Securities and Exchange Commission v. Registration Statement

11124Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
Act and all materials required by section
14(a) or 14(c) of the Exchange Act (15
U.S.C. 78n(a) or 78n(c)) required to be
filed during the 12 months immediately
before filing a registration statement on
this form (or for such shorter period that
the registrant was required to file such
reports and materials); and
(iii) Has filed on a timely basis all
reports required by section 13(a) or
15(d) of the Exchange Act during the 12
calendar months and any portion of a
month immediately preceding the filing
of the registration statement (or for such
shorter period that the registrant was
required to file such reports). If during
that time the registrant has used
§ 240.12b–25 of this chapter with
respect to a report or a part of a report,
that material must have been filed
within the time prescribed by that
section.
(2) If the registrant is an entity formed
by the merger between:
(i) An entity subject to the Exchange
Act reporting requirements that had
only nominal assets at the time of the
merger; and
(ii) An entity that was not subject to
the Exchange Act reporting
requirements at the time of the merger,
the registrant may not file a registration
statement on this form until it has filed
an annual report on Form 10–K or Form
10–KSB (§ 249.310 or §249.310b of this
chapter) containing audited financial
statements for a fiscal year ending after
consummation of the merger.
(b) A registrant may use this form for
registration under the Act of the
following securities:
*       *       *       *       *
3. By amending Form S–8 (referenced
in §239.16b) in General Instruction A to
redesignate paragraphs 1.(a) and 1.(b) as
paragraphs 1.(d) and 1.(e); revise the
introductory text of paragraph 1.; and
add new paragraphs 1.(a) and 1.(b) to
read as follows:
Note: The text of Form S–8 does not, and
this amendment will not, appear in the Code
of Federal Regulations.
Form S–8 Registration Statement Under
the Securities Act of 1933
*       *       *       *       *
General Instructions
A. Rule as to Use of Form S–8
1. A registrant may use this form for
registration under the Securities Act of
1933 of the securities listed in
paragraph 1.(d) and 1.(e) of this section
if the registrant satisfies the
requirements of paragraph 1.(a) and
1.(b) of this section:
(a) A registrant may not file a
registration statement on this form
unless, immediately before filing the
registration statement, the registrant:
(i) Is subject to the reporting
requirements of Sections 13(a) or 15(d)
of the Securities Exchange Act of 1934
(the ‘‘Exchange Act’’) (15 U.S.C. 78m(a)
or 78o(d));
(ii) Has filed all reports required by
Section 13(a) or 15(d) of the Exchange
Act and all materials required by
Section 14(a) or 14(c) of the Exchange
Act (15 U.S.C. 78n(a) or 78n(c)) required
to be filed during the 12 months
immediately before filing a registration
statement on this form (or for such
shorter period that the registrant was
required to file such reports and
materials); and
(iii) Has filed on a timely basis all
reports required by Section 13(a) or
15(d) of the Exchange Act during the 12
calendar months and any portion of a
month immediately preceding the filing
of the registration statement (or for such
shorter period that the registrant was
required to file such reports). If during
that time the registrant has used Rule
12b–25 (§240.12b–25 of this chapter)
under the Exchange Act with respect to
a report or a part of a report, that
material must have been filed within the
time prescribed by that rule.
(b) If the registrant is an entity formed
by the merger between:
(i) An entity subject to the Exchange
Act reporting requirements that had
only nominal assets at the time of the
merger; and
(ii) An entity that was not subject to
the Exchange Act reporting
requirements at the time of the merger,
the registrant may not file a registration
statement on this form until it has filed
an annual report on Form 10–K or Form
10–KSB (§ 249.310 or §249.310b of this
chapter) containing audited financial
statements for a fiscal year ending after
consummation of the merger.
*       *       *       *       *
Dated: February 25, 1999.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99–5298 Filed 3–5–99; 8:45 am]
BILLING  CODE  8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 240
Release No. 34–41110; File No. S7–5–
99
RIN 3235–AH40
Publication or Submission of
Quotations Without Specified
Information
AGENCY: Securities and Exchange
Commission.
ACTION: Reproposed rule.
SUMMARY: The Securities and Exchange
Commission is reproposing for comment
amendments to Rule 15c2–11 under the
Securities Exchange Act of 1934
(Exchange Act). Rule 15c2–11 governs
the publication of quotations for
securities in a quotation medium other
than a national securities exchange or
Nasdaq. Also, we are reproposing a
companion amendment to relocate in
Rule 17a–4 under the Exchange Act the
record retention requirement currently
contained in Rule 15c2–11. The original
proposal was issued in February 1998 in
response to concerns about increased
incidents of fraud and manipulation in
over-the-counter (OTC) securities,
which typically involve thinly-traded
securities of thinly-capitalized issuers
(i.e., microcap securities).
The reproposed amendments are more
limited than the initial proposal and
focus the Rule on those securities the
Commission believes are more likely to
be prone to fraud and manipulation.
The reproposal is part of the
Commission’s continuing efforts in
regulatory, inspections, enforcement,
and investor education areas that are
key to deterring microcap fraud.
In addition, the reproposal will
increase the information that broker-
dealers must review before publishing
quotations for non-reporting issuers’
securities, and will ease the Rule’s
recordkeeping requirements when
broker-dealers have electronic access to
information about reporting issuers.
Finally, we are giving guidance to
broker-dealers on the scope of the
review required by the Rule and
providing examples of ‘‘red flags’’ that
they should look for when reviewing
issuer information.
DATES: Comments must be received on
or before April 7, 1999.
ADDRESSES
: Comments should be
submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange
Commission, 450 Fifth Street, NW, Mail
Stop 6–9, Washington, DC 20549.
Comments may also be submitted
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11125Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
1
The term microcap securities is not defined
under the federal securities laws or regulations. The
use of the term ‘‘microcap securities’’ in this
release, however, should be distinguished from its
use in the mutual fund context. For example,
Lipper Analytical Services, a mutual fund rating
organization, generally categorizes microcap
companies as companies with market capitalization
of less than $300 million. Lipper-Directors’
Analytical Data, Investment Objective Key, 2d ed.
1997.
2
Microcap securities can also be listed on
securities exchanges or Nasdaq or quoted in
alternative trading systems.
3
For a summary of these cases, see Fight Against
Microcap Fraud ‘‘Paying Dividends’’, Press Release
No. 98–92 (September 24, 1998), available through
our Internet website at <http://www.sec.gov/news/
micronew.htm>.
4
For a summary of these cases, see Purveyors of
Fraudulent Spam, Online Newsletters, Message
Board Postings, and Websites Caught, Press Release
No. 98–117 (October 28, 1998), available through
Continued
electronically at the following E-mail
address: [email protected]. All
comment letters should refer to File No.
S7–5–99. All comments received will be
available for public inspection and
copying in the Commission’s Public
Reference Room, 450 Fifth Street, NW,
Washington, DC 20549. Electronically
submitted comment letters will be
posted on the Commission’s Internet
website (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Any
of the following attorneys in the
Division of Market Regulation,
Securities and Exchange Commission,
450 Fifth Street, NW, Mail Stop 10–1,
Washington, DC 20549, at (202) 942–
0772: Nancy J. Sanow, Irene A. Halpin,
Florence E. Harmon, Chester A.
McPherson, or Jerome J. Roche.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Executive Summary
A. Overview of the microcap fraud
problem and efforts to prevent further
abuses
B. Background of Rule 15c2–11 and recent
proposed amendments
II. Overview of Reproposed Amendments
III. Discussion of Amendments
A. Securities excluded from the Rule
1. Securities satisfying a trading value test
2. Securities satisfying a bid price test
3. Securities of issuers satisfying a net
tangible assets test
4. Non-convertible debt, non-participatory
preferred stock, and asset-backed
securities
5. Other Exceptions
B. Quotations subject to the Rule
1. The initial quotation for a covered OTC
security
2. Priced quotations
3. Annual review
C. Information required under the Rule
1. Reporting issuers delinquent in their
filings
2. Issuers in bankruptcy
a. Reporting issuers
b. Non-reporting issuers emerging from
bankruptcy
3. Non-reporting foreign private issuers
4. Other non-reporting issuers
D. Information available upon request
E. Information repository
F. Definitions
G. Preservation of documents and
information
H. Transition and exemptive authority
provisions
I. Information submitted to the NASD
IV. General Request For Comments
V. Effects on Efficiency, Competition, and
Capital Formation
VI. Costs and Benefits of the Amendments
A. Benefits
B. Costs
VII. Initial Regulatory Flexibility Act
VIII. Paperwork Reduction Act
A. Collection of information under the
amendments
B. Proposed use of information
C. Respondents
D. Total annual reporting and
recordkeeping burden
1. Burden-hours for broker-dealers
2. Burden-hours for issuers
3. Total burden-hour costs to broker-
dealers and issuers
4. Capital cost to broker-dealers and issuers
E. General information about the collection
of information
F. Request for comments
IX. Statutory Basis and Text of Proposed
Amendments and Rule
Appendix
I. Introduction
II. Quotation Events Triggering the Review
Requirement
III. The Review Process
A. Introduction
B. Source reliability
1. Determining whether a source is reliable
2. Examples of unreliable sources
C. Document review obligations
D. Scope of review following a trading
suspension
IV. Examples of Red Flags
I. Executive Summary
A. Overview of the Microcap Fraud
Problem and Efforts to Prevent Further
Abuses
Because incidents of fraud and
manipulation involving microcap
securities are a serious concern, the
Commission, along with other
regulators, has made combating
microcap fraud one of its top priorities.
Microcap securities generally are
characterized by low share prices and
little or no analyst coverage.
1
The
issuers of microcap securities typically
are thinly-capitalized and information
about them often is limited, particularly
when they are not subject to the
Commission’s periodic disclosure
requirements. Securities of microcap
companies usually are quoted on the
OTC Bulletin Board operated by the
National Association of Securities
Dealers, Inc. (NASD), or in the Pink
Sheets published by the National
Quotation Bureau, Inc. (NQB), but they
are not exclusive to these quotation
mediums.
2
Microcap fraud often involves
schemes such as ‘‘pump and dump’’
operations, in which unscrupulous
brokers sell the securities of less-
seasoned issuers to retail customers by
using high pressure sales tactics and a
supply of securities under the firm’s
control. The fraudsters create interest in
the security by disseminating false or
misleading information about the issuer
through, for example, oral statements,
press releases, or the Internet. To further
the manipulative scheme, the retail
broker frequently acts as a market maker
in the security or, either on its own or
through the issuer’s promoter, induces
other firms to act as market makers.
By publishing quotations, the market
maker raises the profile of the security,
even though the market maker is not an
active participant in the fraud and
publishes quotations solely in response
to increased demand for the security.
The broker, promoter, or others
orchestrating the fraud can point to
quotations for the security to ‘‘validate’’
its worth. The perpetrators of the fraud
then dispose of their stake at an inflated
price. Once they no longer need to
stimulate interest in the security, the
market for it collapses and innocent
investors are left holding stock with
little or no value.
The defrauded victims of microcap
fraud activities are not the only ones
harmed. When other investors become
reluctant or unwilling to invest in the
kinds of securities they perceive as
prone to fraud, liquidity for those
securities can be impaired. As a result,
existing shareholders can face difficulty
in disposing of their holdings and
legitimate issuers of lower-priced stocks
can find it hard to raise capital to start
up or expand operations or services. In
short, continuing incidents of microcap
fraud are detrimental to the integrity of
our nation’s capital markets.
To combat microcap abuses, we have
initiated several enforcement,
examination, education, and regulatory
measures. These actions include the
following:
•In September 1998, we filed 13
enforcement actions against 41
defendants for their involvement in
fraudulent microcap schemes that
bilked investors of more than $25
million.
3
•We conducted a nationwide sweep
to combat fraud through the Internet,
which resulted in 23 enforcement
actions against 44 stock promoters of
microcap stocks in October 1998.
4
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11126Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
our Internet website at <http://www.sec.gov/news/
netfraud.htm>.
5
See, e.g., ‘‘Microcap Stock: A Guide for
Investors’’ (providing a variety of tips on how to
detect and avoid microcap fraud); ‘‘Cold Calling
Alert’’ (describing the cold calling rules and
instructing investors how to avoid telephone
scams); ‘‘Internet Fraud’’ (describing common
frauds including on-line newsletter and bulletin
board posting scams); and ‘‘Ask Questions’’ (listing
questions that investors should ask about their
investments and their investment professionals).
All of these publications are available for free from
our toll-free publications line at (800) 732–0330 and
can be downloaded through our Internet website at
<http://www.sec.gov>.
6
Securities Exchange Act Release No. 40878
(January 4, 1999), 64 FR 1255 (OTC Bulletin Board
Release).
7
Securities Act Release No. 33–7646 (February
19, 1999). The amendments to Form S–8 restrict the
use of Form S–8 for the sale of securities to
consultants and advisors, among other things.
8
15 U.S.C. 77a et seq.
9
Securities Act Release No. 33–7644 (February
19, 1999). The amendments limit the circumstances
where freely tradable securities may be issued in
reliance on, and general solicitation is permitted
under, Rule 504 of Regulation D.
10
17 CFR 240.15c2–11.
11
15 U.S.C. 78a et seq.
12
In this release, ‘‘OTC stocks’’ or OTC securities
refers to securities that are not listed on a national
securities exchange or Nasdaq. ‘‘Covered OTC
securities’’ refers to those OTC securities that are
subject to Rule 15c2–11. The Rule applies to
securities quoted on the OTC Bulletin Board
operated by the NASD, the Pink Sheets operated by
the NQB, and similar quotation mediums. For
further discussion of quotation mediums, see Part
III.F. below
13
17 CFR 240.10b–5.
14
Rule 15c2–11 defines quotation as any bid or
offer at a specified price with respect to a security,
or any indication of interest by a broker or dealer
in receiving bids or offers from others for a security,
or any indication by a broker or dealer that
advertises its general interest in buying or selling
a particular security. For the purposes of this
release, a ‘‘priced quotation’’ is a bid or offer at a
specified price.
15
See Part III.C. below for a description of the
required issuer and supplemental information.
16
An interdealer quotation system is a quotation
medium of general circulation to brokers or dealers
which regularly disseminates quotations of
identified brokers or dealers. 17 CFR 240.15c2–
11(e)(2). Under the proposed amendments, the
definition of ‘‘interdealer quotation system’’ would
be incorporated into the definition of ‘‘quotation
medium.’’ See Part III.F. below for a discussion of
the term ‘‘quotation medium.’’
17
Securities Exchange Act Release No. 39670
(February 17, 1998), 63 FR 9661 (Proposing
Release).
18
This total includes virtually identical comment
letters from 68 issuers. All comment letters are
available in File No. S7–3–98 at our Public
Reference Room, 450 Fifth Street, NW, Washington,
DC 20549. Comment letters that were submitted
electronically are available through our Internet
website at <http://www.sec.gov/rules/s7398.htm>.
•We initiated examination sweeps of
several firms that are active in the
microcap market. Our examination staff
conducted complex and resource-
intensive reviews of these firms’ records
for evidence of the hallmarks of
microcap fraud, such as patterns of ‘‘bait
and switch’’ sales techniques,
misrepresentations and exaggerated
claims, unauthorized trading and
refusals to sell securities, market
manipulation, and lax or nonexistent
supervision.
•We have held numerous investors’
town meetings across the country to
educate people about investing wisely,
and we have put together several
brochures to assist investors.
5
•We are cooperating with self-
regulatory organizations (SROs) to
improve supervision and regulation of
the OTC securities market. For example,
we recently approved NASD rule
changes that limit quotations on the
OTC Bulletin Board to the securities of
issuers that are current in their reports
filed with the Commission or other
regulatory authority.
6
•We have taken steps to strengthen
our regulations and close loopholes to
help reduce incidents of microcap
fraud.
Today, we are taking action on several
additional regulatory measures aimed at
preventing further incidents of microcap
fraud. In addition to adopting
amendments to Form S–8
7
under the
Securities Act of 1933 (Securities Act)
8
and adopting amendments to Regulation
D,
9
we are reproposing amendments to
Rule 15c2–11
10
under the Securities
Exchange Act of 1934 (Exchange Act),
11
our rule that governs the quotations by
broker-dealers for OTC securities.
12
Rule 15c2–11 is intended to prevent
broker-dealers from becoming involved
in the fraudulent manipulation of OTC
securities. However, even if a broker-
dealer technically complies with the
Rule’s requirements, it would be subject
to liability under other antifraud
provisions of the securities laws, such
as Rule 10b–5, if it publishes quotations
as part of a fraudulent or manipulative
scheme.
13
B. Background of Rule 15c2–11 and
Recent Proposed Amendments
Rule 15c2–11 contains requirements
that are intended to deter broker-dealers
from initiating or resuming quotations
for covered OTC securities that may
facilitate a fraudulent or manipulative
scheme. The Rule currently prohibits a
broker-dealer from publishing (or
submitting for publication) a quotation
for a covered OTC security in a
quotation medium unless it has
obtained and reviewed current
information about the issuer.
14
The
broker-dealer must also have a
reasonable basis for believing that the
issuer information, when considered
along with any supplemental
information, is accurate and is from a
reliable source.
15
The Rule currently contains several
exceptions to its prohibitions. Under the
‘‘piggyback’’ exception, the Rule’s
information requirements do not apply
when a broker-dealer publishes, in an
interdealer quotation system, a
quotation for a covered OTC security
that was already the subject of regular
and frequent quotations in the same
interdealer quotation system.
16
A
broker-dealer is able to ‘‘piggyback’’ on
either its own or other broker-dealers’
previously published quotations. This
exception assumes that regular and
frequent quotations for a security
generally reflect market supply and
demand and are based on independent,
informed pricing decisions. However, as
a result of the piggyback provision, the
Rule’s application is essentially limited
to just the first broker-dealer publishing
quotes.
In February 1998, the Commission
published for comment amendments to
the Rule that were designed to curb
fraud in microcap securities.
17
This
proposal would have eliminated the
piggyback provision by requiring all
broker-dealers to review current issuer
information before publishing their first
quotation for a covered OTC security,
without regard to whether the quotation
was priced or unpriced, and to
thereafter review current issuer
information annually if they published
priced quotations. With limited
exceptions, the proposal would have
applied to any security quoted in a
quotation medium other than a national
securities exchange or Nasdaq. The
proposal would also have expanded the
information required for issuers that do
not file periodic reports with the
Commission (e.g., non-reporting
issuers). In addition, broker-dealers
would have been required to make the
issuer information available to anyone
who requested it.
In response to the Proposing Release,
we received 199 comment letters from
193 commenters.
18
The majority of
commenters, which included broker-
dealers, issuers, attorneys, and
individuals, opposed many of the
proposed changes. Broker-dealers were
especially concerned that they would be
exposed to potential liability in civil
actions as a result of their increased
review obligations under the proposal.
Commenters also expressed views about
the possibility of: reduced liquidity in
covered OTC securities if broker-dealers
stopped making markets; less
transparent markets if broker-dealers
did not publish priced quotes to avoid
the annual review requirement; less
competitive pricing for covered OTC
securities; impaired access to capital by
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11127Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
19
The amendments, however, will prohibit the
first broker-dealer from publishing a priced or
unpriced quotation for a covered OTC security
unless it complies with the Rule. For a discussion
of the requirements concerning the initial quotation
for a covered OTC security, see Part III.B.1. below.
20
15 U.S.C. 781(k).
21
However, we are narrowing the scope of the
requirement contained in the Proposing Release
that broker-dealers provide the Rule 15c2–11
information to others upon their request. See Part
II.D. below.
issuers; and increased compliance costs
for broker-dealers. In addition, some
commenters pointed out that the
proposal would not cover Nasdaq
SmallCap securities, which, they noted,
have also been the subject of abusive
activities. Some commenters also
remarked that the proposal would not
stop microcap fraud, which, in their
view, is really a sales abuse problem.
Several commenters, principally state
securities regulators and their national
association, supported the proposal.
They believed that microcap fraud
would be deterred if broker-dealers are
required to review issuer information
and make their own independent and
substantiated determinations before
publishing quotations. Further,
commenters favoring the proposal stated
that the availability of information via
EDGAR and the speed of
communication via the Internet would
ease any increased burden on broker-
dealers created by the Rule
amendments. Finally, a number of
commenters were more neutral in their
approach and offered views or
suggestions on specific provisions.
II. Overview of Reproposed
Amendments
The Commission is issuing a revised
proposal to amend Rule 15c2–11 to help
curtail abuses in the offer, sale and
trading of microcap securities. Because
these amendments will significantly
change the Rule’s scope, we are
publishing them to give interested
persons an opportunity to provide us
with their comments and views.
The amendments are intended to have
broker-dealers ‘‘stop, look and listen’’
before they begin to quote a covered
OTC security in a quotation medium
other than a national securities
exchange or Nasdaq. However, the
amendments reflect commenters’
concerns about the earlier proposal by
limiting the scope of the Rule
principally to priced quotations and to
those securities that the Commission
believes are more likely to be the subject
of improper activities. Under these
amendments, the Rule will no longer
apply to securities of larger issuers, or
to securities that have a substantial
trading price or that meet a minimum
dollar value of average daily trading
volume. In addition, the Rule will only
cover priced quotations, except in the
case of the first quotation for a covered
OTC security. The provisions relating to
the broker-dealer’s obligations under the
Rule and the issuer information that the
broker-dealer must review are little
changed from the initial proposal.
We also are providing guidance
regarding the steps broker-dealers
should take and ‘‘red flags’’ they should
consider when reviewing the Rule’s
required information. In response to
commenters’ concerns about broker-
dealer liability, we stress that broker-
dealers will have no obligation to
continuously update their Rule 15c2–11
materials. The broker-dealer’s review
obligations under the Rule occur only at
the specific times identified in the Rule.
In general, the amendments would:
•Limit the Rule primarily to priced
quotations;
19
•Eliminate the Rule’s piggyback
provision and require all broker-dealers
to review current issuer information
before publishing priced quotations for
a security;
•Require broker-dealers publishing
priced quotations for a security to
review current information about the
issuer annually and upon the
occurrence of specified events;
•Expand the information required for
certain non-reporting issuers;
•Require documentation of the
broker-dealer’s compliance with the
Rule; and
•Require broker-dealers publishing
quotes in compliance with the Rule to
provide the issuer information upon
request to customers, prospective
customers, information repositories, and
other broker-dealers.
In addition, the amendments would
exclude from the Rule’s coverage:
•Securities with a worldwide
average daily trading volume value of at
least $100,000 during each month of the
six full calendar months immediately
preceding the date of publication of a
quotation, and convertible securities
where the underlying security satisfies
this threshold;
•Securities with a bid price of at
least $50 per share;
•Securities of issuers with net
tangible assets in excess of $10,000,000,
as demonstrated by audited financial
statements;
•Non-convertible debt and non-
participatory preferred stock; and
•Asset-backed securities that are
rated as investment grade by at least one
nationally recognized statistical rating
organization.
These amendments are intended to
enhance the integrity of quotations for
securities in this market sector, to
improve the quality of information
about smaller, lesser-known issuers, and
to foster greater access to this
information by investors. The
amendments also reorganize and
simplify the Rule’s provisions
consistent with the Commission’s Plain
English program.
III. Discussion of Amendments
The amendments restructure Rule
15c2–11 by setting forth more clearly
the quotation events that trigger the
Rule, the requirements that the broker-
dealer must satisfy, and the nature of
the information that the broker-dealer
must review. The amendments state that
no broker-dealer, directly or indirectly,
may publish the described kinds of
quotations for a security in any
quotation medium, without first
complying with the Rule’s provisions.
The Rule will only apply at specified
points in time, namely, when a broker-
dealer publishes:
•The first quotation for a security;
•Its first quotation at a specified
price for a security after another broker
or dealer published the first quotation
for the same security;
•The first quotation following the
termination of a Commission trading
suspension ordered pursuant to section
12(k) of the Exchange Act
20
in any
security of the issuer of the suspended
security;
•A quotation at a specified price for
a security after a period of five or more
consecutive business days when it did
not publish any quotations at a specified
price for that security;
•Its first quotation at a specified
price for a security after the date that is
four months after the end of the issuer’s
fiscal year, unless the issuer is a foreign
private issuer; or
•Its first quotation at a specified
price for a security of a foreign private
issuer after the date that is seven
months after the end of the issuer’s
fiscal year.
