the Penny Stock Rule (Rule 15g-9) has been successful in removing such firms from the non-Nasdaq OTC market.

I believe that the best protection is a knowledgeable investor. The current "micro-cap" and "penny stock" initiatives should be used to protect investors through increased investor education and enforcement of suitability standards. Unsophisticated, inexperienced investors must be kept out of this sector of the market. The issuers, promoters and retail brokerages who commit micro-cap fraud are criminals who violate and ignore existing securities laws. While there will always be criminals, we must increase the consequences and lessen the profitability of rule breaking. The Commission's review of rules and regulations should be designed to increase investor education, close loopholes, enforce responsibility for one's actions and give enforcement better tools to stop frauds.

What Purpose does a Quotation Medium Serve?

Secondary markets for securities are an integral part of the capital raising process. Issuers need capital to operate their businesses. Investors provide capital through the purchase of securities. Investors purchase securities with the assurance that they can sell those securities or buy more based upon changes in their investment outlook, tax situation or the underlying company's financial performance and prospects. The exchanges and Nasdaq provide trading facilities for larger issuers to list their securities. However, there are issuers who do not meet the standards required for listing on the larger markets or do not want to be listed. These are smaller companies with limited operating histories, troubled companies or closely held companies with less than 500 shareholders. But many of them are real, viable companies with capital needs. For many reasons, the issuers may or may not want a public market in their securities. Some of those issuers can, some can't and some won't provide financial information to minority shareholders or the public. However, all of those issuers have securities outstanding, and as long as the securities exist, minority shareholders and investors will want or need to buy or sell those securities.

Quotation media such as the Pink Sheets serve the needs of minority investors' seeking to efficiently buy and sell securities of companies that can't or won't list on an exchange or Nasdaq.

Unlisted securities have traditionally been traded by broker-dealer market makers in a quotation medium. A market's role is to find a price point where supply equals demand. Supply does not always equal demand in unlisted securities, so competitive market makers provide liquidity for buyers and sellers. Without market makers, markets are less liquid and easier to manipulate. Multiple dealers competing in a transparent medium have proven over time to be the best way to trade small-cap stocks.

Numerous attempts to recreate the structure of an exchange for small-cap stocks have met with failure. The American Stock Exchange's Emerging Company Marketplace was host to numerous dubious issuers and was finally dissolved with great embarrassment. The Pacific Stock Exchange SCOR marketplace initiative has just been shuttered due to the failure to attract any suitable listings. Every other attempt to recreate an exchange for small company securities has been started with great fanfare but always ended in failure. The exchange listing has either been overly burdensome for legitimate, small companies or abused by fraudulent issuers to give false legitimacy and respectability to their securities.

The only successful services for small-cap equities have been the National Association of Securities Dealers, Inc. (the "NASD") OTC Bulletin Board (the "OTCBB") and the Pink Sheets. They have served the public's demand for the centralization of competitive buyers and sellers of unlisted securities. There are approximately 8,300 issuers whose equities are quoted on the OTCBB or in the Pink Sheets. We estimate the market capitalization of those companies is over $400,000,000,000. The companies employ millions of workers and have millions of public shareholders. Quotation media also serve the limited partnership and bond markets. There are over 900 limited partnerships quoted in the Partnership Sheets and over 2,500 corporate bonds are quoted in the Yellow Sheets. There is an average of 4.5 market makers for the 11,700 securities quoted in the NASD and the NQB quotation media.

Possible Regulatory Solutions to the Unlisted Markets

The regulatory approaches that have been fantastically successful in creating the greatest exchange markets in the world do not work in the unlisted markets. The Commission primarily regulates three parts of securities markets; the issuance of securities by companies (the primary markets), the listing of securities on exchanges or Nasdaq and the secondary trading of securities. The two most successful tools of the Commission in creating the worlds greatest listed markets have been financial disclosure by issuers and listing standards. Companies that issue securities and list on exchanges all want access to capital and a public market for their securities so they are willing to supply information and comply with rules.

The securities traded in unlisted markets are more problematic. Unlisted issuers either want access to capital and a public market, but don't meet the listing standards of an exchange or Nasdaq or don't want access to capital or a public market for their securities. For that reason, unlisted markets have always troubled regulators. How can regulators control issuers who can't or won't list on an exchange or Nasdaq? What good are listing standards if an issuer can't meet them? You can't impose higher standards. How do you obtain financial disclosure from issuers who don't need access to capital or don't want their minority shareholders to have the benefit of a public market? Especially, when some of the issuers are small businesses that are specifically exempt from the burdens of reporting to the Commission. The truth is you can't.

One regulatory solution would be to not allow these securities to trade. Once a security did not meet certain standards or stops providing financial disclosure, shares would become frozen and disappear. If an issuer doesn't supply financial information, no broker could buy or sell that security. The issuers who don't want a public market for their minority shareholders would approve. Management could then buy back the shares at substantial discounts because there would be no competing offer away from the company. Investors would probably be less willing to provide capital to legitimate small companies if they were never able to sell their stock or only at such discounts. Stopping trading in companies that can't meet listing standards or won't provide full disclosure will not work because it would hurt small companies access to capital and seriously harm minority shareholder's rights. Millions of workers and shareholders would be harmed.

