Herzog Heine Geduld

Established 1926. Member of the New York Stock Exchange.

May 7, 1999

Mr. Jonathan G. Katz


Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, DC 20549

RE: File No. S7-5-99

Dear Mr. Katz:

We thank you for providing us with the opportunity to express our views on the Commission's

re-proposed amendments to Rule 15c2-11 under the Securities Exchange Act of 1934 (the

"Amendments"). We write this letter to register our strong opposition to these Amendments.

Herzog Heine Geduld has been a market maker in securities for more than 70 years. While we are best-known for our participation in the development of the Nasdaq Stock Market, it has also been our privilege to support the evolution of a fairer and more transparent market for less-capitalized issues. We believe that somewhere among the lesser-known, smaller companies are the Microsofts, Lucent Technologies and Viacoms of the future. The American capital markets are strong because they afford an opportunity for the small, unknown enterprise with a good idea to attract the capital needed to bring the idea to market. This process is permitted and encouraged even though the risk of failure and investment loss is great, because our experience tells us that the few survivors produce social benefits that surpass the losses generated by the many enterprises that fail.

Herzog Heine Geduld strongly supports the Commission's efforts to circumvent incidents of fraud and manipulation in over-the-counter securities primarily for two reasons: First, reports of fraudulent activity in the microcap market discourage investors from exploring opportunities in this market. Second, from time to time we are the victims of market manipulation schemes. As described in more detail below, we therefore propose that Rule 15c2-11 be amended to provide that the Commission, or some other appropriate regulatory body, maintain a repository for issuer information using the Internet that is readily available to the investing public. With proper education, investors can then be enlisted to assist the Commission in its enforcement efforts by identifying incidents of fraud and manipulation.

We respectfully must oppose the Amendments because we believe that they will impose costly and unnecessary burdens on market makers for which the investing public will derive little, if any, benefit. Contrary to the Commission's hopes, we believe that the Amendments will actually serve to encourage more fraudulent activity in the microcap market. Finally, we believe that the effect of the rules will be to confuse and mislead investors by inducing them to place undue reliance on the ability of market makers to discover fraudulent activity in the market.

The Amendments will Impose Costs on Market Makers Without Benefit to Investors

Herzog Heine Geduld currently makes markets in more than [3,000] over-the-counter issues that are subject to the information gathering requirements of Rule 15c2-11. In compliance with the Rule, our compliance department has diligently gathered and reviewed the materials required under Rule 15c2-11 since 1971, when the Rule was first promulgated.

Our experience with the current Rule 15c2-11 indicates that our firm expends scarce

compliance resources to gather information that is not used by the market in any beneficial way. We cannot recall a single instance when an investor has requested copies of any of the information gathered pursuant to the rule. Our traders do not use the information gathered under Rule 15c2-11 to make trading decisions. During the time since 1971, numerous examples of microcap fraud and manipulation have come to light, some of which caused us to suffer trading losses. However, we cannot recall a single example where review of the materials diligently gathered at considerable expense in compliance with Rule 15c2-11 enabled us to avoid such losses.

At best, or perhaps worst, Rule 15c2-11 is a litigation trap for market makers. We are asked to show that we have gathered and reviewed the required information in connection with regulatory audits. There is the risk that some enterprising plaintiff's lawyer will try to extract some settlement dollars from us on the theory that our inability to discover fraudulent activity

on the part of a now-bankrupt issuer makes us liable for her client's shattered visions of avarice.

The Amendments and the accompanying Appendix, which require us to conduct a more extensive review of more information gathered in connection with Rule 15c2-11, make a bad situation worse. There is nothing about the Amendments that can be expected to change the reality that market makers are not a reliable source of investment information for the investing public. We would be frankly surprised to receive requests for this information from anyone who might use it to form an investment decision. Our traders will not use the information to make trading decisions. We think it is entirely likely, however, that the requirements of the rule will generate additional grist for the litigation mill.

A rule that requires information to be gathered for its own sake needlessly wastes resources for no good purpose, and we therefore urge the Commission for this reason to reject the proposed Amendments.

The Amendments Will Encourage Microcap Fraud

As noted in the prior section, the effect of the Amendments will be to raise the costs of compliance with Rule 15c2-11 because market makers will be required to gather more information and conduct a more elaborate review than required under the existing rule. Litigation risks, and therefore costs, will increase because incidents of microcap fraud are likely to result in an inquiry as to whether the market maker should have spotted the red flags described in the Appendix to the Amendment. As the costs of doing business increase, market

makers can be expected to make fewer markets.

The Commission's focus on microcap fraud reflects the fact that manipulative schemes are easier to implement in thinly traded markets where there is relatively little good information on which to form an investment decision. Fraudulent operators will not be discouraged from making markets by the information gathering requirements of the Amendments. Only legitimate, rule-abiding market makers will decline to make a market because of the increased costs of compliance and litigation. The absence of legitimate market makers will reduce information and trading activity, which will have the perverse effect of decreasing the costs and risks of doing business for fraudulent market makers. It is to be expected that incidents of microcap fraud will increase.