The broker-dealer’s information
gathering and review requirements are
substantially the same as the initial
proposal.
21
If the Rule applies, the
broker-dealer must:
•Review the Rule’s specified
information;
•Determine that it has a reasonable
basis for believing that the information
is accurate in all material respects and
was obtained from reliable sources;
•Record the date it reviewed the
specified information, the sources of the
information, and the person at the firm
responsible for the broker-dealer’s
compliance with the Rule; and
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11128Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
22
17 CFR 240.17a–4.
23
See, e.g., Letter from Securities Industry
Association (April 28, 1998) (SIA Comment Letter).
24
Of course the general antifraud provisions of
the federal securities laws, including Rule 10b–5
(17 CFR 240.10b–5), apply to transactions in all
securities, whether or not excluded from Rule
15c2–11.
25
We estimate that at least 10% of covered OTC
securities will be excluded from the Rule under
these tests. We estimate that approximately 5% of
the OTC securities of U.S. companies, 10% of the
OTC securities of foreign issuers (excluding ADRs),
and 66% of OTC American Depositary Receipts
(ADRs) will satisfy any one of these three
alternative tests.
26
We have used an ADTV value of $100,000 in
another, but related, context. Rules 101 and 102 of
Regulation M, 17 CFR 242.101 and 102, provide for
a one business day restricted period for securities
with an ADTV value of at least $100,000 (as
measured over a 60 day period), if the issuer has
a public float value of at least $25 million. These
rules are intended to prevent manipulative
activities during a distribution.
27
A broker-dealer will be able to rely on trading
volume as reported by SROs or comparable entities,
or any other source believed to be reliable.
Electronic information systems that provide
information regarding securities in markets around
the world could provide an easy means to
determine worldwide trading volume in a particular
security. Worldwide trading volume includes all
markets, domestic or foreign, where an OTC
security is traded.
28
This is comparable to the calculation of value
of ADTV under Regulation M. See Securities
Exchange Act Release No. 38067 (December 20,
1996), 62 FR 520, 537.
29
See id.
30
Most of the Commission’s recent trading
suspension orders issued under Section 12(k) of the
Exchange Act, 15 U.S.C. 781(k), have involved
securities quoted on the OTC Bulletin Board or the
Pink Sheets. Our staff’s analysis of these trading
suspension orders, issued between April 1, 1994
and January 1, 1998, showed that the suspended
OTC securities had an average bid price of
approximately $5, with a median bid price of
approximately $3. These securities had bid prices
that ranged from a low of approximately $0.50 to
a high of approximately $18.
•Preserve the specified information
in accordance with Rule 17a–4.
22
Commenters on the Proposing Release
did not object to the standards set forth
in these review and documentation
requirements. Rather, they expressed
concerns about the scope of a broker-
dealer’s review obligations under the
earlier proposal, particularly as some of
them misconstrued the proposal to
require continuous updating of
information. To assist broker-dealers
publishing quotations for covered OTC
securities, we are giving guidance in an
appendix to this release about the
nature of the review we expect broker-
dealers to conduct under both the
current Rule and the proposed
amendments.
A. Securities Excluded From the Rule
Several commenters suggested that
the Rule should cover only those
securities that have the characteristics
that have led to abuses in the microcap
market.
23
These commenters noted that,
while the earlier proposal was intended
to focus on microcap abuses, it covered
quotations for a number of non-
reporting foreign and domestic issuers’
securities that are unlikely to be the
targets of microcap schemes. They
suggested that the amendments be
crafted to cover only those equity
securities most likely to be prone to
abusive activities.
We agree that applying the Rule to the
securities of larger issuers, more liquid
securities, and certain fixed-income
debt securities is not directly related to
microcap fraud concerns.
24
We
therefore are proposing to exclude from
Rule 15c2–11 those securities satisfying
any one of three alternative tests based
on: the value of the security’s average
daily trading volume (ADTV); the
security’s bid price; or the issuer’s net
tangible assets.
25
We are also proposing
to exclude debt securities, non-
participatory preferred stock, and
investment grade asset-backed
securities.
1. Securities Satisfying a Trading Value
Test
To tailor the Rule to transactions that
we believe are most likely to involve
microcap fraud, the amendments
exclude securities with a value of
worldwide ADTV of at least $100,000
during each month of the six full
calendar months immediately preceding
the date of publication of a quotation.
26
Convertible securities will also be
excluded when the underlying security
satisfies this threshold.
The majority of OTC stocks of U.S.
companies that are not listed on an
exchange or Nasdaq trade infrequently
and will not satisfy for a test based on
a value of ADTV of $100,000 or more
during each month over a six month
measuring period. However, there are a
number of non-reporting issuers having
securities with significant trading levels,
particularly larger foreign issuers with
actively traded securities in their home
markets. We think that it is appropriate
to take this trading activity into account
in applying the value of ADTV test.
The price of a microcap security that
is the subject of a fraud often is
manipulated upward rapidly so that
those involved in the manipulation can
quickly sell stock at a significant profit,
to the detriment of innocent investors.
Microcap securities involved in such
manipulations often are thinly traded,
and the daily trading volume for such
securities rarely reaches a value of
$100,000 over an extended period of
time. We believe that measuring the
value of the security’s ADTV over a six
month period is a way to ensure that the
securities qualifying for this exclusion
are not involved in the type of short-
term price manipulations frequently
seen in microcap schemes.
A broker-dealer should determine the
value of a security’s ADTV from
information that is publicly available
and that the broker-dealer has a
reasonable basis for believing that the
information is reliable.
27
In calculating
the value of ADTV in U.S. dollars, any
reasonable and verifiable method may
be used.
28
For example, it may be
derived from multiplying the number of
shares by the price in each trade. The
NASD may also be able to assist broker-
dealers in determining whether a
particular security is eligible for the
exclusion.
Q1. Should the dollar value of ADTV
for this exclusion be higher than
$100,000, e.g., $500,000 or $1 million,
or should it be a lower amount, e.g.,
$50,000? Commenters should provide
data and analysis to support suggested
revisions to this proposed threshold.
Q2. Should the dollar value of ADTV
measuring period be longer than six
months, e.g., twelve months, or be
shorter, e.g., three months? Should the
length of the measuring period depend
on the amount of the value of ADTV
threshold, i.e., should a lower value of
ADTV threshold be allowed but require
a longer measuring period?
Q3. Should the exclusion based on
ADTV value also incorporate a value of
public float test, like Regulation M
does? If so, should the public float value
be $25 million or some higher or lower
amount? Would public float information
be easy or difficult to obtain for non-
reporting issuers?
29
Q4. Rule 101 under the Commission’s
Regulation M excludes from that rule’s
trading prohibitions securities with a
value of ADTV of $1 million or more,
using a two month measuring period, if
the issuer has a public float value of at
least $150 million. Should Rule 15c2–
11’s exclusion parallel the terms of this
exclusion?
2. Securities Satisfying a Bid Price Test
To limit the Rule to transactions that
the Commission believes are most likely
to involve microcap fraud, we are
proposing an amendment to exclude
securities with a bid price of at least $50
per share at the time the quotation is
published in the quotation medium.
30
While the vast majority of OTC stocks
are quoted at lower prices and will not
typically satisfy for a test based on a bid
price of at least $50 per share, there are
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11129Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
31
This is comparable to the provisions excluding
equity securities priced at $5 or more from the
definition of ‘‘penny stock’’ contained in 17 CFR
240.3a51–1(d)(2).
32
Analysis of OTC securities that were the subject
of recent Commission-ordered trading suspensions
showed the issuers on average had approximately
$3,500,000 in net tangible assets, with a median of
approximately $225,000 is such assets.
33
17 CFR 210.2–02.
34
These financial statements may be found in
filings with the Commission on Forms 20–F or 6–
K, or in submissions under Rule 12g3–2(b) under
the Exchange Act (17 CFR 240.12g3–2(b)), or
elsewhere.
35
17 CFR 240.3a51–1.
36
See proposed NASD Rule 2315, which the
Commission recently issued for public comment.
Securities Exchange Act Release No. 41075
(February 19, 1999). The proposed rule will be
available through the NASD Regulation Internet
website at <http://www.nasdr.com> and our
Internet website at <http://www.sec.gov>.
37
IASC’s accounting standards are summarized
on, and may be ordered through, the IASC’s Internet
website at <http://www.iasc.org.uk>.
38
Non-participatory preferred stock means non-
convertible capital stock, the holders of which are
entitled to a preference in payment of dividends
and in distribution of assets on liquidation,
dissolution, or winding up of the issuer, but are not
entitled to participate in residual earnings or assets
of the issuer. See paragraph (j)(8) of the Rule
proposal, which is based upon a definition
contained in Rule 902(a)(1) of Regulations S (17
CFR 230.902(a)(1)).
39
17 CFR 240.15c3–1 (net capital requirements
for broker-dealers).
40
The Commission’s staff is engaged in a project
to consider the development of disclosure and
registration requirements specifically related to
asset-backed securities. As part of that project, the
staff intends to examine further the role of ratings
with respect to asset-backed securities. Therefore,
we consider it appropriate to limit the proposed
Continued
securities of closely-held issuers that are
quoted at significant share prices. The
broker-dealer publishing the quotation
can use its own bona fide quotation to
satisfy the test. The broker-dealer cannot
use its own or another broker-dealer’s
unpriced quotation to rely on this test,
even if the broker-dealer publishing a
name-only quotation provides a bid
price of at least $50 per share upon
inquiry. If a security is a unit composed
of one or more securities, the bid price
of the unit, when divided by the number
of shares of the unit that are not
warrants, options, rights, or similar
securities, must be at least $50 to be
excepted from the Rule.
31
Q5. Should this exclusion be based on
a bid price higher than $50 per share,
e.g., $100 per share or lower, e.g., $20
per share? Commenters should provide
data and analysis to support suggested
alternatives to the proposed threshold.
Q6. Should this exclusion be available
only if the security has a bid price of
$50 over a specified period of time?
Q7. Should this test be based instead
on the security’s last sale price? If so,
should there be a time limit added to
such a test so that a stale last sale price
cannot be used?
3. Securities of Issuers Satisfying a Net
Tangible Assets Test
Microcap fraud schemes generally
involve issuers with limited assets.
32
We are therefore proposing to exclude
securities of issuers having net tangible
assets in excess of $10,000,000, as
determined by audited financial
statements.
If the issuer is not a foreign private
issuer, a broker-dealer should make this
determination using the most recent
financial statements for the issuer that
have been audited and reported on by
an independent public accountant in
accordance with the provisions of Rule
2–02 of Regulation S–X.
33
If the issuer
is a foreign private issuer, a broker-
dealer should make this determination
using the most recent financial
statements for the issuer (dated less than
18 months prior to the date of the
publication of the quotation) that are
prepared in accordance with a
comprehensive body of accounting
principles, audited in compliance with
requirements of the country of
incorporation, and reported on by an
accountant duly registered and in good
standing under the regulations of that
jurisdiction.
34
If audited financial
statements are unavailable, the broker-
dealer may not rely on this exception.
Some commenters suggested that we
look to the current definition of ‘‘penny
stock’’ in assessing the scope of Rule
15c2–11. Exchange Act Rule 3a51–1
excludes from the definition of penny
stock a security of an issuer having net
tangible assets in excess of $2 million,
if the issuer has been in continuous
operation for at least 3 years, or $5
million, if the issuer has been in
continuous operation for less than three
years.
35
We preliminarily believe that,
for purposes of an exclusion from the
Rule, the net tangible assets amount
should be higher, and, unlike the
definition of penny stock, the threshold
need not distinguish between newer and
more seasoned issuers.
Q8. Should the threshold amount for
this net tangible assets test be higher
than $10 million, e.g., $20 million?
Under what circumstances would it be
appropriate to permit a lower threshold
amount? Commenters should provide
data and analysis to support their views
on whether the threshold amount
should be raised or lowered.
Q9. For ease of compliance with both
Commission and NASD rules, should
this exclusion parallel the exclusion
contained in the NASD’s proposed rule
that would require broker-dealers to
review current information about the
issuer of an OTC security before
recommending a transaction in the
security?
36
The NASD proposal would
exclude the securities of issuers having
total assets of at least $100 million and
shareholders’ equity of at least $10
million, based on audited financial
statements.
Q10. Will there be sufficient
information in financial statements,
particularly those of non-reporting
issuers, to permit broker-dealers to make
the net tangible assets calculation?
Q11. Should the use of financial
statements of a foreign private issuer be
limited to financial statements prepared
in accordance with U.S. generally
accepted accounting principles (GAAP)?
Q12. Should the use of financial
statements of a foreign private that are
not prepared in accordance with U.S.
GAAP be limited to financial statements
prepared in accordance with the
accounting standards promulgated by
the International Accounting Standards
Committee (IASC)?
37
Commenters are invited to provide us
with their views on the alternative tests
for an exclusion from Rule 15c2–11, as
described above.
Q13. Should all three of the tests
based on value of ADTV, bid price, and
net tangible assets be incorporated into
Rule 15c2–11?
Q14. Should the proposed exclusions
from the Rule be limited to those
securities that satisfy at least two of the
three tests?
Q15. Are there other tests that are
more appropriate to exclude the
securities of larger, more seasoned
issuers from Rule 15c2–11? For
example, should a security that has no
or very minimal trading volume be
excluded from the Rule’s requirements?
What would be an appropriate low
volume threshold? If trading volume
suddenly exceeded the low volume
threshold, would broker-dealers
publishing quotes find it easy or
difficult to have to obtain and review
information before continuing to
publish priced quotations?
4. Non-Convertible Debt, Non-
Participatory Preferred Stock, and Asset-
Backed Securities
We are proposing to exclude non-
convertible debt securities, non-
participatory preferred stock,
38
and
asset-backed securities that are rated by
at least one nationally recognized
statistical rating organization, as that
term is used in Rule 15c3–1 under the
Exchange Act,
39
in one of its generic
rating categories that signifies
investment grade.
40
Commenters on this
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11130Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
exclusion to investment grade asset-backed
securities at this time.
41
Proposing Release, 63 FR at 9669. Also, we are
combining into a single provision the current
exceptions for exchange-listed and Nasdaq
securities.
42
For a discussion of the requirements under the
reproposed amendments concerning the submission
of information to the NASD, see Part III.I. below.
43
15 U.S.C. 781(k).
44
The initial proposal would have permitted a
broker-dealer to conduct the annual review as of the
anniversary date of the initial quotation.
45
See Letter from A.G. Edwards & Sons, Inc.,
(April 27, 1998) (A.G. Edwards Comment Letter);
and Letter from National Quotation Bureau, LLC,
(April 27, 1998) (NQB Comment Letter).
issue generally supported excluding
fixed-income securities from the Rule.
The fraud and manipulation that we
have observed in the microcap
securities have not been evident in the
fixed-income market. In addition, non-
convertible debt securities, non-
participatory preferred stock, and
investment grade asset-backed securities
generally trade at prices and in
denominations that make them less
likely targets for manipulation. Further,
the type of issuer information required
by the Rule is much less relevant to the
pricing and trading of these types of
securities.
Q16. Should this exclusion apply to
all asset-backed securities or should the
exclusion apply only to asset-backed
securities that are rated investment
grade on the basis that those securities
are even less likely to be subject to
fraudulent activities?
Q17. Should the Rule exclude all non-
convertible debt and non-participatory
preferred stock or should the exclusion
apply only to non-convertible debt and
non-participatory preferred stock that
are rated investment grade?
5. Other Exceptions
The exceptions relating to quotations
for exchange-listed and Nasdaq
securities, quotations representing a
customer’s unsolicited order, and
quotations for exempted securities
remain substantively the same as
currently in the Rule. As we indicated
in the Proposing Release, the
unsolicited status of the customer orders
would be called into question if a
broker-dealer repeatedly publishes
quotations on the basis of the
unsolicited customer order exception.
41
Q18. Should unsolicited customer
orders be required to be identified as
such in the quotation medium? Is it
feasible for quotation mediums to show
that the quote represents an unsolicited
customer order?
B. Quotations Subject to the Rule
1. The Initial Quotation for a Covered
OTC Security
As indicated above, the Rule’s
requirements will apply at the time of
discrete quotation events. Subject to the
Rule’s exceptions, the amendments will
prohibit the first broker-dealer from
publishing a priced or unpriced
quotation for a covered OTC security in
a quotation medium unless it has
obtained and reviewed specified
information about the issuer and the
security. Further, this information will
need to be submitted to the NASD, in
accordance with the NASD’s rules, at
least three business days before the
quotation is published.
42
There is one
situation that ‘‘restarts’’ the Rule’s
requirements: following the termination
of a Commission trading suspension
ordered pursuant to Exchange Act
Section 12(k),
43
the broker-dealer
publishing the first quote, whether it is
priced or unpriced, must comply with
Rule 15c2–11. In essence, this is the
way the Rule currently works.
We believe that the Rule should cover
the first quotation as a means to assure
that there is basic information about the
issuer available to the marketplace
before trading in the security begins and
to alert regulators that trading in the
security will be starting. The NASD uses
Rule 15c2–11 submissions for
surveillance and enforcement purposes
and routinely provides copies of this
information to the Commission.
2. Priced Quotations
While the first broker-dealer must
obtain the required information for the
initial quotation (priced or unpriced) for
a covered OTC security as discussed
above, thereafter the Rule will only
apply to broker-dealers submitting their
first priced quotations. The Rule’s
review requirements are also triggered
when a broker-dealer first publishes a
priced quotation following the lapse of
five or more business days of its priced
quotations for the security. In addition,
as discussed below, a broker-dealer
must satisfy the Rule’s requirements if
it publishes a priced quotation as of a
specific date following the end of the
issuer’s fiscal year.
We propose to focus the Rule’s
requirements after publication of the
first quote on priced quotations, because
recent microcap manipulation schemes
have primarily involved priced
quotations. In addition, priced quotes
are used as indicia of value for a variety
of purposes (e.g., bank loans or pledges
of securities). This revision also
responds to the concerns of several
commenters that the earlier proposal
could have resulted in some broker-
dealers being precluded from publishing
any quotations if they could not obtain
the Rule’s required information. We
solicit commenters’ views, however, on
whether unpriced indications of interest
will be used more often in unlawful
microcap activities, and, if so, whether
the Rule should cover all initial
quotations.
3. Annual Review
The amendments require a broker-
dealer to review the specified
information annually if the broker-
dealer publishes priced quotations for
the security. The date by which the
annual review must be performed
depends on whether the issuer is a
domestic or a foreign company:
•Domestic Issuers: The annual
review must occur prior to the first
priced quotation that is more than four
months after the end of the issuer’s
fiscal year.
•Foreign Private Issuers: The annual
review must occur prior to the first
priced quotation that is more than seven
months following the end of the issuer’s
fiscal year.
The purpose of this requirement is to
make sure that the broker-dealer
periodically reviews fundamental
information about the issuer if the
broker-dealer continues to publish
priced quotations. The broker-dealer
should know if no current information
about the issuer exists or if current
information reflects a significant change
in the issuer’s ownership, operations, or
financial condition.
While we originally proposed two
alternative dates for conducting the
annual review, to simplify the Rule we
are reproposing only one date for each
type of security.
44
Four months after the
end of the issuer’s fiscal year, a broker-
dealer publishing priced quotes for a
covered OTC security of a domestic
issuer must have conducted the annual
review. In the case of a foreign private
issuer’s security, the annual review
must occur before the broker-dealer
publishes a priced quote following the
date that is seven months after the
issuer’s fiscal year end. We believe that
these time periods give a broker-dealer
sufficient time to obtain and review
updated issuer information for both
reporting and non-reporting issuers.
Some commenters opposed the
annual review requirement because of
potential recordkeeping burdens, the
perceived difficulty of obtaining the
required information, and the loss of
liquidity that could potentially occur if
broker-dealers could not publish priced
quotes because current issuer
information was unavailable.
45
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11131Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
46
See, e.g., A.G. Edwards Comment Letter.
47
See, e.g., NQB Comment Letter.
48
See Letter from NASD Regulation, Inc., (July
17, 1998) (NASD Comment Letter); Letter from
North American Securities Administrators
Association, Inc., (April 27, 1998) (NASAA
Comment Letter); and SIA Comment Letter.
49
15 U.S.C. 78m and 78o(d).
50
15 U.S.C. 78l(g)(2)(G).
51
In response to the 78 comment letters that we
received from issuers of securities quoted on the
OTC Bulletin Board who were concerned about
continued liquidity for their securities, we note that
33 of these issuers are reporting companies. Also,
under recently approved amendments to NASD
Rules 6530 and 6540, all of these issuers ultimately
will need to be reporting companies current in their
reporting obligations in order for their securities to
remain on the OTC Bulletin Board. See note 6 above
and accompanying text. There should be no
burdens on reporting issuers to provide information
to broker-dealers wishing to publish quotations
because the issuer information should be available
on EDGAR, as long as the issuers are current in
their reporting obligations.
Commenters stated that the Rule’s
review requirements represented a shift
from the Commission and the SROs to
broker-dealers of the burdens of
overseeing issuer compliance with
regulatory requirements.
46
Some
commenters wrote that the annual
review is only appropriate for certain
non-reporting companies or issuers for
which only limited information is
available. Other commenters stated that
the annual review should not apply to
issuers that are current in their reporting
requirements because this information
is available on EDGAR.
47
A number of
commenters, however, generally
supported some sort of required annual
review for broker-dealers publishing
priced quotations, although they
differed as to the securities that should
be subject to this provision.
48
The amendments will apply the
annual review requirement to priced
quotations for both reporting and non-
reporting issuers’ securities. We believe
that an annual review requirement for
both reporting and non-reporting
issuers’ securities fulfills the objectives
of the Rule without imposing significant
burdens on broker-dealers. This is
especially so because we are revising
the Rule to cover only those securities
that, in our view, are most likely to be
the subject of microcap fraud schemes
and are also limiting the scope of the
annual review to priced quotations. We
also note that because information about
reporting issuers is available on the
Commission’s website, the review of
information about these issuers can be
accomplished quite easily.
Commenters are requested to provide
us with their views on the reproposal’s
focus on priced quotations.
Q19. Should the Rule cover all broker-
dealers’ initial quotations, whether
priced or unpriced, as the earlier
proposal would have? Will the
reproposal cause broker-dealers to
publish unpriced quotes to avoid
complying with the Rule?
Q20. Should the Rule apply
exclusively to priced quotes, i.e., the
Rule would not cover any unpriced
quotes?
Q21. Are there other approaches that
would be more appropriate, e.g., to
cover any initial quote for a covered
OTC security by a broker-dealer,
whether priced or unpriced, but not to
apply the Rule or at least the annual
review requirement to reporting issuers’
securities? How would such a proposal
help reduce instances of microcap
fraud?
Q22. Is the Rule text sufficiently clear
in identifying the quotation events that
are subject to the Rule’s provisions? Are
there other quotation events that should
be covered by the Rule?
Q23. Should the provision pertaining
to a lapse in quotations of five
consecutive business days or more
provide for a longer time period, e.g.,
ten consecutive business days without a
priced quotation, or a shorter time
period, e.g., three consecutive business
days without a priced quotation?
Q24. Should the Rule give broker-
dealers the option to conduct the annual
review as of the anniversary date of the
initial quotation by the broker-dealer?
C. Information Required Under the Rule
The amendments are substantially
identical to the earlier proposal with
respect to the issuer information that a
broker-dealer must review before
publishing a quotation for a covered
OTC security. Under the reproposal, a
broker-dealer subject to the Rule must
gather, review, and maintain in its
records the following issuer
information:
•For an issuer that has conducted a
recent public offering either registered
under the Securities Act of 1933
(Securities Act) or effected pursuant to
Regulation A under the Securities Act,
a copy of the prospectus or offering
circular;
•For an issuer that files reports with
the Commission pursuant to Sections 13
or 15(d) of the Exchange Act
49
(reporting issuer), the issuer’s most
recent annual or semi-annual report and
any subsequent quarterly and current
reports;
•For an issuer that is an insurance
company of the kind specified in
Section 12(g)(2)(G) of the Exchange
Act,
50
the issuer’s most recent annual
statement referred to in Section
12(g)(2)(G)(i);
•For an issuer that is not required to
file reports pursuant to Sections 13 or
15(d) of the Exchange Act and that is a
bank or savings association, the issuer’s
most recent annual report and any
subsequent reports filed with its
appropriate federal or state banking
authority; and
•For any other issuer, the
information, including certain financial
information, specified in proposed
paragraph (c)(6) of the Rule, which must
be reasonably current in relation to the
day a quotation is submitted.
