Securities and Exchange Commission v. Registration Statement
raw: 11124Federal Register/ Vol. 64, No. 44/ Monday, March 8, 1999/ Proposed Rules
11124Federal Register/ Vol. 64, No. 44/ Monday, March 8, 1999/ Proposed Rules (Feb. 21, 2019)
summary
The Securities and Exchange Commission (SEC) reproposed amendments to Rule 15c2-11 to combat microcap fraud by increasing the information broker-dealers must review before publishing quotations for non-reporting issuers' securities.
paragraph
The proposed amendments aim to combat microcap fraud by requiring broker-dealers to conduct thorough reviews of current issuer information before publishing priced quotations for OTC securities. The rule applies to both reporting and non-reporting issuers, with exceptions for high-volume, high-price, or asset-rich securities. The estimated annual costs of the amendments would be $5,731,120 and 143,278 burden hours for all broker-dealers.
narrative
The Securities and Exchange Commission (SEC) reproposed amendments to Rule 15c2-11 to combat microcap fraud by increasing the information broker-dealers must review before publishing quotations for non-reporting issuers' securities. The proposed amendments aim to combat microcap fraud by requiring broker-dealers to conduct thorough reviews of current issuer information, including financial statements, trading suspensions, and red flags like shell company activity or forged documents, before publishing priced quotations for OTC securities. The rule applies to both reporting and non-reporting issuers, with exceptions for high-volume, high-price, or asset-rich securities, as well as investment-grade debt and asset-backed securities. The estimated annual costs of the amendments would be $5,731,120 and 143,278 burden hours for all broker-dealers. The rule also eliminates the 'piggyback' exception and mandates annual reviews for all quoted securities. Broker-dealers must form a reasonable belief in the accuracy of information, avoid reliance on unreliable sources like promoters, and are held liable under Rule 10b-5 for participating in manipulative or deceptive practices.
Classified pump-and-dump(confidence 95%). EDGAR detection: forms S-8/S-1/424B/8-K· recall 69% / precision 12%. detection rule →
Statutes
15 U.S.C. 78n(a)15 U.S.C. 78m(a)15 U.S.C. 77a15 U.S.C. 78a15 U.S.C. 781(k)15 U.S.C. 78m15 U.S.C. 78l(g)11 U.S.C. 110111 U.S.C. 112515 U.S.C. 78w(a)15 U.S.C. 78c5 U.S.C. 60344 U.S.C. 350144 U.S.C. 3507(d)44 U.S.C. 3506(c)15 U.S.C. 78l(k)15 U.S.C. 77j(a)15 U.S.C. 80a15 U.S.C. 78l12 U.S.C. 181311 U.S.C. 112915 U.S.C. 78c(a)15 U.S.C. 78u(a)15 U.S.C. 77k15 U.S.C. 78r17 CFR 240.15c217 CFR 240.10b17 CFR 240.17a17 CFR 242.10117 CFR 240.3a5117 CFR 210.217 CFR 240.12g317 CFR 230.902(a)17 CFR 240.15c317 CFR 249.30817 CFR 200.3017 CFR 239.3617 CFR 230.25117 CFR 239.1327 CFR 249.308Sections 13(a) or 15(d) of the Securities Exchange ActSections 13(a) or 15(d) of the Securities Exchange ActSections 3, 10(b), 15(c), 15(g), 17(a), and 23(a) of the Securities Exchange ActSections 3, 10(b), 15(c), 15(g), 17(a), and 23(a) of the Securities Exchange ActSections 3, 10(b), 15(c), 15(g), 17(a), and 23(a) of the Securities Exchange ActSections 3, 10(b), 15(c), 15(g), 17(a), and 23(a) of the Securities Exchange ActSections 3, 10(b), 15(c), 15(g), 17(a), and 23(a) of the Securities Exchange ActSections 3, 10(b), 15(c), 15(g), 17(a), and 23(a) of the Securities Exchange Actsection 10(a) of the Securities Actsection 13 or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) or section 30(a) of the Investment Company Actsection 13 or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) or section 30(a) of the Investment Company Actsection 13 or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) or section 30(a) of the Investment Company Actsection 13 or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) or section 30(a) of the Investment Company Actsection 13 or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) or section 30(a) of the Investment Company Actsection 13 or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) or section 30(a) of the Investment Company ActSections 11 and 27 of the Securities ActSections 11 and 27 of the Securities Act
Parties
Securities and Exchange CommissionRegistration Statement
Keywords
informationsecuritiesissuerissuersquotationquotationsreviewbroker-dealersbroker-dealersecurityunderexchangeotcreportingcommission
Extracted insights
Dollar amounts 30
- $300.00M $300 million $100M–$1B
- $150.00M $150 million $100M–$1B
- $100.00M $100 million $100M–$1B
- $100.00M $100,000,000 $100M–$1B
- $25.00M $25 million $10M–$100M
- $20.00M $20 million $10M–$100M
- $10.00M $10,000,000 $10M–$100M
- $10.00M $10 million $10M–$100M
- $5.73M $5,731,120 $1M–$10M
- $5.00M $5,000,000 $1M–$10M
- $3.50M $3,500,000 $1M–$10M
- $2.15M $2,150,000 $1M–$10M
Entities 1
- person registration statement
Triples 31
- registrant has filed all reports required by Section 13(a) or 15(d) of the Exchange Act
- registrant has filed all materials required by Section 14(a) or 14(c) of the Exchange Act
- registrant has filed all reports required by Section 13(a) or 15(d) of the Exchange Act during the 12 calendar months
- registrant may not file a registration statement on this form
- registrant may use this form for registration under the Securities Act of 1933
- registrant may not file a registration statement on this form unless, immediately before filing the registration statement
- registrant is subject to the reporting requirements of Sections 13(a) or 15(d) of the Exchange Act
- registrant may use Form S-8
- registrant may not file registration statement
- registrant is subject to reporting requirements
- registrant has filed reports
- registrant has filed materials
- registrant has used Rule 12b-25
- registrant may not file registration statement
- registrant has filed annual report
- registrant must file registration statement
- registrant must file all reports required by section 13(a) or 15(d)
- registrant must file all materials required by section 14(a) or 14(c)
- registrant must file annual report on Form 10–K or Form 10–KSB
- registrant may use this form for registration
- amendment will not appear in the Code of Federal Regulations
- entity had only nominal assets
- registrant is subject to reporting requirements of Sections 13(a) or 15(d)
- registrant file registration statement
- registrant use Form S-8
- registrant satisfy requirements of paragraph 1.(a) and 1.(b)
- registrant file annual report on Form 10-K or Form 10-KSB
- registrant merge entity subject to Exchange Act reporting requirements
- registrant file reports required by Section 13(a) or 15(d) of Exchange Act
- registrant file materials required by Section 14(a) or 14(c) of Exchange Act
- registrant use Rule 12b-25
Text layers
Extracted body text (327,657c)
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11124 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
Act and all materials required by section unless, immediately before filing the SECURITIES AND EXCHANGE
14(a) or 14(c) of the Exchange Act (15 registration statement, the registrant: COMMISSION
U.S.C. 78n(a) or 78n(c)) required to be (i) Is subject to the reporting
filed during the 12 months immediately 17 CFR Part 240
requirements of Sections 13(a) or 15(d)
before filing a registration statement on of the Securities Exchange Act of 1934
this form (or for such shorter period that Release No. 34–41110; File No. S7–5–
(the ‘‘Exchange Act’’) (15 U.S.C. 78m(a) 99
the registrant was required to file such
or 78o(d));
reports and materials); and RIN 3235–AH40
(iii) Has filed on a timely basis all (ii) Has filed all reports required by
reports required by section 13(a) or Section 13(a) or 15(d) of the Exchange Publication or Submission of
15(d) of the Exchange Act during the 12 Act and all materials required by Quotations Without Specified
calendar months and any portion of a Section 14(a) or 14(c) of the Exchange Information
month immediately preceding the filing Act (15 U.S.C. 78n(a) or 78n(c)) required AGENCY: Securities and Exchange
of the registration statement (or for such to be filed during the 12 months Commission.
shorter period that the registrant was immediately before filing a registration ACTION: Reproposed rule.
required to file such reports). If during statement on this form (or for such
that time the registrant has used shorter period that the registrant was SUMMARY: The Securities and Exchange
§ 240.12b–25 of this chapter with required to file such reports and Commission is reproposing for comment
respect to a report or a part of a report, materials); and amendments to Rule 15c2–11 under the
that material must have been filed Securities Exchange Act of 1934
within the time prescribed by that (iii) Has filed on a timely basis all
(Exchange Act). Rule 15c2–11 governs
section. reports required by Section 13(a) or
the publication of quotations for
(2) If the registrant is an entity formed 15(d) of the Exchange Act during the 12
securities in a quotation medium other
by the merger between: calendar months and any portion of a than a national securities exchange or
(i) An entity subject to the Exchange month immediately preceding the filing Nasdaq. Also, we are reproposing a
Act reporting requirements that had of the registration statement (or for such companion amendment to relocate in
only nominal assets at the time of the shorter period that the registrant was Rule 17a–4 under the Exchange Act the
merger; and required to file such reports). If during record retention requirement currently
(ii) An entity that was not subject to that time the registrant has used Rule contained in Rule 15c2–11. The original
the Exchange Act reporting 12b–25 (§ 240.12b–25 of this chapter) proposal was issued in February 1998 in
requirements at the time of the merger, under the Exchange Act with respect to response to concerns about increased
the registrant may not file a registration a report or a part of a report, that incidents of fraud and manipulation in
statement on this form until it has filed material must have been filed within the over-the-counter (OTC) securities,
an annual report on Form 10–K or Form time prescribed by that rule. which typically involve thinly-traded
10–KSB (§ 249.310 or § 249.310b of this securities of thinly-capitalized issuers
chapter) containing audited financial (b) If the registrant is an entity formed
by the merger between: (i.e., microcap securities).
statements for a fiscal year ending after The reproposed amendments are more
consummation of the merger. (i) An entity subject to the Exchange limited than the initial proposal and
(b) A registrant may use this form for Act reporting requirements that had focus the Rule on those securities the
registration under the Act of the only nominal assets at the time of the Commission believes are more likely to
following securities: merger; and be prone to fraud and manipulation.