In the release accompanying the Amendments, the Commission suggests that there is a trade-off between the needs of investors for liquidity and the need to protect the public from microcap fraud. We believe that this analysis is fundamentally flawed. The dissemination of public quotations increases the visibility of an issue, and more public quotations provide and foster increased public disclosures. Fraud and manipulative activity depend on secrecy and less information, and more public quotations, being tools of disclosure, make frauds more difficult to conduct successfully. Accordingly, the need of investors for liquidity and protecting the public from fraud are not trade-offs, but rather complimentary goals that serve to support each other.

We urge the Commission to reject the Amendments because they will serve the perverse effect of encouraging fraud and manipulative activity.

The Amendments Will Confuse and Mislead Investors

Rule 15c2-11 is flawed by its reliance on the specious theory that a market maker's two-sided priced quotation is in itself an indication that the issue is a meritorious investment. This theory ignores marketplace realities.

A market maker's decision to trade a particular issue is based on its perception of investor interest. It is in the nature of providing two-sided quotations that there will be investors who think a stock should be sold, while others believe it should be purchased. To be successful, the market maker must deal with both sets of beliefs without favoring one over the other. Trading decisions are based, therefore, on the realities of supply and demand at any particular time, rather than the investment merits of an issue.

We are concerned that investors will view the new requirements of Rule 15c2-11 as an indication that market makers research the investment merits of issues. Moreover, we fear that unsophisticated investors will view the Rule as evidence that we can identify fraud or vouch for the investment worthiness of an issue. History shows that market makers are not qualified to make such judgments. We do not retain investment analysts to perform research in support of our market making functions. Instead, the analysis performed under the Rule will continue to be a compliance function. Investors, of course, are not really interested in the views of a compliance professional as to the investment merits of an issue. We therefore fear that investors will be mislead by the requirement of the Amendments and the accompanying Appendix into

the erroneous belief that our decision to make a market indicates that our traders have made a

judgment based on careful investment research, rather than customer demand, that an issue is a worthy investment.

At Herzog Heine Geduld, we continually search for ways to educate the investing public regarding our role as market makers. Our website contains much useful information about the working realities of the marketplace, and our traders and executives have devoted considerable time to industry functions intended to illuminate the role of market makers in a multi-dealer environment. We have volunteered our time to participate in Town Meetings and other events sponsored by regulators to provide information about the role of market makers to the investing public. The Amendments would, in our view, run completely counter to these educational efforts, lending the impression that market makers can be relied upon to identify fraud in the marketplace, a function we are neither qualified nor competent to perform.

We urge the Commission to reject the proposed Amendments because they have the potential to mislead the investing public about the activities of market makers.

A Commission-Managed Information Repository

We completely agree with the statement of Justice Brandeis: "Sunlight is the best disinfectant." We believe that the current and proposed formulations of Rule 15c2-11 fail to provide the "best disinfectant" because the information gathered, whatever its value, must necessarily remain hidden in some compliance file only to see a glimmer of light in the course of a regulatory audit. The Rule will only achieve its stated purpose if this information is brought into public>view, where members of the public can view it and make comments on its veracity.

We propose that the Commission maintain an information repository accessible through the Internet. As in the current rule, market makers would not be permitted to make markets in an issue unless the information required under the Rule was placed in the repository. The information could be placed there by the issuer, an interested investor or a market maker, in each case stating the source of the information.

We believe that members of the investing public will take the opportunity to review the information presented in the repository. To encourage investor awareness of fraudulent activity, we would suggest that the Commission present the research suggestions contained in the Appendix and encourage members of the investment public to conduct their own independent research into the activities of the issuer and its promoters. The Commission could encourage interested investors to report evidence of fraudulent activity to the Commission in a confidential manner, which would greatly assist the Commission's enforcement activities.

We are mindful that the Commission has rejected earlier proposals that it maintain an information repository on the grounds that issuers are not required to make such filings with the Commission. Nonetheless, the Commission could accomplish this objective without issuer participation by simply insisting, as in the current formulation of Rule 15c2-11, that market makers cannot make priced quotations unless appropriate information from a reliable source is available in the repository. It should be noted that the NASD has recently proposed a rule that would permit market makers to file with the NASD an issuer's current financial information for>stocks traded through the OTC Bulletin Board.


Herzog Heine Geduld strongly supports the Commission's efforts to eliminate fraudulent activity in microcap securities. We oppose the proposed Amendments because we believe the proposed Rule 15c2-11 will fail to achieve its stated purpose and will perversely facilitate more incidents of fraud and manipulation in the microcap market. Moreover, the Rule will increase compliance and litigation costs without providing any tangible benefit to the investing public.

Finally, we believe that the proposed Amendment will confuse and mislead investors about the role of market makers.

Sunlight is the best disinfectant, and we believe the worthy goals of Rule 15c2-11 may be achieved if the Commission takes steps to make the information gathered under the Rule readily available to investors. To that end, we respectfully suggest that the Commission maintain a voluntary information repository readily accessible to the public together with information, such as that contained in the Appendix, that may assist members of the public to identify fraudulent activity and report it to the Commission, thereby providing voluntary public support for the Commission's enforcement efforts.

We very much appreciate this opportunity to explain the reasons for our opposition to the Commission's re-proposed amendments to Rule 15c2-11 under the Securities Exchange Act of 1934. Please call me at (201) 418-4100 if you have any questions.


E.E. Geduld