The broker-dealer also must obtain
and review the supplemental
information contained in paragraph (d)
of the reproposed Rule. A broker-dealer
must review a copy of any trading
suspension order issued under Section
12(k) for any of the issuer’s securities
during the 12 months preceding the
publication of the quotation, as well as
any other material information,
including adverse information, that
comes to the broker-dealer’s knowledge
or possession before publication of the
quotation. A broker-dealer must
consider this supplemental information,
along with the issuer information, when
it determines whether it has a
reasonable basis for believing that the
issuer information is accurate and from
reliable sources. While we are not
including a requirement that the broker-
dealer obtain and review any trading
suspension for a foreign security that
was issued by a foreign financial
regulatory authority, this information
must be taken into account by the
broker-dealer if it comes to the broker-
dealer’s knowledge or possession at the
time that a review is required.
In addition, the broker-dealer must
make a record of the significant
relationship information contained in
paragraph (e) of the reproposed Rule,
which is unchanged from the Proposing
Release. Under this provision, a broker-
dealer would have to document
specified information such as whether
the broker-dealer has any affiliation
with the issuer or arrangements to
receive any consideration to publish the
quote, and whether the quote is being
published on behalf of another broker-
dealer or the issuer, any of its insiders,
or any large shareholder.
Commenters generally did not object
to the issuer, significant relationship,
and supplemental information
requirements; in fact, some commenters
favored the enhanced information
requirements for non-reporting
issuers.
51
Therefore, we are reproposing
these requirements without any
substantive changes, other than
revisions relating to financial statements
for non-reporting issuers, as discussed
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11132Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
52
See Part II.A.4. of the Proposing Release at 63
FR 9661, 9664–9669.
53
See, e.g., NASAA Comment Letter.
54
See, e.g., Letter from Daniel J. Demers (March
27, 1998) (Demers Comment Letter); Letter from
Robotti & Company, Inc., (April 27, 1998) (Robotti
Comment Letter); and NQB Comment Letter. In
1989, we sought comment on whether there were
situations, such as bankruptcy, that should be
addressed if the piggyback provision were revised.
See Securities Exchange Act Release No. 27247
(September 14, 1989), 54 FR 39194 (1989 Release).
Commenters on the 1989 Release argued that it was
appropriate to permit broker-dealers to continue
quoting the securities of issuers that had filed for
bankruptcy because it provided liquidity for these
securities and suggested that issuers in bankruptcy
be identified in the quotation system by using a
special indicator.
55
11 U.S.C. 1101 et seq.
56
Demers Comment Letter; see also 11 U.S.C.
1125. The disclosure statement includes, among
other things, a description of the issuer’s business
plan, a description of any securities to be issued,
and financial information.
57
Broker-dealers would be able to continue to
publish unpriced quotations.
58
See Federal Rule of Bankruptcy Procedure 2015
(Rule 2015 bankruptcy reports).
59
See Staff Legal Bulletin No. 2 (April 15, 1997)
(CF) (Staff Legal Bulletin No. 2), which is available
through our Internet website at <http://
www.sec.gov/rules/othern/slbcf2.txt>. Under Staff
Legal Bulletin No. 2, our Division of Corporation
Finance has granted no-action relief permitting an
issuer in Chapter 11 reorganization to satisfy its
Exchange Act reporting obligations by filing the
Rule 2015 bankruptcy reports on Exchange Act
Form 8–K. See 17 CFR 249.308. Under Staff Legal
Bulletin No. 2, the staff has allowed a company to
substitute its Rule 2015 bankruptcy reports for its
Exchange Act periodic reports when there is little
or no trading in the debtor’s securities.
60
See Staff Legal Bulletin No. 2.
61
See 11 U.S.C. 1125. The disclosure statement
includes, among other things, a description of the
issuer’s business plan, a description of any
securities to be issued, and financial information.
62
See Letter from Florida Division of Securities
(April 27, 1998) (Florida Comment Letter); NQB
Comment Letter; Demers Comment Letter; and
Robotti Comment Letter. Mr. Demers suggested that
the required financial information for non-reporting
issuers emerging from bankruptcy be from the
‘‘effective date’’ of the plan, instead of the
‘‘confirmation date’’ of the plan. We are retaining
below in Part III.C.4. We are addressing
below specific points that a few
commenters raised about the
information requirements and other
provisions. Commenters are welcome to
provide their views on the information
requirements for the various categories
of issuers and should consult the
Proposing Release for a more detailed
description of these provisions.
52
1. Reporting Issuers Delinquent in Their
Filings
In the case of an issuer delinquent in
its reporting obligations, a broker-dealer
will not be able to publish an initial
priced quotation, or continue to publish
priced quotations after the annual
review date, because it will not be able
to obtain the specified reports. A few
commenters indicated concern about
the possible adverse implications for the
market for delinquent issuers’ securities
if broker-dealers could not publish
quotes when current issuer information
was unavailable.
53
As noted above, we
are revising the Rule to permit broker-
dealers to publish unpriced quotations,
even in the absence of current issuer
information (except in the case of the
first quotation for the security).
2. Issuers in Bankruptcy
a. Reporting Issuers
A few commenters urged us to permit
broker-dealers to continue to quote the
securities of reporting issuers that had
filed for reorganization under federal
bankruptcy law because it would
provide liquidity for these securities.
54
They noted that it was often
burdensome for small companies that
had filed for reorganization under
Chapter 11 of the Bankruptcy Code
55
to
produce audited financial statements to
comply with Exchange Act reporting
requirements.
Commenters suggested that broker-
dealers could satisfy the Rule’s
requirements by reviewing bankruptcy
court filings made by an issuer in
Chapter 11 reorganization when current
Exchange Act reports were unavailable.
One commenter also suggested that the
Commission permit delinquent
reporting companies that experience a
51% ownership change as a result of a
confirmed plan of reorganization to
begin reporting from the effective date
of the reorganization plan with a filing
with the Commission, attaching the
court-approved disclosure statement
together with a certified audited balance
sheet as of the effective date.
56
The reproposal will require a broker-
dealer publishing quotations for a
reporting issuer’s securities to obtain the
issuer’s Exchange Act reports, even if
the reporting issuer has filed for Chapter
11 reorganization. Thus, if a reporting
issuer that has filed for Chapter 11
reorganization becomes delinquent in
its reporting obligations, a broker-dealer
will not be able to publish priced
quotations covered by the Rule. For
example, a broker-dealer could not
continue to publish priced quotations as
of the annual review date for a covered
security of a reporting debtor that has
become delinquent in its reporting
obligations.
57
The bankruptcy court filings for an
issuer undergoing reorganization under
Chapter 11 are not adequate to satisfy
the Rule’s requirements. These Rule
2015 bankruptcy reports ordinarily
contain only data about issuer receipts
and disbursements and not the type of
issuer financial information
contemplated by Rule 15c2–11.
58
In
some cases, our Division of Corporation
Finance may grant issuers in bankruptcy
no-action relief with respect to
Exchange Act filing requirements.
59
These no-action positions, however, are
predicated on little or no trading
occurring in the debtor’s securities. The
Rule 2015 bankruptcy reports that the
Division of Corporation Finance accepts
under its no-action position do not
satisfy Rule 15c2–11 because this
financial report usually contains only
information about issuer receipts and
disbursements. Where a reporting issuer
receives this type of no-action position,
a broker-dealer would not be able to
obtain the issuer information required
by the Rule until the debtor’s
reorganization plan becomes effective,
and the debtor files a Form 8–K, which
instead of attaching the Rule 2015
bankruptcy reports, now includes the
issuer’s audited balance sheet. Under
Rule 15c2–11, broker-dealers could
review this 8–K, which contains an
issuer’s audited balance sheet, and then
publish priced quotations. From then
on, the issuer must file its Exchange Act
periodic reports for all periods that
begin after the plan becomes effective.
60
The publication of quotations by a
broker-dealer indicates that a market
exists for the issuer’s securities. It
would be inconsistent with the premise
of the no-action position (i.e., that there
is no trading in the issuer’s securities)
if a broker-dealer were able to stimulate
trading by publishing quotations
without having the issuer’s Exchange
Act reports.
Q25. Are there circumstances in
which a broker-dealer should be
permitted to publish priced quotations
for the securities of delinquent reporting
issuers in bankruptcy? Please describe
these circumstances. Should the Rule
prohibit broker-dealers from publishing
unpriced quotes for the securities of
these issuers?
b. Non-Reporting Issuers Emerging From
Bankruptcy
The Proposing Release contained
amendments to permit broker-dealers
that quote the securities of non-
reporting companies emerging from
bankruptcy to review the bankruptcy
court-approved disclosure statement
and issuer financial information
required by the Rule from the date that
the bankruptcy court confirms the
reorganization plan.
61
The commenters
who addressed this issue supported the
proposal to limit a broker-dealer’s
review to the post-reorganization
information.
62
The amendments are
unchanged from the original proposal.
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11133Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
this amendment from the confirmation date because
adequate information is available about the non-
reporting issuer at this point for Rule 15c2–11
purposes.
63
15 U.S.C. 78l(g).
64
17 CFR § 240.12g3–2(b).
65
Some of the paragraph (c)(6) information that
broker-dealers will have to obtain and review may
be present in the foreign issuer’s Rule 12g3–2(b)
materials.
66
See Part III.C.4. below.
67
For example, some commenters stated that we
should delete the reference to Rule 12g3–2(b) and
require broker-dealers to review the same
information as required for all other foreign non-
reporting issuers whose securities are subject to
Rule 15c2–11. See, e.g., Florida Comment Letter.
Other commenters, however, indicated that we
should continue to require broker-dealers to review
only the home country information that certain
foreign issuers submit to the Commission under
Rule 12g3–2(b). See, e.g., SIA Comment Letter.
68
See NASAA Comment Letter.
69
See, e.g., Letter from David B. Schneider (April
21, 1998).
70
This provision is a presumption that financial
information that is less than 15 months old is
current. However, if the broker-dealer has other
information that indicates that the issuer’s financial
condition has materially changed from that shown
in the financial statements, this presumption may
not apply, and the broker-dealer should determine
whether more recent financial information is
available. Financial information older than 15
months is not current and does not satisfy the
Rule’s requirements. The presumption for non-
financial information is that this information is
considered current if it is as of a date within 12
months of publication of the quotation.
3. Non-Reporting Foreign Private Issuers
In the case of a foreign private issuer
that relies on an exemption from
registration under Section 12(g)
63
of the
Exchange Act by complying with
Exchange Act Rule 12g3–2(b), Rule
15c2–11 specifies that a broker-dealer
must review the information submitted
to the Commission under Rule 12g3–
2(b).
64
To qualify for the registration
exemption, the issuer must furnish to
the Commission information that the
issuer has made or is required to make
public under the law of the country in
which the foreign private issuer is
domiciled or incorporated; has filed or
is required to file with a stock exchange
on which the securities are traded and
which the exchange has made public; or
has distributed or is required to
distribute to its securityholders. For
foreign private issuers that do not
furnish the Commission with
information under Rule 12g3–2(b), the
Rule currently requires broker-dealers to
obtain and review the same kind of
information, including financial
information, as required for non-
reporting domestic issuers.
We note that Rule 12g3–2(b) contains
no specific requirements governing the
categories of information the issuer
must furnish to the Commission under
the exemption. As a result, there is no
assurance that broker-dealers publishing
quotes will obtain the same type of
information for each foreign private
issuer that claims the Rule 12g3–2(b)
exemption as they must for other non-
reporting foreign private issuers. This
can be problematic since a number of
issuers claiming the Rule 12g3–2(b)
exemption are foreign microcap
companies that can potentially be
subject to the same kinds of abusive
practices as their U.S. counterparts.
Therefore, we are proposing to change
Rule 15c2–11 requirements with respect
to quotations for the securities of foreign
issuers complying with Rule 12g3–2(b).
Broker-dealers publishing quotations for
the securities of Rule 12g3–2(b) issuers
will have to obtain and review the
information specified in paragraph (c)(6)
of the reproposed Rule.
65
However, as
described in more detail below, we
propose to revise the financial
statements that must be reviewed for
non-reporting foreign private issuers to
recognize the foreign status of these
issuers.
66
By eliminating the provision
for Rule 12g3–2(b) issuers, all non-
reporting foreign private issuers will be
treated similarly under Rule 15c2–11.
Commenters were divided on whether
we should amend the provisions of the
Rule governing the review of
information for non-reporting foreign
private issuers.
67
Because the
reproposal excludes the securities of
many larger foreign issuers from Rule
15c2–11 and also distinguishes between
U.S. and foreign accounting standards
for those foreign issuers that continue to
be covered, many of the reasons for
permitting broker-dealers to rely on
Rule 12g3–2(b) information have been
addressed.
Q26. Should broker-dealers be
required to obtain and review the same
type of issuer information with respect
to non-reporting foreign private issuers
providing information under Rule 12g3–
2(b) as they must for other non-reporting
foreign issuers? Are there reasons to
retain a special provision in Rule 15c2–
11 for foreign issuers furnishing
information under Rule 12g3–2(b)?
Q27. What is the experience of broker-
dealers under the Rule when the foreign
issuer has not furnished information to
the Commission under Rule 12g3–2(b)?
How difficult or easy will it be for
broker-dealers to obtain the paragraph
(c)(6) information for a non-reporting
foreign private issuer?
4. Other Non-Reporting Issuers
The amendments parallel the
Proposing Release in their treatment of
non-reporting issuers (i.e., those non-
reporting issuers that are not financial
institutions covered by paragraph
(c)(4)), except for the new exclusions
discussed in Part III.A. above and the
revisions to the required financial
information for non-reporting issuers.
As in the Proposing Release, the Rule
will require broker-dealers to review
more information than currently
required about the issuer’s outstanding
securities; the issuer’s insiders,
including their disciplinary history; and
certain significant events involving the
issuer, among other items. This
information will provide a broker-dealer
that is considering whether to publish
quotations for such an issuer greater
understanding of the issuer’s operations
and a better indication of whether
potential or actual fraud or
manipulation may be present.
Several commenters supported the
requirement for a broker-dealer to
review the disciplinary information
about the insiders of non-reporting
issuers. One commenter believed that if
broker-dealers are allowed to publish
quotations without obtaining this
disciplinary information, it would
create a loophole for issuers to avoid
disclosing information that would be of
utmost importance and would thereby
defeat the goal of the Commission.
68
While no commenters directly opposed
the requirement to obtain disciplinary
information, several commenters
objected to the enhanced information
requirements in general as too difficult
and burdensome, especially when
issuers are unwilling to volunteer
information.
69
Q28. Should the Rule require the
disciplinary history information for the
insiders of all issuers of covered OTC
securities, and not just insiders of non-
reporting issuers, on the basis that
microcap fraud can involve issuers
whose insiders have histories of prior
misconduct?
We are proposing to amend the
financial information that a broker-
dealer must review when publishing
quotations of both domestic and foreign
non-reporting issuers. The reproposal
lists the financial statements required
for a domestic issuer, which must be
prepared in accordance with U.S.
GAAP, and sets forth when these
financial statements will be presumed
‘‘current’’ under the Rule. Absent
contrary information, a domestic
issuer’s balance sheet will be considered
current if it is as of a date that is less
than 15 months before the quotation is
published, rather than less than16
months as now specified in the Rule.
70
This revision comports with existing
Exchange Act requirements regarding
when a domestic reporting issuer’s
financial statements are considered
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11134Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
71
This presumption will operate in the same
manner as for domestic issuers. See footnote 70
above.
72
See, e.g., Letter from Security Traders
Association (April 28, 1998) (STA Comment Letter).
We originally proposed that the information be
made available to anyone upon request.
73
See e.g., Letter from Richard P. Ryder, Esq.
(May 12, 1998).
74
See e.g., Letter from The Bond Market
Association Comment Letter (April 27, 1998); NQB
Comment Letter; and Florida Comment Letter.
75
A broker-dealer may charge for the reasonable
expenses it incurs in producing and forwarding
copies of the Rule 15c2–11 information.
76
We note that, for reporting issuers, information
repositories already exist. Broker-dealers are able to
access and review the required information on our
EDGAR system, available through our Internet
website at <http://www.sec.gov>. In addition,
broker-dealers may consult federal or state
electronic information systems for information
about issuers of covered OTC securities.
77
See e.g., Letter from Singer Frumento
Sichenzia, LLP, (April 13, 1998).
78
This authority will be delegated to the Director
of the Commission’s Division of Market Regulation.
We propose to amend Rule 200.30–3, which
provides for delegation of authority to the Director,
to include the designation of information
repositories. See 17 CFR 200.30–3.
current. The reproposal also will require
broker-dealers to review the specified
financial information for such part of
the two preceding fiscal years (in the
case of the balance sheet, the preceding
fiscal year) that the issuer (or any
predecessor) has been in existence.
The reproposal also will revise the
requirements with respect to the
financial statements that broker-dealers
must review when publishing a
quotation for a non-reporting foreign
private issuer’s security. The reproposal
lists the financial statements that the
broker-dealer must review, which must
be prepared in accordance with a
comprehensive body of accounting
principles, and sets forth when these
financial statements will be considered
current under the Rule. For a non-
reporting foreign private issuer, its
balance sheet will be presumed current
if it is as of a date less than 18 months
before the quotation is published.
71
Also, if the balance sheet is as of a date
more than 9 months before the
quotation is published, the broker-
dealer must obtain more current
financial information only to the extent
that the issuer has prepared it. The
broker-dealer must obtain the specified
financial information for the two
preceding fiscal years (one year with
respect to the balance sheet) that the
issuer has been in existence.
Q29. Are the financial statement
requirements, including the
presumption regarding when the
information is considered current, clear
and capable of being complied with by
broker-dealers publishing quotations?
Should there be longer time periods for
the presumption regarding when the
financial statements for a non-reporting
foreign private issuer are considered
current? If so, what time periods would
be appropriate?
Q30. Are there any information
requirements for non-reporting issuers
that should be added or removed from
reproposed paragraph (c)(6)?
D. Information Available Upon Request
We believe that some microcap frauds
could be prevented if there were greater
investor access to information about
those securities and their issuers.
Accordingly, we are reproposing, with
some revisions, the requirement that a
broker-dealer publishing quotations for
any covered OTC security make the
information promptly available upon
request. In response to the Proposing
Release, several commenters suggested
that we restrict the types of persons and
entities to which a broker-dealer must
provide the information.
72
The
amendments require a broker-dealer to
provide information upon request to any
current customer, prospective customer,
information repository, or other broker-
dealer.
A few commenters asserted that
broker-dealers should not be required to
provide information that already is
generally available to the public from
other sources (e.g., information for
reporting companies that is available on
EDGAR).
73
We are addressing these
concerns in the amendments by
requiring broker-dealers to provide the
required information that is not
accessible through EDGAR, any other
federal or state electronic information
system, or an information repository.
Further, most commenters responding
to this issue were concerned about the
cost of providing information to others
upon request.
74
We believe that the cost
of requiring broker-dealers to make the
information available (including to
other broker-dealers) upon request is
minimal.
75
The amendments retain in substantial
form the clause that providing
information to others does not
constitute a representation by the
broker-dealer that the information is
accurate. Rather, providing the
information to others constitutes a
representation that the information is
current in relation to the date the
information was reviewed, and that the
broker-dealer has a reasonable basis for
believing that the information was
accurate as of the date recorded and was
obtained from reliable sources.
Q31. Should we require broker-
dealers to make the information
available to anyone who requests it,
particularly if broker-dealers are
permitted to charge reasonable fees?
Should broker-dealers be required to
provide information to fewer classes of
persons?
E. Information Repository
The amendments, as in the Proposing
Release, eliminate the piggyback
provision of the Rule. The elimination
of the piggyback provision and the
potential for increased costs of
compliance suggest the desirability of
having a data base of information about
the non-reporting issuers of covered
OTC securities.
76
Such a data base also
would enhance the availability of
information about little-known issuers
to investors, other professionals, and
regulators. The consensus among the
commenters who specifically addressed
this issue was that the creation of a
repository would foster access to
information about issuers that do not
participate in the public disclosure
system.
77
For these reasons, we
encourage the development of one or
more repositories of Rule 15c2–11
information, but we note that the
existence of a repository will not be
necessary for broker-dealers to comply
with the Rule.
The amendments establish that the
Commission may, upon written
application, designate an entity as an
information repository.
78
In determining
whether to grant or deny such a
designation, the Commission will
consider whether an entity:
•Collects information about a
substantial segment of issuers of
securities subject to the Rule;
•Maintains current and accurate
information about such issuers;
•Has effective acquisition, retrieval,
and dissemination systems;
•Places no inappropriate limits on
the issuers from or about which it will
accept or request information;
•Provides access to the documents
deposited with it to anyone willing and
able to pay the applicable fees; and
•Charges reasonable fees.
In general, the Commission will
consider whether an entity wishing to
act as an information repository is so
organized and has the capacity to be
able reasonably to obtain and provide to
others current information required by
the Rule. An information repository will
be required to notify the Commission of
any material changes in the facts and
circumstances of their application for
designation as an information
repository. In the event that an
information repository no longer
satisfies these attributes, we may
withdraw such designation.
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11135Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
79
See, e.g., STA Comment Letter.
80
Under the current Rule, interdealer quotation
system is defined as any system of general
circulation to brokers or dealers which regularly
disseminates quotations of identified brokers or
dealers. A separate definition of ‘‘interdealer
quotation system’’ is no longer necessary because of
the proposed elimination of the piggyback
provision and the revision that the information be
furnished to the NASD in accordance with NASD
rules, rather than to interdealer quotation systems.
81
We are using the term ‘‘alternative trading
system,’’ which encompasses the term ‘‘electronic
communications network.’’ See Securities Exchange
Act Release No. 40760 (December 8, 1998), 63 FR
70844.
82
See e.g., Letter from Instinet (April 22, 1998).
83
For example, some broker-dealers have claimed
to submit customer ‘‘orders’’ in quotations mediums
following the termination of a Commission trading
suspension issued under Exchange Act Section
12(k).
84
To rely on the exception for an unsolicited
customer order, the order must represent an
unsolicited indication of interest of a customer
(other than a person acting as or for a dealer) of the
broker-dealer submitting the order to the ATS.
85
We have previously interpreted the Rule to
require a broker-dealer that was publishing
quotations in a particular interdealer quotation
system to review issuer information before
publishing quotations in another interdealer
quotation system unless it relied upon an
exemption. See Letter re: OTC Bulletin Board
Display Service (December 20, 1993) (conditional
exemption permitting broker-dealers that are
currently publishing quotations in an interdealer
quotation system to publish quotations in the OTC
Bulletin Board without reviewing issuer
information under the Rule); and Letter re: OTC
Bulletin Board; Modification of Exemption
(December 1, 1998) (modifying the exemption
granted in 1993). Upon adoption of the reproposed
amendments, we will rescind this interpretation
and related exemptions.
86
17 CFR 240.17a–4. We will add new paragraph
(b)(11).
87
This proposed recordkeeping requirement was
discussed by few commenters and generally was
viewed favorably. See e.g., NASAA Comment
Letter.
88
Broker-dealers publishing quotes for securities
of exempt financial institutions may obtain the
regulatory reports from the financial institution by
contacting their primary bank regulatory agency.
Broker-dealers can access the Federal Reserve
System’s National Information Center of Banking
Information Internet website at <http://
www.ffiec.gov/NIC>, the Office of the Comptroller
of the Currency’s Internet website at <http://
www.occ.treas.gov>, which has information about
individual nationally chartered banks, or the
Federal Deposit Insurance Corporation’s (FDIC)
Internet website at <http://www.fdic.gov>, which
provides the most recent Call Reports for all FDIC
insured banks. Broker-dealers that access exempt
financial institution information through these
websites would be able to satisfy the Rule’s
requirements by recording their review and
preserving the information in the same manner as
for EDGAR information discussed above.
Some commenters suggested that the
Commission assume the task of serving
as the Rule 15c2–11 information
repository.
79
Because the issuers that
would be the focus of any information
repository generally would not be
required to file periodic reports with the
Commission, this is not a function that
we can assume at this time. The NASD
has also advised us preliminarily that it
is unable to undertake the responsibility
of serving as an information repository
at the present time. Therefore, we
encourage private sector initiatives for
the creation of one or more Rule 15c2–
11 information repositories.