* * * * * (ii) An entity that was not subject to The reproposal is part of the
3. By amending Form S–8 (referenced the Exchange Act reporting Commission’s continuing efforts in
in § 239.16b) in General Instruction A to requirements at the time of the merger, regulatory, inspections, enforcement,
redesignate paragraphs 1.(a) and 1.(b) as the registrant may not file a registration and investor education areas that are
paragraphs 1.(d) and 1.(e); revise the key to deterring microcap fraud.
statement on this form until it has filed
introductory text of paragraph 1.; and In addition, the reproposal will
an annual report on Form 10–K or Form
add new paragraphs 1.(a) and 1.(b) to increase the information that broker-
10–KSB (§ 249.310 or § 249.310b of this
read as follows: dealers must review before publishing
chapter) containing audited financial
Note: The text of Form S–8 does not, and quotations for non-reporting issuers’
statements for a fiscal year ending after securities, and will ease the Rule’s
this amendment will not, appear in the Code
of Federal Regulations.
consummation of the merger. recordkeeping requirements when
* * * * * broker-dealers have electronic access to
Form S–8 Registration Statement Under Dated: February 25, 1999. information about reporting issuers.
the Securities Act of 1933
By the Commission. Finally, we are giving guidance to
* * * * * Margaret H. McFarland, broker-dealers on the scope of the
General Instructions Deputy Secretary.
review required by the Rule and
providing examples of ‘‘red flags’’ that
[FR Doc. 99–5298 Filed 3–5–99; 8:45 am]
A. Rule as to Use of Form S–8 they should look for when reviewing
BILLING CODE 8010–01–P
1. A registrant may use this form for issuer information.
registration under the Securities Act of DATES: Comments must be received on
1933 of the securities listed in or before April 7, 1999.
paragraph 1.(d) and 1.(e) of this section ADDRESSES: Comments should be
if the registrant satisfies the submitted in triplicate to Jonathan G.
requirements of paragraph 1.(a) and Katz, Secretary, Securities and Exchange
1.(b) of this section: Commission, 450 Fifth Street, NW, Mail
(a) A registrant may not file a Stop 6–9, Washington, DC 20549.
registration statement on this form Comments may also be submitted
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11125
electronically at the following E-mail D. Total annual reporting and using high pressure sales tactics and a
address: [email protected]. All recordkeeping burden supply of securities under the firm’s
comment letters should refer to File No. 1. Burden-hours for broker-dealers control. The fraudsters create interest in
2. Burden-hours for issuers
S7–5–99. All comments received will be 3. Total burden-hour costs to broker-
the security by disseminating false or
available for public inspection and dealers and issuers misleading information about the issuer
copying in the Commission’s Public 4. Capital cost to broker-dealers and issuers through, for example, oral statements,
Reference Room, 450 Fifth Street, NW, E. General information about the collection press releases, or the Internet. To further
Washington, DC 20549. Electronically of information the manipulative scheme, the retail
submitted comment letters will be F. Request for comments broker frequently acts as a market maker
posted on the Commission’s Internet IX. Statutory Basis and Text of Proposed in the security or, either on its own or
website (http://www.sec.gov). Amendments and Rule through the issuer’s promoter, induces
FOR FURTHER INFORMATION CONTACT: Any Appendix other firms to act as market makers.
of the following attorneys in the I. Introduction By publishing quotations, the market
Division of Market Regulation, II. Quotation Events Triggering the Review maker raises the profile of the security,
Securities and Exchange Commission, Requirement even though the market maker is not an
450 Fifth Street, NW, Mail Stop 10–1, III. The Review Process active participant in the fraud and
A. Introduction publishes quotations solely in response
Washington, DC 20549, at (202) 942–
B. Source reliability
0772: Nancy J. Sanow, Irene A. Halpin, to increased demand for the security.
1. Determining whether a source is reliable
Florence E. Harmon, Chester A. 2. Examples of unreliable sources The broker, promoter, or others
McPherson, or Jerome J. Roche. C. Document review obligations orchestrating the fraud can point to
SUPPLEMENTARY INFORMATION: D. Scope of review following a trading quotations for the security to ‘‘validate’’
suspension its worth. The perpetrators of the fraud
Table of Contents IV. Examples of Red Flags then dispose of their stake at an inflated
I. Executive Summary price. Once they no longer need to
A. Overview of the microcap fraud I. Executive Summary
stimulate interest in the security, the
problem and efforts to prevent further A. Overview of the Microcap Fraud
abuses
market for it collapses and innocent
Problem and Efforts to Prevent Further investors are left holding stock with
B. Background of Rule 15c2–11 and recent
proposed amendments
Abuses little or no value.
II. Overview of Reproposed Amendments Because incidents of fraud and The defrauded victims of microcap
III. Discussion of Amendments manipulation involving microcap fraud activities are not the only ones
A. Securities excluded from the Rule securities are a serious concern, the harmed. When other investors become
1. Securities satisfying a trading value test Commission, along with other reluctant or unwilling to invest in the
2. Securities satisfying a bid price test kinds of securities they perceive as
3. Securities of issuers satisfying a net
regulators, has made combating
tangible assets test microcap fraud one of its top priorities. prone to fraud, liquidity for those
4. Non-convertible debt, non-participatory Microcap securities generally are securities can be impaired. As a result,
preferred stock, and asset-backed characterized by low share prices and existing shareholders can face difficulty
securities little or no analyst coverage.1 The in disposing of their holdings and
5. Other Exceptions issuers of microcap securities typically legitimate issuers of lower-priced stocks
B. Quotations subject to the Rule are thinly-capitalized and information can find it hard to raise capital to start
1. The initial quotation for a covered OTC about them often is limited, particularly up or expand operations or services. In
security when they are not subject to the short, continuing incidents of microcap
2. Priced quotations
3. Annual review
Commission’s periodic disclosure fraud are detrimental to the integrity of
C. Information required under the Rule requirements. Securities of microcap our nation’s capital markets.
1. Reporting issuers delinquent in their companies usually are quoted on the To combat microcap abuses, we have
filings OTC Bulletin Board operated by the initiated several enforcement,
2. Issuers in bankruptcy National Association of Securities examination, education, and regulatory
a. Reporting issuers Dealers, Inc. (NASD), or in the Pink measures. These actions include the
b. Non-reporting issuers emerging from Sheets published by the National following:
bankruptcy Quotation Bureau, Inc. (NQB), but they • In September 1998, we filed 13
3. Non-reporting foreign private issuers are not exclusive to these quotation
4. Other non-reporting issuers
enforcement actions against 41
D. Information available upon request mediums.2 defendants for their involvement in
E. Information repository Microcap fraud often involves fraudulent microcap schemes that
F. Definitions schemes such as ‘‘pump and dump’’ bilked investors of more than $25
G. Preservation of documents and operations, in which unscrupulous million.3
information brokers sell the securities of less- • We conducted a nationwide sweep
H. Transition and exemptive authority seasoned issuers to retail customers by to combat fraud through the Internet,
provisions which resulted in 23 enforcement
I. Information submitted to the NASD 1 The term microcap securities is not defined
IV. General Request For Comments
actions against 44 stock promoters of
under the federal securities laws or regulations. The
V. Effects on Efficiency, Competition, and use of the term ‘‘microcap securities’’ in this microcap stocks in October 1998.4
Capital Formation release, however, should be distinguished from its
VI. Costs and Benefits of the Amendments use in the mutual fund context. For example, 3 For a summary of these cases, see Fight Against
A. Benefits Lipper Analytical Services, a mutual fund rating Microcap Fraud ‘‘Paying Dividends’’, Press Release
organization, generally categorizes microcap No. 98–92 (September 24, 1998), available through
B. Costs
companies as companies with market capitalization our Internet website at <http://www.sec.gov/news/
VII. Initial Regulatory Flexibility Act of less than $300 million. Lipper-Directors’ micronew.htm>.
VIII. Paperwork Reduction Act Analytical Data, Investment Objective Key, 2d ed. 4 For a summary of these cases, see Purveyors of
A. Collection of information under the 1997. Fraudulent Spam, Online Newsletters, Message
amendments 2 Microcap securities can also be listed on Board Postings, and Websites Caught, Press Release
B. Proposed use of information securities exchanges or Nasdaq or quoted in No. 98–117 (October 28, 1998), available through
C. Respondents alternative trading systems. Continued
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11126 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
• We initiated examination sweeps of our rule that governs the quotations by broker-dealer is able to ‘‘piggyback’’ on
several firms that are active in the broker-dealers for OTC securities.12 either its own or other broker-dealers’
microcap market. Our examination staff Rule 15c2–11 is intended to prevent previously published quotations. This
conducted complex and resource- broker-dealers from becoming involved exception assumes that regular and
intensive reviews of these firms’ records in the fraudulent manipulation of OTC frequent quotations for a security
for evidence of the hallmarks of securities. However, even if a broker- generally reflect market supply and
microcap fraud, such as patterns of ‘‘bait dealer technically complies with the demand and are based on independent,
and switch’’ sales techniques, Rule’s requirements, it would be subject informed pricing decisions. However, as
misrepresentations and exaggerated to liability under other antifraud a result of the piggyback provision, the
claims, unauthorized trading and provisions of the securities laws, such Rule’s application is essentially limited
refusals to sell securities, market as Rule 10b–5, if it publishes quotations to just the first broker-dealer publishing
manipulation, and lax or nonexistent as part of a fraudulent or manipulative quotes.
supervision. scheme.13 In February 1998, the Commission
• We have held numerous investors’ published for comment amendments to
town meetings across the country to B. Background of Rule 15c2–11 and the Rule that were designed to curb
educate people about investing wisely, Recent Proposed Amendments fraud in microcap securities.17 This
and we have put together several Rule 15c2–11 contains requirements proposal would have eliminated the
brochures to assist investors.5 that are intended to deter broker-dealers piggyback provision by requiring all
• We are cooperating with self- from initiating or resuming quotations broker-dealers to review current issuer
regulatory organizations (SROs) to for covered OTC securities that may information before publishing their first
improve supervision and regulation of facilitate a fraudulent or manipulative quotation for a covered OTC security,
the OTC securities market. For example, scheme. The Rule currently prohibits a without regard to whether the quotation
we recently approved NASD rule broker-dealer from publishing (or was priced or unpriced, and to
changes that limit quotations on the submitting for publication) a quotation thereafter review current issuer
OTC Bulletin Board to the securities of for a covered OTC security in a information annually if they published
issuers that are current in their reports quotation medium unless it has priced quotations. With limited
filed with the Commission or other obtained and reviewed current exceptions, the proposal would have
regulatory authority.6 information about the issuer.14 The applied to any security quoted in a
• We have taken steps to strengthen broker-dealer must also have a quotation medium other than a national
our regulations and close loopholes to reasonable basis for believing that the securities exchange or Nasdaq. The
help reduce incidents of microcap issuer information, when considered proposal would also have expanded the
fraud. along with any supplemental information required for issuers that do
Today, we are taking action on several information, is accurate and is from a not file periodic reports with the
additional regulatory measures aimed at reliable source.15 Commission (e.g., non-reporting
preventing further incidents of microcap The Rule currently contains several issuers). In addition, broker-dealers
fraud. In addition to adopting exceptions to its prohibitions. Under the would have been required to make the
amendments to Form S–8 7 under the ‘‘piggyback’’ exception, the Rule’s issuer information available to anyone
Securities Act of 1933 (Securities Act) 8 information requirements do not apply who requested it.
and adopting amendments to Regulation when a broker-dealer publishes, in an In response to the Proposing Release,
D,9 we are reproposing amendments to interdealer quotation system, a we received 199 comment letters from
Rule 15c2–11 10 under the Securities quotation for a covered OTC security 193 commenters.18 The majority of
Exchange Act of 1934 (Exchange Act),11 that was already the subject of regular commenters, which included broker-
and frequent quotations in the same dealers, issuers, attorneys, and
our Internet website at <http://www.sec.gov/news/ interdealer quotation system.16 A individuals, opposed many of the
netfraud.htm>. proposed changes. Broker-dealers were
5 See, e.g., ‘‘Microcap Stock: A Guide for 12 In this release, ‘‘OTC stocks’’ or OTC securities especially concerned that they would be
Investors’’ (providing a variety of tips on how to refers to securities that are not listed on a national
detect and avoid microcap fraud); ‘‘Cold Calling
exposed to potential liability in civil
securities exchange or Nasdaq. ‘‘Covered OTC
Alert’’ (describing the cold calling rules and securities’’ refers to those OTC securities that are
actions as a result of their increased
instructing investors how to avoid telephone subject to Rule 15c2–11. The Rule applies to review obligations under the proposal.
scams); ‘‘Internet Fraud’’ (describing common securities quoted on the OTC Bulletin Board Commenters also expressed views about
frauds including on-line newsletter and bulletin operated by the NASD, the Pink Sheets operated by
board posting scams); and ‘‘Ask Questions’’ (listing
the possibility of: reduced liquidity in
the NQB, and similar quotation mediums. For
questions that investors should ask about their further discussion of quotation mediums, see Part
covered OTC securities if broker-dealers
investments and their investment professionals). III.F. below stopped making markets; less
All of these publications are available for free from 13 17 CFR 240.10b–5. transparent markets if broker-dealers
our toll-free publications line at (800) 732–0330 and 14 Rule 15c2–11 defines quotation as any bid or did not publish priced quotes to avoid
can be downloaded through our Internet website at
<http://www.sec.gov>.
offer at a specified price with respect to a security, the annual review requirement; less
6 Securities Exchange Act Release No. 40878
or any indication of interest by a broker or dealer competitive pricing for covered OTC
in receiving bids or offers from others for a security,
(January 4, 1999), 64 FR 1255 (OTC Bulletin Board or any indication by a broker or dealer that securities; impaired access to capital by
Release). advertises its general interest in buying or selling
7 Securities Act Release No. 33–7646 (February
a particular security. For the purposes of this medium.’’ See Part III.F. below for a discussion of
19, 1999). The amendments to Form S–8 restrict the release, a ‘‘priced quotation’’ is a bid or offer at a the term ‘‘quotation medium.’’
use of Form S–8 for the sale of securities to specified price. 17 Securities Exchange Act Release No. 39670
consultants and advisors, among other things. 15 See Part III.C. below for a description of the (February 17, 1998), 63 FR 9661 (Proposing
8 15 U.S.C. 77a et seq.
required issuer and supplemental information. Release).