Since the securities quoted in the Pink Sheets and the OTC Bulletin Board already exist and regulators can't make them disappear without causing irreparable harm to thousands of legitimate small companies and millions of shareholders, what can they do? Throw them out of the system and make them trade only in private transactions? No. The Commission does not want to create an underground and unregulated black market. The securities exist and investors need to buy or sell them. That demand will not disappear. Transactions should take place where regulators can oversee them.

Many of these securities are for small banks, companies in bankruptcy or liquidation, and closely held companies that won't disclose financial information to the public. If legitimate on-shore markets become unavailable, the danger is that the legitimate securities that don't have current financials available or won't supply current financials to shareholders are forced to less regulated offshore markets or the Internet. Ten years ago, the trading of a non-Nasdaq OTC security would stop if it weren't quoted in the Pink Sheets. That is not the case today. Individuals buy and sell used computers, beanie babies and baseball cards on the Internet today (see,, and ). They can and will trade securities. If the legitimate securities owned by legitimate investors are thrown out of the regulated markets, a black market of unregulated entities will develop to fill the need.

The Commission could smother the unlisted marketplace in regulation. Make the marketplace opaque and inefficient. Increase costs, burden participants and the activity will definitely slow down. However, it is a strategy that is doomed to failure. If regulation increases the cost of quoting securities in the Pink Sheets and the OTCBB, market makers will pass on the cost to investors in the form of wider spreads and less liquidity for all non-Nasdaq OTC securities. Legitimate investors will lose out. Legitimate issuers and investors will then seek lower cost trading forums with less regulatory overhead such as issuer web sites or offshore market makers. Under the cover of those legitimate securities, fraudulent ones will find added credibility. It is terrible that issuers and promoters tell lies on the Internet and the trading takes place through legitimate broker-dealers, on the exchanges, and in the OTC markets. However, the public would be worse served and the opportunities for fraud and manipulation increased if the securities were traded on an issuer or promoter web site that briefly appears and then disappears.

In short, I rapidly conclude that the only answer in is to make markets so competitive, transparent, efficient and inclusive that there is never the need for other trading forums. Every legitimate security with minority shareholders should be traded through a regulated and supervised broker-dealer. Rather than resist technology, markets should exploit technology to reach these goals.

What Should the Commission do?

The securities covered by the rule proposal are like children, some are good, some are bad, but all need to be supervised and disciplined when they get out of line. The Commission cannot control the children all the time but they must impose and enforce rules to protect the good children and the community from the bad children. Just because there are some bad children, the Commission shouldn't throw all the children out into the street. The bad children would run rampant through the community and the good children would suffer from neglect. Nor can they ask others to take on the Commission's responsibilities to supervise the children.

Therefore, the most important emphasis should be on a comprehensive review of market rules and regulations to increase the professional standards of the securities industry to protect retail customers and increase oversight of issuers. Since the Commission cannot impose listing standards or require financial disclosure from issuers, they must limit unsophisticated investors access to the securities. OTC securities are a dangerous asset class. Investors must be educated with respect to and sophisticated enough to understand the risks of the securities. Rules must protect the public from being lied to by a dishonest salesman or unwittingly buying stock from or selling stock to an insider.

The Commission should clearly limit insiders access to OTC markets if there is no current information available in the marketplace. Many of the problems in this marketplace were created by the Commission's easing of restrictions on insider sales of stock through Regulation D and Regulation S. Insiders should not be free to trade stock if there is no information in the marketplace. Issuers must be current in their filings with the Commission if they are reporting companies.

If they are not, there should be information repository for issuers, officers, directors, affiliates, promoters and significant shareholders to post needed information before insiders are able to buy from or sell into the public markets. If insiders want to sell any stock covered by Rule 15c2-11 they must make a filing with the Commission or appropriate state regulator in advance. The repository should include that information. State banking and insurance filings should also be available.

Insiders should be limited to private transactions if there is not current information in the marketplace, and their stock should be restricted so that any stock sold in a private transaction does not become "washed" and find its way into the public markets.

Minority shareholding outsiders are entitled to buy and sell their interests in as transparent and competitive media as possible, however insiders should not be able to prey them upon. The public would be protected from insiders dumping securities on an unsuspecting public. However, insiders would not be able to limit minority shareholders liquidity options by restricting information when insiders try to repurchase securities. In short, public securities markets should be strictly limited to outsiders if insiders won't or can't supply current information in the form of 15c211, bank or insurance regulatory, or other filings with the repository.