Q32. Are there other criteria that
should be used to determine the
information repository designation?
F. Definitions
Reproposed paragraph (j) of the Rule
sets forth the definitions applicable to
all provisions of the Rule. Most of the
definitions are unchanged from the
Proposing Release, but a few definitions
are revised to respond to commenters’
suggestions or to add clarity to the
amendments.
Quotation Medium. The current
definition of ‘‘interdealer quotation
system’’ will be incorporated into the
definition of ‘‘quotation medium’’ in
paragraph (j)(12).
80
This definition of
quotation medium is quite inclusive: it
covers any publication, alternative
trading system (ATS), or other device
that is used by brokers or dealers to
make known to others their interest in
transactions in any security, including
offers to buy or sell at a stated price or
otherwise, or invitations of offers to buy
or sell.
81
A few ATSs expressed concern
about whether they would have to
comply with the Rule’s information
review requirements with regard to any
covered OTC security that is traded on
their systems by broker-dealer
subscribers to such ATSs.
82
ATSs are
included in the definition of ‘‘quotation
medium’’ if they display subscriber
orders to any person other than ATS
employees. The Rule’s information
review requirements, however, apply
only to the broker-dealers that submit
quotations for publication by the ATS,
and not to the ATS functioning as the
quotation medium for them. The Rule
will apply to an ATS only if, as a
registered broker-dealer, it displays its
own orders in the ATS.
An issue has also been raised about
whether Rule 15c2–11 applies to broker-
dealers submitting orders through an
ATS. We understand that some broker-
dealers have taken the position that
compliance with Rule 15c2–11 is not
necessary when they submit an order
through an ATS.
83
They have viewed
such an order for the security as not
constituting a quotation within the
meaning of Rule 15c2–11. These orders
may represent transactions for the
broker-dealer’s own account. The Rule’s
definition of quotation makes clear that
the Rule covers any indication of
interest by a broker or dealer in
receiving bids or offers from others for
a security, or any indication by a broker
or dealer that it wishes to advertise its
general interest in buying or selling a
particular security. Thus, broker-dealers
are subject to the Rule when they place
any indication of interest in any
quotation medium, including an ATS,
that they wish to receive bids or offers
in a covered OTC security, unless they
can rely on one of the Rule’s
exceptions.
84
Also, we are clarifying the Rule’s
application to broker-dealers that
publish quotations in multiple
quotation mediums or move their
quotations from one quotation medium
to another. If the broker-dealer complies
with the Rule’s provisions, based upon
a review of information, it may publish
quotations in one or more quotation
mediums.
85
Net tangible assets. We are proposing
to add a definition to the Rule to assist
broker-dealers in assessing whether or
not a security can meet the proposed
exception to the Rule for securities of
issuers with net tangible assets
exceeding $10 million. Net tangible
assets means total assets less intangible
assets and liabilities and this
determination must be based on the
issuer’s current financial statements,
which must be audited.
G. Preservation of Documents and
Information
To facilitate compliance with the
Rule’s recordkeeping requirements, we
believe that it is appropriate to codify
the Rule’s record preservation
requirements in Rule 17a–4,
86
rather
than in Rule 15c2–11. Rule 17a–4
obligates broker-dealers to preserve
documents and information that they
must compile pursuant to Commission
rules for the time period and in the
manner specified in the various
provisions of Rule 17a–4. As in the
Proposing Release, Rule 17a–4 would be
amended to add the information
specified in reproposed paragraphs (c),
(d), and (e) of Rule 15c2–11 to the other
information that broker-dealers are
already required to preserve under Rule
17a–4.
87
With regard to issuer information that
is accessible to broker-dealers through
our EDGAR system, any other federal or
state electronic information system,
88
or
an information repository, the
amendments provide different
requirements. If broker-dealers obtain
and review the information contained
on such systems, they will not need to
preserve such information separately, as
long as they document the review and
the information is accessible on such
system for the same period of time that
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11136Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
89
The reproposal would provide the Commission
with the authority to grant an exemption from the
Rule for any quotation for a security or any class
of security.
90
See, e.g., Florida Comment Letter.
91
15 U.S.C. 78w(a)(2).
92
15 U.S.C. 78c.
93
See, e.g., SEC v. Global Financial Traders, Ltd.,
Litigation Release Nos. 15291 (March 14, 1997), and
15338 (April 17, 1997).
the broker-dealers are obligated to
preserve such information pursuant to
Rule 17a–4.
H. Transition and Exemptive Authority
Provisions
We are reproposing the transition
provision covering quotations by broker-
dealers that were initiated prior to the
effective date of the proposed
amendments and, with a slight
modification, the provision giving the
Commission the authority to grant
exemptions from the Rule.
89
These
proposed provisions were viewed as
adequate by the few commenters who
discussed them.
90
I. Information submitted to the NASD
Rule 15c2–11 currently requires any
broker-dealer covered by the Rule to
submit the information required under
paragraph (a)(5) (i.e., for non-reporting
issuers) to the interdealer quotation
system, in the form prescribed by the
system, at least three business days
before submitting a quotation for
publication. We intend to amend this
obligation by requiring broker-dealers to
submit the information that they must
review only to the NASD, in accordance
with the NASD’s rules.
The amendments are substantially the
same as originally proposed, except for
one change. Under the Proposing
Release, a broker-dealer would be in
compliance with the requirement to
obtain current reports filed by a
reporting issuer, if the broker-dealer
obtained all current reports filed with
the Commission by an issuer as of a date
up to three business days before the
earlier of the date the broker-dealer
submitted the quotations to the
quotation medium and the date the
broker-dealer submitted information to
the NASD. To reduce the chance that a
broker-dealer would overlook a recently
filed report containing material issuer
information, we are proposing to
eliminate the reference to the date the
information was submitted to the
NASD. This means that a broker-dealer
would be required to obtain current
reports filed by a reporting issuer after
the broker-dealer had submitted
information to the NASD, if such reports
were filed more than three business
days in advance of the publication of
the quotation.
IV. General Request for Comments
We solicit comment on all aspects of
the amendments to Rule 15c2–11, as
well as on any other matter that might
have an impact on the reproposal
discussed above. In particular, we seek
comment on the whether the reproposal
will help focus the Rule on those
securities and quotations most likely to
be involved in microcap fraud.
Commenters are requested to address
whether there are other ways to amend
the Rule that would help reduce fraud
and manipulation in the OTC market.
Commenters also are invited to address
whether the Rule’s text is sufficiently
clear and understandable, or whether it
can be simplified without sacrificing its
purposes. We also request commenters
to provide us with their views regarding
whether the original proposal, or
aspects of it, are preferable to the
reproposal.
We encourage commenters to focus on
the various provisions of the reproposal
and bring to our attention any
compliance or other specific issues that
they may encounter if the reproposal is
adopted. Commenters are urged to
provide us with their views as
expeditiously as possible so that we can
complete our review of Rule 15c2–11.
V. Effects on Efficiency, Competition,
and Capital Formation
Section 23(a)(2) of the Exchange Act
requires the Commission, in adopting
rules under the Exchange Act, to
consider the anti-competitive effects of
any rules it adopts thereunder, and to
not adopt any rule that would impose a
burden on competition not necessary or
appropriate in the public interest.
91
Furthermore, Section 3(f) of the
Exchange Act
92
requires the
Commission, when engaged in
rulemaking, to consider or determine
whether an action is necessary or
appropriate in the public interest, and
whether the action will promote
efficiency, competition, and capital
formation.
We preliminarily believe that the
reproposal would not have any anti-
competitive effects that are not
necessary or appropriate in the public
interest. By applying the Rule to the first
broker-dealer publishing any quotations
for a security in a quotation medium
and to other broker-dealers publishing
priced quotations thereafter, the
availability of information about issuers
of covered OTC securities should be
increased. This should help improve the
level of competition among broker-
dealers publishing priced quotations
and enhance the extent of information
about OTC issuers that is available to
the investing public. Moreover, by
excluding unpriced quotations from the
Rule, anti-competitive burdens will be
reduced because broker-dealers that
cannot, or do not want to, obtain the
specified information can still advertise
their interest in buying or selling a
particular OTC security in a quotation
medium. Finally, the reproposal should
have a beneficial impact on capital
formation because microcap fraud
ultimately increases the costs of raising
capital for legitimate smaller issuers.
Investors may be less willing to commit
their resources if they are concerned
about fraudulent activities in OTC
securities.
We request comments on the benefits,
as well as the adverse consequences,
that may result with respect to
efficiency, competition and capital
formation, if the reproposal is adopted.
VI. Costs and Benefits of the
Amendments
We request commenters to evaluate
the costs and benefits associated with
the amendments to Rule 15c2–11. We
have identified certain costs and
benefits relating to the reproposal,
which are discussed below, and
encourage commenters to discuss any
additional costs or benefits. In
particular, we request comments on the
potential costs for any necessary
modifications to information gathering,
management, and reporting systems or
procedures that would be necessary to
implement the amendments, as well as
any potential benefits resulting from the
reproposal for issuers, investors, broker-
dealers, securities industry
professionals, regulators or others.
Commenters should provide analysis
and data to support their views on the
costs and benefits associated with the
amendments.
A. Benefits
Incidents of microcap fraud
frequently involve issuers for which
public information is limited.
93
Without
information, it is difficult for investors,
securities professionals, and others to
evaluate the risks presented by these
securities. Consequently, many
investors fall prey to persons who make
false representations and unrealistic
predictions about these securities. The
publication of quotations by broker-
dealers can facilitate the fraudulent
promotion of microcap securities.
In our view, the reproposal generally
would improve the quality of the
markets for securities subject to Rule
15c2–11 and would help protect
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11137Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
94
NASD Manual, Marketplace Rules, Rule 6740.
95
We computed these cost estimates after
reviewing, among other sources, responses to a
survey of broker-dealers conducted by the NQB
about issues raised in the Proposing Release. The
results of the NQB’s survey are available in File No.
S7–3–98 at the Commission’s Public Reference
Room, 450 Fifth Street N.W., Washington, D.C.
20549.
96
The cost estimate assumes that clerical staff are
paid at an average rate of $15 per hour and
supervisory compliance staff are paid at an average
rate of $100 per hour. The blended compensation
rate assumes that 70% of the time is clerical and
30% is supervisory compliance [(0.7 × $15) + (0.3
× $100) = $40].
97
See OTC Bulletin Board Release.
investors from fraudulent schemes
involving these securities. The
reproposal is focused on the OTC-
quoted securities of smaller issuers.
Absent the amendments, we believe that
some broker-dealers would submit
quotations without regard to basic
information about relatively unknown
issuers. In our view, when broker-
dealers must review specified issuer
information before publishing priced
quotations, they are less likely to
become unwitting participants in
unlawful schemes of unscrupulous
broker-dealers or promoters. Market
makers in the securities of legitimate
microcap issuers, as well as the issuers
themselves, also would benefit from
improving the integrity of this market
sector. One benefit of the reproposal is
that the scope of the Rule will be
revised so that broker-dealers will not
have to obtain information about those
securities that satisfy any one the
proposed alternative tests.
We also believe that the amendments
will serve an important surveillance
function. Currently, only the first
broker-dealer quoting a security in a
quotation medium must gather, review,
and preserve the information. The
amendments will require the first
broker-dealer initiating any quotation
and all broker-dealers initiating priced
quotations thereafter to satisfy the
Rule’s information review requirements.
Moreover, under NASD Rule 6740,
94
broker-dealers demonstrate their
compliance with that rule by filing the
Rule 15c2–11 information with the
NASD. Recently, the review of Forms
211 filed with the NASD has resulted in
a number of Commission trading
suspensions and other enforcement
actions.
The amendments require broker-
dealers publishing quotes in compliance
with the Rule to provide the information
upon request to any customer,
prospective customer, other broker-
dealers, or information repository unless
the information is available through a
government sponsored database. This
amendment will help make information
about non-reporting issuers more widely
available to the public.
We also believe that the amendments
will ease significantly the Rule’s
recordkeeping requirement because
broker-dealers will not have to retain
information that is available on the
Commission’s EDGAR system or on the
information systems of other federal or
state authorities. Access to EDGAR and
similar government-sponsored
information systems is free on the
Internet. Given that approximately 60%
of securities on the OTC Bulletin Board
and Pink Sheets are issued by reporting
companies, whose reports are included
on EDGAR, a significant recordkeeping
cost savings to broker-dealers should
result.
We do not have the data to quantify
the value of the benefits described
above. We seek comments on the value
of these benefits and on any benefits,
not already identified, that may result
from the adoption of the amendments.
B. Costs
We anticipate that the elimination of
the piggyback provision will create the
most significant costs that the industry
will incur. Currently, only those broker-
dealers that publish quotations during
the first 30 days of the security’s trading
are required to obtain and review the
specified information before they
initiate quotations. As reproposed, the
Rule will continue to require the first
broker-dealer, before initiating a priced
or unpriced quotation for a covered OTC
security in a quotation medium, to
review the specified information.
Thereafter, the reproposed Rule will
impose the review requirement only on
broker-dealers publishing priced
quotations, including in connection
with the annual review requirement. Of
course, if the Commission suspends
trading under Exchange Act Section
12(k) for any of the issuer’s securities,
the Rule’s requirements are triggered.
The first broker-dealer, before
initiating any quotation for a covered
OTC security, is currently required to
incur the cost of having to gather and
review the issuer information. As a
result of the amendments, that broker-
dealer will incur the cost to update that
information annually if it continues to
publish priced quotations. Thereafter,
any broker-dealer publishing priced
quotations for a covered OTC security
will incur costs when it first publishes
a priced quotation and when it conducts
the required annual review. To the
extent a broker-dealer does not already
have the required information, it will
incur costs for the collection and review
of this information. Moreover, a broker-
dealer also will incur costs associated
with creating the records required by
the Rule and retaining the Rule’s
required information for the specified
period of time under the amendment to
Rule 17a–4.
We estimate that approximately 60%
of the issuers of OTC stocks are
reporting issuers, while the remaining
40% are non-reporting issuers. Based on
this assumption, broker-dealers
publishing priced quotations for the
OTC securities of reporting issuers
should be able to obtain the prescribed
information required by the reproposed
Rule from the Commission’s EDGAR
system and therefore should incur
minimal costs to comply with the Rule.
We believe that it will take a broker-
dealer a maximum of 4 hours to collect,
review, record, retain, and supply to the
NASD the information pertaining to a
reporting issuer, and a maximum of 8
hours to collect, review, record, retain,
and supply to the NASD the information
pertaining to a non-reporting issuer.
95
We estimate that it will cost a broker-
dealer an average cost of $40 per hour
(based on a blended compensation rate
for clerical and supervisory compliance
staff) to obtain and review the necessary
information required by the Rule.
96
We recently approved changes to
NASD Rules 6539 and 6540 to limit the
quotations on the OTC Bulletin Board to
securities of issuers that are current in
their reports filed with us or other
regulatory authority, and to prohibit
NASD members from quoting a security
on the OTC Bulletin Board unless the
issuer has made current filings with
us.
97
While these NASD Rule changes
may result in more issuers choosing to
become reporting issuers in order to
continue to qualify for quotation on the
OTC Bulletin Board, we are at this time
unable to adequately quantify the cost
impact or burden that the reproposal
imposes in relation to these rule
changes. However, we believe that,
generally, any increase in the number of
reporting issuers subject to the Rule will
cause a reduction in the number of the
burden hours and associated costs. We
are of the view that because reporting
issuer information is readily available
from the Commission’s EDGAR system
and, because we estimate that broker-
dealers only have to spend 4 hours
reviewing reporting issuer information,
instead of the estimated 8 hours to
review non-reporting issuer
information, the reduced time spent
reviewing issuer information will result
in lower costs to broker-dealers.
However, broker-dealers publishing
priced quotations for the OTC securities
of non-reporting issuers are likely to
incur greater costs in complying with
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11138Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
98
See 5 U.S.C. 603.
99
For purposes of the regulatory flexibility
analysis, a broker-dealer is considered ‘‘small’’ if its
total capital is less than $500,000, and is not
affiliated with a broker-dealer that has $500,000 or
more in total capital.
100
See Securities Exchange Act Release No.
40122 (June 24, 1998), 63 FR 35508 (adopting
amendments to the definitions of ‘‘small business’’
or ‘‘small organization’’ under the Investment
Company Act of 1940, the Investment Advisers Act
of 1940, the Securities Exchange Act of 1934, and
the Securities Act of 1933).
the Rule. For purposes of the Paperwork
Reduction Act, we estimate the total
burden hours for all broker-dealers to be
143,278 hours and the total cost to be
$5,731,120. Some broker-dealers may
not want to expend the time or the cost
to obtain the non-reporting issuer
information and may therefore choose
not to publish priced quotes. On the
other hand, the costs broker-dealers
incur in obtaining and reviewing
information about non-reporting issuers
may be reduced if one or more on-line
information repositories of this
information are established. We seek
comments on the reasonableness of
these estimates for annual hourly and
dollar costs to broker-dealers. We also
seek comments on the extent to which
these cost estimates will be affected by
the new NASD rule to limit the OTC
Bulletin Board to the securities of
issuers current in their periodic filings.
Although Rule 15c2–11 does not
regulate issuers, there may be some
indirect costs imposed on issuers,
particularly non-reporting issuers,
because they may be contacted by
broker-dealers to provide the
information specified in the Rule. Non-
reporting issuers would incur the cost of
having to collect and provide the
requested information to each
requesting broker-dealer. However, we
are assuming that non-reporting issuers
maintain their financial information in
compliance with prevailing accounting
standards and, in most instances, would
have available updated financial
information prepared in accordance
with generally accepted accounting
principles (GAAP). The NASD has
informed us that financial statements
submitted with the Form 211 generally
are prepared in accordance with GAAP,
and many are audited.
Regarding start-up, operating, and
maintenance costs, we believe that
broker-dealers that collect, review, and
retain the information currently
required by the Rule, would incur only
marginal start-up, operating, and
maintenance costs (i.e., to expand
systems already in place) to comply
with the Rule as reproposed. Further,
some broker-dealers already may be
collecting the required information for
other purposes. However, we believe
that some broker-dealers may not have
adequate systems in place to retain
issuer information and would, therefore,
incur start-up, operating, and
maintenance costs in order to comply
with the requirements of the
amendments.
We estimate that about 100 broker-
dealers in the aggregate will incur start-
up, operating, and maintenance costs of
$100,000 ($1,000×100) associated with
reporting issuer information, and
$400,000 ($4,000×100) associated with
non-reporting issuer information. Total
start-up, operating and maintenance
cost burden for broker-dealers is
estimated to be $500,000
($100,000+$400,000) or an average of
$5,000 for each broker-dealer.
We assume that non-reporting issuers,
because they generally maintain their
financial information in compliance
with prevailing accounting standards,
will not incur any start-up costs to
prepare the required information in
response to broker-dealers’ requests. We
also believe that reporting issuers of
covered OTC securities will not incur
start-up costs as a result of the
amendments since such issuers already
provide the required information to the
Commission under the federal securities
laws. Therefore, we believe issuers will
not incur start-up costs as a
consequence of the adoption of the Rule
amendments, as reproposed.
Finally, the Rule, as modified by the
amendments, could affect the liquidity
of some securities. If broker-dealers are
unable to obtain the required issuer
information, they would have to refrain
from publishing priced quotations in
that security. This could make it
somewhat more difficult for investors to
determine what prices other market
participants are willing to bid or offer
for the security, although they could call
a broker-dealer publishing a name-only
quotation to obtain a priced quotation.
Thus, while investors are still able to
obtain price information, the cost of
obtaining this information may increase.
However, under the reproposal, after the
first quotation for a security is
published, broker-dealers could publish
unpriced quotes without complying
with the Rule’s provisions. In addition,
broker-dealers could rely on the
exception that permits them to publish
quotes representing unsolicited
customer orders.
Any effect on liquidity must be
weighed against the benefit of reducing
instances of fraud or manipulation.
Greater investor access to information
should result in more informed investor
decisions and potentially could result in
additional trading, and thus liquidity,
for covered OTC securities. We have
modified the proposals to permit broker-
dealers to publish unpriced quotations
for OTC securities without reviewing
the specified information (other than the
first broker-dealer to quote the security).
This revision responds to the views of
those commenters that expressed
concerns about the Rule’s impact on
liquidity.
VII. Initial Regulatory Flexibility Act
We have prepared an Initial
Regulatory Flexibility Analysis (IRFA)
98
regarding the amendments to Rule
15c2–11 and the reproposed companion
amendment to Rule 17a–4 under the
Exchange Act. The following
summarizes the IRFA.
As discussed in the IRFA, the
amendments specify the information
that a broker-dealer must gather and
review before publishing quotations for
covered OTC securities. The reproposed
Rule is intended to prevent broker-
dealers from publishing quotations for
covered OTC securities in a quotation
medium without obtaining, reviewing,
and retaining current information about
the issuer. The reproposed Rule applies
primarily to priced quotations.
The amendments to the Rule would
affect all broker-dealers, including a
number of small broker-dealers, seeking
to publish quotations for covered OTC
securities.
99
The number of small
broker-dealers that publish quotations
for covered OTC securities in quotation
mediums is not known at this time.
However, we recently estimated that
about 13% of all registered broker-
dealers would be characterized as
small.
100
We estimate that, at any given
time, there are approximately 400
broker-dealers, including small broker-
dealers, that submit quotations for
covered OTC securities. Therefore,
based on this estimate, we believe that
approximately 52 small broker-dealers
(400×13%) would be affected by the
amendments. In fact, it is possible that
few, if any, broker-dealers publishing
quotations for covered OTC securities
would be classified as a small business,
because as market makers they typically
require more than $500,000 in capital to
support their market making activities.
In the Proposing Release, we solicited
but did not receive any comments on
the number of small broker-dealers that
would be affected by the amendments.
We are again soliciting comments on the
number of small broker-dealers that
would be affected by the amendments.
The amendments would indirectly
have an impact on those small issuers
that may be requested to provide the
information required by the Rule to
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11139Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
101
44 U.S.C. 3501 et seq.
102
The Commission notes that a separate PRA
filing was not prepared to reflect the proposed
companion changes to Rule 17a–4. The burden
hours and costs described for the Rule include and
account for the anticipated burdens that may arise
as a result of the proposed change to Rule 17a–4.
103
The NASD has a rule requiring broker-dealers
that initiate or resume quotations for covered equity
securities to submit verification that they have
collected the information necessary to comply with
NASD requirements, as well as Rule 15c2–11. See
NASD Manual, Marketplace Rules, Rule 6740.
broker-dealers publishing quotations in
those issuers’ securities. Based on
Exchange Act Rule 0–10(a), a small
issuer is one that on the last day of its
most recent fiscal year had total assets
of $5,000,000 or less. In the Proposing
Release, we solicited but did not receive
any comments on the total number of
issuers of covered OTC securities; the
number (or percentages) of these issuers
that are small issuers; and the total
number (or percentage) of small issuers
of covered OTC securities that are
reporting and non-reporting issuers,
respectively. We are again seeking
comments on these issues.
The IRFA notes that the availability of
the Commission’s EDGAR system and
similar systems sponsored by federal or
state authorities should assist broker-
dealers in collecting and reviewing the
reports required by the Rule. In
addition, the prevalent use of computers
and the Internet, on which access to
EDGAR is free, should also reduce the
recordkeeping and compliance costs for
all broker-dealers by automating the
information collection and retention
process.
The IRFA recognizes that the
amendments indirectly affect certain
issuers, particularly non-reporting
issuers. The amendments would require
the first broker-dealer to publish any
quotation for a covered security to
review the Rule’s information.
Thereafter, other broker-dealers must
review information about the issuer
when they first publish or resume
publishing a priced quotation for a
covered security, and all broker-dealers
publishing priced quotations must
conduct an annual review. We are not
aware of any information repository,
electronically accessible or otherwise,
now in existence that covers all of the
information about non-reporting issuers
that broker-dealers must gather to
comply with the Rule. Consequently,
non-reporting issuers must collect and
provide the required information to
each requesting broker-dealer. We
assume that non-reporting issuers
maintain their financial information in
compliance with generally accepted
accounting standards and that the costs
incurred by non-reporting issuers to
prepare the necessary information in
response to broker-dealers’ requests
would be minimal.