9 Securities Act Release No. 33–7644 (February 16 An interdealer quotation system is a quotation 18 This total includes virtually identical comment
19, 1999). The amendments limit the circumstances medium of general circulation to brokers or dealers letters from 68 issuers. All comment letters are
where freely tradable securities may be issued in which regularly disseminates quotations of available in File No. S7–3–98 at our Public
reliance on, and general solicitation is permitted identified brokers or dealers. 17 CFR 240.15c2– Reference Room, 450 Fifth Street, NW, Washington,
under, Rule 504 of Regulation D. 11(e)(2). Under the proposed amendments, the DC 20549. Comment letters that were submitted
10 17 CFR 240.15c2–11.
definition of ‘‘interdealer quotation system’’ would electronically are available through our Internet
11 15 U.S.C. 78a et seq. be incorporated into the definition of ‘‘quotation website at <http://www.sec.gov/rules/s7398.htm>.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11127
issuers; and increased compliance costs should take and ‘‘red flags’’ they should amendments also reorganize and
for broker-dealers. In addition, some consider when reviewing the Rule’s simplify the Rule’s provisions
commenters pointed out that the required information. In response to consistent with the Commission’s Plain
proposal would not cover Nasdaq commenters’ concerns about broker- English program.
SmallCap securities, which, they noted, dealer liability, we stress that broker-
III. Discussion of Amendments
have also been the subject of abusive dealers will have no obligation to
activities. Some commenters also continuously update their Rule 15c2–11 The amendments restructure Rule
remarked that the proposal would not materials. The broker-dealer’s review 15c2–11 by setting forth more clearly
stop microcap fraud, which, in their obligations under the Rule occur only at the quotation events that trigger the
view, is really a sales abuse problem. the specific times identified in the Rule. Rule, the requirements that the broker-
Several commenters, principally state In general, the amendments would: dealer must satisfy, and the nature of
securities regulators and their national • Limit the Rule primarily to priced the information that the broker-dealer
association, supported the proposal. quotations; 19 must review. The amendments state that
They believed that microcap fraud • Eliminate the Rule’s piggyback no broker-dealer, directly or indirectly,
would be deterred if broker-dealers are provision and require all broker-dealers may publish the described kinds of
required to review issuer information to review current issuer information quotations for a security in any
and make their own independent and before publishing priced quotations for quotation medium, without first
substantiated determinations before a security; complying with the Rule’s provisions.
publishing quotations. Further, • Require broker-dealers publishing The Rule will only apply at specified
commenters favoring the proposal stated priced quotations for a security to points in time, namely, when a broker-
that the availability of information via review current information about the dealer publishes:
EDGAR and the speed of issuer annually and upon the • The first quotation for a security;
communication via the Internet would occurrence of specified events; • Its first quotation at a specified
ease any increased burden on broker- • Expand the information required for price for a security after another broker
dealers created by the Rule certain non-reporting issuers; or dealer published the first quotation
amendments. Finally, a number of • Require documentation of the for the same security;
commenters were more neutral in their broker-dealer’s compliance with the • The first quotation following the
approach and offered views or Rule; and termination of a Commission trading
suggestions on specific provisions. • Require broker-dealers publishing suspension ordered pursuant to section
quotes in compliance with the Rule to 12(k) of the Exchange Act 20 in any
II. Overview of Reproposed
provide the issuer information upon security of the issuer of the suspended
Amendments
request to customers, prospective security;
The Commission is issuing a revised customers, information repositories, and • A quotation at a specified price for
proposal to amend Rule 15c2–11 to help other broker-dealers. a security after a period of five or more
curtail abuses in the offer, sale and In addition, the amendments would consecutive business days when it did
trading of microcap securities. Because exclude from the Rule’s coverage: not publish any quotations at a specified
these amendments will significantly • Securities with a worldwide price for that security;
change the Rule’s scope, we are average daily trading volume value of at • Its first quotation at a specified
publishing them to give interested least $100,000 during each month of the price for a security after the date that is
persons an opportunity to provide us six full calendar months immediately four months after the end of the issuer’s
with their comments and views. preceding the date of publication of a fiscal year, unless the issuer is a foreign
The amendments are intended to have quotation, and convertible securities private issuer; or
broker-dealers ‘‘stop, look and listen’’ where the underlying security satisfies • Its first quotation at a specified
before they begin to quote a covered this threshold; price for a security of a foreign private
OTC security in a quotation medium • Securities with a bid price of at issuer after the date that is seven
other than a national securities least $50 per share; months after the end of the issuer’s
exchange or Nasdaq. However, the • Securities of issuers with net fiscal year.
amendments reflect commenters’ tangible assets in excess of $10,000,000, The broker-dealer’s information
concerns about the earlier proposal by as demonstrated by audited financial gathering and review requirements are
limiting the scope of the Rule statements; substantially the same as the initial
principally to priced quotations and to • Non-convertible debt and non- proposal.21 If the Rule applies, the
those securities that the Commission participatory preferred stock; and broker-dealer must:
believes are more likely to be the subject • Asset-backed securities that are • Review the Rule’s specified
of improper activities. Under these rated as investment grade by at least one information;
amendments, the Rule will no longer nationally recognized statistical rating • Determine that it has a reasonable
apply to securities of larger issuers, or organization. basis for believing that the information
to securities that have a substantial These amendments are intended to is accurate in all material respects and
trading price or that meet a minimum enhance the integrity of quotations for was obtained from reliable sources;
dollar value of average daily trading securities in this market sector, to • Record the date it reviewed the
volume. In addition, the Rule will only improve the quality of information specified information, the sources of the
cover priced quotations, except in the about smaller, lesser-known issuers, and information, and the person at the firm
case of the first quotation for a covered to foster greater access to this responsible for the broker-dealer’s
OTC security. The provisions relating to information by investors. The compliance with the Rule; and
the broker-dealer’s obligations under the
20 15 U.S.C. 781(k).
Rule and the issuer information that the 19 The amendments, however, will prohibit the
broker-dealer must review are little first broker-dealer from publishing a priced or 21 However, we are narrowing the scope of the
unpriced quotation for a covered OTC security requirement contained in the Proposing Release
changed from the initial proposal. unless it complies with the Rule. For a discussion that broker-dealers provide the Rule 15c2–11
We also are providing guidance of the requirements concerning the initial quotation information to others upon their request. See Part
regarding the steps broker-dealers for a covered OTC security, see Part III.B.1. below. II.D. below.
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11128 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
• Preserve the specified information 1. Securities Satisfying a Trading Value reasonable and verifiable method may
in accordance with Rule 17a–4.22 Test be used.28 For example, it may be
Commenters on the Proposing Release To tailor the Rule to transactions that derived from multiplying the number of
did not object to the standards set forth we believe are most likely to involve shares by the price in each trade. The
in these review and documentation microcap fraud, the amendments NASD may also be able to assist broker-
requirements. Rather, they expressed exclude securities with a value of dealers in determining whether a
worldwide ADTV of at least $100,000 particular security is eligible for the
concerns about the scope of a broker-
during each month of the six full exclusion.
dealer’s review obligations under the Q1. Should the dollar value of ADTV
earlier proposal, particularly as some of calendar months immediately preceding
the date of publication of a quotation.26 for this exclusion be higher than
them misconstrued the proposal to $100,000, e.g., $500,000 or $1 million,
require continuous updating of Convertible securities will also be
excluded when the underlying security or should it be a lower amount, e.g.,
information. To assist broker-dealers $50,000? Commenters should provide
publishing quotations for covered OTC satisfies this threshold.
The majority of OTC stocks of U.S. data and analysis to support suggested
securities, we are giving guidance in an revisions to this proposed threshold.
companies that are not listed on an
appendix to this release about the Q2. Should the dollar value of ADTV
exchange or Nasdaq trade infrequently
nature of the review we expect broker- measuring period be longer than six
and will not satisfy for a test based on
dealers to conduct under both the months, e.g., twelve months, or be
a value of ADTV of $100,000 or more
current Rule and the proposed during each month over a six month shorter, e.g., three months? Should the
amendments. measuring period. However, there are a length of the measuring period depend
number of non-reporting issuers having on the amount of the value of ADTV
A. Securities Excluded From the Rule threshold, i.e., should a lower value of
securities with significant trading levels,
Several commenters suggested that particularly larger foreign issuers with ADTV threshold be allowed but require
the Rule should cover only those actively traded securities in their home a longer measuring period?
securities that have the characteristics Q3. Should the exclusion based on
markets. We think that it is appropriate
ADTV value also incorporate a value of
that have led to abuses in the microcap to take this trading activity into account
public float test, like Regulation M
market.23 These commenters noted that, in applying the value of ADTV test.
The price of a microcap security that does? If so, should the public float value
while the earlier proposal was intended
is the subject of a fraud often is be $25 million or some higher or lower
to focus on microcap abuses, it covered amount? Would public float information
quotations for a number of non- manipulated upward rapidly so that
those involved in the manipulation can be easy or difficult to obtain for non-
reporting foreign and domestic issuers’ reporting issuers? 29
securities that are unlikely to be the quickly sell stock at a significant profit,
to the detriment of innocent investors. Q4. Rule 101 under the Commission’s
targets of microcap schemes. They Regulation M excludes from that rule’s
suggested that the amendments be Microcap securities involved in such
manipulations often are thinly traded, trading prohibitions securities with a
crafted to cover only those equity value of ADTV of $1 million or more,
securities most likely to be prone to and the daily trading volume for such
securities rarely reaches a value of using a two month measuring period, if
abusive activities. the issuer has a public float value of at
$100,000 over an extended period of
We agree that applying the Rule to the time. We believe that measuring the least $150 million. Should Rule 15c2–
securities of larger issuers, more liquid value of the security’s ADTV over a six 11’s exclusion parallel the terms of this
securities, and certain fixed-income month period is a way to ensure that the exclusion?
debt securities is not directly related to securities qualifying for this exclusion 2. Securities Satisfying a Bid Price Test
microcap fraud concerns.24 We are not involved in the type of short-
therefore are proposing to exclude from To limit the Rule to transactions that
term price manipulations frequently the Commission believes are most likely
Rule 15c2–11 those securities satisfying seen in microcap schemes. to involve microcap fraud, we are
any one of three alternative tests based A broker-dealer should determine the
proposing an amendment to exclude
on: the value of the security’s average value of a security’s ADTV from
securities with a bid price of at least $50
daily trading volume (ADTV); the information that is publicly available
per share at the time the quotation is
security’s bid price; or the issuer’s net and that the broker-dealer has a
published in the quotation medium.30
tangible assets.25 We are also proposing reasonable basis for believing that the
While the vast majority of OTC stocks
to exclude debt securities, non- information is reliable.27 In calculating
are quoted at lower prices and will not
participatory preferred stock, and the value of ADTV in U.S. dollars, any
typically satisfy for a test based on a bid
investment grade asset-backed
price of at least $50 per share, there are
securities. 26 We have used an ADTV value of $100,000 in
another, but related, context. Rules 101 and 102 of
28 This is comparable to the calculation of value
Regulation M, 17 CFR 242.101 and 102, provide for
22 17 CFR 240.17a–4.
a one business day restricted period for securities of ADTV under Regulation M. See Securities
23 See, e.g., Letter from Securities Industry Exchange Act Release No. 38067 (December 20,
with an ADTV value of at least $100,000 (as
Association (April 28, 1998) (SIA Comment Letter). measured over a 60 day period), if the issuer has 1996), 62 FR 520, 537.