Registered transfer Agents obligations under Section 17A should be expanded to support the repository. The transfer agents should be required to report to any exchange, inter-dealer quotation system or quotation medium, information regarding the issuers and securities listed or quoted. The transfer agent should be required to report to such organization on their request and at least on an annual basis the issuer address, officers, state of incorporation and shares of the security outstanding. The transfer agent should be required to report significant intervening events such as significant securities offerings, splits, name changes, moves and other events that the Commission deems important. While the Commission only has power over registered transfer agents for securities issued under 12(A) the majority of non-reporting issuers use registered transfer agents. If unregistered transfer agents became a significant problem, the Commission could work with state securities commissioners to gain access to the information. The transfer agent has a contractual relationship with the issuer and thus is in a position to collect factual information. The exchange, inter-dealer quotation system or quotation medium can distribute the information to market participants through the repository.

I believe that responsibility for customer protection should lie with the firm who holds the customer's account. Regulation must walk the fine line of protecting a customer while not unduly restricting or limiting their opportunities. Therefore, I am in favor of the NASD proposed Rules 2315 and 2350. The proposed rules would require members to review current issuer financial statements prior to recommending a transaction to a customer in a OTC equity security and to deliver a disclosure statement to a customer prior to an initial purchase of an OTC equity security. I believe that the NASD should go further and replicate their rules regarding options accounts. Options are an asset class that involves a high degree of risk for investors. The only difference between options and OTC equity securities is that the big firms want to sell options to their customers and probably deals with non-Nasdaq equities only when forced by the customer. The industry has developed rules and procedures to adequately inform investors of the risks and keep unsuitable customers from trading options. Why shouldn't we impose those same protections for non-Nasdaq OTC equities? Rules which mimic NASD Rule 2860 (sections: (11) Delivery of disclosure documents, (16) Opening of accounts, (18) Discretionary accounts, (19) Suitability and (20) Supervision of accounts) should be written for non-Nasdaq OTC equities.

NASDR should consider sales practice rules that warn the customer of what primary market center a security is listed on or quoted in at the time they place an order, and that information should be repeated on their confirmation. Properly identifying primary market centers would help differentiate securities for customers and reinforce the prestige of Nasdaq and the exchanges and the risks of the non-Nasdaq market. The public would no longer view all securities with symbols as having the same risk characteristics.

NASDR's and other SRO's regulatory divisions should have the ability to stop member firms and associated persons from transacting in any non-Nasdaq security for ten out of twenty working days for practically no reason at all. This rule would allow market surveillance to instantly stop trading in a security simply as a precaution on suspicion of manipulation or questionable information in the marketplace. The restriction that it only is allowed for ten out of twenty days would limit it from being used capriciously and provide a window in which to initiate more formal suspension for cause shown. The halt in transactions should not effect quotations under 15c2-11. The Commission would have ten days to research whether a trading suspension pursuant to 12(k) is warranted. The rule would have many benefits. Investors would be instantly stopped from buying or selling a security based on potentially false information. Fraudulent promoters and manipulators would lose the ability to continue profiting as NASDR and the Commission researched whether a trading suspension was justified. Investors and market makers would be much more wary of owning speculative issues that could halt trading with no warning (unlike a 12(k) suspension that the market place is always warned of days in advance by the Commission's subpoenas of documents).

We support the Commission's recent initiative of imposing an increasing number of trading suspensions pursuant to 12(k). The Commission ordered 12 suspensions in fiscal year 1997, 8 in 1996, 4 in 1995 and 1 in 1994. See SEC Increasingly Using Trading Suspensions to Combat Fraud, Dow Jones Newswire, Paul Beckett (2/4/98). However, a faster response is now required. The best way to limit fraud is to cut down on the potential for fraudulent profit.

The NASD is presently developing the Order Audit Trail System (the "OATS"), to track customer orders in NASDAQ equities. OATS should be expanded to include all non-NASDAQ OTC equities, be they OTCBB, Pink Sheets, unlisted or foreign, i.e. any order from a domestic customer for an equity security and any order by a foreign customer for a domestic equity security. OATS should include information if the order was solicited or unsolicited, the registered representative's CRD# and the branch office. The ability to easily track solicited orders will aid NASDR in identifying cornered or controlled markets. OATS will give NASDR market surveillance a valuable tool in tracking where orders are coming from in times of unusual volume or price change. NASDR will be able to recognize what firms are soliciting orders in active securities and trace the reason for such activity. The NASDR surveillance systems will be able to easily identify firms that may be soliciting business in securities and not recording the orders as solicited.

I would hope that the Commission and the NASD form a permanent joint task force on micro-cap fraud. The task force would be in charge of market surveillance, enforcement and investor education for non-Nasdaq OTC equities. The task force would be able to quickly stop and prosecute fraud in the OTC markets. The joint powers of the Commission and the NASD should increase the ease of prosecution. Publicity of enforcement actions would serve to deter potential wrongdoers and educate the public regarding the risks in non-Nasdaq OTC markets. The Section 31(a) fees that the Commission has been receiving from the OTC markets could fund the task force. The task force would design industry wide programs to educate the public on smart investing.

Increase Transparency and Efficiency

Since the Commission cannot turn back the clocks on technology, they must embrace technology to identify and stop frauds quickly. The best first defense against fraud is an efficient, competitive and transparent marketplace that is well policed. In response to the proposed changes to the OTCBB, the NQB has initiated plans to provide quotation transparency for securities quoted OTC through an electronic bulletin board and messaging facility. The OTCBB has provided a transparent and efficient medium for issuers and investors, however it's association with Nasdaq has given the securities an implied legitimacy. The quoting of securities in the Pink Sheets does not give the same respectability or visibility as a system sponsored by a SRO.