The IRFA discusses the kinds of
possible alternative proposals that we
have considered. These include, among
others, creating differing compliance or
reporting requirements or timetables
that take into account the resources
available to small entities, and whether
such entities could be exempted from
the reproposed rule, or any part thereof.
Therefore, having considered the
foregoing alternatives in the context of
the amendments, we do not believe they
would accomplish the stated objectives
of the proposal.
We encourage the submission of
written comments regarding any aspect
of the IRFA. In particular, we seek
comments on: (i) the number of small
entities that would be affected by the
amendments, including the number of
small broker-dealers and issuers; (ii) the
number of small entities that are issuers
of covered OTC securities; and (iii) the
number of small entities that are
reporting and non-reporting issuers of
covered securities, respectively.
Comments should also specify the costs
of compliance with the amendments,
and suggest alternatives that would
meet the objectives of the amendments
in a more effective manner, while
imposing costs equal to or less than the
amendments. In describing the nature of
any impact that the amendments would
have, empirical data supporting these
views should be provided.
For purposes of the Small Business
Regulatory Enforcement Fairness Act of
1996, we are also requesting information
regarding the potential impact of the
proposed amendments on the economy
on an annual basis. In particular,
comments should address whether the
proposed changes, if adopted, would
have a $100,000,000 annual effect on
the economy, cause a major increase in
costs or prices, or have a significant
adverse effect on competition,
investment, or innovations. Commenters
should provide empirical data to
support their views.
Comments should be submitted in
triplicate to Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
450 Fifth Street, NW, Washington, DC
20549. Comments may also be
submitted electronically at the following
E-mail address: [email protected].
All comment letters should refer to File
No. S7–5–99; this file number should be
included on the subject line if E-mail is
used. Comment letters will be available
for public inspection and copying in the
Commission’s Public Reference Room,
450 Fifth Street, NW, Washington, DC
20549. Electronically submitted
comment letters will also be posted on
the Commission’s Internet website
(http://www.sec.gov).
A copy of the Initial Regulatory
Flexibility Analysis may be obtained by
contacting Chester A. McPherson, Office
of Risk Management and Control,
Division of Market Regulation,
Securities and Exchange Commission,
450 Fifth Street, NW, Washington, DC
20549, at (202) 942–0772.
VIII. Paperwork Reduction Act
Certain provisions of the amendments
contain ‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act of 1995
(PRA).
101
The title for the collection of
information is: ‘‘Publication or
submission of quotations without
specified information.’’ Accordingly, the
collection of information requirements
contained in the Rule and the initial
proposal were submitted to the Office of
Management and Budget (OMB) for
review, in accordance with 44 U.S.C.
3507(d) and 5 CFR 1320.11, and were
approved by OMB. The Rule has been
assigned OMB Control No. 3235–
0202.
102
A. Collection of Information Under the
Amendments
As reproposed, the Rule would
require the first broker-dealer, before
initiating a priced or unpriced quotation
for a covered OTC security in a
quotation medium, to gather and review
the issuer information, and to review
updated information annually if it
continues to publish priced quotations.
This review requirement would also be
imposed on any other broker-dealer
publishing a priced quotation for a
covered OTC security. Broker-dealers
submitting priced quotations for the
security would be required to collect,
review, and retain the Rule’s specified
information annually. Broker-dealers
would also have to record the sources of
their information, the date their review
occurred, and the person responsible for
the review. Also, the proposals would
require broker-dealers publishing
quotations for a covered OTC security to
collect, review, and retain more
information than is required currently.
Under Rule 15c2–11, the information
that is collected pursuant to the Rule
must be submitted to the NASD at least
three business days before any quotation
is published.
103
Finally, the
amendments would require broker-
dealers to provide the information
specified to any customer, prospective
customer, other broker-dealer or
information repository that requests it.
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11140Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
104
We recognize that there may be covered OTC
securities quoted in other quotation mediums, but
at this time we do not have the empirical data to
include them in our estimations.
105
This estimate is based on the assumption that
the NASD will, in the first year after the reproposal
becomes effective, approve 10% fewer Form 211
filings than the 1,400 applications approved in
1998.
B. Proposed Use of Information
Broker-dealers must collect and
review the information required under
the amendments if they publish the first
quotation for a covered OTC security or
if they publish priced quotations.
Moreover, the Rule requires that broker-
dealers have a reasonable basis for
believing that the information about the
issuer and related persons is accurate
and from reliable sources. This
information collection protects investors
by deterring fraudulent or manipulative
quotations for thinly-traded securities
whose issuers are relatively unknown.
Because information about these issuers
is not widely disseminated and often is
not current, fraudulent and
manipulative schemes are easier to
perpetrate. Moreover, this collection of
information helps broker-dealers guard
against becoming unwitting participants
in fraudulent or manipulative schemes.
The Rule 15c2–11 information gathering
requirements also serve an important
surveillance function for both the
Commission and the NASD. Recently,
the Commission has used the Rule
15c2–11 information to suspend trading
in the issuers’ securities pursuant to
Section 12(k) of the Exchange Act where
publicly available information about the
issuer raised questions about the
accuracy and adequacy of the issuers’
disclosures.
C. Respondents
The amendments would apply to
those broker-dealers that publish
quotations for a covered OTC security in
a quotation medium as of specified
quotation events. The amendments also
indirectly affect issuers that are asked
by broker-dealers to provide this
information. Most of the Rule 15c2–11
information that would be required for
issuers that publicly file periodic
reports with the Commission (reporting
issuers) is available electronically on
EDGAR or through the Internet. Thus,
the reproposal is likely to have a greater
paperwork burden when broker-dealers
publish quotations for the securities of
issuers that do not participate in the
Commission’s public reporting program,
(i.e., non-reporting issuers) or do not file
reports with other federal or state
regulatory authorities.
D. Total Annual Reporting and
Recordkeeping Burden
The amendments would require
broker-dealers to collect, review, retain,
and record certain issuer and
supplemental information when they
are the first broker-dealer to quote the
security; when they first publish priced
quotations for a covered OTC security;
and if they are publishing priced
quotations as of the annual review
requirement. The discussion below
estimates the collection of information
burden one year after the anticipated
date of effectiveness of the amendments
when broker-dealers that publish quotes
for covered OTC securities qualifying
for the reproposed transition provision
must fully comply with the Rule’s
information requirements. The
discussion below also provides
estimates for the same period for issuers
that may be contacted to provide the
information. In particular, the following
analysis measures the cost to broker-
dealers of: (1) collecting, reviewing,
recording, and retaining the required
issuer information and supplying it to
the NASD; (2) responding to requests for
issuer information from customers,
prospective customers, other broker-
dealers and information repositories;
and (3) starting up or maintaining
systems for the collection and retention
of issuer information. The analysis
below also addresses the indirect cost to
issuers who must furnish information to
requesting broker-dealers.
1. Burden-Hours for Broker-Dealers
Based on information provided by the
NASD and NQB, we estimate that as of
December 31, 1998, there were
approximately 6,625 covered OTC
securities quoted in the OTC Bulletin
Board and 3,225 quoted in the Pink
Sheets for a total of 9,850 covered OTC
securities.
104
We also believe that
approximately 10% (985) of these
securities would not be subject to the
Rule, based on the exceptions that are
included in this reproposing Release
and that approximately 8,865 securities
would be subject to the Rule. According
to NASD estimates, we also believe that
approximately 1,400 new applications
from broker-dealers to initiate or resume
publication of covered equity securities
in the OTC Bulletin Board and/or the
Pink Sheets or other quotation mediums
were approved by the NASD for the
1998 calendar year. We have estimated
that 60% of the covered OTC securities
were issued by reporting issuers, while
the other 40% were issued by non-
reporting issuers. We also estimate that
broker-dealers publish priced quotations
for approximately 90% of the covered
OTC securities quoted in the OTC
Bulletin Board and publish priced
quotes for about 10% of the covered
OTC securities quoted in the Pink
Sheets. According to NASD and NQB
estimates, we believe that, on average,
there are approximately 4.3 broker-
dealers publishing priced quotations for
each covered OTC security, and that at
any given time there are no more than
400 broker-dealers that submit priced
quotations for covered OTC securities.
Finally, the reproposed Rule’s transition
provision would not subject the broker-
dealers quoting the securities of the
estimated 8,865 potentially covered
securities currently quoted in the OTC
Bulletin Board and/or the Pink Sheets
until the annual review requirement is
triggered. Therefore, only those new
applications that are submitted after the
reproposal becomes effective would be
subject to the initial review
requirement.
Because the amendments would
require the first broker-dealer
publishing a quotation, priced or
unpriced, for a particular security to
collect issuer information, we believe
that during the first year after the
amendments are effective, broker-
dealers that are publishing the first
quotations (whether priced or unpriced)
for covered OTC securities in the
aggregate would have to conduct
approximately 1,260 initial reviews of
issuer information.
105
We believe that it
will take a broker-dealer about 4 hours
to collect, review, record, retain, and
supply to the NASD the information
pertaining to a reporting issuer, and
about 8 hours to collect, review, record,
retain, and supply to the NASD the
information pertaining to a non-
reporting issuer.
We therefore estimate that after the
reproposal has become effective, the
broker-dealers who are the first to
publish the first quote for a covered
OTC security of a reporting issuer
(priced or unpriced) will require 3,024
hours (1,260×60%×4) to collect, review,
record, retain, and supply to the NASD
the information required by the Rule as
reproposed. We estimate that after the
reproposal has become effective the
broker-dealers who are the first to
publish the first quote for a covered
OTC security of a non-reporting issuer
(priced or unpriced) will require 4,032
hours (1,260×40%×8) to collect, review,
record, retain, and supply to the NASD
the information required by the Rule as
reproposed. We therefore estimate the
total annual burden hours for the first
broker-dealers to be 7,056 hours
(3,024+4,032).
The Rule also would require an
annual review for broker-dealers
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11141Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
106
Some securities have priced quotations
published in both of these quotation systems. To
avoid double counting, such securities are counted
as OTC Bulletin Board securities.
publishing priced quotations for
covered OTC securities. We have
estimated that each issuer is quoted by
about 4.3 broker-dealers. We are
assuming that of the universe of
approximately 8,865 potentially affected
covered OTC securities, broker-dealers
would publish priced quotations for
approximately 90% of the OTC Bulletin
Board securities or 5,366 securities
((6,625×90%)×90%) and for 10% of the
Pink Sheet securities or 290 securities
(3,225×90%)×10%).
106
Therefore, we
estimate that priced quotations will be
published for approximately 5,656
(5,366+290) covered OTC securities.
Given that about 60% of OTC stocks are
issued by reporting issuers and the other
40% by non-reporting issuers, and that
it would take a broker-dealer 4 and 8
hours, respectively, to meet the
requirements of the reproposed Rule for
these issuers, we estimate the burden
hours as follows: for reporting issuers
we estimate approximately 58,375 hours
(3,394×4.3×4), and for non-reporting
issuers we estimate approximately
77,847 hours (2,263×4.3×8). Therefore,
we estimate the total annual paperwork
burden hours for all broker-dealers to be
143,278 hours (7,056+58,375+77,847).
2. Burden-Hours for Issuers
Regarding the burden on issuers to
provide broker-dealers with the required
information, we believe that the 5,319
issuers of covered OTC securities (based
on our estimate that 60% of the 8,865
potentially covered OTC securities are
reporting issuers) will not bear any
additional hourly burdens under the
amendments because these issuers
already report the required information
to the Commission through mandated
periodic filings. Further, reporting
issuer information is widely available to
broker-dealers through a variety of
media. However, non-reporting issuer
information is not widely available.
Consequently, these issuers must
provide the information required by the
amendments to requesting broker-
dealers before quotations in their
securities can be published. We believe
that the 3,546 issuers of non-reporting
covered OTC securities (based on an
estimate that 40% of the 8,865
potentially covered OTC securities are
non-reporting ) will spend an average of
9 hours each to collect, prepare, and
supply the information required by the
proposals to the first broker-dealer that
requests this information. Thereafter, we
estimate that it will take an average of
1 hour for an issuer to provide the same
information to the remaining 3.3 broker-
dealers that request the information.
Accordingly, we estimate the 3,546 non-
reporting issuers annually will incur
31,914 hours (3,546×9×1) to comply
with the first broker-dealer’s request for
information, and 11,702 hours
(3,546×1×3.3) to comply with the
subsequent 3.3 broker-dealer requests
for an annual total of 43,616 burden
hours (31,914+11,702). On average,
therefore, each non-reporting issuer
would spend approximately 12.3
burden hours (43,616/3,546) per year to
comply with these requests.
3. Total Burden-Hour Costs to Broker-
Dealers and Issuers
We estimate the collection of
information will require approximately
186,894 burden hours annually (143,278
+ 43,616) from approximately 3,946
respondents (400 broker-dealers and
3,546 issuers).
4. Capital Cost to Broker-Dealers and
Issuers
We believe that broker-dealers that
now collect, review, and retain the
information required by the current
Rule will not incur any significant start-
up costs to expand systems already in
place. Further, broker-dealers that are
collecting the information required by
the proposals for other purposes also
will not incur significant start-up costs.
However, we believe some broker-
dealers may not have adequate systems
in place to retain issuer information and
will incur start-up costs in order to
comply with the requirements of the
amendments. We assume that of the 400
broker-dealers that provide quotations
for covered OTC securities, about 100
broker-dealers will incur additional
start-up costs, while the remaining 300
broker-dealers will only incur
incremental costs. Because the
information for reporting issuers will be
generally available on EDGAR and such
availability satisfies the recordkeeping
requirements of the proposals, we are
assuming that the start-up costs
associated with retaining information on
reporting issuers will average $1,000 per
broker-dealer, whereas the same costs
will be $4,000 per broker-dealer for non-
reporting issuer information. We
estimate that broker-dealers in the
aggregate will incur start-up, operating,
and maintenance costs of $100,000
($1,000 × 100) associated with reporting
issuer information, and $400,000
($4,000 × 100) associated with non-
reporting issuer information. Total start-
up, operating and maintenance cost
burden for broker-dealers is estimated to
be $500,000 ($100,000 + $400,000) or an
average of $5,000 for each broker-dealer.
We assume that non-reporting issuers,
because they maintain their financial
information in compliance with
prevailing accounting standards, will
not incur any start-up costs to prepare
the required information in response to
broker-dealers’ requests. We also believe
that reporting issuers of covered OTC
securities will not incur start-up costs as
a result of the amendments since such
issuers already provide the required
information to the Commission under
the federal securities laws. Therefore,
we believe issuers will not incur start-
up costs as a consequence of the
adoption of the Rule amendments, as
reproposed.
E. General Information About the
Collection of Information
The collection of information under
the amendments is mandatory and
would be required at periodic intervals:
by the first broker-dealer to publish any
quote for a covered OTC security, by
broker-dealers publishing priced quotes
thereafter, and by broker-dealers
publishing priced quotes at the time of
the annual review requirement. Broker-
dealers would be required to retain the
information they collect for a period of
not less than three years. Information
collected under the Rule would not be
kept confidential. Any agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of
information unless it displays a
currently valid control number.
F. Request for comments
Pursuant to 44 U.S.C. 3506(c)(2)(B),
we are soliciting comments to:
(i) evaluate whether the reproposed
collection of information is necessary
for the proposed performance of the
functions of the agency, including
whether the information will have
practical utility;
(ii) evaluate the accuracy of our
estimates of the burden of the
reproposed collection of information;
(iii) enhance the quality, utility, and
clarity of the information to be
collected; and
(iv) minimize the burden of collection
of information on those who are to
respond, including through the use of
automated collection techniques or
other forms of information technology.
We seek data about quotations for
covered OTC securities in OTC
quotation mediums other than the OTC
Bulletin Board and the Pink Sheets. We
seek comments on our estimate of the
number of issuers affected by the
reproposed Rule and on the time
estimates made for broker-dealers and
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11142Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
issuers to comply with the information
collection requirements.
Persons desiring to submit comments
on the collection of information
requirements should direct them to the
Office of Management and Budget,
Attention: Desk Officer for the
Securities and Exchange Commission,
Office of Information and Regulatory
Affairs, Room 10102, New Executive
Office Building, Washington, DC 20503,
and should also send a copy of their
comments to Jonathan G. Katz,
Secretary, Securities and Exchange
Commission, 450 Fifth Street, NW,
Washington, DC 20549, and refer to File
No. S7–5–99. OMB is required to make
a decision concerning the collections of
information between 30 and 60 days
after publication of this release in the
Federal Register, so a comment to OMB
is best assured of having its full effect
if OMB receives it within 30 days of this
publication.
IX. Statutory Basis and Text of
Proposed Amendments and Rule
The rule amendments are being
proposed pursuant to Sections 3, 10(b),
15(c), 15(g), 17(a), and 23(a) of the
Securities Exchange Act of 1934, 15
U.S.C. §§78c, 78j(b), 78o(c), 78o(g),
78q(a), and 78w(a).
List of Subjects in 17 CFR Part 240
Broker-dealers, Fraud, Reporting and
recordkeeping requirements, Securities.
Text of Reproposed Rule
In accordance with the foregoing,
Title 17, chapter II, part 240 of the Code
of Federal Regulations is proposed to be
amended as follows:
PART 240—GENERAL RULES AND
REGULATIONS, SECURITIES
EXCHANGE ACT OF 1934
1. The authority citation for part 240
continues to read, in part, as follows:
Authority: 15 U.S.C. §§ 77c, 77d, 77g, 77j,
77s, 77z–2, 77eee, 77ggg, 77nnn, 77sss, 77ttt,
78c, 78d, 78f, 78i, 78j, 78j–1, 78k, 78k–1, 78l,
78m, 78n, 78o, 78p, 78q, 78s, 78u–5, 78w,
78x, 78ll(d), 78mm, 79q, 79t, 80a–20, 80a–23,
80a–29, 80a–37, 80b–3, 80b–4 and 80b–11,
unless otherwise noted.
*       *       *       *       *
2. Section 240.15c2–11 and the
section heading are revised to read as
follows:
§ 240.15c2–11    Publication or submission
of quotations without current information.
Preliminary Note: As a means reasonably
designed to prevent fraudulent, deceptive, or
manipulative acts or practices, this section
prevents a broker or dealer from publishing
a quotation for a security or, directly or
indirectly, submitting a quotation for a
security for publication in a quotation
medium, unless the broker or dealer
complies with the provisions of this section
or relies on an exception contained in
paragraph (h) of this section. As used in this
section, the term ‘‘you’’ refers to a broker or
dealer.
(a) When a broker or dealer must
comply with this section. You must
comply with paragraph (b) of this
section when you publish:
(1) The first quotation for a security;
(2) The first quotation following the
termination of a Commission trading
suspension ordered pursuant to section
12(k) of the Act (15 U.S.C. 78l(k)) in any
security of the issuer of the suspended
security;
(3) Your first quotation at a specified
price for the same security after another
broker or dealer publishes the first
quotation for a security as described in
paragraph (a)(1) or (a)(2) of this section;
(4) A quotation at a specified price for
a security after a period of five or more
consecutive business days when you
did not publish any quotations at a
specified price for that security;
(5) Your first quotation at a specified
price for a security after the date that is
four months after the end of the issuer’s
fiscal year, unless the issuer is a foreign
private issuer; or
(6) Your first quotation at a specified
price for a security of a foreign private
issuer after the date that is seven
months after the end of the issuer’s
fiscal year.
(b) The steps a broker or dealer must
take to comply with this section. For
each security in which you publish any
of the quotations listed in paragraph (a)
of this section, you must:
(1) Review the issuer information
described in paragraph (c) of this
section and the supplemental
information described in paragraph (d)
of this section;
(2) Determine that you have a
reasonable basis under the
circumstances for believing that the
issuer information described in
paragraph (c) of this section, when
considered in conjunction with the
supplemental information described in
paragraph (d) of this section, is accurate
in all material respects and was
obtained from reliable sources;
(3) Make a record of:
(i) The issuer information described
in paragraph (c) of this section, the
supplemental information described in
paragraph (d) of this section, and the
sources from which you obtained the
information. You will be considered to
have obtained the issuer information
described in paragraphs (c) or (d)(1) of
this section if you obtained it through
the EDGAR system, any other federal or
state electronic information system, or
an electronic information system
operated by an information repository,
and you have the means to access the
information for the period required
under §240.17a–4(b)(11);
(ii) Any significant relationship
information described in paragraph (e)
of this section;
(iii) The date that you reviewed the
information described in paragraphs (c),
(d), and (e) of this section; and
(iv) The person responsible for your
compliance with the requirements of
this section; and
(4) Preserve the records required to be
made under paragraph (b)(3) of this
section in accordance with §240.17a–
4(b)(11).
(c) The issuer information that a
broker or dealer must review. The type
of information that is considered ‘‘issuer
information’’ and that must be reviewed
under paragraph (b) of this section
depends on the status of the issuer.
(1) Issuers with a recent public
offering. If the issuer filed a registration
statement under the Securities Act
(other than a registration statement on
Form F–6 (17 CFR 239.36)) that became
effective less than 90 calendar days
before you publish the quotation, and
that is not the subject of a stop order,
the issuer information is the prospectus
specified by section 10(a) of the
Securities Act (15 U.S.C. 77j(a)).
(2) Issuers with a recent Regulation A
offering. If the issuer filed a notification
under Regulation A under the Securities
Act (17 CFR 230.251 through 230.263)
and was authorized to commence the
offering less than 40 calendar days
before you publish a quotation, and the
offering circular provided for under
Regulation A is not the subject of a
suspension order, the issuer information
is the offering circular.
(3) Certain reporting issuers. If the
issuer is current in filing annual or
semi-annual reports required under
section 13 or 15(d) of the Act (15 U.S.C.
78m or 78o(d)) or section 30(a) of the
Investment Company Act of 1940 (15
U.S.C. 80a–29(a)), the issuer information
is the issuer’s most recent annual or
semi-annual report and any quarterly
and current reports filed by the issuer
after such annual or semi-annual report.
You will be considered in compliance
with the requirement to obtain current
reports filed by the issuer if you obtain
all current reports filed by that issuer as
of the date that is three business days
before you publish the quotation.
However, until the issuer has filed its
first annual or semi-annual report, the
issuer information is:
(i) The prospectus specified by
section 10(a) of the Securities Act (15
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11143Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
U.S.C. 77j(a)) that was included in a
registration statement filed by the issuer
under the Securities Act and that
became effective within the prior 15
months; or
(ii) The registration statement filed by
the issuer under section 12 of the Act
(15 U.S.C. 78l) that became effective
within the prior 15 months (other than
a registration statement on Form F–6 (17
CFR 239.36)), and any quarterly and
current reports filed by the issuer after
the registration statement became
effective.
(4) Certain financial institutions. If
the issuer is not required to file reports
under sections 13 or 15(d) of the Act
and is a bank or savings association, as
those terms are defined in 12 U.S.C.
1813, the issuer information is the
issuer’s most recent annual report and
any subsequent reports filed with the
issuer’s appropriate Federal banking
agency or State bank supervisor, as
those terms are defined in 12 U.S.C.
1813.
(5) Certain exempted insurance
companies. If the issuer is exempt from
section 12(g) of the Act (15 U.S.C. 78l(g))
by complying with section 12(g)(2)(G) of
the Act (15 U.S.C. 78l(g)(2)(G)), the
issuer information is the issuer’s most
recent annual statement referred to in
section 12(g)(2)(G)(i) of the Act (15
U.S.C. 78l(g)(2)(G)(i)).