24 Of course the general antifraud provisions of a public float value of at least $25 million. These 29 See id.
the federal securities laws, including Rule 10b–5 rules are intended to prevent manipulative 30 Most of the Commission’s recent trading
(17 CFR 240.10b–5), apply to transactions in all activities during a distribution. suspension orders issued under Section 12(k) of the
securities, whether or not excluded from Rule 27 A broker-dealer will be able to rely on trading Exchange Act, 15 U.S.C. 781(k), have involved
15c2–11. volume as reported by SROs or comparable entities, securities quoted on the OTC Bulletin Board or the
25 We estimate that at least 10% of covered OTC or any other source believed to be reliable. Pink Sheets. Our staff’s analysis of these trading
securities will be excluded from the Rule under Electronic information systems that provide suspension orders, issued between April 1, 1994
these tests. We estimate that approximately 5% of information regarding securities in markets around and January 1, 1998, showed that the suspended
the OTC securities of U.S. companies, 10% of the the world could provide an easy means to OTC securities had an average bid price of
OTC securities of foreign issuers (excluding ADRs), determine worldwide trading volume in a particular approximately $5, with a median bid price of
and 66% of OTC American Depositary Receipts security. Worldwide trading volume includes all approximately $3. These securities had bid prices
(ADRs) will satisfy any one of these three markets, domestic or foreign, where an OTC that ranged from a low of approximately $0.50 to
alternative tests. security is traded. a high of approximately $18.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11129
securities of closely-held issuers that are incorporation, and reported on by an Q12. Should the use of financial
quoted at significant share prices. The accountant duly registered and in good statements of a foreign private that are
broker-dealer publishing the quotation standing under the regulations of that not prepared in accordance with U.S.
can use its own bona fide quotation to jurisdiction.34 If audited financial GAAP be limited to financial statements
satisfy the test. The broker-dealer cannot statements are unavailable, the broker- prepared in accordance with the
use its own or another broker-dealer’s dealer may not rely on this exception. accounting standards promulgated by
unpriced quotation to rely on this test, Some commenters suggested that we the International Accounting Standards
even if the broker-dealer publishing a look to the current definition of ‘‘penny Committee (IASC)?37
name-only quotation provides a bid stock’’ in assessing the scope of Rule Commenters are invited to provide us
price of at least $50 per share upon 15c2–11. Exchange Act Rule 3a51–1 with their views on the alternative tests
inquiry. If a security is a unit composed excludes from the definition of penny for an exclusion from Rule 15c2–11, as
of one or more securities, the bid price stock a security of an issuer having net described above.
of the unit, when divided by the number tangible assets in excess of $2 million, Q13. Should all three of the tests
of shares of the unit that are not if the issuer has been in continuous based on value of ADTV, bid price, and
warrants, options, rights, or similar operation for at least 3 years, or $5 net tangible assets be incorporated into
securities, must be at least $50 to be million, if the issuer has been in Rule 15c2–11?
excepted from the Rule.31 continuous operation for less than three Q14. Should the proposed exclusions
Q5. Should this exclusion be based on years.35 We preliminarily believe that, from the Rule be limited to those
a bid price higher than $50 per share, for purposes of an exclusion from the securities that satisfy at least two of the
e.g., $100 per share or lower, e.g., $20 Rule, the net tangible assets amount three tests?
per share? Commenters should provide should be higher, and, unlike the Q15. Are there other tests that are
data and analysis to support suggested definition of penny stock, the threshold more appropriate to exclude the
alternatives to the proposed threshold. need not distinguish between newer and securities of larger, more seasoned
Q6. Should this exclusion be available more seasoned issuers. issuers from Rule 15c2–11? For
only if the security has a bid price of Q8. Should the threshold amount for example, should a security that has no
$50 over a specified period of time? this net tangible assets test be higher or very minimal trading volume be
Q7. Should this test be based instead than $10 million, e.g., $20 million? excluded from the Rule’s requirements?
on the security’s last sale price? If so, Under what circumstances would it be What would be an appropriate low
should there be a time limit added to appropriate to permit a lower threshold volume threshold? If trading volume
such a test so that a stale last sale price amount? Commenters should provide suddenly exceeded the low volume
cannot be used? data and analysis to support their views threshold, would broker-dealers
on whether the threshold amount publishing quotes find it easy or
3. Securities of Issuers Satisfying a Net should be raised or lowered. difficult to have to obtain and review
Tangible Assets Test Q9. For ease of compliance with both information before continuing to
Microcap fraud schemes generally Commission and NASD rules, should publish priced quotations?
involve issuers with limited assets.32 this exclusion parallel the exclusion
4. Non-Convertible Debt, Non-
We are therefore proposing to exclude contained in the NASD’s proposed rule
Participatory Preferred Stock, and Asset-
securities of issuers having net tangible that would require broker-dealers to
Backed Securities
assets in excess of $10,000,000, as review current information about the
issuer of an OTC security before We are proposing to exclude non-
determined by audited financial
recommending a transaction in the convertible debt securities, non-
statements.
security?36 The NASD proposal would participatory preferred stock,38 and
If the issuer is not a foreign private
exclude the securities of issuers having asset-backed securities that are rated by
issuer, a broker-dealer should make this
total assets of at least $100 million and at least one nationally recognized
determination using the most recent
shareholders’ equity of at least $10 statistical rating organization, as that
financial statements for the issuer that
million, based on audited financial term is used in Rule 15c3–1 under the
have been audited and reported on by
statements. Exchange Act,39 in one of its generic
an independent public accountant in
Q10. Will there be sufficient rating categories that signifies
accordance with the provisions of Rule
information in financial statements, investment grade.40 Commenters on this
2–02 of Regulation S–X.33 If the issuer
is a foreign private issuer, a broker- particularly those of non-reporting
37 IASC’s accounting standards are summarized
dealer should make this determination issuers, to permit broker-dealers to make
on, and may be ordered through, the IASC’s Internet
using the most recent financial the net tangible assets calculation? website at <http://www.iasc.org.uk>.
Q11. Should the use of financial
statements for the issuer (dated less than 38 Non-participatory preferred stock means non-
statements of a foreign private issuer be convertible capital stock, the holders of which are
18 months prior to the date of the
limited to financial statements prepared entitled to a preference in payment of dividends
publication of the quotation) that are and in distribution of assets on liquidation,
in accordance with U.S. generally
prepared in accordance with a dissolution, or winding up of the issuer, but are not
accepted accounting principles (GAAP)?
comprehensive body of accounting entitled to participate in residual earnings or assets
principles, audited in compliance with of the issuer. See paragraph (j)(8) of the Rule
34 These financial statements may be found in proposal, which is based upon a definition
requirements of the country of filings with the Commission on Forms 20–F or 6– contained in Rule 902(a)(1) of Regulations S (17
K, or in submissions under Rule 12g3–2(b) under CFR 230.902(a)(1)).
31 This is comparable to the provisions excluding the Exchange Act (17 CFR 240.12g3–2(b)), or 39 17 CFR 240.15c3–1 (net capital requirements
equity securities priced at $5 or more from the elsewhere. for broker-dealers).
definition of ‘‘penny stock’’ contained in 17 CFR 35 17 CFR 240.3a51–1. 40 The Commission’s staff is engaged in a project
240.3a51–1(d)(2). 36 See proposed NASD Rule 2315, which the to consider the development of disclosure and
32 Analysis of OTC securities that were the subject
Commission recently issued for public comment. registration requirements specifically related to
of recent Commission-ordered trading suspensions Securities Exchange Act Release No. 41075 asset-backed securities. As part of that project, the
showed the issuers on average had approximately (February 19, 1999). The proposed rule will be staff intends to examine further the role of ratings
$3,500,000 in net tangible assets, with a median of available through the NASD Regulation Internet with respect to asset-backed securities. Therefore,
approximately $225,000 is such assets. website at <http://www.nasdr.com> and our we consider it appropriate to limit the proposed
33 17 CFR 210.2–02. Internet website at <http://www.sec.gov>. Continued
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11130 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
issue generally supported excluding obtained and reviewed specified microcap activities, and, if so, whether
fixed-income securities from the Rule. information about the issuer and the the Rule should cover all initial
The fraud and manipulation that we security. Further, this information will quotations.
have observed in the microcap need to be submitted to the NASD, in
3. Annual Review
securities have not been evident in the accordance with the NASD’s rules, at
fixed-income market. In addition, non- least three business days before the The amendments require a broker-
convertible debt securities, non- quotation is published.42 There is one dealer to review the specified
participatory preferred stock, and situation that ‘‘restarts’’ the Rule’s information annually if the broker-
investment grade asset-backed securities requirements: following the termination dealer publishes priced quotations for
generally trade at prices and in of a Commission trading suspension the security. The date by which the
denominations that make them less ordered pursuant to Exchange Act annual review must be performed
likely targets for manipulation. Further, Section 12(k),43 the broker-dealer depends on whether the issuer is a
the type of issuer information required publishing the first quote, whether it is domestic or a foreign company:
by the Rule is much less relevant to the priced or unpriced, must comply with • Domestic Issuers: The annual
pricing and trading of these types of Rule 15c2–11. In essence, this is the review must occur prior to the first
securities. way the Rule currently works. priced quotation that is more than four
Q16. Should this exclusion apply to We believe that the Rule should cover months after the end of the issuer’s
all asset-backed securities or should the the first quotation as a means to assure fiscal year.
exclusion apply only to asset-backed that there is basic information about the • Foreign Private Issuers: The annual
securities that are rated investment issuer available to the marketplace review must occur prior to the first
grade on the basis that those securities before trading in the security begins and priced quotation that is more than seven
are even less likely to be subject to to alert regulators that trading in the months following the end of the issuer’s
fraudulent activities? security will be starting. The NASD uses fiscal year.
Q17. Should the Rule exclude all non- Rule 15c2–11 submissions for The purpose of this requirement is to
convertible debt and non-participatory surveillance and enforcement purposes make sure that the broker-dealer
preferred stock or should the exclusion and routinely provides copies of this periodically reviews fundamental
apply only to non-convertible debt and information to the Commission. information about the issuer if the
non-participatory preferred stock that broker-dealer continues to publish
2. Priced Quotations priced quotations. The broker-dealer
are rated investment grade?