Subject to discussions with the Commission, the NQB would become a centralized information clearinghouse, accepting prices from market makers and other information from issuers and market makers. I realize that there is potential for misinformation within that role, but believe that misinformation circulates today and that in collecting it we are making a record that benefit's the markets and regulators well beyond any incremental damage that its centralized availability may introduce.

NQB would have an information repository for issuers that aren't required to register with the Commission. The NQB believes for a repository to be successful, it must be driven issuers supplying the information. No matter how respected the market maker firm is that supplies information to a Repository, any other market maker would have to obtain source documents from the issuer to be certain they are from reliable sources. Thus, NQB would have to establish private contracts with issuers, advising them that anti-fraud provisions covered the information supplied. The contract would require the issuers to supply financial information on a timely schedule that NQB would store in an electronic repository. The issuers would be contractually obligated to notify NQB of important intervening events such as mergers, acquisitions, name changes, resignation of accountants, bankruptcy and significant offerings. NQB would make all information in the repository available to our broker-dealer subscribers. The public could access the information through their broker-dealer. NQB would place identifiers on the securities quoted in our service identifying whether the issuer's filings were current with the Commission, current with our repository or not current. Customers would be warned that securities in the latter category would be "buyer beware". I believe that if current information is not available in the marketplace, issuers, insiders and promoters should not be able to access the marketplace to buy or sell. However, outsiders should still be able to buy or sell their securities with other outsiders in an efficient, competitive and transparent medium.

The NQB disagrees with the viewpoint that the public is more easily defrauded by widespread dissemination of quotation information. The public is hurt by information that does not come with education and risk warnings. The de-listing of the securities from the Pink Sheets or the OTCBB will not have an effect on the uneducated investor who still will see volume, high, low and last trades through the widely available Nasdaq ticker. It will not matter if there is no bid or ask. The NQB would only distribute our quotation information to customers who have been suitably warned and educated of the dangers and differences the various OTC markets. We would like to incorporate the proposed NASD Rule 2350-disclosure document into our subscriber agreement. The NQB will require quote vendors to clearly identify securities quoted on the NQS as different from exchange and Nasdaq issues. The quotes would be distributed with the current information availability or "buyer beware" identifier. The public is always benefited by increased information if they are properly educated.

Rule 15c2-11

Rule 15c2-11 regulates the publication of quotations in a quotation medium. I will first briefly describe the features of the proposal I like. I like the increased disclosure for non-reporting companies. I like the fact that court confirmed bankruptcy reorganization plans would be an acceptable document. I like the fact that significant relationship information has been expanded to all covered securities. I think that the significant relationship information should be provided when market makers start trading any equity security.

The rest of the rule proposal I totally, unequivocally disagree with. I disagree with the Commission's reasoning, logic and supporting basis for the proposal. I expect the results will be that competition, transparency and liquidity will be significantly diminished and opportunities for manipulation will be increased. The potential liability from an implied right of action by investors will drive legitimate firms from making markets in all non-Nasdaq OTC securities and give an incentive for the remaining market makers to refrain from publishing prices. Transparency and liquidity will disappear from the secondary market for small companies; harming legitimate issuers access to capital. It is much easier to manipulate markets when there is no competition or transparency. The crooks will have free reign as the honest players exit the business.

Rule 15c2-11 presently requires that market maker which introduces a security into an inter-dealer quotation medium, must obtain, review, and believe certain information for the security. After thirty days, any market maker can quote the security without having to perform the review process. Thus, once a security is in the system, competition and ease of entry are promoted. The new rule proposal will drastically change the market structure.

The rule proposal requires every market maker to review and vouch for a security when they initiate quotations and on annual basis if they publish a price. The proposed rule requires market makers to have a reasonable basis under the circumstances for believing the issuer information is accurate and current in all material respects, and that it is obtained from reliable sources. According to the proposal, the review process will help market makers ascertain if there are indications of whether potential or actual fraud or manipulation may be present. The review process will apply to both reporting and non-reporting issuers. Not only does the rule cover quotations in the Pink Sheets and on the OTC Bulletin Board but OTC markets in corporate bonds and foreign securities.

A Good Idea with Bad Consequences

The rule proposal is based on a simple idea; "Market makers should know the securities they trade." The NQB agrees that all market participants should be as informed as possible so the market price reflects all available information. The best way to achieve that goal is to make the market structure so competitive that participants need information to give them a maximum advantage.