(6) Other issuers. If the issuer is not
covered by paragraphs (c)(1) through
(c)(5) of this section, the issuer
information is the information listed
below in paragraphs (c)(6)(i) through
(c)(6)(xiii) of this section. Except as
specified in paragraph (c)(6)(xiii) of this
section, this information is presumed to
be current if it is as of a date within 12
months before you publish the
quotation and must be the most current
information that you know or have
reason to know is available:
(i) The exact name of the issuer and
any predecessor;
(ii) The address and telephone
number of the issuer’s principal
executive offices;
(iii) The state of incorporation of the
issuer, if it is a corporation;
(iv) The date on which the issuer’s
fiscal year ends;
(v) For each class of the issuer’s
securities outstanding:
(A) The exact title of the security;
(B) The par or stated value of the
security;
(C) The number of securities or total
principal amount outstanding of the
security;
(D) The class and number of securities
issuable upon the security’s exercise,
exchange or conversion, if applicable;
and
(E) The total number of
securityholders of record for the
security as of the end of the issuer’s
most recent fiscal year or a more recent
date;
(vi) The exact title and class of the
security to be quoted;
(vii) The name, address and telephone
number of the transfer agent;
(viii) A description of the issuer’s
business and facilities;
(ix) A description of the issuer’s
products or services;
(x) The full names and business
addresses of the executive officers,
directors, general partners, promoters,
and control persons of the issuer, and
the number of securities of each class of
the issuer’s securities that are
beneficially owned by each such person
as of the end of the issuer’s last fiscal
year or a more recent date;
(xi) The following information:
(A) A description of any of the
following actions to which any
executive officer, director, general
partner, promoter, or control person of
the issuer has been the subject during
the prior five years:
(1) A conviction in a criminal
proceeding or named as a defendant in
a pending criminal proceeding
(excluding traffic violations and other
minor offenses);
(2) The entry of an order, judgment,
or decree, not subsequently reversed,
suspended or vacated, by a court of
competent jurisdiction that permanently
or temporarily enjoins, bars, suspends
or otherwise limits involvement in any
type of business, securities,
commodities, or banking activities;
(3) A finding or judgment by a court
of competent jurisdiction (in a civil
action), the Commission, the
Commodity Futures Trading
Commission, or a state securities
regulator of a violation of federal or state
securities or commodities law, which
has not been reversed, suspended, or
vacated; and
(4) The entry of an order by a self-
regulatory organization that
permanently or temporarily bars,
suspends or otherwise limits
involvement in any type of business or
securities activities; or
(B) A statement from the issuer that
no executive officer, director, general
partner, promoter, or control person of
the issuer is the subject of any of the
actions listed in paragraphs
(c)(6)(xi)(A)(1) through (4) of this
section; or
(C) A description of the steps you
have taken to obtain from the issuer the
information needed to comply with
paragraphs (c)(6)(xi)(A) or (c)(6)(xi)(B) of
this section and a statement that the
issuer failed or refused to provide this
information;
(xii) The following information:
(A) A description of any of the
following events involving the issuer, its
predecessor, or any of its majority-
owned subsidiaries that occurred in the
prior two years:
(1) A change in control;
(2) An increase of 10% or more of the
same class of outstanding equity
securities;
(3) A merger, acquisition, or business
combination;
(4) An acquisition or disposition of
significant assets;
(5) A bankruptcy proceeding; and
(6) The delisting of securities by any
securities exchange or Nasdaq; or
(B) A statement from the issuer that
the issuer, its predecessor, and its
majority-owned subsidiaries have not
been the subject of any of the actions or
events listed in paragraphs
(c)(6)(xii)(A)(1) through (6) of this
section; or
(C) A description of the steps you
have taken to obtain from the issuer the
information needed to comply with
paragraphs (c)(6)(xii)(A) or (c)(6)(xii)(B)
of this section and that the issuer failed
or refused to provide this information;
and
(xiii) The financial information listed
below in paragraphs (c)(6)(xiii)(A) or
(c)(6)(xiii)(B) and (c)(6)(xiii)(C) of this
section:
(A) If the issuer is not a foreign
private issuer, the issuer’s most recent
balance sheet, statement of cash flows,
statement of comprehensive income,
and statement of operations (income),
prepared in accordance with U.S.
generally accepted accounting
principles. Unless you know or have
reason to know that more current
information is available, this
information will be presumed to be
current if:
(1) The balance sheet is as of a date
that is less than 15 months before you
publish the quotation;
(2) The statement of cash flows,
statement of comprehensive income,
and statement of operations (income)
are for the 12 months preceding the date
of such balance sheet; and
(3) If the balance sheet is as of a date
that is more than 6 months before you
publish the quotation, it must be
accompanied by an additional statement
of cash flows, statement of
comprehensive income, and statement
of operations (income) for the period
from the date of such balance sheet to
a date that is less than 6 months before
you publish the quotation.
(B) If the issuer is a foreign private
issuer, the issuer’s most recent balance
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11144Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
sheet and statement of operations
(income), and to the extent prepared by
the issuer, statement of cash flows,
statement of comprehensive income,
and statement of changes in
shareholders’ equity, prepared in
accordance with a comprehensive body
of accounting principles. Unless you
know or have reason to know that more
current information is available, this
information will be considered current
if:
(1) The balance sheet is as of a date
that is less than 18 months before you
publish the quotation;
(2) The statement of cash flows,
statement of comprehensive income,
statement of operations (income), and
statement of changes in shareholders’
equity are for the 12 months preceding
the date of such balance sheet; and
(3) If the balance sheet is as of a date
that is more than 9 months before you
publish the quotation, it must be
accompanied by an additional statement
of cash flows, statement of
comprehensive income, statement of
operations (income), and statement of
changes in shareholders’ equity for the
period from the date of such balance
sheet until a date that is less than 9
months before you publish the
quotation, if any such statements have
been prepared by the issuer.
(C) The same financial information
required by paragraph (c)(6)(xiii)(A) and
(B) of this section for such part of the
two preceding fiscal years as the issuer
or any predecessor has been in existence
(one year with respect to the balance
sheet), prepared in accordance with U.S.
generally accepted accounting
principles (or prepared in accordance
with a comprehensive body of
accounting principles in the case of a
foreign private issuer). However, if the
issuer has emerged from reorganization
pursuant to Chapter 11 of the
Bankruptcy Code (11 U.S.C. 1101 et
seq.) and the reorganization plan has
been in effect less than two years, the
financial information required under
this paragraph (c)(6)(xiii) is the court-
approved disclosure statement filed
under 11 U.S.C. 1125 and the financial
information described in this paragraph
(c)(6)(xiii) from the date of the entry of
the bankruptcy court order confirming
the issuer’s reorganization plan
pursuant to 11 U.S.C. 1129.
(d) The supplemental information
that a broker or dealer must review. The
type of information that is considered
‘‘supplemental information’’ and that
you must review under paragraph (b) of
this section is the following:
(1) A copy of any trading suspension
order issued by the Commission under
section 12(k) of the Act (15 U.S.C.
78l(k)) for any securities of the issuer or
its predecessor (if any) during the 12
months before you publish the
quotation, or a copy of the public
release issued by the Commission
announcing such trading suspension
order; and
(2) A copy or a written record of any
other material information (including
adverse information) about the issuer
that comes to your knowledge or
possession before you publish a
quotation.
(e) The significant relationship
information that the broker or dealer
must make and keep a record of. The
type of information that is considered
‘‘significant relationship’’ information
and that you must make and keep a
record of under paragraph (b) of this
section is the following:
(1) Any direct or indirect affiliation
between the issuer and you or between
the issuer and any of your associated
persons;
(2) Whether you are publishing the
quotation on behalf of any other broker
or dealer, or any of its associated
persons, and, if so, the name of such
broker or dealer, or the associated
person, and the terms of the
arrangement;
(3) Whether you have received, or
have any arrangement to receive, any
monetary or other consideration from
any person for publishing the quotation
and, if so, a description of the
consideration and the name of the
person providing the consideration; and
(4) Whether you are publishing the
quotation directly or indirectly on
behalf of the issuer, or any executive
officer, director, general partner,
promoter, control person, or any person,
who is directly or indirectly the
beneficial owner of more than 10
percent of the outstanding units or
shares of any equity security of the
issuer, and, if so, the name of such
person, and the basis for any exemption
under the federal securities laws for any
sales of such securities on behalf of such
person.
(f) The information a broker or dealer
must submit to the NASD. At least three
business days before you publish a
quotation covered by paragraph (a) of
this section, you must submit to the
NASD, in accordance with NASD rules,
the information required in paragraphs
(c), (d), and (e) of this section.
(g) The broker or dealer must make
certain information required by this
section available upon request.
(1) If you publish a quotation for a
security in compliance with this
section, you must make the issuer,
supplemental, and significant
relationship information specified in
paragraphs (c)(5), (c)(6), (d), and (e) of
this section promptly available upon
request to any customer, prospective
customer, other broker or dealer, or
information repository. By providing
this information to others under this
paragraph (g), you do not represent that
the information is accurate; rather, you
represent that, as of the date recorded
under paragraph (b)(3)(iii) of this
section, you had a reasonable basis
under the circumstances for believing
that the information was accurate and
current in all material respects and was
obtained from reliable sources; but
(2) You do not need to comply with
paragraph (g)(1) of this section to the
extent that the information is reasonably
available through EDGAR, any other
federal or state electronic information
system, or an information repository.
(h) When a broker or dealer is not
required to comply with this section.
You are not required to comply with
this section when you publish a
quotation for:
(1) A security that is listed on a
national securities exchange or Nasdaq;
is traded on such exchange or Nasdaq
on the same day as, or on the business
day immediately before, the day you
publish the quotation; and is not
suspended, terminated, or prohibited
from trading on such exchange or
Nasdaq;
(2) An exempted security, as defined
in section 3(a)(12) of the Act (15 U.S.C.
78c(a)(12));
(3) A security where the quotation
represents the unsolicited order of a
customer (other than a person acting as
or for a dealer);
(4) A non-convertible debt security or
a non-participatory preferred stock;
(5) An asset-backed security that is
rated by at least one nationally
recognized statistical rating
organization, as that term is used in
§ 240.15c3–1, in one of its generic rating
categories that signifies investment
grade;
(6) A security with a worldwide
average daily trading volume value of at
least $100,000 during each month of the
six full calendar months immediately
before the date you publish the
quotation;
(7) A convertible security, if the
underlying security meets the
requirements of paragraph (h)(6) of this
section;
(8) A security that has bid price, as
published on a national securities
exchange, Nasdaq, or quotation
medium, of at least $50 per share. If the
security is a unit composed of one or
more securities, the bid price of the unit
divided by the number of shares of the
unit that are not warrants, options,
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11145Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
1
17 CFR 240.15c2–11.
2
15 U.S.C. 78a et seq.
rights, or similar securities must be at
least $50; or
(9) A security of an issuer that has net
tangible assets in excess of $10,000,000.
(i) The steps to take to become an
information repository.
(1) An entity seeking information
repository designation must file an
application with the Director of the
Commission’s Division of Market
Regulation in Washington, DC. The
application should provide detailed
information explaining how the entity
satisfies the attributes set forth in
paragraph (i)(2) of this section. The
entity must also file any additional
information relating to the attributes set
forth in paragraph (i)(2) of this section
that the Director of the Commission’s
Division of Market Regulation
subsequently requests;
(2) In determining whether to
designate an entity as an information
repository, the Commission will
consider whether the entity:
(i) Collects information about a
substantial segment of issuers of
securities subject to this section;
(ii) Maintains current and accurate
information about such issuers;
(iii) Has effective acquisition,
retrieval, and dissemination systems;
(iv) Places no inappropriate limits on
the issuers from or about which it will
accept information;
(v) Provides access to the documents
deposited with it to anyone willing and
able to pay the applicable fees;
(vi) Charges reasonable fees; and
(vii) In general, is so organized and
has the capacity to be able to reasonably
carry out the purposes of this section.
(3) An information repository must
notify the Director of the Commission’s
Division of Market Regulation of any
material changes that occur in the facts
and circumstances of its application for
such designation; and
(4) In the event it is determined that
an information repository no longer
satisfies all of the attributes set forth in
paragraph (i)(2) of this section, the
Director of the Commission’s Division of
Market Regulation may revoke such
designation.
(j) The definitions applicable to this
section. For purposes of this section, the
following definitions apply:
(1) Alternative trading system has the
same meaning contained in §242.300(a)
of this chapter.
(2) Asset backed security has the
meaning contained in General
Instruction I.B.5. to Form S–3 (17 CFR
239.13).
(3) Information repository means an
entity that:
(i) Gathers and provides to brokers or
dealers and others current issuer
information described in paragraph (c)
of this section when this information is
not routinely or widely made available,
electronically or otherwise; and
(ii) Is designated by the Commission
as an information repository as
described in paragraph (i) of this
section.
(4) Issuer, in the case of quotations for
American Depositary Receipts, means
the issuer of the deposited shares
represented by such American
Depositary Receipts.
(5) NASD means the National
Association of Securities Dealers, Inc.,
and its wholly owned subsidiaries
(including, but not limited to, NASD
Regulation, Inc. and The Nasdaq Stock
Market, Inc.).
(6) Nasdaq means The Nasdaq
National Market and The Nasdaq
SmallCap Market, both operated by The
Nasdaq Stock Market, Inc.
(7) Net tangible assets means total
assets less intangible assets and
liabilities. For purposes of this section,
net tangible assets must be
demonstrated by current financial
statements, as described in paragraph
(c)(6)(xiii) of this section, and:
(i) If the issuer is not a foreign private
issuer, the financial statements must be
audited and reported on by an
independent public accountant in
accordance with §210.2–02 of this
chapter; or
(ii) If the issuer is a foreign private
issuer, the financial statements must be
prepared in accordance with a
comprehensive body of accounting
principles, audited in compliance with
requirements of the country of
incorporation, and reported on by an
accountant duly registered and in good
standing in accordance with the
regulations of that jurisdiction.
(8) Non-participatory preferred stock
means non-convertible capital stock, the
holders of which are entitled to a
preference in payment of dividends and
in distribution of assets on liquidation,
dissolution, or winding up of the issuer,
but are not entitled to participate in
residual earnings or assets of the issuer.
(9) Promoter has the same meaning
contained in §230.405 of this chapter.
(10) Publish means to publish a
quotation for a security in a quotation
medium or, directly or indirectly, to
submit a quotation for a security for
publication in a quotation medium.
(11) Quotation means any bid or offer
at a specified price with respect to a
security, or any indication of interest by
a broker or dealer in receiving bids or
offers from others for a security, or any
indication by a broker or dealer that
advertises its general interest in buying
or selling a particular security.
(12) Quotation medium means any:
(i) System of general circulation to
brokers or dealers that regularly
disseminates quotations of identified
brokers or dealers; or
(ii) Publication, alternative trading
system, or other device that is used by
brokers or dealers to disseminate
quotations to others.
(13) Securities Act means the
Securities Act of 1933 (15 U.S.C. 77a et
seq.).
(k) How this section applies to
securities for which a broker or dealer
is publishing quotations immediately
before the effective date of the
amendments. If you were publishing a
quotation for a security on the business
day immediately before April 7, 1999,
you may continue to publish quotations
for the security without complying with
paragraph (b) of this section until you
publish a quotation described in
paragraphs (a)(2), (a)(3), (a)(4), (a)(5), or
(a)(6) of this section.
(l) The Commission can grant
exemptions from this section. This
section does not prohibit the
publication of any quotation for a
security or a class of securities, if the
Commission, on written request or its
own motion, exempts such quotation,
either unconditionally or on specified
terms and conditions.
3. Section 240.17a–4 is amended by
adding paragraph (b)(11) to read as
follows:
§ 240.17a–4Records to be preserved by
certain exchange members, brokers and
dealers.
*       *       *       *       *
(b) *  *  *
(11) The records required to be
obtained pursuant to §240.15c2–11.
*       *       *       *       *
Dated: February 25, 1999.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
Note: This Appendix to the Preamble will
not appear in the Code of Federal
Regulations.
Appendix
Guidance on the Scope of a Broker-Dealer’s
Review Under Current Rule 15c2–11 and the
Amendments
I. Introduction
To assist broker-dealers in complying
with Rule 15c2–11 (Rule)
1
under the
Securities Exchange Act of 1934
(Exchange Act),
2
we are setting forth the
factors that they should consider in
carrying out their review obligations
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11146Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
3
This appendix sets forth guidance on a broker-
dealer’s review obligations under the Rule as it
currently exists and under the proposed
amendments. If the Commission takes final action
on the proposed amendments, the Appendix will be
revised to delete references to the proposal and to
reflect the final rule. We expect that the Appendix
will provide useful guidance to broker-dealers in
conducting the document review required by the
Rule.
4
Securities Exchange Act Release No. 39670
(February 17, 1998), 63 FR 9661 (Proposing
Release).
5
A quotation is broadly defined as any indication
that a broker-dealer is willing to buy or sell a
particular security. The reproposed Rule, however,
applies most directly to priced quotations. Rule
15c2–11 applies to broker-dealers that publish
quotations for securities traded in the OTC markets.
In this appendix, ‘‘OTC stocks’’ or ‘‘OTC securities’’
refers to securities that are not listed on a national
securities exchange or Nasdaq. ‘‘Covered OTC
securities’’ refers to those OTC securities that are
subject to Rule 15c2–11. Rule 15c2–11 applies to
securities quoted on the OTC Bulletin Board,
operated by the National Association of Securities
Dealers, Inc. (NASD); the Pink Sheets operated by
the National Quotation Bureau, Inc. (NQB); and
similar quotation systems.
6
See footnote 14 below for a description of
‘‘supplemental information.’’
7
This discussion confirms and supplements
earlier guidance on Rule 15c2–11 issues. See
Securities Exchange Act Release No. 29094 (April
17, 1991), 56 FR 19148 (1991 Adopting Release);
Securities Exchange Act Release No. 27247
(September 14, 1989), 54 FR 39194 (1989 Proposing
Release).
8
17 CFR 240.15c2–11(f)(3). The security must
have been the subject of quotations on at least 12
business days during the previous 30 calendar days,
with no more than 4 consecutive business days
elapsing without a quotation. Effectively, the Rule
applies only to those market makers publishing
quotations during the first 30 days of a security’s
trading. The ability to piggyback on one’s own
quotations is referred to as ‘‘self-piggybacking.’’
9
The piggyback exception would be eliminated
under the proposed amendments.
10
The current Rule applies to an interdealer
quotation system, which is a quotation medium of
general circulation to brokers or dealers which
regularly disseminates quotations of identified
brokers or dealers. 17 CFR 240.15c2–11(e)(2). Under
the proposed amendments, the definition of
‘‘interdealer quotation system’’ would be
incorporated into the definition of ‘‘quotation
medium.’’ Under the amendments, a ‘‘quotation
medium’’ will be a system of general circulation to
brokers or dealers that regularly disseminates
quotations of identified brokers or dealers; or
publication, alternative trading system, or other
device that is used by brokers or dealers to
disseminate quotations to others.]
11
15 U.S.C. 78l(k).
12
17 CFR 240.17a–4.
13
Currently, a broker-dealer must review and
maintain in its records certain issuer information,
which, depending on the issuer, may include
prospectuses or offering circulars; certain Exchange
Act reports; other regulatory filings; information
furnished to the Commission pursuant to Section
12(g)(2)(G)(i) of the Exchange Act; or certain
financial information for non-reporting issuers. The
amendments expand the information required for
issuers that do not file periodic reports with the
Commission (e.g., non-reporting issuers). In
addition, broker-dealers would be required to make
the issuer information available to anyone who
requested it.
14
In addition to a copy of any trading suspension
order issued by the Commission pursuant to
Exchange Act Section 12(k), the broker-dealer must
record and consider any other material information
(including adverse information) regarding the issuer
that comes to its knowledge or possession before
publishing a quotation under the Rule. Paragraph
(b) [reproposed paragraph (d)] does not require a
broker-dealer to maintain trivial information or
information from an uncertain source. Also, the
under the Rule as it currently exists and
under the amendments proposed in
Securities Exchange Act Release No. 34–
41110.
3
We are providing this guidance
because commenters on the initial
proposal
4
expressed concerns about
their review obligations under its
provisions, particularly in light of
elimination of the piggyback provision,
the addition of an annual review
requirement, and the obligation to
obtain enhanced issuer information.
This guidance applies, unless otherwise
noted, to a broker-dealer’s obligations
under the current Rule as well as under
the reproposal.
Rule 15c2–11 regulates the publication of
quotations for OTC securities in a quotation
medium.
5
The Rule generally prohibits
broker-dealers from publishing a quotation
unless they have reviewed specified
information about the issuer. The kind of
information depends on the nature of the
issuer, e.g., whether the issuer is subject to
the Exchange Act’s periodic reporting
requirements (reporting issuer) or is an issuer
that is not subject to the Exchange Act’s
reporting requirements (non-reporting
issuer). Broker-dealers must also have a
reasonable basis for believing that the issuer
information, when considered in conjunction
with any supplemental information,
6
is
accurate in all material respects and that it
was obtained from a reliable source.
The Rule is precise about the kind of issuer
and other information that the broker-dealer
must obtain and review before publishing
quotations and about how current that
information must be. However, some
commenters on the Proposing Release stated
that they were unclear about the nature of the
broker-dealer’s obligation to determine that
the broker-dealer reasonably believes that the
source of the Rule 15c2–11 information is
reliable and that the information is accurate
in all material respects. We are giving our
views on the steps a broker-dealer should
take to assess the reliability of the source of
the required information and the accuracy of
that information.
7
II. Quotation Events Triggering the
Review Requirement
Under the current Rule, the first broker-
dealer to publish a priced quotation must
obtain and review the Rule’s required
information. Under the current Rule’s
piggyback exception, a broker-dealer does not
have to satisfy these information
requirements when it publishes a quotation
for a security if it, or any other broker-dealer,
is already publishing regular quotations for
the security.
8
This means that the first market
maker publishing a quotation is the only one
that has to obtain the required information,
and thereafter, any other market maker can
publish quotations in the security
indefinitely, unless there is a significant
lapse in quotation activity.
9
The amendments will restructure Rule
15c2–11 by setting forth more clearly the
quotation events that trigger the Rule, the
requirements that the broker-dealer must
satisfy, and the nature of the information that
the broker-dealer must review. The
amendments state that no broker-dealer,
directly or indirectly, may publish the
described kinds of quotations for a security
in any quotation medium, without first
complying with the Rule’s provisions.
10
Under the amendments, the Rule will apply
at specified points in time, namely, when a
broker-dealer publishes:
•the first quotation for a security;
•its first quotation at a specified price for
a security after another broker or dealer
published the first quotation for the same
security.
•the first quotation following the
termination of a Commission trading
suspension ordered pursuant to section 12(k)
of the Exchange Act
11
in any security of the
issuer of the suspended security;
•a quotation at a specified price for a
security after a period of five or more
consecutive business days when it did not
publish any quotations at a specified price
for that security;
•its first quotation at a specified price for
a security after the date that is four months
after the end of the issuer’s fiscal year, unless
the issuer is a foreign private issuer; or
•its first quotation at a specified
price for a security of a foreign private
issuer after the date that is seven
months after the end of the issuer’s
fiscal year.
If the Rule applies, under both the current
Rule and the amendments, the broker-dealer
must:
•review the Rule’s specified information;
•determine that it has a reasonable basis
for believing that the information is accurate
in all material respects and was obtained
from reliable sources;
•Record the date it reviewed the specified
information, the sources of the information,
and the person at the firm responsible for the
broker-dealer’s compliance with the Rule;
and
•Preserve the specified information in
accordance with Rule 17a–4.
12
We set out below in more detail the review
obligation required of a broker-dealer before
it publishes a quotation for covered OTC
securities. In general, the broker-dealer must
first form a reasonable belief about the
source’s reliability. Then the broker-dealer
should examine the materials to make sure it
has obtained all of the information required
by the Rule, including any supplemental
information known by the broker-dealer. In
reviewing this information, the Rule requires
that the broker-dealer must have a reasonable
basis under the circumstances for believing
that the issuer information described in
paragraph (a) [reproposed paragraph (c)] of
the Rule,
13
when considered in conjunction
with the supplemental information described
in paragraph (b) [reproposed paragraph (d)]
of the Rule,
14
is accurate in all material
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11147Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
broker-dealer is not required to affirmatively seek
out information about the issuer beyond that
specifically required by the Rule. However, if
material information about the issuer comes to its
knowledge or possession (orally or in writing), the
broker-dealer must take that information into
account in assessing whether the issuer information
is accurate and is from a reliable source. See
footnote 35 below regarding how to obtain
information about Commission trading suspensions.
15
17 CFR 230.251–230.263.
16
Under the reproposal, the broker-dealer can
look to filings made with other federal or state
regulatory authorities for certain types of issuers,
e.g., financial institutions.
17
See text of reproposed Rule 15c2–11(b)(3)(iv).
18
17 CFR 240.10b–5.
19
Because of recent microcap fraud cases
involving promoters, a broker-dealer should not
presume a promoter is a reliable source of issuer
information. See SEC Charges 44 Stock Promoters
in First Internet Securities Fraud Sweep, Press
Release 98–117 (October 28, 1998) available at
<http://www.sec.gov/news/press/98–117.txt>.