While the first broker-dealer must should know if no current information
5. Other Exceptions obtain the required information for the about the issuer exists or if current
The exceptions relating to quotations initial quotation (priced or unpriced) for information reflects a significant change
for exchange-listed and Nasdaq a covered OTC security as discussed in the issuer’s ownership, operations, or
securities, quotations representing a above, thereafter the Rule will only financial condition.
customer’s unsolicited order, and apply to broker-dealers submitting their While we originally proposed two
quotations for exempted securities first priced quotations. The Rule’s alternative dates for conducting the
remain substantively the same as review requirements are also triggered annual review, to simplify the Rule we
currently in the Rule. As we indicated when a broker-dealer first publishes a are reproposing only one date for each
in the Proposing Release, the priced quotation following the lapse of type of security.44 Four months after the
unsolicited status of the customer orders five or more business days of its priced end of the issuer’s fiscal year, a broker-
would be called into question if a quotations for the security. In addition, dealer publishing priced quotes for a
broker-dealer repeatedly publishes as discussed below, a broker-dealer covered OTC security of a domestic
quotations on the basis of the must satisfy the Rule’s requirements if issuer must have conducted the annual
unsolicited customer order exception.41 it publishes a priced quotation as of a review. In the case of a foreign private
Q18. Should unsolicited customer specific date following the end of the issuer’s security, the annual review
orders be required to be identified as issuer’s fiscal year. must occur before the broker-dealer
such in the quotation medium? Is it We propose to focus the Rule’s publishes a priced quote following the
feasible for quotation mediums to show requirements after publication of the date that is seven months after the
that the quote represents an unsolicited first quote on priced quotations, because issuer’s fiscal year end. We believe that
customer order? recent microcap manipulation schemes these time periods give a broker-dealer
have primarily involved priced sufficient time to obtain and review
B. Quotations Subject to the Rule updated issuer information for both
quotations. In addition, priced quotes
1. The Initial Quotation for a Covered are used as indicia of value for a variety reporting and non-reporting issuers.
OTC Security of purposes (e.g., bank loans or pledges Some commenters opposed the
of securities). This revision also annual review requirement because of
As indicated above, the Rule’s potential recordkeeping burdens, the
requirements will apply at the time of responds to the concerns of several
commenters that the earlier proposal perceived difficulty of obtaining the
discrete quotation events. Subject to the required information, and the loss of
Rule’s exceptions, the amendments will could have resulted in some broker-
dealers being precluded from publishing liquidity that could potentially occur if
prohibit the first broker-dealer from broker-dealers could not publish priced
publishing a priced or unpriced any quotations if they could not obtain
the Rule’s required information. We quotes because current issuer
quotation for a covered OTC security in information was unavailable.45
a quotation medium unless it has solicit commenters’ views, however, on
whether unpriced indications of interest 44 The initial proposal would have permitted a
exclusion to investment grade asset-backed will be used more often in unlawful broker-dealer to conduct the annual review as of the
securities at this time. anniversary date of the initial quotation.
41 Proposing Release, 63 FR at 9669. Also, we are 42 For a discussion of the requirements under the 45 See Letter from A.G. Edwards & Sons, Inc.,
combining into a single provision the current reproposed amendments concerning the submission (April 27, 1998) (A.G. Edwards Comment Letter);
exceptions for exchange-listed and Nasdaq of information to the NASD, see Part III.I. below. and Letter from National Quotation Bureau, LLC,
securities. 43 15 U.S.C. 781(k). (April 27, 1998) (NQB Comment Letter).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11131
Commenters stated that the Rule’s securities? How would such a proposal The broker-dealer also must obtain
review requirements represented a shift help reduce instances of microcap and review the supplemental
from the Commission and the SROs to fraud? information contained in paragraph (d)
broker-dealers of the burdens of Q22. Is the Rule text sufficiently clear of the reproposed Rule. A broker-dealer
overseeing issuer compliance with in identifying the quotation events that must review a copy of any trading
regulatory requirements.46 Some are subject to the Rule’s provisions? Are suspension order issued under Section
commenters wrote that the annual there other quotation events that should 12(k) for any of the issuer’s securities
review is only appropriate for certain be covered by the Rule? during the 12 months preceding the
non-reporting companies or issuers for Q23. Should the provision pertaining publication of the quotation, as well as
which only limited information is to a lapse in quotations of five any other material information,
available. Other commenters stated that consecutive business days or more including adverse information, that
the annual review should not apply to provide for a longer time period, e.g., comes to the broker-dealer’s knowledge
issuers that are current in their reporting ten consecutive business days without a or possession before publication of the
requirements because this information priced quotation, or a shorter time quotation. A broker-dealer must
is available on EDGAR.47 A number of period, e.g., three consecutive business consider this supplemental information,
commenters, however, generally days without a priced quotation? along with the issuer information, when
supported some sort of required annual Q24. Should the Rule give broker- it determines whether it has a
review for broker-dealers publishing dealers the option to conduct the annual reasonable basis for believing that the
priced quotations, although they review as of the anniversary date of the issuer information is accurate and from
differed as to the securities that should initial quotation by the broker-dealer? reliable sources. While we are not
be subject to this provision.48 including a requirement that the broker-
The amendments will apply the C. Information Required Under the Rule
dealer obtain and review any trading
annual review requirement to priced The amendments are substantially suspension for a foreign security that
quotations for both reporting and non- identical to the earlier proposal with was issued by a foreign financial
reporting issuers’ securities. We believe respect to the issuer information that a regulatory authority, this information
that an annual review requirement for broker-dealer must review before must be taken into account by the
both reporting and non-reporting publishing a quotation for a covered broker-dealer if it comes to the broker-
issuers’ securities fulfills the objectives OTC security. Under the reproposal, a dealer’s knowledge or possession at the
of the Rule without imposing significant broker-dealer subject to the Rule must time that a review is required.
burdens on broker-dealers. This is gather, review, and maintain in its In addition, the broker-dealer must
especially so because we are revising records the following issuer make a record of the significant
the Rule to cover only those securities information: relationship information contained in
that, in our view, are most likely to be • For an issuer that has conducted a paragraph (e) of the reproposed Rule,
the subject of microcap fraud schemes recent public offering either registered which is unchanged from the Proposing
and are also limiting the scope of the under the Securities Act of 1933 Release. Under this provision, a broker-
annual review to priced quotations. We (Securities Act) or effected pursuant to dealer would have to document
also note that because information about Regulation A under the Securities Act, specified information such as whether
reporting issuers is available on the a copy of the prospectus or offering the broker-dealer has any affiliation
Commission’s website, the review of circular; with the issuer or arrangements to
information about these issuers can be • For an issuer that files reports with receive any consideration to publish the
accomplished quite easily. the Commission pursuant to Sections 13 quote, and whether the quote is being
Commenters are requested to provide or 15(d) of the Exchange Act49 published on behalf of another broker-
us with their views on the reproposal’s (reporting issuer), the issuer’s most dealer or the issuer, any of its insiders,
focus on priced quotations. recent annual or semi-annual report and or any large shareholder.
Q19. Should the Rule cover all broker- any subsequent quarterly and current Commenters generally did not object
dealers’ initial quotations, whether reports; to the issuer, significant relationship,
priced or unpriced, as the earlier • For an issuer that is an insurance and supplemental information
proposal would have? Will the company of the kind specified in requirements; in fact, some commenters
reproposal cause broker-dealers to Section 12(g)(2)(G) of the Exchange favored the enhanced information
publish unpriced quotes to avoid Act,50 the issuer’s most recent annual requirements for non-reporting
complying with the Rule? statement referred to in Section issuers.51 Therefore, we are reproposing
Q20. Should the Rule apply 12(g)(2)(G)(i); these requirements without any
exclusively to priced quotes, i.e., the • For an issuer that is not required to substantive changes, other than
Rule would not cover any unpriced file reports pursuant to Sections 13 or revisions relating to financial statements
quotes? 15(d) of the Exchange Act and that is a for non-reporting issuers, as discussed
Q21. Are there other approaches that bank or savings association, the issuer’s
would be more appropriate, e.g., to most recent annual report and any 51 In response to the 78 comment letters that we
cover any initial quote for a covered received from issuers of securities quoted on the
subsequent reports filed with its OTC Bulletin Board who were concerned about
OTC security by a broker-dealer, appropriate federal or state banking continued liquidity for their securities, we note that
whether priced or unpriced, but not to authority; and 33 of these issuers are reporting companies. Also,
apply the Rule or at least the annual • For any other issuer, the under recently approved amendments to NASD
review requirement to reporting issuers’ information, including certain financial Rules 6530 and 6540, all of these issuers ultimately
will need to be reporting companies current in their
information, specified in proposed reporting obligations in order for their securities to
46 See, e.g., A.G. Edwards Comment Letter.
paragraph (c)(6) of the Rule, which must remain on the OTC Bulletin Board. See note 6 above
47 See, e.g., NQB Comment Letter.
be reasonably current in relation to the and accompanying text. There should be no
48 See Letter from NASD Regulation, Inc., (July burdens on reporting issuers to provide information
17, 1998) (NASD Comment Letter); Letter from
day a quotation is submitted. to broker-dealers wishing to publish quotations
North American Securities Administrators because the issuer information should be available
49 15 U.S.C. 78m and 78o(d).
Association, Inc., (April 27, 1998) (NASAA on EDGAR, as long as the issuers are current in
Comment Letter); and SIA Comment Letter. 50 15 U.S.C. 78l(g)(2)(G). their reporting obligations.
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11132 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
below in Part III.C.4. We are addressing Chapter 11 reorganization when current satisfy Rule 15c2–11 because this
below specific points that a few Exchange Act reports were unavailable. financial report usually contains only
commenters raised about the One commenter also suggested that the information about issuer receipts and
information requirements and other Commission permit delinquent disbursements. Where a reporting issuer
provisions. Commenters are welcome to reporting companies that experience a receives this type of no-action position,
provide their views on the information 51% ownership change as a result of a a broker-dealer would not be able to
requirements for the various categories confirmed plan of reorganization to obtain the issuer information required
of issuers and should consult the begin reporting from the effective date by the Rule until the debtor’s
Proposing Release for a more detailed of the reorganization plan with a filing reorganization plan becomes effective,
description of these provisions.52 with the Commission, attaching the and the debtor files a Form 8–K, which
court-approved disclosure statement instead of attaching the Rule 2015
1. Reporting Issuers Delinquent in Their
together with a certified audited balance bankruptcy reports, now includes the
Filings
sheet as of the effective date.56 issuer’s audited balance sheet. Under
In the case of an issuer delinquent in The reproposal will require a broker- Rule 15c2–11, broker-dealers could
its reporting obligations, a broker-dealer dealer publishing quotations for a review this 8–K, which contains an
will not be able to publish an initial reporting issuer’s securities to obtain the issuer’s audited balance sheet, and then
priced quotation, or continue to publish issuer’s Exchange Act reports, even if publish priced quotations. From then
priced quotations after the annual the reporting issuer has filed for Chapter on, the issuer must file its Exchange Act
review date, because it will not be able 11 reorganization. Thus, if a reporting periodic reports for all periods that
to obtain the specified reports. A few issuer that has filed for Chapter 11 begin after the plan becomes effective.60
commenters indicated concern about reorganization becomes delinquent in The publication of quotations by a
the possible adverse implications for the its reporting obligations, a broker-dealer broker-dealer indicates that a market
market for delinquent issuers’ securities will not be able to publish priced exists for the issuer’s securities. It
if broker-dealers could not publish quotations covered by the Rule. For would be inconsistent with the premise
quotes when current issuer information example, a broker-dealer could not of the no-action position (i.e., that there
was unavailable.53 As noted above, we continue to publish priced quotations as is no trading in the issuer’s securities)
are revising the Rule to permit broker- of the annual review date for a covered if a broker-dealer were able to stimulate
dealers to publish unpriced quotations, security of a reporting debtor that has trading by publishing quotations
even in the absence of current issuer become delinquent in its reporting without having the issuer’s Exchange
information (except in the case of the obligations.57 Act reports.