The consequences of the rule are worrisome. If a market maker uncovers indications of fraud or manipulation, is the firm supposed to stop trading the security? Why not adjust its quote to more accurately reflect its suspicions. The rule proposal states "responsible broker-dealers should refrain from publishing quotations in questionable securities." What is a questionable security? According to the rule proposal it is one where "potential or actual fraud or manipulation may be present." What are a market maker's obligations if third parties are trying to manipulate a security they trade? Salomon Brothers was convicted of manipulating the treasury market and Morgan Stanley has just been fined by NASDR $1,000,000 for manipulating ten securities in the Nasdaq 100 Index. When those manipulations occurred, should all of the legitimate firms have stopped trading those securities? Won't it be easier to manipulate securities when any market maker that disagrees with the trading valuation is forced to stop quoting the security? The market maker should have their viewpoint reflected in the market by adjusting their quotations. The market maker has no powers under the rule proposal to make a "citizens arrest" and stop the parties that are defrauding or manipulating. The market maker is not required to contact regulators. Nor should it be. The information it has is not "hard" enough to admit of such reporting to regulators. The best "first defense" against fraud and manipulation is a competitive and transparent marketplace representing many opposing points of view. The rule proposal would make the legitimate market maker walk away and the crimes continue.

Imagine if basketball rules were structured so that when a foul is committed, any honest player must quit the game and leave the court. The bad guys would have a field day. Basketball needs referees to enforce the rules of the game and securities trading needs to have rules enforced by regulators. If this rule proposal is an attempt to make the market self policing it will accomplish nothing. You cannot make crime go away by imposing additional burdens on the legitimate participants in the market place. Rule proposals should concentrate on speeding up the regulator's whistle and creating harsher penalties for rule breakers.

Potential civil liability will be drastically increased for market makers if they are now forced to police the securities they trade. In eliminating the "piggyback" provisions, the Commission's 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. The proposal changes the process of review from a thirty-day obligation for the initial market maker, to a continuing review process for all market makers. The potential liability risks to subsequent market makers are substantial, and include not only the sanctions of administrative proceedings but, more significantly, the risk of civil liability under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. While marker makers perform primarily a dealer market function, and thus in that capacity may not be in a direct relationship with customers, most market makers are broker/dealers who also buy from or sell to their retail accounts the stocks in which they make a market. Many courts have held that brokers owe substantial duties of care to their customers, including in some cases fiduciary duties.

Under the Commission proposal, every market maker would be required to hold itself out as having undertaken due diligence including all reasonable steps to ensure the truthfulness of the company's disclosures and that such information is current. If market losses thereafter occurred, individual and class plaintiffs may well institute legal proceedings claiming that these market makers failed to disclose material information pursuant to their obligations under Rule 15c2-11, and are therefore liable under Section 10(b) and Rule 10b-5. See In Matter of Greg M. Anderson, Russell G. Koch, Litig. Rel. No. 13829 (Oct. 7, 1995); Rel. No. 36282 (Sept. 26, 1995) (enjoining market maker from future violations of sections 5(a), 5(c), 17(a) of the Securities Act of 1933, and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934). Even if the market maker did not act with actual intent to deceive, recklessness is generally sufficient to constitute scienter in a civil action.

The proposed change thus effects a significant additional burden on broker/dealers and potentially increases their obligations to their customers with no offsetting advantage to them. If adopted in its present form, it can be expected to discourage brokers and dealers from seeking to make markets or publish prices, thus impairing the liquidity, transparency and competition of such stocks and the market generally.

The NQB has tried to dramatically reduce the costs for market makers in our service. As a result of expense cutting, we have been able to reduce the average security-listing fee for market makers from $8.10 per month to $3.98 per month. Market maker listings have increased by 30% due to lowering fees less than $50 per year. The public has benefited by more competition in illiquid securities. If the rule proposal increases the market maker costs by any significant amount, the number of market makers will drop dramatically. See enclosed supporting documentation.

The consequence of the rule proposal will be that legitimate market makers stop submitting prices to remove themselves from the continuing review obligations of the proposal. Market makers currently exhibit a willingness to publish prices for covered securities. If the publication of prices incurred potential liabilities or potential civil litigation as the "deep pocket" in a class action, priced quotations would be substantially reduced in the covered securities. The OTC market is currently structured so that almost all order-flow is internalized or directed through "payment for order-flow" agreements. Thus, legitimate market makers do not need to use publishing prices to attract order-flow. The current efficiency benefits of published prices would be nullified by market makers needs to protect themselves from continuing oversight liability. Firms would hire more telephone clerks, make more phone calls, and charge investors through wider spreads and increased profits due to market fragmentation.

With the very likely potential of substantially fewer quotations in covered securities, the Commission should consider the effects of last sale trade reporting in the absence of real-time quotations. Trade reports are much easier to manipulate than firm quotations. A trade report is advertising some of the terms of an event that happened in the past. Firm quotations are open to all and thus accessible by all market participants. Other market participants easily police firms not honoring their quoted markets and can place backing away charges with NASDR. Retail firms use contemporaneous transactions to justify prices charged customers. With no real-time quotations, the door will be open to abuses by retail firms. In the absence of dynamic quotations, other market participants cannot effectively display their better prices when they see trades outside their markets. The Commission should create market structures where customer orders have the maximum interaction with all possible sources of liquidity. The NQB believes that inefficient, opaque markets breed bad market practices. The first defense against fraud should be an efficient, competitive and transparent marketplace.