20
Examples of an ‘‘independent retrieval service’’
would be the SEC’s Public Reference Room or a
document retrieval service.
21
Examples of ‘‘standard research sources’’
include publications such as Standard & Poor’s
Standard Corporation Manual and Moody’s
Investors Service Manuals.
22
The proposed Rule will require a broker-dealer
to provide the information to another broker-dealer
upon request.
23
See Bunker Securities, Inc., 48 S.E.C. 859
(1987), aff’d without opinion, 833 F.2d 303 (3d Cir.
1987).
24
50 S.E.C. 489 (1991). The Laser Arms Report
was issued pursuant to the investigative authority
granted to the Commission under Section 21(a) of
the Exchange Act (15 U.S.C. 78u(a)).
25
Laser Arms Report at 501, citing Securities
Exchange Act Release No. 34–29095 (April 17,
1991), 56 FR 19158 (1991 Proposing Release).
respects and was obtained from reliable
sources.
In addition, we are providing numerous
examples of ‘‘red flags’’ often associated with
Rule 15c2–11 documents. A red flag is
information that under the circumstances
signals that one or more of the required items
of information may be materially inaccurate.
We consider these red flags to be indications
that should lead a broker-dealer to inquire
whether it had a reasonable basis to believe
that the issuer information is accurate in all
material respects and that it was obtained
from a reliable source.
The red flags that we discuss have been
present in Commission enforcement actions,
examinations conducted by our staff, and
reviews of Rule 15c2–11 conducted by the
National Association of Securities Dealers,
Inc. (NASD) submissions, but our discussion
is not meant to be exhaustive. Other
information may come into the broker-
dealer’s knowledge or possession that would
lead it to question whether the source is
reliable or whether the required information
is accurate in all material respects. The
adequacy of a broker-dealer’s review must be
considered on a case-by-case basis.
The reproposed Rule would require a
broker-dealer to obtain and review some
issuer information not required by the
current Rule, such as criminal or securities
law violations and additional issuer
information. Until the proposal is adopted,
the Rule does not require the broker-dealer to
obtain and review this information. This
information, however, would be a red flag
and, under the current Rule, could be
‘‘material information’’ that the broker-dealer
must take into account when conducting its
review obligations.
III. The Review Process
A. Introduction
While the broker-dealer must obtain and
review the required information, the standard
of review is based on a broker-dealer’s
arriving at a reasonable belief, not a certainty,
that the information is accurate and was
obtained from a reliable source. Although
broker-dealers often refer to their Rule 15c2–
11 files as ‘‘due diligence’’ files, the Rule’s
standard of review does not approach the
depth of inquiry generally associated with an
underwriter’s obligations in a registered
public offering or with a retail broker’s
obligations in recommending a security to a
customer. As discussed below, the scope of
review is relatively simple in the case of an
issuer that has just completed a public
offering or an offering under Regulation A
15
or that files periodic reports with the
Commission.
16
In these cases, the broker-
dealer must obtain and review information
that is on file with the Commission, in
addition to any supplemental information. In
the case of a non-reporting issuer, where
there may be no information filed with a
regulatory authority, the broker-dealer must
obtain the required information from sources
its deems reliable and must review this
information together with any supplemental
information.
The Rule does not currently specify the
status of the person who must conduct the
review on the broker-dealer’s behalf. Under
the reproposed Rule, the broker-dealer must
make a record of the person at the firm who
is responsible for the broker-dealer’s
compliance with the Rule’s provisions.
17
Generally, the person performing the review
should have sufficient experience or
authority at the firm to make sure that the
Rule’s requirements are fully satisfied.
Rule 15c2–11 is intended to prevent
broker-dealers from becoming involved in the
fraudulent manipulation of OTC securities.
However, even if a broker-dealer technically
complies with the Rule’s requirements, it
would be subject to liability under other
antifraud provisions of the securities laws,
such as Rule 10b–5, if a broker-dealer
publishes quotations as part of a fraudulent
or manipulative scheme.
18
B. Source Reliability
1. Determining Whether a Source is Reliable
The broker-dealer must first have a
reasonable basis for believing that Rule 15c2–
11 information comes from a reliable source.
In general, this means that the information
was derived from the issuer. If the
information is from the issuer or its officers
and directors, attorney, or accountant, the
broker-dealer generally can assume that the
source is reliable, absent red flags to the
contrary.
19
If the information is from EDGAR
or another governmental website or an
independent retrieval service
20
or standard
research sources
21
or an information
repository contemplated under the
reproposed Rule, the broker-dealer can
satisfy the Rule’s requirement to have a
reasonable basis for believing that the source
of the information is reliable. If the broker-
dealer receives the information from an
independent and objective source, such as a
bank that is not a market maker in the
security, which represents that it has
prepared the information or received the
information directly from the issuer, the
broker-dealer typically may rely on that
representation as to the source. Because
broker-dealers frequently obtain the Rule
15c2–11 information from these sources, the
reliability of the information’s source is not
often called into question.
Occasionally, the broker-dealer may obtain
the Rule 15c2–11 information from sources
not associated with the issuer, such as
another market maker.
22
In this case, the
requesting broker-dealer should inquire
about the original source of the information.
The broker-dealer providing the information
must make a record of the source of the
issuer information and can supply this
information to the requesting broker-dealer.
When a red flag regarding the source’s
reliability exists, the broker-dealer must
inquire further to reasonably determine
whether the information’s source is reliable.
To satisfy the Rule’s requirements, the
broker-dealer must ascertain the original
source of the information, especially when a
broker-dealer is provided information from
another broker-dealer that encourages the
publication of quotations rather than
responds to a request for information.
23
If the
broker-dealer providing the information
refuses to substantiate that the information is
from the issuer, this refusal is a red flag that
may indicate that the source is unreliable. If
the broker-dealer is told that the issuer has
prepared or approved the information, the
broker-dealer may need to verify that
representation by directly contacting the
issuer.
2. Examples of Unreliable Sources
The Report of Investigation Regarding
Transactions in the Securities of Laser
Arms Corporation (Laser Arms Report)
illustrates when a broker-dealer did not
have a reasonable basis to believe that
the information about a non-reporting
issuer was from a reliable source.
24
The
Laser Arms Report noted that ‘‘inherent
in the requirement of paragraph (a)(5)
[reproposed paragraph (c)(6)] is ’the
premise that the broker-dealer must at
least verify that it has received the
required information and know that
source of the information.’’
25
The broker-dealer that submitted the
initial application to quote Laser Arms
stock did not make any attempt to verify
the source of the issuer information
contained in the Laser Arms
Memorandum. In fact, it was a fictitious
document prepared by a recidivist
securities law violator who was the
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11148Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
26
The Laser Arms Memorandum misrepresented
Laser Arms as a high technology weapons
manufacturer and the developer of a self-chilling
beverage can. The memorandum also included
forged certificates of incorporation, fictitious
balance sheets, and auditor’s report which the
signature of the accountant had been forged.
27
Another broker-dealer who attempted to call
Laser Arms learned there was no telephone listing
for the company. This broker-dealer nevertheless
initiated a market in Laser Arms’ securities.
28
See also Bunker Securities, Inc., 48 S.E.C. 859
(1987, aff’d without opinion, 833 F.2d 303 (3d Cir.
1987).
29
See footnote 14 above for a definition of
supplemental information.
30
See Sections 11 and 27 of the Securities Act,
15 U.S.C. 77k and 77x, and Sections 18 and 32 of
the Exchange Act, 15 U.S.C. 78r and 78ff. See 1991
Adopting Release, 56 FR 19148, 19150 (1991).
31
If the issuer’s registration statement, pursuant
to Item 401 of Regulation S–K, describes criminal
or other disciplinary proceedings involving a
reporting issuer’s officer, director, general partner,
promoter, or control person, this would be a red
flag. Reproposed Rule 15c2–11(c)(6)(xi) will require
broker-dealers to inquire about these types of
criminal or other disciplinary proceedings
involving a non-reporting issuer’s office, director,
general partner, promoter, or control person. Under
the current Rule, however, a broker-dealer’s
knowledge of criminal or other disciplinary
proceedings involving a reporting or non-reporting
issuer’s officer, director, general partner, promoter,
or control person would be a red flag.
32
17 CFR 249.308.
33
27 CFR 249.308.
34
Even thought he criminal and securities law
violations specified in reproposed paragraph
(c)(6)(xi) are not specified in paragraph (a)(5) of the
current Rule, a broker-dealer’s knowledge of such
information would be material adverse information
under the current rule, and such violations would
be a red flag.
undisclosed principal of Laser Arms.
26
The broker-dealer’s immediate source of
the Laser Arms Memorandum was a
trader at another broker-dealer whom he
had known for less than one year, had
seen on only a few occasions, and had
dealt with primarily by telephone. The
broker-dealer did not review or attempt
to determine the source of any part of
the information in the Laser Arms
Memorandum. Any attempt to contact
the issuer directly probably would have
led to the discovery that Laser Arms was
a shell corporation with no assets,
operations, or products.
27
Under these
circumstances, the Commission did not
believe that this broker-dealer, or any of
the broker-dealers to subsequently
publish quotations, had a reasonable
basis for believing that the source of the
Rule 15c2–11 information was
reliable.
28
C. Document Review Obligations
Once the broker-dealer has formed a
reasonable belief about the source’s
reliability, it should examine the
materials to make sure it has obtained
all of the information required by the
Rule. This means that a broker-dealer
must not only review the information
about the issuer of the security to be
quoted but also consider any
supplemental information.
29
The Rule
requires that the broker-dealer must
have a reasonable basis under the
circumstances for believing that the
issuer information described in
paragraph (a) [reproposed paragraph (c)]
of the Rule, when considered in
conjunction with the supplemental
information described in paragraph (b)
[reproposed paragraph (d)] of the Rule,
is accurate in all material respects.
Unlike the duties of an underwriter in
a securities offering, Rule 15c2–11
ordinarily does not require a broker-
dealer to conduct an independent
inquiry about the issuer of the security
to be quoted. A broker-dealer publishing
quotes for a covered OTC security may
have no relationship with the issuer,
and the Rule does not demand that the
broker-dealer develop one to obtain
information. However, the broker-dealer
must review the required information,
together with any supplemental
information that comes to its attention,
and should be alert to red flags.
Because documents filed with the
Commission are subject to liability
provisions, a broker-dealer generally can
reach a reasonable belief as to the accuracy
of information contained in these
documents.
30
This also would be true for
documents filed with financial institutions’
regulatory authorities, which broker-dealers
may obtain and review when publishing
quotes for the securities of certain banks,
provided for in paragraph (c)(4) of the
reproposed Rule.
If a registration statement incorporates
other documents by reference, the broker-
dealer may be required to obtain some of the
incorporated documents to satisfy the Rule’s
information gathering and review
requirements. It should not be necessary for
the broker-dealer to be familiar with all
aspects of the filed documents. The broker-
dealer should focus on those sections that
describe the items of information set forth in
Rule 15c2–11(a)(5) [reproposed Rule 15c2–
11(c)(6)], the issuer’s identified ‘‘risk
factors,’’
31
any recent material business
combinations, such as the merger of a
reporting shell into a non-reporting company,
and current financial information.
In contrast to information from other kinds
of issuers, non-reporting issuer information
generally has not been filed with any
regulatory authority. Thus, the broker-dealer
cannot make any assumptions about the
accuracy of such information. Similarly, a
broker-dealer cannot make any assumptions
about the accuracy of information to
documents and other materials that are
submitted to the Commission by foreign
private issuers under Rule 12g3–2(b).
Although they are submitted to the
Commission, these documents are not ‘‘filed’’
and so are not subject to the liabilities that
attach to reporting issuer information. These
documents are prepared in accordance with
the standards of the issuer’s home
jurisdiction, not the standards set forth under
the U.S. federal securities laws, and broker-
dealers should independently assess the
accuracy of such information. Broker-dealers
will also need to independently assess the
accuracy of information filed with foreign
securities regulatory authorities, based on
considerations such as the disclosure and
liability standards under foreign law. In
reviewing the Rule’s required information for
non-reporting issuers, the kinds of significant
events that require a domestic reporting
issuer to file a Form 8–K under the Exchange
Act
32
also should be considered red flag
events.
Where no red flags appear during the
review of current and complete information,
the broker-dealer would have a reasonable
basis for believing that the Rule’s information
is accurate. At this point, the broker-dealer’s
review ordinarily would end, i.e., the broker-
dealer would not be required to question the
financial statements or any other information
required to be obtained and reviewed. The
Rule does not require the broker-dealer to
question any information unless the
information contains apparent material
discrepancies, or other information in the
broker-dealer’s knowledge or possession (i.e.,
paragraph (b) [reproposed paragraph (d)]
information) reasonably indicates that the
paragraph (a) [reproposed paragraph (c)]
information is materially inaccurate.
When red flags are present, the broker-
dealer’s efforts to satisfy itself with respect to
the accuracy of the information will vary
with the circumstances and may require the
broker-dealer to obtain additional
information or seek to verify existing
information. If the broker-dealer is aware that
the required issuer information is materially
inaccurate, it may nevertheless publish
quotations without violating the Rule, as long
as the broker-dealer can supplement that
information with additional information that
the broker-dealer reasonably believes is
accurate. If the immediate source of the
issuer information is unreliable, however, the
broker-dealer should view that source with
skepticism and attempt to obtain the Rule’s
information from another source. For
example, a broker-dealer that is aware that
the required issuer information is inaccurate
could produce a written record reflecting the
additional, corrected information or could
obtain other materials, such as a more recent
Form 8–K,
33
that would permit the broker-
dealer to comply with the Rule. If the broker-
dealer sees that the auditor’s report in an
issuer’s financial statements is qualified, the
broker-dealer may need to contact the
accountants about the basis for such
qualification. If the broker-dealer learns that
an issuer’s control person has been convicted
of securities fraud, it should contact the
appropriate regulatory authority to ascertain
the facts.
34
The Rule’s provisions are triggered by
discrete quotation events. Once the broker-
dealer has complied with the Rule’s
requirements with respect to a particular
quotation event, there is no continuing duty
to obtain and review the information. Of
course, when a quotation event occurs, e.g.,
the broker-dealer is publishing priced
quotations as of the annual review date
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11149Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
35
See Section 12(k) of the Exchange Act.
Information regarding recent trading suspension
orders can be obtained by calling 800–SEC–0330.
The broker-dealer must obtain a copy of the trading
suspension order or a copy of the Commission
release announcing the trading suspension. Copies
of Commission releases may be obtained through
our Internet website at <http://www.sec.gov/
enforce/tsuspend.htm> or from the Commission’s
Public Reference Room in Washington, D.C. and in
regional Commission offices. Also, Commission
releases are available form information databases
(e.g., LEXIS), and also are published in the SEC
Docket, which is available from publication services
(e.g., Commerce Clearing House, Inc.).
36
The reproposal contains a presumption that the
financial information of both reporting issuers and
domestic and foreign non-reporting issuers is
current if it is less than 15 months old. However,
if the broker-dealer has other information that
indicates that the issuer’s financial condition has
materially changed from that shown in the financial
statements, this presumption may not apply, and
the broker-dealer should determine whether more
recent financial information is available. Financial
information older than 15 months is not current and
does not satisfy the Rule’s requirements.
37
General Bond & Share Co., 51 S.E.C. 411 (1993)
(Commission opinion), rev’d on other grounds,
General Bond & Share Co. v. SEC, 39 F.3d 1451
(10th Cir. 1994); See also Robin Rushing and Harold
Gallison, Jr., Securities Exchange Act Release No.
36910 (February 29, 1996).
38
Robin Rushing and Harold Gallison, Jr.,
Securities Exchange Act Release No. 36910
(February 29, 1996); see also Bagle Securities, Inc.,
Securities Exchange Act Release No. 27673
(February 5, 1990); William V. Frankel & Company,
Securities Exchange Act Release No. 27649 (January
26, 1990); Richfield Securities, Inc., Securities
Exchange Act Release No. 26129 (September 29,
1988).
39
See New Allied Development Corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996)(New Allied’s control persons
had substantial stock interest in nominee accounts);
Douglass and Co., Inc., 46 S.E.C. 1189 (1978);
Gotham Securities Corporation, 46 S.E.C. 723
(1976). Paragraph (c)(6)(x) of the reproposed Rule
will require disclosure of the beneficial ownership
of the issuer’s stock by its executive officers,
directors, general partners, promoters, or control
persons.
40
Emshwiller, ‘‘Reverse Stock Splits At Many
Firms Spark Outcry.’’ The Wall Street Journal,
November 20, 1998, at Cl; SEC v. Magna
Technologies, Inc., Litigation Release No. 12227
(August 21, 1989) (insiders of Magna effected a 4-
for-1 reverse stock split, concentrated ownership in
themselves, and then manipulated the price of
Magna’s stock by disseminating false and
misleading information).
required by the reproposed Rule, it must
conduct a review of current issuer
information. In this case, the review process
would be the same as described above.
However, the review process should be
somewhat simpler because the broker-dealer
would already have gained some familiarity
with the issuer as a result of its prior review.
D. Scope of Review Following a Trading
Suspension
A Commission trading suspension is a
material event affecting the market for an
issuer’s securities.
35
After the termination of
a trading suspension, a broker-dealer may not
enter a quotation unless and until it has
strictly complied with all the provisions of
the Rule. Before initiating or resuming a
quotation for securities subject to Rule 15c2–
11, the broker-dealer must conduct a careful
review in a professional manner of the basis
for the trading suspension to determine
whether there is a reasonable basis for the
broker-dealer to believe that the information
about the issuer is accurate and current. The
broker-dealer may be unable to reach a
reasonable basis for relying on the questioned
financial statements in the Commission’s
order even if the information otherwise
satisfies the Rule’s presumption of ‘‘current’’
information.
36
This presumption is obviated
if the broker-dealer has information to the
contrary.
37
The broker-dealer must also check the
reliability of the source of the information,
particularly when the same source is
providing updated information. If the broker-
dealer seeks assurances or additional
information from the source (in most cases,
the issuer) about the matters cited in the
Commission trading suspension order, great
caution should be used before relying on the
statements or assurances from the issuer. The
broker-dealer may have to test the accuracy
of the information or the source’s reliability
by conducting an independent review or
obtaining verification of information
provided by the issuer. The broker-dealer
may need to seek an opinion of an
independent accountant or attorney to form
a reasonable basis to believe that the Rule’s
information is accurate and from a reliable
source. In one enforcement action, a broker-
dealer unreasonably relied on pre-suspension
financial statements when the Commission’s
trading suspension was based upon a lack of
accurate financial information and the
issuer’s auditors indicated to the broker-
dealer that they were having problems
verifying the issuer’s financial information.
38
A broker-dealer may have difficulty
obtaining the necessary information about an
issuer after the expiration of a trading
suspension. This difficulty, however, does
not relieve the broker-dealer of its
responsibilities under the Rule. If any broker-
dealer is uncertain as to what is required by
the Rule, it should refrain from entering
quotations relating to the securities in
question until the Rule’s provisions have
been met.
IV. Examples of Red Flags
If the broker-dealer discovers at any stage
of the review process any red flags in the
issuer information (whether the issuer is a
reporting or non-reporting company), it
cannot publish a quote unless and until those
red flags are reasonably addressed. Material
inconsistencies in the paragraph (a)
[reproposed paragraph (c)] information, or
material inconsistencies between that
information and the paragraph (b)
[reproposed paragraph (d)] information, are
red flags. We have set out below examples of
red flags that we have noticed in microcap
fraud cases or in Rule 15c2–11 submissions
made to the NASD. These examples,
however, are not comprehensive, as red flags
depend on the facts and circumstances of
each case.
We are providing examples of red flags that
require additional scrutiny by the broker-
dealer to comply with Rule 15c2–11. These
examples, however, are not exhaustive.
Conversely, the presence of these or other red
flags is not necessarily an indication of
microcap fraud or even inaccurate issuer
information. The red flag simply means that
the broker-dealer should question whether
the issuer information is accurate, and in
certain cases, from a reliable source. The
more red flags that are present, the more a
broker-dealer should scrutinize the issuer
information.
1. Commission Trading Suspensions. As
indicated above, Commission trading
suspension orders generally raise significant
red flags as to whether the Rule 15c2–11
information is accurate and whether its
source is reliable. Broker-dealers publishing
quotes once a trading suspension terminates
must satisfy the Rule’s requirements, which
may include seeking verification from the
issuer or soliciting the views of an
independent professional.
2. Foreign Trading Suspensions. A trading
suspension by a foreign regulator may
indicate that the issuer information is
unreliable or inaccurate. However, a trading
suspension in a foreign market may be
imposed simply because the issuer failed to
meet exchange listing standards. If the
broker-dealer learns of a foreign trading
suspension, it should attempt to determine
the basis for the suspension order and assess
whether the issuer information is still
accurate and whether its source is still
reliable.
3. Concentration of ownership of the
majority of outstanding, freely tradeable
stock. Concentration of ownership of freely
tradeable securities is a prominent feature of
microcap fraud cases. When one person or
group controls the flow of freely tradeable
securities, this person or persons can have a
much greater ability to manipulate the stock’s
price than when the securities are widely
held. In a ‘‘pump and dump’’ scheme, retail
interest is stimulated, and the price of the
securities is manipulated upward, at the
behest or under the control of the
manipulators who control much of the stock.
Often, other broker-dealers that are not
intentionally participating in improper
activities publish quotations in response to
escalating demand for the security resulting
from increasing retail sales. The promoters of
these companies, company insiders, and
unscrupulous brokers make substantial
profits when they sell their shares at inflated
prices. When the scheme is over, the
security’s price plummets, and innocent
investors who paid a premium price are left
holding worthless shares.
39
4. Large reverse stock splits. Microcap
fraud schemes can involve the substantial
concentration of the publicly-traded float
through a reverse stock split. The subsequent
issuance of large amounts of stock to insiders
increases their control over both the issuer
and trading of the stock.
40
5. Companies in which assets are large and
revenue is minimal without any explanation.
A red flag exists when the issuer assigns a
high value on its financial statements to
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11150Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
41
New Allied Development Corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996).
42
See In the Matter of Rom N. De Guzman,
Securities Exchange Act Release No. 37747
(September 30, 1996).
43
See New Allied Development Corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996); Stylex Homes, Inc., Securities
Exchange Act Release No. 36299 (September 29,
1995); Bunker Securities, Inc., 48 S.E.C. 859 (1987),
aff’d without opinion, 833 F. 2d 303 (3d Cir. 1987);
Butcher & Singer, Inc., 48 S.E.C,. 640, aff’d without
opinion, 833 F. 2d 303 (ed Cir. 1987); Douglass and
Co., Inc., 46 S.E.C. 1189 (1978); A.J. Carno Co., 1976
SEC LEXIS 2764 (February 23, 1976) (initial
decision), order dismissing proceeding and
withdrawing broker-dealer registration, Securities
Exchange Act Release No. 14647 (April 10, 1978);
Gotham Securities Corporation, 46 S.E.C. 723
(1976).
44
See example ι6, above.
45
See Securities Act Release No. 33–7644
(February 19, 1999) in which we adopted
amendments to Rule 504 of Regulation D that limit
the circumstances where general solicitation is
permitted and ‘‘freely tradeable’’ securities may be
issued in reliance on Rule 504 to transactions (1)
registered under state law requiring public filing
and delivery of a disclosure document to investors
before sale, or (2) exempted under state law
permitting general solicitation and general
advertising so long as sales are made only to
‘‘accredited investors.’’
46
Emshwiller, ‘‘NASD Quietly Takes Aim at IPO
Bridge-Loan Trend,’’ The Wall Street Journal,
January 20, 1998, at Cl.
47
See Memory Metals, Inc., Securities Act Release
No. 6820 (February 22, 1989).
48
New Allied Development corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996); see also Frederick R. Grant,
Securities Exchange Release No. 38239 (February 5,
1997); Atlantis Group, Inc., securities Exchange Act
Release No. 37932 (November 8, 1996); Eli
Buchalter, Securities Exchange Act Release No.
37702 (September 19, 1996); Milton Mermelstein,
Securities Exchange Act Release No. 37222 (May
16, 1996).
49
See New Allied Development Corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996) (the respondents obtained new
Allied, a public shell, which was a dormant
uranium mining company with no assets, in a
transaction which resulted in insiders controlling
52.4% of New Allied’s stock; New Allied then
acquired an interest in real estate associated with
worthless gambling concerns in exchange for New
Allied stock); Douglass and Co., Inc., 46 S.E.C. 1189
(1978).