first quotation for the security). The bankruptcy court filings for an Q25. Are there circumstances in
issuer undergoing reorganization under which a broker-dealer should be
2. Issuers in Bankruptcy Chapter 11 are not adequate to satisfy permitted to publish priced quotations
a. Reporting Issuers the Rule’s requirements. These Rule for the securities of delinquent reporting
A few commenters urged us to permit 2015 bankruptcy reports ordinarily issuers in bankruptcy? Please describe
broker-dealers to continue to quote the contain only data about issuer receipts these circumstances. Should the Rule
securities of reporting issuers that had and disbursements and not the type of prohibit broker-dealers from publishing
filed for reorganization under federal issuer financial information unpriced quotes for the securities of
bankruptcy law because it would contemplated by Rule 15c2–11.58 In these issuers?
provide liquidity for these securities.54 some cases, our Division of Corporation
Finance may grant issuers in bankruptcy b. Non-Reporting Issuers Emerging From
They noted that it was often Bankruptcy
burdensome for small companies that no-action relief with respect to
had filed for reorganization under Exchange Act filing requirements.59 The Proposing Release contained
Chapter 11 of the Bankruptcy Code 55 to These no-action positions, however, are amendments to permit broker-dealers
produce audited financial statements to predicated on little or no trading that quote the securities of non-
comply with Exchange Act reporting occurring in the debtor’s securities. The reporting companies emerging from
requirements. Rule 2015 bankruptcy reports that the bankruptcy to review the bankruptcy
Commenters suggested that broker- Division of Corporation Finance accepts court-approved disclosure statement
dealers could satisfy the Rule’s under its no-action position do not and issuer financial information
requirements by reviewing bankruptcy required by the Rule from the date that
56 Demers Comment Letter; see also 11 U.S.C.
court filings made by an issuer in the bankruptcy court confirms the
1125. The disclosure statement includes, among
other things, a description of the issuer’s business
reorganization plan.61 The commenters
52 See Part II.A.4. of the Proposing Release at 63 plan, a description of any securities to be issued, who addressed this issue supported the
FR 9661, 9664–9669. and financial information. proposal to limit a broker-dealer’s
53 See, e.g., NASAA Comment Letter. 57 Broker-dealers would be able to continue to
review to the post-reorganization
54 See, e.g., Letter from Daniel J. Demers (March publish unpriced quotations. information.62 The amendments are
27, 1998) (Demers Comment Letter); Letter from 58 See Federal Rule of Bankruptcy Procedure 2015
Robotti & Company, Inc., (April 27, 1998) (Robotti (Rule 2015 bankruptcy reports).
unchanged from the original proposal.
Comment Letter); and NQB Comment Letter. In 59 See Staff Legal Bulletin No. 2 (April 15, 1997)
60 See Staff Legal Bulletin No. 2.
1989, we sought comment on whether there were (CF) (Staff Legal Bulletin No. 2), which is available
situations, such as bankruptcy, that should be through our Internet website at <http:// 61 See 11 U.S.C. 1125. The disclosure statement
addressed if the piggyback provision were revised. www.sec.gov/rules/othern/slbcf2.txt>. Under Staff includes, among other things, a description of the
See Securities Exchange Act Release No. 27247 Legal Bulletin No. 2, our Division of Corporation issuer’s business plan, a description of any
(September 14, 1989), 54 FR 39194 (1989 Release). Finance has granted no-action relief permitting an securities to be issued, and financial information.
Commenters on the 1989 Release argued that it was issuer in Chapter 11 reorganization to satisfy its 62 See Letter from Florida Division of Securities
appropriate to permit broker-dealers to continue Exchange Act reporting obligations by filing the (April 27, 1998) (Florida Comment Letter); NQB
quoting the securities of issuers that had filed for Rule 2015 bankruptcy reports on Exchange Act Comment Letter; Demers Comment Letter; and
bankruptcy because it provided liquidity for these Form 8–K. See 17 CFR 249.308. Under Staff Legal Robotti Comment Letter. Mr. Demers suggested that
securities and suggested that issuers in bankruptcy Bulletin No. 2, the staff has allowed a company to the required financial information for non-reporting
be identified in the quotation system by using a substitute its Rule 2015 bankruptcy reports for its issuers emerging from bankruptcy be from the
special indicator. Exchange Act periodic reports when there is little ‘‘effective date’’ of the plan, instead of the
55 11 U.S.C. 1101 et seq. or no trading in the debtor’s securities. ‘‘confirmation date’’ of the plan. We are retaining
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11133
3. Non-Reporting Foreign Private Issuers recognize the foreign status of these quotations for such an issuer greater
In the case of a foreign private issuer issuers.66 By eliminating the provision understanding of the issuer’s operations
that relies on an exemption from for Rule 12g3–2(b) issuers, all non- and a better indication of whether
registration under Section 12(g) 63 of the reporting foreign private issuers will be potential or actual fraud or
Exchange Act by complying with treated similarly under Rule 15c2–11. manipulation may be present.
Exchange Act Rule 12g3–2(b), Rule Commenters were divided on whether Several commenters supported the
15c2–11 specifies that a broker-dealer we should amend the provisions of the requirement for a broker-dealer to
must review the information submitted Rule governing the review of review the disciplinary information
to the Commission under Rule 12g3– information for non-reporting foreign about the insiders of non-reporting
2(b).64 To qualify for the registration private issuers.67 Because the issuers. One commenter believed that if
exemption, the issuer must furnish to reproposal excludes the securities of broker-dealers are allowed to publish
the Commission information that the many larger foreign issuers from Rule quotations without obtaining this
issuer has made or is required to make 15c2–11 and also distinguishes between disciplinary information, it would
public under the law of the country in U.S. and foreign accounting standards create a loophole for issuers to avoid
which the foreign private issuer is for those foreign issuers that continue to disclosing information that would be of
domiciled or incorporated; has filed or be covered, many of the reasons for utmost importance and would thereby
is required to file with a stock exchange permitting broker-dealers to rely on defeat the goal of the Commission.68
on which the securities are traded and Rule 12g3–2(b) information have been While no commenters directly opposed
which the exchange has made public; or addressed. the requirement to obtain disciplinary
Q26. Should broker-dealers be information, several commenters
has distributed or is required to
required to obtain and review the same objected to the enhanced information
distribute to its securityholders. For
type of issuer information with respect requirements in general as too difficult
foreign private issuers that do not
to non-reporting foreign private issuers and burdensome, especially when
furnish the Commission with
providing information under Rule 12g3– issuers are unwilling to volunteer
information under Rule 12g3–2(b), the
2(b) as they must for other non-reporting information.69
Rule currently requires broker-dealers to
foreign issuers? Are there reasons to Q28. Should the Rule require the
obtain and review the same kind of
retain a special provision in Rule 15c2– disciplinary history information for the
information, including financial
11 for foreign issuers furnishing insiders of all issuers of covered OTC
information, as required for non-
information under Rule 12g3–2(b)? securities, and not just insiders of non-
reporting domestic issuers.
We note that Rule 12g3–2(b) contains Q27. What is the experience of broker- reporting issuers, on the basis that
no specific requirements governing the dealers under the Rule when the foreign microcap fraud can involve issuers
categories of information the issuer issuer has not furnished information to whose insiders have histories of prior
must furnish to the Commission under the Commission under Rule 12g3–2(b)? misconduct?
How difficult or easy will it be for We are proposing to amend the
the exemption. As a result, there is no
broker-dealers to obtain the paragraph financial information that a broker-
assurance that broker-dealers publishing
(c)(6) information for a non-reporting dealer must review when publishing
quotes will obtain the same type of
foreign private issuer? quotations of both domestic and foreign
information for each foreign private
non-reporting issuers. The reproposal
issuer that claims the Rule 12g3–2(b) 4. Other Non-Reporting Issuers lists the financial statements required
exemption as they must for other non-
The amendments parallel the for a domestic issuer, which must be
reporting foreign private issuers. This
Proposing Release in their treatment of prepared in accordance with U.S.
can be problematic since a number of
non-reporting issuers (i.e., those non- GAAP, and sets forth when these
issuers claiming the Rule 12g3–2(b)
reporting issuers that are not financial financial statements will be presumed
exemption are foreign microcap
institutions covered by paragraph ‘‘current’’ under the Rule. Absent
companies that can potentially be
(c)(4)), except for the new exclusions contrary information, a domestic
subject to the same kinds of abusive
discussed in Part III.A. above and the issuer’s balance sheet will be considered
practices as their U.S. counterparts.
Therefore, we are proposing to change revisions to the required financial current if it is as of a date that is less
Rule 15c2–11 requirements with respect information for non-reporting issuers. than 15 months before the quotation is
to quotations for the securities of foreign As in the Proposing Release, the Rule published, rather than less than16
issuers complying with Rule 12g3–2(b). will require broker-dealers to review months as now specified in the Rule.70
more information than currently This revision comports with existing
Broker-dealers publishing quotations for
required about the issuer’s outstanding Exchange Act requirements regarding
the securities of Rule 12g3–2(b) issuers
securities; the issuer’s insiders, when a domestic reporting issuer’s
will have to obtain and review the
including their disciplinary history; and financial statements are considered
information specified in paragraph (c)(6)
of the reproposed Rule.65 However, as certain significant events involving the
described in more detail below, we issuer, among other items. This 68 See NASAA Comment Letter.
69 See, e.g., Letter from David B. Schneider (April
propose to revise the financial information will provide a broker-dealer
21, 1998).
statements that must be reviewed for that is considering whether to publish 70 This provision is a presumption that financial
non-reporting foreign private issuers to information that is less than 15 months old is
66 See Part III.C.4. below.
current. However, if the broker-dealer has other
67 For example, some commenters stated that we information that indicates that the issuer’s financial
this amendment from the confirmation date because should delete the reference to Rule 12g3–2(b) and condition has materially changed from that shown
adequate information is available about the non- require broker-dealers to review the same in the financial statements, this presumption may
reporting issuer at this point for Rule 15c2–11 information as required for all other foreign non- not apply, and the broker-dealer should determine
purposes. reporting issuers whose securities are subject to whether more recent financial information is
63 15 U.S.C. 78l(g).
Rule 15c2–11. See, e.g., Florida Comment Letter. available. Financial information older than 15
64 17 CFR § 240.12g3–2(b).
Other commenters, however, indicated that we months is not current and does not satisfy the
65 Some of the paragraph (c)(6) information that should continue to require broker-dealers to review Rule’s requirements. The presumption for non-
broker-dealers will have to obtain and review may only the home country information that certain financial information is that this information is
be present in the foreign issuer’s Rule 12g3–2(b) foreign issuers submit to the Commission under considered current if it is as of a date within 12
materials. Rule 12g3–2(b). See, e.g., SIA Comment Letter. months of publication of the quotation.