What is a broker-dealer's obligation to their customers who want to buy a security on an unsolicited basis? If a customer has been sufficiently warned of the risks, and is sophisticated and experienced enough to understand those risks, should the broker-dealer not accept the order from the customer? I don't think so. The broker-dealer should accept the order and try to get their customer the best execution. Since the broker-dealer's obligation to their customer is to provide best execution, what if there is only one market maker that is quoting a very wide spread? Since the broker-dealer now has the order, should they try to cross their internal buyers and sellers to provide price improvement for their customers? Probably, yes. Now since market orders of buyers and sellers may not appear simultaneously, a responsible broker-dealer may want to make an internal market for customers. The broker-dealer could risk firm capital to serve their customer's immediate liquidity needs. If the broker-dealer can provide better pricing and liquidity for their customers than the market makers, should they? Probably, yes. Now should that liquidity be available to the public? The National Market System 1975 Amendments gave the Commission the objective of the centralization of all buying and selling interest so that each investor has the opportunity for the best possible execution of his or her order, regardless of where the investor places that order. The rule proposal is inconsistent with Congress' goals if it fosters the creation of numerous internal "gray markets" where broker-dealers do not publish their price quotations for covered securities. Does the Commission believe that non-Nasdaq OTC securities should be exempt from the NMS goals of protecting investors from the potential negative effects of fragmented markets?

If the rule proposal does substantially reduce the amount of available quotation information, it may conflict with the Commission's duties under Section 17B of the Securities Exchange Act of 1934. The section states "The Congress finds that; 1.) the market for penny stocks suffers from a lack of reliable and accurate quotation and last sale information available to investors and regulators; 2.) it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to improve significantly the information available to brokers, dealers, investors, and regulators with respect to quotations for and transactions in penny stocks" Since Congress thinks increasing quotation transparency is beneficial for penny stocks, why is the Commission proposing to introduce a rule that could potentially achieve the complete opposite? The proposed rule creates a disincentive for broker dealers to quote securities in quotation mediums because of the lower regulation on securities that are not published or quoted in a quotation medium. Regulation should encourage quotation transparency and competition, not discourage it.

What are the Commissions Goals?

The NQB strongly supports all efforts to identify and eradicate fraud in all sectors of the markets. However, as the Honorable Arthur Levitt stated in the Commission's 1996 annual report "Throughout its existence, the Commission has balanced the need for full disclosure and investor protection against the burden that its rules, regulations, and requirements may impose on capital formation." The proposed rule will impose significant burdens on all of the legitimate issuers, investors and broker-dealers in the covered securities. Many of the proposed rules effects will actually be quite helpful for the criminals who are conducting frauds and deceiving investors. So why is the Commission trying to impose a rule with such unintended consequences?

Rather than look at and understand the unique characteristics of this marketplace, the Commission is moving to adopt a proposal that was overwhelmingly opposed in the 1991 public comment period. Has the Commission decided that for a security to have quotation transparency and market making competition it must achieve certain disclosure standards? What should happen to the securities that can't meet such standards? How does the proposal benefit shareholders of issuers who won't supply the disclosure? They will have no transparency or market maker competition. The management of many covered securities has a predatory disposition toward their minority shareholders. Rather than looking at how they can increase the pie for all, insiders would like to steal the minority shareholder slices. The New York Stock Exchange Rule 500 was originally instituted to protect shareholders from issuers for this very reason. I would expect there are many issuers who would applaud the rule proposal and use it as a tool to disenfranchise shareholders. The Commission should review the Kohler Co.'s (KHCO) current attempt to reverse merge out their minority shareholders at half the public market price.

Is it proper to impose listing standards on this sector of the market when every other exchange or system that has tried such a course for this sector has been a resounding failure? Will the proposal give an unwarranted legitimacy to the securities that do supply the required information? The Commission has only one example in the proposal of micro-cap fraud involving issuers for which public information is limited. See, e.g. SEC v. Global Financial Traders, Ltd., Litig. Rel. 15291 (3/14/97) and 15338 (3/17/97). In the case mentioned, the issuer, American Image Motor Co. Inc. (USMC) did issue over fourteen press releases to newswires, including their signing of Deloitte & Touche as accountants. The majority of fraudulent issuers provide the marketplace with copious amounts of information.

The history of using disclosure and listing standards in this sector of the market has either been proven to be overly burdensome for legitimate, small companies or abused by fraudulent issuers to give false legitimacy and respectability to their securities. Why would the proposal have any different results on this marketplace? Fraudulent issuers have always been able to supply whatever financial information is required to commit the fraud. It is relatively easy to manufacture information. It is much harder to provide accurate, verified information. The vast majority of fraudulent issuers have been reporting companies. Comparator Systems Corp. and Systems of Excellence, Inc. both filed with the Commission.