50
See New Allied Development corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996) (the respondents disseminated
materially false documents to market makers,
including unaudit financial statements, that valued
new Allied’s medical and consumer products at
$2,150,000 although their historical costs were
approximately $17,000); A.J. Carno Co., 1976 SEC
LEXIS 2764 (February 23, 1976) (Initial Decision),
order dismissing proceeding and withdrawing
broker-dealer registration, Securities Exchange Act
Release No. 14647 (April 10, 1978) (Management
Dynamics, Inc.’s (MD) founding officer and director
wrote MD shareholders to recommend the
acquisition of the assets of a real estate developer.
Press releases and shareholder letters reinforced the
misleading impression that the transaction was
certain to generate substantial income for MD).
51
When two companies merge, compliance with
Generally Accepted Accounting Principles requires
that the combination be accounted for as either the
‘‘pooling method’’ or ‘‘purchase method.’’ With the
pooing method, the historical costs of the two
companies are added together. With purchase
method accounting, the company being acquired
writes up its assets to fair market value, which
generally are greater than the historical costs.
52
Ronald Effren, Securities Act Release No.
7256, Securities Exchange Act Release No. 36713
(January 16, 1996); see also Martin Halpern,
Securities Exchange Act Release No. 34727
(September 27, 1994).
53
See Securities Exchange Act Form 8–K, Item
4; Merle S. Finkel, Securities Act Release No. 7401
(March 12, 1997) (original auditors notified systems
of Excellence that purported registration statement
on Form S–8 had not been filed and that other
certain assets that are often unrelated to the
company’s business and were recently
acquired in a non-cash transaction. In this
situation, the company’s revenues often are
minimal and there appears to be no valid
explanation for such large assets and
minimal revenues.
41
Also, a red flag is present when the
financial statements of a development stage
issuer list as the principal component of the
issuer’s net worth an asset wholly unrelated
to the issuer’s line of business. For example,
from a review of Rule 15c2–11 submissions,
art collections or other collectibles that are
unrelated to the issuer’s business apparently
have been overvalued on the financial
statements of some issuers.
42
While assets
that are unrelated to the business of the
issuer are not always an indication of
potential microcap fraud, some unscrupulous
issuers have overvalued these types of assets
in an effort to inflate their balance sheets.
6. Shell corporation’s acquisition of private
company. A shell corporation is
characterized by no business operations and
little or no assets. In a fraud scheme, a
reporting company with a large number of
shares controlled by one person or a small
number of persons often merges with a non-
reporting company having some business
operations. The new public company is then
used as the vehicle for ‘‘pump and dump’’
and other fraudulent schemes. Broker-dealers
placing quotes for these issuers’ securities
should be mindful of the potential for
abuse.
43
7. Offerings under Rule 504 of Regulation
D where one or more of the following factors
are present:
•Little capital is raised in the Rule 504
offering and there appears to be no business
purpose except to provide some shareholders
with free-trading shares;
•The Rule 504 offering is preceded by an
unregistered offering to insiders or others for
services rendered at prices well below the
price in the subsequent offering;
•Sales immediately following the Rule
504 offering are at substantially higher prices
than those paid in the Rule 504 offering; or
•A shell company and an operating
company merge, which results in the
operating entity becoming the surviving
entity. The surviving entity goes ‘‘public’’ by
issuing shares pursuant to Rule 504.
44
Rule 504 of Regulation D allows non-
reporting companies to raise up to $1 million
per year in ‘‘seed capital’’ without complying
with Securities Act registration requirements.
The freely tradable nature of securities issued
in Rule 504 offerings has facilitated a number
of fraudulent schemes through the OTC
Bulletin Board Display Service (OTC Bulletin
Board) or the Pink Sheets published by the
National Quotation Bureau, Inc. (NQB).
45
Broker-dealers should be alert to information
in the Rule 15c2–11 materials where an
active trading market is being promoted for
securities issued solely in a Rule 504
transaction.
8. A registered or unregistered offering
raises proceeds that are used to repay a
bridge loan made or arranged by the
underwriter where:
•The bridge loan was made at a high
interest rate for a short period;
•The underwriter received securities at
below-market rates prior to the offering; and
•The issuer has no apparent business
purpose for the bridge loan.
Broker-dealers have given small issuers
bridge loans at a high interest rate for a short
time period.
46
In exchange for this bridge
loan, the broker-dealer receives a significant
number of shares of the issuer’s common
stock at a price that is substantially below
market rates. The broker-dealer then engages
in a scheme to manipulate the stock’s price
and ultimately benefits when it dumps the
stock at an artificially high price.
47
9. Significant write-up of assets upon a
company obtaining a patent or trademark for
a product. The significant write-up of assets
upon the issuer’s obtaining a patent or
trademark for a product is a technique used
by issuers engaged in microcap fraud to
inflate their balance sheets.
48
10. Significant asset consists of OTC
Bulletin Board or Pink Sheet companies. We
have noticed that some microcap fraud
schemes involve issuers whose major assets
are substantial amounts of shares in other
OTC Bulletin Board or Pink Sheet
companies.
11. Assets acquired for shares of stock
when the stock has no market value. In
microcap fraud cases, the issuer’s financial
statements often indicate that the issuer
acquired assets to which it assigned
substantial value in exchange for its
essentially worthless stock.
49
12. Significant write-up of assets in a
business combination of entities under
common control.
Those persons engaged in microcap fraud
often use a business combination such as a
merger as an opportunity to falsify financial
statements.
50
We have seen microcap fraud
schemes in which unscrupulous issuers use
purchase method accounting
51
to write up
the historical value of an asset to an
artificially high value in situations when the
entities involved in the business combination
are under common control or otherwise have
a high degree of common ownership. For
example, Generally Accepted Accounting
Principles (GAAP) requires that the
acquisition of one entity by another entity be
accounted for at historical cost in a manner
similar to that in ‘‘pooling of interests’’
accounting when these entities are under
common control.
52
13. Unusual auditing issues.
•Auditors refuse to certify financial
statements or they issue a qualified opinion;
or
•There has been a change of
accountants.
53
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11151Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
irregularities exist in connection with issuance of
this stock; thereafter, Systems of Excellence
retained new auditor who issued materially false or
inaccurate audit reports.
54
See Robin Rushing and Harold Gallison, Jr.,
Securities Exchange Act Release No. 36910
(February 29, 1996). In this case, the SEC also had
entered a trading suspension for lack of accurate
financial information.
55
See Ronald Effren, Securities Exchange Act
Release No. 36713 (January 16, 1996).
56
Douglass and Co., Inc., 46 S.E.C. 1189 (1978).
57
See also Butcher & Singer, Inc., 48 S.E.C. 640,
aff’d without opinion, 833 F.2d 303 (3d Cir. 1987)
(a salesman and later an officer of Butcher & Singer
apparently obtained some blank stock certificates
and forged former officers’ signatures as well as the
certificates’ amounts and purported dates of
issuance to himself and his family members; the
broker-dealer, Butcher & Singer, failed to review the
Rule’s required information; Butcher & Singer might
have noticed red flags that would have led to the
discovery of the underlying fraud if it had reviewed
the Rule’s required information).
5
See United States v. Marshall Zolp, Litigation
Release Nos. 11494 (July 23, 1987) and 11236
(October 2, 1986)(fictitious certificates of
incorporation and fictitious financial statements on
which the name of another company had been
whited out and the name of Laser Arms filled in).
59
See, e.g., A. J. Carno Co., 1976 SEC LEXIS 2764
(February 23, 1976)(Initial Decision), order
dismissing proceedings and withdrawing broker-
dealer registration, Securities Exchange Act Release
No. 14647 (April 10, 1978).
60
See Combined Companies International Corp.,
Securities Exchange Act Release No. 38653 (May
19, 1997); Robin Rushing and Harold Gallison, Jr.,
Securities Exchange Act Release No. 36910
(February 29, 1996).
61
Stylex Homes, Inc., Securities Exchange Act
Release No. 36299 (September 29, 1995).
62
The reproposed text of Rule 15c2–
11(c)(6)(xi)(A)(2) requires the broker-dealer to
review these factors for non-reporting issuers.
Otherwise, under the reproposed text of Rule 15c2–
11(c)(6)(xi)(B) or (C), the broker-dealer must obtain
a statement from the issuer that none of these
events has occurred or must record the steps taken
to obtain this information and that the issuer
refused or failed to provide it. Even though the
current Rule does not require the broker-dealer to
obtain and review this information, we consider
such information to be red flags under the Rule if
it comes to the broker-dealer’s attention.
63
See SEC v. I-Net Providers, Litigation Release
No. 15219 (January 17, 1997); New Allied
Development Corporation, Securities Exchange Act
Release No. 37990 (November 26, 1996).
64
See Exchange Act Form 8–K, Item 1.
65
See Exchange Act Form 8–K, Item 2.
66
See Exchange Act Form 8–K, Item 3.
67
The proposed text of Rule 15c2–11(c)(6)(xii)(A)
requires the broker-dealer to review these factors.
Otherwise, under the proposed text of Rule 15c2–
11(c)(6)(xii)(B) or (C), the broker-dealer must obtain
a statement from the issuer that none of these
events has occurred or must record the steps taken
to obtain this information and that the issuer
refused or failed to provide it. Even though the
current Rule does not require the broker-dealer to
obtain and review this information, we consider
such information to be red flags under the Rule if
it comes to the broker-dealer’s attention.
Rule 15c2–11 does not contemplate that
the broker-dealer scrutinize the issuer’s
financial statements with the expertise of an
accountant. The above red flags, however, do
not require an expertise in accounting
matters and have appeared in several
microcap fraud schemes. In one case, the
respondents stated in the Form 211
submissions to the NASD that they relied on
audited financial statements. However, the
auditors orally advised the associated
persons of the broker-dealer before they
submitted the Form 211 that the auditor’s
opinion attached to the pro forma financial
statement was qualified because of the
auditor’s inability to verify the issuer’s
financial information.
54
An accountant’s resignation or dismissal is
a characteristic found in some microcap
fraud cases. If a broker-dealer sees any of
these red flags, it should confirm the
auditor’s credentials with the appropriate
state licensing authority, question the
circumstances of the change in accountants,
and carefully scrutinize the Rule’s required
information.
14. Extraordinary items in notes to the
financial statements, e.g., unusual related
party transactions. Unusual related party
transactions are sometimes found in
microcap fraud schemes. For example, an
issuer’s financial statements may show a
related party transaction between two
companies, which later merge and inflate the
worth of their assets by using purchase
method accounting.
55
15. Suspicious documents.
•Inconsistent financial statements;
•Altered financial statements; or
•Altered certificates of incorporation.
Altered or facially inconsistent issuer
documents have been present in various
microcap fraud schemes. For example,
Polaris Mining Co. was a shell corporation
with no meaningful assets and no trading
market for its stock.
56
Douglass and Co., Inc.,
a broker-dealer, published quotations for
Polaris in the Pink Sheets in violation of Rule
15c2–11 because the Polaris financial
information upon which Douglass and Co.,
Inc. relied was deficient and contradictory on
its face: two balance sheets for the same years
contained blatant disparities. Both balance
sheets valued certain mined but unprocessed
ores at the estimated eventual selling price
even though significant processing work
remained to be done. One statement did not
list property location. One statement had an
item for capitalized expenses and the other
statement for the same year did not. The
former statement showed no retained
earnings or accumulated deficit, suggesting
that the figure for capitalized expenses was
an arbitrary one designed to make assets and
liabilities balance out.
57
In addition, issuer information that is
altered on its face raises red flags that, at a
minimum, require the broker-dealer to
contact the issuer.
58
16. Broker-dealer receives substantially
similar offering documents from different
issuers with the following characteristics:
•The same attorney is involved;
•The same officers and directors are
listed; and/or
•The same shareholders are listed.
It is not uncommon for the same
individuals to be involved in multiple
microcap frauds. If a broker-dealer realizes
after reviewing the information for several
issuers that the same individuals are
involved with these entities, the broker-
dealer should make further inquiries to
determine whether it has a reasonable basis
to believe that the issuer information is
accurate.
17. Extraordinary gains in year-to-year
operations. In microcap fraud cases, the
issuer may show extraordinary gains in its
year-to-year operations. This may be
accomplished through assigning an
artificially high value to certain assets or
through other manipulative devices that are
red flags, such as the significant write-up of
assets upon merger or acquisition.
59
18. Reporting company fails to file an
annual report. The fact that a reporting
company has not filed an annual report
suggests that there is a potential problem
with the company.
60
19. Disciplinary actions against an issuer’s
officers, directors, general partners,
promoters, or control persons.
The following types of disciplinary actions
should trigger further investigation by a
broker-dealer:
•Indictment or conviction in a criminal
proceeding;
61
•Order permanently or temporarily
enjoining, barring, suspending or otherwise
limiting an officer, director, general partner,
promoter, or control person’s involvement in
any type of business, securities,
commodities, or banking activities;
•Adjudication by civil court of competent
jurisdiction, the Commission, the Commodity
Futures Trading Commission or a state
securities regulator to have violated federal
or state securities or commodities law; or
•Order by a self-regulatory organization
permanently or temporarily barring,
suspending or otherwise limiting
involvement in any type of business or
securities activities.
62
Many microcap fraud cases involve
recidivist securities law violators.
63
If a
broker-dealer has information or could
reasonably discover information about the
above types of violations, it should question
whether it has a reasonable basis to believe
that the issuer’s information is accurate and
complete in these circumstances.
20. Significant events involving an issuer
or its predecessor, or any of its majority
owned subsidiaries.
The following types of significant events
should prompt further investigation by a
broker-dealer:
•Change in control of the issuer;
64
•Substantial increase in equity securities;
•Merger, acquisition, or business
combination;
•Acquisition or disposition of significant
assets;
65
Bankruptcy proceedings;
66
or
Delisting from any securities exchange or
the Nasdaq Stock Market.
67
While not necessarily problematic, these
are material events involving the issuer. The
change in control of the issuer, merger,
acquisition, or business combination,
acquisition or disposition of significant assets
can provide unscrupulous issuers an
opportunity to artificially overvalue the
issuer’s assets to support an upward
manipulation of the issuer’s worthless
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11152Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
68
See New Allied Development Corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996); A. J. Carno Co., 1976 SEC
LEXIS 2764 (February 23, 1976)(Initial Decision),
order dismissing proceedings and withdrawing
broker-dealer registration, Securities Exchange Act
Release No. 14647 (April 10, 1978); see also Bion
Environmental Technologies, Inc., Securities
Exchange Act Release No. 36111 (August 16, 1995).
69
See B.J. Thomas, Securities Exchange Act
Release No. 38727 (June 10, 1997); SEC v. Magna
Technologies, Inc., Litigation Release No. 12227
(August 21, 1989); see e.g., Milton Mermelstein,
Securities Exchange Act Release No. 37222 (May
16, 1996).
70
Alessandrini & Co., Inc., 45 S.E.C. 399 (1971),
citing D.H. Blair & Co., 44 S.E.C. 320 (1970).
71
Butcher & Singer, Inc., 48 SEC 640, aff’d
without opinion, 833 F.2d 303 (3d Cir. 1987)(a
salesman received 400,000 shares of an obscure
penny stock for helping to develop and maintain a
market in the stock); see Brent Duane Green,
Securities Exchange Act Release No. 39210 (October
7, 1997); Steven Ira Wertman, Securities Exchange
Act Release No. 38751 (June 20, 1997); Christopher
D. Jennings, Securities Exchange Act Release No.
38696 (May 30, 1997).
72
NASD Rule 2460, Payments for Market Making,
prohibits any payment by an issuer or the issuer’s
affiliates and promoters, directly or indirectly, to a
member for publishing a quotation, acting as a
market maker, or submitting an application.
73
See reproposed Rule 15c2–11(e); see also
current Rule 15c2–11(a)(5)(xvi).
74
Douglass and Co., Inc., 46 S.E.C. 1189 (1978);
see also See Robin Rushing and Harold Gallison, Jr.,
Securities Exchange Act Release No. 36910
(February 29, 1996); General Bond & Share Co., 51
S.E.C. 411 (1993)(Commission opinion), rev’d on
other grounds, General Bond & Share Co. v. SEC,
39 F.3d 1451 (10th Cir. 1994).
75
17 CFR 230.901–230.905 and Preliminary
Notes.
76
Securities Act Release No. 7505 (February 17,
1998), 63 FR 9632. We also adopted amendments
that would affect applicable reporting requirements
along with other amendments intended to prevent
abuses of Regulation S. Since January 1, 1999,
Regulation S transactions are required to be
reported quarterly on Forms 10–Q and 10–K.
77
See Frederick R. Grant, Securities Exchange
Release No. 38239 (February 5, 1997); S.E.C. v.
Enviromint Holdings, Inc., Litigation Release No.
14683 (October 6, 1995).
78
Form S–8 under the Securities Act of 1933 (15
U.S.C. 77a et seq.).
79
See S.E.C. v. Enviromint Holdings, Inc.,
Litigation Release No. 14683 (October 6, 1995).
80
See, e.g., Spectrum Information Technologies,
Inc., Securities Act Release No. 7426 (June 25,
1997); SEC v. Hollywood Trenz, Inc., Litigation
Release No. 15730.
81
See S.E.C. v. Charles O. Huttoe, Litigation
Release Nos. 15153 (November 7, 1996); 15185
(December 12, 1996)(unregistered public offering
purporting to use Form S–8).
82
Securities Act Release No. 33–7646 (February
19, 1999).
83
Securities Act Release No. 33–7647 (February
19, 1999).
84
See Douglass and Co., Inc., 46 S.E.C. 1189
(1978) (November 26, 1996)(mining operation); see
also S.E.C. v. Bradley J. Simmons and American
Energy Group, Ltd, Litigation Release No. 15353
(April 29, 1997)(oil and gas company).
85
Laser Arms Report, 50 S.E.C. 489, 503; see also
Butcher & Singer, Inc., 48 S.E.C. 640, aff’d without
opinion, 833 F.2d 303 (3d Cir. 1987); Gotham
Securities Corporation, 46 S.E.C. 723 (1976) (the
family of the broker-dealer’s principal owned a
significant amount of the stock of Marcon
Electronics Corp., which was a shell corporation
with no assets; the family benefited when the
broker-dealer manipulated upward the price of the
Marcon stock).
86
Merle S. Finkel, Securities Act Release No.
7401 (March 12, 1997).
stock.
68
An increase in the issuer’s equity
securities provides the securities necessary
for such manipulation. Bankruptcy
proceedings or a delisting from an exchange
or the Nasdaq Stock Market may also indicate
problems with an issuer that could lead the
broker-dealer to conclude that it does not
have a reasonable basis to believe that the
issuer’s financial information is accurate.
69
21. Request to publish both bid and ask
quotes on behalf of a customer for the same
stock. The highly unusual request from a
customer for the broker-dealer to publish
both bid and ask quotes is a red flag ‘‘that
calls for appropriate inquiry on [the broker-
dealer’s] part.’’
70
22. Issuer or promoter offers to pay a ‘‘due
diligence’’ fee. If a market maker receives an
offer from an issuer to pay a ‘‘due diligence’’
fee in connection with making a market in
the issuer’s security, this is not solely a red
flag.
71
It is a violation of NASD Rule 2460 for
the broker-dealer to accept this offer.
72
If the
broker-dealer receives any consideration in
connection with publishing a quotation, the
reproposed Rule requires the broker-dealer to
disclose any such compensation, as well as
any other significant relationship information
between the issuer and the broker-dealer
publishing the quotation or any of its
associated persons.
73
In Douglass and Co.,
Inc., a registered representative said he
would try to get the broker-dealer to initiate
a market in the stock of Polaris Mining Co.,
but that it would cost the issuer about $1,500
to cover ‘‘expenses.’’ The registered
representative later agreed to accept Polaris
stock (some of which he kept himself)
instead of the $1,500.
74
23. Regulation S transactions of domestic
issuers. Regulation S
75
provides a safe harbor
from the registration requirements of the
Securities Act of 1933 for offers and sales of
securities by both foreign and domestic
issuers that are made outside the United
States. We recently adopted amendments to
Regulation S that are designed to prevent the
abuses that relate to offshore offerings of
equity securities of domestic issuers.
76
Prior
to the recent amendments, Regulation S
transactions involving large amounts of the
securities of U.S. issuers were particularly
vulnerable to fraud and manipulation.
77
The
perpetrators of the fraud sold the securities
to U.S. investors after the 40-day holding
period expired, and little information was
available to investors about the issuers.
Under the amendments, equity securities
of U.S. issuers that are sold offshore under
Regulation S are classified as ‘‘restricted
securities’’ within the meaning of Rule 144
under the Securities Act, and the period
during which these securities cannot be
distributed in the United States is lengthened
from 40 days to one year. These amendments
make Regulation S abuses less likely, but
broker-dealers should be alert to any
questionable activities once the one-year
holding period expires.
24. Form S–8 stock. Form S–8 is the short-
form registration statement for offers and
sales of a company’s securities to its
employees, including consultants and
advisors.
78
The form has been abused by
unscrupulous issuers to register on Form S–
8 securities nominally offered and sold to
employees or, more commonly, to so-called
consultants and advisors. These persons then
resell the securities in the public markets, at
the direction of the issuer or a promoter.
79
In
a typical pattern, an issuer registers on Form
S–8 securities underlying options issued to
so-called consultants where, by
prearrangement, the issuer directs the
consultants’ exercise of the options and
resale of the underlying securities in the
public market. The consultants then either
remit to the issuer the proceeds from the sale
of the underlying shares, or apply the
proceeds to pay debts of the issuer that are
not related to any services provided by the
consultants.
80
In some cases, these
consultants perform little or no other service
for the issuer. In other microcap frauds, the
issuer uses Form S–8 to sell securities to
‘‘employees’’ who act as conduits by selling
the securities to the public and remitting the
proceeds (or their economic benefit) to the
issuer.
81
This public sale of securities by the
issuer has not been registered, although the
Securities Act requires registration. The
failure to register this sale of securities
deprives public investors of the protections
afforded by the Securities Act.
To prevent these abuses, Form S–8 and
related rules impose certain restrictions on
the use of the form for the sale of securities
to certain consultants and advisors.
82
We are
also proposing additional amendments to
Form S–8.
83
Although these amendments
should deter microcap abuses, broker-dealers
nevertheless should be aware of the prior
abuses of Form S–8 in microcap fraud cases.
25. ‘‘Hot industry’’ microcap stocks.
Another characteristic of microcap fraud
cases is that they often involve stocks that are
in vogue.
84
In the past, oil and gas ventures
and mining operations, as well as stocks of
issuers with purportedly innovative
products, have been popular in frauds
involving low-priced stocks.
26. Unusual activity in brokerage accounts
of issuer affiliates, especially involving
‘‘related’’ shareholders. Many microcap
frauds begin with the deposit and sale of
large blocks of an obscure stock by a new and
unfamiliar customer who often is affiliated
with an issuer.
85
At the same time, the
broker-dealer is encouraged to make a market
in the stock by the issuer.
27. Companies that frequently change
names. Frequent name changes are another
characteristic that we have seen in microcap
fraud cases. For example, Twenty First
Century Health (TFCH) was originally a
company called Big Valley Energy, Inc. Big
Valley then changed its name to Biotronic
Energy Engineering, Inc., then to The
Sonoron Group, then to Zorro International,
Inc., then to Health & Wealth, Inc., and
finally became TFCH in 1995. At the
promoter’s request, TFCH issued false
audited financial statements that recorded
material, nonexistent assets.
86
28. Companies that frequently change their
line of business. Besides companies that
frequently change their names, we also see
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11153Federal  Register/ Vol.  64,  No.  44/ Monday,  March  8,  1999/ Proposed  Rules
87
New Allied Development Corporation,
Securities Exchange Act Release No. 37990
(November 26, 1996).
companies that frequently change their line
of business in microcap fraud cases. For
example, New Allied Development started
out as a uranium mining company that was
a dormant public shell with no assets.
87
New
Allied then acquired the rights to medical
products in exchange for its overvalued
stock. Next, New Allied became a vehicle to
enter the gaming business purportedly to
build a casino.
[FR Doc. 99–5299 Filed 3–5–99; 8:45 am]
BILLING  CODE  8010–01–P
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