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11134 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
current. The reproposal also will require entities to which a broker-dealer must having a data base of information about
broker-dealers to review the specified provide the information.72 The the non-reporting issuers of covered
financial information for such part of amendments require a broker-dealer to OTC securities.76 Such a data base also
the two preceding fiscal years (in the provide information upon request to any would enhance the availability of
case of the balance sheet, the preceding current customer, prospective customer, information about little-known issuers
fiscal year) that the issuer (or any information repository, or other broker- to investors, other professionals, and
predecessor) has been in existence. dealer. regulators. The consensus among the
The reproposal also will revise the A few commenters asserted that commenters who specifically addressed
requirements with respect to the broker-dealers should not be required to this issue was that the creation of a
financial statements that broker-dealers provide information that already is repository would foster access to
must review when publishing a generally available to the public from information about issuers that do not
quotation for a non-reporting foreign other sources (e.g., information for participate in the public disclosure
private issuer’s security. The reproposal reporting companies that is available on system.77 For these reasons, we
lists the financial statements that the EDGAR).73 We are addressing these encourage the development of one or
broker-dealer must review, which must concerns in the amendments by more repositories of Rule 15c2–11
be prepared in accordance with a requiring broker-dealers to provide the information, but we note that the
comprehensive body of accounting required information that is not existence of a repository will not be
principles, and sets forth when these accessible through EDGAR, any other necessary for broker-dealers to comply
financial statements will be considered federal or state electronic information with the Rule.
current under the Rule. For a non- system, or an information repository. The amendments establish that the
reporting foreign private issuer, its Further, most commenters responding Commission may, upon written
balance sheet will be presumed current to this issue were concerned about the application, designate an entity as an
if it is as of a date less than 18 months cost of providing information to others information repository.78 In determining
before the quotation is published.71 upon request.74 We believe that the cost whether to grant or deny such a
Also, if the balance sheet is as of a date of requiring broker-dealers to make the designation, the Commission will
more than 9 months before the information available (including to consider whether an entity:
quotation is published, the broker- other broker-dealers) upon request is • Collects information about a
dealer must obtain more current minimal.75 substantial segment of issuers of
financial information only to the extent The amendments retain in substantial securities subject to the Rule;
that the issuer has prepared it. The form the clause that providing • Maintains current and accurate
broker-dealer must obtain the specified information to others does not information about such issuers;
constitute a representation by the • Has effective acquisition, retrieval,
financial information for the two
broker-dealer that the information is and dissemination systems;
preceding fiscal years (one year with • Places no inappropriate limits on
respect to the balance sheet) that the accurate. Rather, providing the
information to others constitutes a the issuers from or about which it will
issuer has been in existence. accept or request information;
Q29. Are the financial statement representation that the information is
current in relation to the date the • Provides access to the documents
requirements, including the deposited with it to anyone willing and
presumption regarding when the information was reviewed, and that the
broker-dealer has a reasonable basis for able to pay the applicable fees; and
information is considered current, clear • Charges reasonable fees.
and capable of being complied with by believing that the information was
accurate as of the date recorded and was In general, the Commission will
broker-dealers publishing quotations? consider whether an entity wishing to
Should there be longer time periods for obtained from reliable sources.
Q31. Should we require broker- act as an information repository is so
the presumption regarding when the organized and has the capacity to be
dealers to make the information
financial statements for a non-reporting able reasonably to obtain and provide to
available to anyone who requests it,
foreign private issuer are considered others current information required by
particularly if broker-dealers are
current? If so, what time periods would the Rule. An information repository will
permitted to charge reasonable fees?
be appropriate? be required to notify the Commission of
Should broker-dealers be required to
Q30. Are there any information any material changes in the facts and
provide information to fewer classes of
requirements for non-reporting issuers circumstances of their application for
persons?
that should be added or removed from designation as an information
reproposed paragraph (c)(6)? E. Information Repository repository. In the event that an
D. Information Available Upon Request The amendments, as in the Proposing information repository no longer
Release, eliminate the piggyback satisfies these attributes, we may
We believe that some microcap frauds withdraw such designation.
provision of the Rule. The elimination
could be prevented if there were greater
of the piggyback provision and the
investor access to information about 76 We note that, for reporting issuers, information
potential for increased costs of
those securities and their issuers. repositories already exist. Broker-dealers are able to
compliance suggest the desirability of
Accordingly, we are reproposing, with access and review the required information on our
some revisions, the requirement that a EDGAR system, available through our Internet
72 See, e.g., Letter from Security Traders
website at <http://www.sec.gov>. In addition,
broker-dealer publishing quotations for Association (April 28, 1998) (STA Comment Letter). broker-dealers may consult federal or state
any covered OTC security make the We originally proposed that the information be electronic information systems for information
information promptly available upon made available to anyone upon request. about issuers of covered OTC securities.
73 See e.g., Letter from Richard P. Ryder, Esq. 77 See e.g., Letter from Singer Frumento
request. In response to the Proposing
(May 12, 1998). Sichenzia, LLP, (April 13, 1998).
Release, several commenters suggested 74 See e.g., Letter from The Bond Market 78 This authority will be delegated to the Director
that we restrict the types of persons and Association Comment Letter (April 27, 1998); NQB of the Commission’s Division of Market Regulation.
Comment Letter; and Florida Comment Letter. We propose to amend Rule 200.30–3, which
71 This presumption will operate in the same 75 A broker-dealer may charge for the reasonable provides for delegation of authority to the Director,
manner as for domestic issuers. See footnote 70 expenses it incurs in producing and forwarding to include the designation of information
above. copies of the Rule 15c2–11 information. repositories. See 17 CFR 200.30–3.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11135
Some commenters suggested that the only to the broker-dealers that submit Net tangible assets. We are proposing
Commission assume the task of serving quotations for publication by the ATS, to add a definition to the Rule to assist
as the Rule 15c2–11 information and not to the ATS functioning as the broker-dealers in assessing whether or
repository.79 Because the issuers that quotation medium for them. The Rule not a security can meet the proposed
would be the focus of any information will apply to an ATS only if, as a exception to the Rule for securities of
repository generally would not be registered broker-dealer, it displays its issuers with net tangible assets
required to file periodic reports with the own orders in the ATS. exceeding $10 million. Net tangible
Commission, this is not a function that An issue has also been raised about assets means total assets less intangible
we can assume at this time. The NASD whether Rule 15c2–11 applies to broker- assets and liabilities and this
has also advised us preliminarily that it dealers submitting orders through an determination must be based on the
is unable to undertake the responsibility ATS. We understand that some broker- issuer’s current financial statements,
of serving as an information repository dealers have taken the position that which must be audited.
at the present time. Therefore, we compliance with Rule 15c2–11 is not
necessary when they submit an order G. Preservation of Documents and
encourage private sector initiatives for
through an ATS.83 They have viewed Information
the creation of one or more Rule 15c2–
11 information repositories. such an order for the security as not To facilitate compliance with the
Q32. Are there other criteria that constituting a quotation within the Rule’s recordkeeping requirements, we
should be used to determine the meaning of Rule 15c2–11. These orders believe that it is appropriate to codify
information repository designation? may represent transactions for the the Rule’s record preservation
broker-dealer’s own account. The Rule’s requirements in Rule 17a–4,86 rather
F. Definitions than in Rule 15c2–11. Rule 17a–4
definition of quotation makes clear that
Reproposed paragraph (j) of the Rule the Rule covers any indication of obligates broker-dealers to preserve
sets forth the definitions applicable to interest by a broker or dealer in documents and information that they
all provisions of the Rule. Most of the receiving bids or offers from others for must compile pursuant to Commission
definitions are unchanged from the a security, or any indication by a broker rules for the time period and in the
Proposing Release, but a few definitions or dealer that it wishes to advertise its manner specified in the various
are revised to respond to commenters’ general interest in buying or selling a provisions of Rule 17a–4. As in the
suggestions or to add clarity to the particular security. Thus, broker-dealers Proposing Release, Rule 17a–4 would be
amendments. are subject to the Rule when they place amended to add the information
Quotation Medium. The current any indication of interest in any specified in reproposed paragraphs (c),
definition of ‘‘interdealer quotation quotation medium, including an ATS, (d), and (e) of Rule 15c2–11 to the other
system’’ will be incorporated into the that they wish to receive bids or offers information that broker-dealers are
definition of ‘‘quotation medium’’ in in a covered OTC security, unless they already required to preserve under Rule
paragraph (j)(12).80 This definition of can rely on one of the Rule’s 17a–4.87
quotation medium is quite inclusive: it exceptions.84 With regard to issuer information that
covers any publication, alternative Also, we are clarifying the Rule’s is accessible to broker-dealers through
trading system (ATS), or other device application to broker-dealers that our EDGAR system, any other federal or
that is used by brokers or dealers to publish quotations in multiple state electronic information system,88 or
make known to others their interest in quotation mediums or move their an information repository, the
transactions in any security, including quotations from one quotation medium amendments provide different
offers to buy or sell at a stated price or to another. If the broker-dealer complies requirements. If broker-dealers obtain
otherwise, or invitations of offers to buy with the Rule’s provisions, based upon and review the information contained
or sell.81 A few ATSs expressed concern a review of information, it may publish on such systems, they will not need to
about whether they would have to quotations in one or more quotation preserve such information separately, as
comply with the Rule’s information mediums.85 long as they document the review and
review requirements with regard to any the information is accessible on such
covered OTC security that is traded on 83 For example, some broker-dealers have claimed system for the same period of time that
their systems by broker-dealer to submit customer ‘‘orders’’ in quotations mediums
subscribers to such ATSs.82 ATSs are following the termination of a Commission trading 86 17 CFR 240.17a–4. We will add new paragraph
suspension issued under Exchange Act Section (b)(11).
included in the definition of ‘‘quotation 12(k). 87 This proposed recordkeeping requirement was
medium’’ if they display subscriber 84 To rely on the exception for an unsolicited
discussed by few commenters and generally was
orders to any person other than ATS customer order, the order must represent an viewed favorably. See e.g., NASAA Comment
employees. The Rule’s information unsolicited indication of interest of a customer Letter.
review requirements, however, apply (other than a person acting as or for a dealer) of the 88 Broker-dealers publishing quotes for securities
broker-dealer submitting the order to the ATS. of exempt financial institutions may obtain the
85 We have previously interpreted the Rule to
79 See, e.g., STA Comment Letter. regulatory reports from the financial institution by
require a broker-dealer that was publishing contacting their primary bank regulatory agency.
80 Under the current Rule, interdealer quotation
quotations in a particular interdealer quotation Broker-dealers can access the Federal Reserve
system is defined as any system of general system to review issuer information before System’s National Information Center of Banking
circulation to brokers or dealers which regularly publishing quotations in another interdealer Information Internet website at <http://
disseminates quotations of identified brokers or quotation system unless it relied upon an www.ffiec.gov/NIC>, the Office of the Comptroller
dealers. A separate definition of ‘‘interdealer exemption. See Letter re: OTC Bulletin Board of the Currency’s Internet website at <http://
quotation system’’ is no longer necessary because of Display Service (December 20, 1993) (conditional www.occ.treas.gov>, which has information about
the proposed elimination of the piggyback exemption permitting broker-dealers that are individual nationally chartered banks, or the
provision and the revision that the information be currently publishing quotations in an interdealer Federal Deposit Insurance Corporation’s (FDIC)
furnished to the NASD in accordance with NASD quotation system to publish quotations in the OTC Internet website at <http://www.fdic.gov>, which
rules, rather than to interdealer quotation systems. Bulletin Board without reviewing issuer provides the most recent Call Reports for all FDIC
81 We are using the term ‘‘alternative trading
information under the Rule); and Letter re: OTC insured banks. Broker-dealers that access exempt
system,’’ which encompasses the term ‘‘electronic Bulletin Board; Modification of Exemption financial institution information through these
communications network.’’ See Securities Exchange (December 1, 1998) (modifying the exemption websites would be able to satisfy the Rule’s
Act Release No. 40760 (December 8, 1998), 63 FR granted in 1993). Upon adoption of the reproposed requirements by recording their review and
70844. amendments, we will rescind this interpretation preserving the information in the same manner as
82 See e.g., Letter from Instinet (April 22, 1998). and related exemptions. for EDGAR information discussed above.
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11136 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
the broker-dealers are obligated to well as on any other matter that might excluding unpriced quotations from the
preserve such information pursuant to have an impact on the reproposal Rule, anti-competitive burdens will be
Rule 17a–4. discussed above. In particular, we seek reduced because broker-dealers that
comment on the whether the reproposal cannot, or do not want to, obtain the
H. Transition and Exemptive Authority
will help focus the Rule on those specified information can still advertise
Provisions
securities and quotations most likely to their interest in buying or selling a
We are reproposing the transition be involved in microcap fraud. particular OTC security in a quotation
provision covering quotations by broker- Commenters are requested to address medium. Finally, the reproposal should
dealers that were initiated prior to the whether there are other ways to amend have a beneficial impact on capital
effective date of the proposed the Rule that would help reduce fraud formation because microcap fraud
amendments and, with a slight and manipulation in the OTC market. ultimately increases the costs of raising
modification, the provision giving the Commenters also are invited to address capital for legitimate smaller issuers.
