May 24, 1999


(212) 506-5130

U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Attention Jonathan G. Katz, Secretary

Re: Securities Exchange Act Release No. 41110, File No. S7-5-99

Ladies and Gentlemen:

Attached is a cost-benefit study ("Study") prepared by PricewaterhouseCoopers, LLC ("PwC") at our request, in response to the Securities and Exchange Commission's ("Commission" or "SEC") re-proposed amendments to rule 15c2-11 ("rule 15c2-11") under the Securities and Exchange Act of 1934 ("Exchange Act"). We represent clients with an interest in the re-proposed amendments and submit this letter to address the Commission's cost-benefit analysis for the re-proposed amendments and to summarize the Study's findings.

I. Summary of the Study's Findings


A. Time Estimates


The SEC estimated that the time necessary to comply with the re-proposed amendments would be 4 hours for a reporting issuer, and 8 for a non-reporting issuer. The Study tested this estimate by having two junior professionals, one of whom had previous broker-dealer compliance experience, perform reviews for randomly selected micro-cap securities of reporting issuers. A third professional tested the supervisory review function. This tester was a supervisor-level director with more than 13 yearsí broker-dealer compliance and risk management experience. The testers found that a basic review required 2 hours just to gather the essential documents and check preliminarily for "red flags." This did not include any time for resolving questions about an issuerís documents, gathering material information in the brokerís possession, or performing any administrative tasks. The Study concluded that the time necessary to complete all steps involved in collecting, reviewing, preserving and distributing the issuer information would exceed 12 hours even for a domestic reporting issuer for a relatively uncomplicated review. These hours do not include time attributable to additional start-up and recurrent measures not directly related to the collection, review, preservation and distribution of the issuer information, but which nevertheless would be necessary to comply with the proposal.


B. Cost Estimates


The Study reveals a fundamental deficiency in the Commission's method for calculating the personnel cost to a broker-dealer in complying with the proposed requirements. The Study points out that the SEC only considered the salary of the staff conducting the review, not the cost to the broker-dealer of employing such staff, which will necessarily include various overhead costs, such as taxes and employee benefits.


The Study also notes that the Commissionís cost-benefit analysis ignores the hidden cost involved with the reallocation of resources that accompanies the assumption of new compliance obligations. The Study notes that a firm must either postpone or limit other compliance efforts or hire additional staff in response to the new requirements. In the case of new hires, the additional costs involved may be more readily ascertainable than those for limiting other compliance efforts; nonetheless, both bear costs.


In addition, the Study indicates that the SEC has significantly underestimated the level of expertise of personnel necessary to collect and review effectively the information that would be required by the proposal, and consequently has underestimated the salaries of such personnel. The Study assumes that the cost to a broker-dealer would average from $159 per hour for junior-level professionals to $400 per hour for periodic supervisory reviews by senior-level professionals. The Study also estimates $70 per hour for clerical assistance in assembling information packages. These costs reflect the overhead and salary costs associated with employing staff. The Study estimates that, considering all steps necessary for compliance with the re-proposed amendments, the total cost per issuer would be $6,109.31 including contingencies for litigation related expenses.


C. Compliance Steps


The Study identifies five basic tasks necessary for compliance with the proposed requirements: the identification of those securities for which a brokerage firm would be responsible for compliance with rule 15c2-11; the collection of the necessary information for those securities; reviewing the information; submitting the information to the NASD, maintaining the necessary records and supplying the information to customers, prospective customers, other broker-dealers and information repositories upon request; and periodic monitoring.


The Study further delineates the actual steps necessary for performing these tasks. The steps involved in identifying those securities subject to the proposed requirements include: identifying those securities in which a brokerage firm makes a market; analyzing and documenting which ones would be exempt from the rule; and dividing the remaining securities into classes for reporting and non-reporting issuers and domestic and foreign issuers.


The steps involved in collecting the issuer information include: obtaining the prospectus or offering circular for those issuers that have conducted a recent public offering; obtaining the relevant annual, semi-annual and periodic company reports; and obtaining relevant supplemental information and identifying any other material information that comes to the broker-dealerís knowledge.


The steps involved in reviewing the information include: evaluating the reliability of the source of information; creating a method to identify and analyze "red flags;" and reconsidering the source and accuracy of information for which "red flags" are detected.


The steps involved in submitting the information to the NASD, maintaining it and supplying it to others include: assembling the information for each issuer and preparing a transmittal form to the NASD; sending this information to the NASD; and establishing sufficient database systems for the storage and retrieval of the information. The Study cautions that information that comes to the broker-dealer's knowledge at any time up to the point that the information is submitted to the NASD could require the reevaluation of the reliability of the information. This would necessitate the repetition of certain steps. In addition, supervisory reviews must be performed for all the foregoing tasks.


D. Other Costs


In addition, the Study notes that compliance with the proposed amendments would entail both initial and recurrent costs not directly associated with the collection and review of the issuer information. Start-up costs would include those for developing or updating databases and internal forms for recording information; revisions to the firmís policies-and-procedures manuals to reflect the amendments to rule 15c2-11; and hiring at least one full-time staff person to oversee compliance with the new procedures. Recurrent costs would include personnel training as to the policies and procedures necessary to comply with amended rule 15c2-11; periodic database audits; and record maintenance costs.