The rule proposal will require broker-dealers "to review fundamental information about the issuer and have a reasonable basis for believing that the information is accurate, current, and from reliable sources." The review and reasonable basis requirements apply for both reporting and non-reporting issuers. If the rule proposal's intention is to make sure there is information in the marketplace, why should market makers have to police issuers from lying to the Commission? Shouldn't that be the Commission's job? The New York Times' Market Watch Column stated in reference to accounting irregularities at Cendent Corporation: "If Henry Silverman and his team can't spot accounting tricks, even when they are allowed to look at confidential information during the due diligence for a merger, how can the rest of us be confident that we are not being deceived?" N.Y.T., Floyd Norris, 4/19/98. How does the Commission think market makers that have no contractual relationship with or regulatory powers over issuers will be able to identify frauds? Does the Commission believe that fraud is easy to identify? If so, why aren't short sellers a lot wealthier?

If having market makers know the securities they trade is so beneficial for markets, why does Rule 15c2-11 exclude securities that are listed on Nasdaq or the exchanges? The Commission has offered no statistical evidence that fraud and manipulation are limited to non-Nasdaq OTC equities. There is statistical evidence that market makers in small stocks do know more about the securities they trade than market makers in big stocks. Highly computerized firms such as D.E. Shaw Investments, L.P. or Bernard L. Madoff Investments have been unable to trade these securities as numbers. The boiler shops of Stratton Oakmont and A.R. Baron concentrated on Nasdaq listed issues, so the proposed rule would not have protected thousands of investors defrauded by them. Shouldn't the rule's supposed benefits be extended to all markets? If the proposed rule would be too burdensome for Nasdaq market makers or exchange specialists, why is it justified for the smaller, legitimate companies that are quoted on the OTCBB or in the Pink Sheets. The rule should not unduly limit legitimate issuers access to capital

The Commission is using the rule proposal to punish issuers that are late in their reporting responsibilities. The rule proposal states that allowing for active trading of securities "would remove an incentive that delinquent issuers may have to provide current information to their shareholders and the marketplace." What if the issuer does not want an active marketplace for their minority, outside shareholders? The Commission is giving issuers who want to disenfranchise shareholders a tool to control the outsider market for their shares. Proposed rule 15c2-11 will be used as a reverse New York Stock Exchange Rule 500. The Commission must give issuers an incentive to continue to provide current information to shareholders and file timely reports to the Commission by bringing enforcement actions against issuers who don't. We applaud the Commission's recent enforcement actions against issuers that have failed to file timely reports and hope that the Commission continues to enforce issuers responsibilities under securities rules and regulations in this market sector.

The Commission has no examples of the "improper retail sales practices" in issuers that are late in their filing of reports that they surmise may exist. NASD proposed rule 2315 would stop any of these practices that the Commission "thinks" may be happening, but has no evidence of. The Commission should clearly rethink their position on this issue. The past public and SRO commenters' suggestions of identifying issuers that do not have current information available should not be so hastily dismissed by the Commission. The Commission should release a daily list of issuers that are late in their filling of reports. Rule breakers must be prosecuted for breaking rules. Having a competitive and transparent market away from the issuer will serve to protect minority shareholders. The rule proposal will hurt the innocent to punish the guilty.

NQB applauds the Commissions proposed changes relating to issuers exiting bankruptcy. The inclusion of a bankruptcy court approved disclosure statement, as an acceptable document is a needed modification for Rule 15c2-11. However, the Commission's reasoning, logic and supporting basis for limiting quotation transparency of issuers in bankruptcy are plainly and utterly wrong. Bankrupt issuers are operating under the supervision of a federal judge and file a significant amount of information with the bankruptcy court. NQB understands that the Commission is unhappy that many issuers in bankruptcy have failed to comply with their Exchange Act reporting requirements. The solution to that problem is enforcement actions on rule breakers. The Commission should understand that the management of a bankrupt issuer might be trying to disenfranchise the shareholders to lower their payment. Since the majority of the value of a bankrupt issuer usually goes creditors, the management will naturally represent creditor interests over shareholders, especially minority shareholders. If management can reduce the market price of the securities, shareholders will settle for less of the pie in the reorganization. Shareholders in bankrupt companies need a competitive and transparent marketplace to value their securities and provide liquidity for those shareholders that may need to capture tax losses or average down. The Commission should clearly rethink their position on this issue. The Commission should not so hastily dismiss the past public and SRO commenters' suggestions of identifying issuers that are in bankruptcy. The Commission should not pass a rule that can be used to significantly harm minority shareholders.

The Commission has always been wary of allowing foreign issuers securities to trade in the OTC marketplace. The Commission has continually sought to make the market fragmented and opaque. Institutional investors have access to pricing transparency while the public is continually overcharged by controlled order flow, wide spreads and market fragmentation. If you compare reported volume in OTC trading of foreign issuers securities to published market maker quotations, you will find that the largest market makers try to limit the marketplaces transparency. We understand that the Commission wants to protect domestic investors by requiring foreign issuers to provide full disclosure if they want visibility in our marketplace. However, since the securities are available for investors in an overseas marketplace, that regulatory approach should be reviewed. If a security can be traded in the domestic OTC marketplace, we believe that it should trade with the maximum transparency and competition that transparency provides.

The Commission should instead look to protect investors through investor suitability rules and disclosure requirements for recommended transactions. Investors should be educated of the risks and disclosure differences of foreign issuers and issuers should be forced to provide full disclosure if they want their securities recommended to domestic investors. However, if a customer understands the risks, the Commission should concentrate on providing that investor with the best possible execution of that order and protecting the investor's ownership of the security. The Commission should continue to provide such tools as American Depository Receipt (the "ADR") facilities to protect investors. ADR facilities protect investors from many dangers, such as undependable settlements, costly currency conversions, unreliable custody services, poor information flow, unfamiliar market practices and confusing tax conventions. ADR facilities benefit and provide savings for investors because global custodian safekeeping charges are eliminated, saving ADR investors 10 to 40 basis points annually and dividends and other cash distributions are converted into dollars at competitive foreign exchange rates.

The 1991 release used the reasoning that Rule 15c2-11 should be changed because "Today, the rule applies principally to the non-Nasdaq market, predominantly consisting of infrequently traded, relatively unknown securities with unpriced quotation entries and little or no competition among market makers." Today, the vast majority of OTCBB market maker quotations are two-sided and almost all are priced. We expect the Pink Sheets would have the same characteristics if market makers were able to update their quotations on a real-time basis. The Commission's standard of best execution for a non-Nasdaq OTC security has been three competing quotes. Since the average security has over four market makers we wonder if the Commission would classify them as having little competition? I suspect that the rule proposal avoids mentioning such reasoning because it's supporting basis has disappeared.

The rule proposal takes the position that "Market makers' quotations are important to the success of micro-cap fraud schemes. By publishing quotations in the Bulletin Board, in the Pink Sheets, or in similar quotation mediums, broker-dealers give the market for the securities an aura of credibility." That statement requires some analysis because I believe it is fundamentally wrong.

In the 1980's, before dynamic pricing and trade reporting, the industry would judge the liquidity and respectability of a security by the names and number of market makers in the Pink Sheets. Today, credibility is judged by reviewing price and volume. There is much more information available today than ten years ago. I believe that competition and multiple market makers cuts down on the opportunity for fraud and manipulation. It is much easier to mug someone in a dark alley than a busy well-lighted street. In a Business Week cover article "The Mob on Wall Street" Business Week, Gary Weiss (12/16/96) the operations of mob linked stock manipulators was detailed. The mob's only contact with legitimate market makers was trying to induce them to stop trading the stocks that the mob was manipulating. It seems criminals don't like the competition of honest market makers trading their stocks.

What to do?

The NQB would recommend that the Commission should leave Rule 15c2-11 alone and concentrate on other more beneficial rule changes with less potential adverse consequences. NASD proposed Rule 2315 should close the loophole in Rule 15c2-11 by imposing the rules obligations on firms that recommend transactions in non-Nasdaq OTC equity securities. As terrible as it may seem, the "piggyback" exemptions must be continued. The potential benefits of market makers knowing the securities they trade are vastly overweighed by need to maximize the competitive forces in the OTC marketplace. Any allocation of oversight responsibly on the market makers will bring with it civil liability. Market makers should make markets and regulators should enforce rules, there is no other way.

If the rule proposal is passed, investors will suffer from illiquid, opaque OTC markets. Legitimate investors and shareholders will be harmed. 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 are willing to trade OTC securities. Transparency will decrease, as fewer market makers are willing to publish prices. Some securities may disappear from the public markets.

Small issuers will have less liquid and transparent markets for their securities. The cost of capital will rise if there is not an efficient secondary market for small or troubled companies. Legitimate capital sources for small or troubled companies will dry up. Market makers will be less inclined to quote new securities. The good companies will be forced to pay for others misdeeds.

I highly respect the Commission's skill in regulating markets and expect that they will not implement a rule with disastrous consequences. One of the reasons I bought the NQB and am attempting to make changes is the leadership I saw from the Commission's Order Handling Rules. The push for quotation transparency and competition that has been so well implemented in the listed markets is totally at odds with the effects that the proposal may have on the unlisted marketplace.

I hope that the Commission couples their regulatory initiatives with significant market surveillance and enforcement resources to keep the trading of securities in the OTC markets honest. There has always been fraud and there will always be fraud. Before the OTCBB, there was fraud in securities quoted on the Pink Sheets, and before the Pink Sheets there was still securities fraud. Turning back the clock or slowing things down are not answers that will work. The advance of technology and widespread distribution of information has greatly benefited investors. Regulation should react to and exploit technology's good and bad points. Promoters and manipulators are using all available technologies to defraud and spread misinformation. The Commission must use those same channels to warn, educate and inform the public. Regulators should not try to slow down the speed at which information travels or cut back the distribution of information just because unknown portions of it may pose danger, but increase the speed at which regulators react to and stop fraud. No regulation will be a silver bullet because criminals ignore and violate laws. Market surveillance, enforcement and educated investors will always be the best tool to keep criminals out of the public markets.

I would be glad to discuss these or any other issues raised in the comment period with any members of your staff.

R. Cromwell Coulson