The Study also recommends budgeting for contingencies to address litigation that might arise from the broker-dealer's review of the issuer information and conducting periodic reviews to detect material information that may undermine confidence in the reliability of previously reviewed issuer information. While the Re-proposing Release specifically states that the amendments are not intended to create a continuing review obligation or to support private causes of action, the Study concludes that these risks are, in fact, associated with the re-proposal.


The proposal would require a market-maker to review issuer information, refrain from publishing quotes for the issuer's securities until all red-flag information has been checked out, and provide information to investors upon request that includes a statement that the broker-dealer has reviewed the information and found it accurate and its source reliable as of the date of the review. We believe that these collective requirements would leave a market-maker vulnerable to various plaintiff's claims if it continued to publish quotes in a security even if it learned of adverse information after the necessary reviews were complete, even though this would be permissible under the re-proposal.


For example, a private plaintiff's attorney may argue that a market-maker should have reasonably believed that an issuer's information remained reliable at the time the market-maker provided this information to investors along with a statement of the market-maker's review and reliance on the information as of the review date. If, on the other hand, the market-maker had information that undermined its confidence in the reliability of the information, plaintiff's counsel may question the market-maker's continued publication of quotes in the security after providing the information and statement to an investor without otherwise disclosing the new adverse information, claiming that such omission was misleading.


Thus, as a practical matter, we believe that a market-maker will feel obliged to monitor material developments about the issuers of the micro-cap securities in which it makes a market to avoid claims that it misled investors by omitting to disclose adverse information it did or should have had at the time it sent to investors the issuer information and statement of its belief in the accuracy and reliability of the information as of the review date.


II. Additional Observations

In addition to the analysis contained in the Study, we question the Commission's time estimates for a market-maker to collect and review the issuer information, as well as to supply the information to investors, other broker-dealers and information repositories. In its release, the Commission estimates that collection and review of the issuer information will entail 4 hours for reporting issuers and 8 for non-reporting issuers. However, the Commission also estimates 9 hours for non-reporting issuers to collect, prepare and supply the information to the first market-maker requesting the information. We fail to appreciate how the issuer, who presumably has better access to the necessary information, will require more time to collect, prepare and supply the information to the market-maker than the market-maker will need to collect and review the information.

In addition, the Commission estimates 1 additional hour per request for a non-reporting issuer to supply the same information to subsequent market-makers. Although the Commission estimates this period of time for issuers, it does not identify the time necessary for a market-maker to supply the issuer information to investors, other broker-dealers and information repositories. This cost-and-time burden for market-makers should be acknowledged, particularly as the issuer is presumed to only supply the information to 3.3 additional market-makers, but the market-maker in turn may need to supply this information to many more persons.

In addition, we believe that any extension of the rule to securities with bid prices up to $50 per share would subject an overly broad group of securities to the rule, for which the Commission has not offered a satisfactory justification. The Commission explains the proposed $50 per share level by citing the average bid price for securities that have been subject to trading suspensions. The Commission reviewed data from April 1, 1994 through January 1, 1998 and found the average bid price for these securities was $5 per share ($3 per share as a median bid price) and that the range of bid prices was from approximately $0.50 to $18 per share. We believe that the rule, as proposed to be amended, would cover a large group of securities not readily susceptible to manipulation, i.e., those with bid prices between $18 and $50 per share. Broker-dealers should not have to bear costs to comply with rule 15c2-11 for this group of securities, especially because the Commission has not found a substantial threat of manipulation with respect to these securities. Although the Commission suggests that some thinly traded issuersí securities may have higher prices, the Commission has not identified any real abuses involving these issuers. Thus, under the Commissionís own analysis, securities with a bid price over $18 per share do not merit the costs involved and should be dealt with under the traditional anti-fraud and anti-manipulation provisions.

Finally, we note that the Commission's cost-benefit analysis in the re-proposing release fails to account for the substantial negative costs that the proposed amendments would impose on investors, issuers, and the marketplace in terms of reduced transparency, increased transaction costs, increased incidence of fraud, and more difficult access to capital for micro-cap issuers. The Commission itself acknowledges that the proposal may negatively impact liquidity and impede investor access to pricing information, yet states that the proposalís benefits, which outweigh this cost, include "reducing instances of fraud and manipulation." We disagree with the Commission's assessment that reduced liquidity and market information will counteract fraud and manipulation. On the contrary, reduced liquidity and information will result in the decrease of active independent price-discovery forces in the market, thus leaving micro-cap issues more vulnerable to manipulative efforts. The Commission has recognized that less actively-traded securities are more susceptible to manipulation in the release adopting Regulation M. The reduction of liquidity and pricing information can only lead an issue to be more, rather than less, thinly traded.



III. Conclusion


We believe that the Commission has underestimated the costs, and overestimated the benefits, that may accompany adoption of the re-proposed amendments to rule 15c2-11. We strongly urge the Commission to reconsider its analysis, and whether, as we believe, the costs of the proposal would dwarf its potential benefits.


Very truly yours,




Sam Scott Miller



cc: Arthur Levitt, Chairman

Norman S. Johnson, Commissioner

Isaac C. Hunt, Jr., Commissioner

Paul R. Carey, Commissioner

Laura S. Unger, Commissioner

Annette L. Nazareth, Director

Division of Market Regulation

Robert L.D. Colby, Deputy Director

Division of Market Regulation

Larry Bergmann, Associate Director

Division of Market Regulation

Catherine McGuire, Associate Director and Chief Counsel

Division of Market Regulation

Elizabeth P. Gray, Assistant Director

Division of Enforcement

Mary L. Schapiro, President

NASD Regulation, Inc.