Commission the authority to grant whether the Rule’s text is sufficiently Investors may be less willing to commit
exemptions from the Rule.89 These clear and understandable, or whether it their resources if they are concerned
proposed provisions were viewed as can be simplified without sacrificing its about fraudulent activities in OTC
adequate by the few commenters who purposes. We also request commenters securities.
discussed them.90 to provide us with their views regarding We request comments on the benefits,
I. Information submitted to the NASD whether the original proposal, or as well as the adverse consequences,
aspects of it, are preferable to the that may result with respect to
Rule 15c2–11 currently requires any reproposal. efficiency, competition and capital
broker-dealer covered by the Rule to We encourage commenters to focus on formation, if the reproposal is adopted.
submit the information required under the various provisions of the reproposal
paragraph (a)(5) (i.e., for non-reporting and bring to our attention any VI. Costs and Benefits of the
issuers) to the interdealer quotation compliance or other specific issues that Amendments
system, in the form prescribed by the they may encounter if the reproposal is We request commenters to evaluate
system, at least three business days adopted. Commenters are urged to the costs and benefits associated with
before submitting a quotation for provide us with their views as the amendments to Rule 15c2–11. We
publication. We intend to amend this expeditiously as possible so that we can have identified certain costs and
obligation by requiring broker-dealers to complete our review of Rule 15c2–11. benefits relating to the reproposal,
submit the information that they must which are discussed below, and
review only to the NASD, in accordance V. Effects on Efficiency, Competition,
and Capital Formation encourage commenters to discuss any
with the NASD’s rules.
additional costs or benefits. In
The amendments are substantially the Section 23(a)(2) of the Exchange Act
same as originally proposed, except for particular, we request comments on the
requires the Commission, in adopting potential costs for any necessary
one change. Under the Proposing rules under the Exchange Act, to
Release, a broker-dealer would be in modifications to information gathering,
consider the anti-competitive effects of management, and reporting systems or
compliance with the requirement to any rules it adopts thereunder, and to
obtain current reports filed by a procedures that would be necessary to
not adopt any rule that would impose a implement the amendments, as well as
reporting issuer, if the broker-dealer burden on competition not necessary or
obtained all current reports filed with any potential benefits resulting from the
appropriate in the public interest.91 reproposal for issuers, investors, broker-
the Commission by an issuer as of a date Furthermore, Section 3(f) of the
up to three business days before the dealers, securities industry
Exchange Act 92 requires the professionals, regulators or others.
earlier of the date the broker-dealer Commission, when engaged in
submitted the quotations to the Commenters should provide analysis
rulemaking, to consider or determine and data to support their views on the
quotation medium and the date the whether an action is necessary or
broker-dealer submitted information to costs and benefits associated with the
appropriate in the public interest, and amendments.
the NASD. To reduce the chance that a whether the action will promote
broker-dealer would overlook a recently efficiency, competition, and capital A. Benefits
filed report containing material issuer formation. Incidents of microcap fraud
information, we are proposing to We preliminarily believe that the frequently involve issuers for which
eliminate the reference to the date the reproposal would not have any anti- public information is limited.93 Without
information was submitted to the competitive effects that are not information, it is difficult for investors,
NASD. This means that a broker-dealer necessary or appropriate in the public securities professionals, and others to
would be required to obtain current interest. By applying the Rule to the first evaluate the risks presented by these
reports filed by a reporting issuer after broker-dealer publishing any quotations securities. Consequently, many
the broker-dealer had submitted for a security in a quotation medium investors fall prey to persons who make
information to the NASD, if such reports and to other broker-dealers publishing false representations and unrealistic
were filed more than three business priced quotations thereafter, the predictions about these securities. The
days in advance of the publication of availability of information about issuers publication of quotations by broker-
the quotation. of covered OTC securities should be dealers can facilitate the fraudulent
IV. General Request for Comments increased. This should help improve the promotion of microcap securities.
level of competition among broker- In our view, the reproposal generally
We solicit comment on all aspects of dealers publishing priced quotations
the amendments to Rule 15c2–11, as would improve the quality of the
and enhance the extent of information markets for securities subject to Rule
89 The reproposal would provide the Commission
about OTC issuers that is available to 15c2–11 and would help protect
with the authority to grant an exemption from the the investing public. Moreover, by
Rule for any quotation for a security or any class 93 See, e.g., SEC v. Global Financial Traders, Ltd.,
of security. 91 15 U.S.C. 78w(a)(2).
Litigation Release Nos. 15291 (March 14, 1997), and
90 See, e.g., Florida Comment Letter. 92 15 U.S.C. 78c. 15338 (April 17, 1997).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11137
investors from fraudulent schemes of securities on the OTC Bulletin Board information required by the reproposed
involving these securities. The and Pink Sheets are issued by reporting Rule from the Commission’s EDGAR
reproposal is focused on the OTC- companies, whose reports are included system and therefore should incur
quoted securities of smaller issuers. on EDGAR, a significant recordkeeping minimal costs to comply with the Rule.
Absent the amendments, we believe that cost savings to broker-dealers should We believe that it will take a broker-
some broker-dealers would submit result. dealer a maximum of 4 hours to collect,
quotations without regard to basic We do not have the data to quantify review, record, retain, and supply to the
information about relatively unknown the value of the benefits described NASD the information pertaining to a
issuers. In our view, when broker- above. We seek comments on the value reporting issuer, and a maximum of 8
dealers must review specified issuer of these benefits and on any benefits, hours to collect, review, record, retain,
information before publishing priced not already identified, that may result and supply to the NASD the information
quotations, they are less likely to from the adoption of the amendments. pertaining to a non-reporting issuer.95
become unwitting participants in B. Costs We estimate that it will cost a broker-
unlawful schemes of unscrupulous dealer an average cost of $40 per hour
broker-dealers or promoters. Market We anticipate that the elimination of (based on a blended compensation rate
makers in the securities of legitimate the piggyback provision will create the for clerical and supervisory compliance
microcap issuers, as well as the issuers most significant costs that the industry staff) to obtain and review the necessary
themselves, also would benefit from will incur. Currently, only those broker- information required by the Rule.96
improving the integrity of this market dealers that publish quotations during We recently approved changes to
sector. One benefit of the reproposal is the first 30 days of the security’s trading NASD Rules 6539 and 6540 to limit the
that the scope of the Rule will be are required to obtain and review the quotations on the OTC Bulletin Board to
revised so that broker-dealers will not specified information before they securities of issuers that are current in
have to obtain information about those initiate quotations. As reproposed, the their reports filed with us or other
securities that satisfy any one the Rule will continue to require the first regulatory authority, and to prohibit
proposed alternative tests. broker-dealer, before initiating a priced NASD members from quoting a security
We also believe that the amendments or unpriced quotation for a covered OTC on the OTC Bulletin Board unless the
will serve an important surveillance security in a quotation medium, to issuer has made current filings with
function. Currently, only the first review the specified information. us.97 While these NASD Rule changes
broker-dealer quoting a security in a Thereafter, the reproposed Rule will may result in more issuers choosing to
quotation medium must gather, review, impose the review requirement only on become reporting issuers in order to
and preserve the information. The broker-dealers publishing priced continue to qualify for quotation on the
amendments will require the first quotations, including in connection OTC Bulletin Board, we are at this time
broker-dealer initiating any quotation with the annual review requirement. Of unable to adequately quantify the cost
and all broker-dealers initiating priced course, if the Commission suspends impact or burden that the reproposal
quotations thereafter to satisfy the trading under Exchange Act Section imposes in relation to these rule
Rule’s information review requirements. 12(k) for any of the issuer’s securities, changes. However, we believe that,
Moreover, under NASD Rule 6740,94 the Rule’s requirements are triggered. generally, any increase in the number of
broker-dealers demonstrate their The first broker-dealer, before reporting issuers subject to the Rule will
compliance with that rule by filing the initiating any quotation for a covered cause a reduction in the number of the
Rule 15c2–11 information with the OTC security, is currently required to burden hours and associated costs. We
NASD. Recently, the review of Forms incur the cost of having to gather and are of the view that because reporting
211 filed with the NASD has resulted in review the issuer information. As a issuer information is readily available
a number of Commission trading result of the amendments, that broker- from the Commission’s EDGAR system
suspensions and other enforcement dealer will incur the cost to update that and, because we estimate that broker-
actions. information annually if it continues to dealers only have to spend 4 hours
The amendments require broker- publish priced quotations. Thereafter, reviewing reporting issuer information,
dealers publishing quotes in compliance any broker-dealer publishing priced instead of the estimated 8 hours to
with the Rule to provide the information quotations for a covered OTC security review non-reporting issuer
upon request to any customer, will incur costs when it first publishes information, the reduced time spent
prospective customer, other broker- a priced quotation and when it conducts reviewing issuer information will result
dealers, or information repository unless the required annual review. To the in lower costs to broker-dealers.
the information is available through a extent a broker-dealer does not already However, broker-dealers publishing
government sponsored database. This have the required information, it will priced quotations for the OTC securities
amendment will help make information incur costs for the collection and review of non-reporting issuers are likely to
about non-reporting issuers more widely of this information. Moreover, a broker- incur greater costs in complying with
available to the public. dealer also will incur costs associated
We also believe that the amendments with creating the records required by 95 We computed these cost estimates after
will ease significantly the Rule’s the Rule and retaining the Rule’s reviewing, among other sources, responses to a
survey of broker-dealers conducted by the NQB
recordkeeping requirement because required information for the specified about issues raised in the Proposing Release. The
broker-dealers will not have to retain period of time under the amendment to results of the NQB’s survey are available in File No.
information that is available on the Rule 17a–4. S7–3–98 at the Commission’s Public Reference
Commission’s EDGAR system or on the We estimate that approximately 60% Room, 450 Fifth Street N.W., Washington, D.C.
20549.
information systems of other federal or of the issuers of OTC stocks are 96 The cost estimate assumes that clerical staff are
state authorities. Access to EDGAR and reporting issuers, while the remaining paid at an average rate of $15 per hour and
similar government-sponsored 40% are non-reporting issuers. Based on supervisory compliance staff are paid at an average
information systems is free on the this assumption, broker-dealers rate of $100 per hour. The blended compensation
rate assumes that 70% of the time is clerical and
Internet. Given that approximately 60% publishing priced quotations for the 30% is supervisory compliance [(0.7 × $15) + (0.3
OTC securities of reporting issuers × $100) = $40].
94 NASD Manual, Marketplace Rules, Rule 6740. should be able to obtain the prescribed 97 See OTC Bulletin Board Release.
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11138 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
the Rule. For purposes of the Paperwork reporting issuer information, and VII. Initial Regulatory Flexibility Act
Reduction Act, we estimate the total $400,000 ($4,000×100) associated with We have prepared an Initial
burden hours for all broker-dealers to be non-reporting issuer information. Total Regulatory Flexibility Analysis (IRFA) 98
143,278 hours and the total cost to be start-up, operating and maintenance regarding the amendments to Rule
$5,731,120. Some broker-dealers may cost burden for broker-dealers is 15c2–11 and the reproposed companion
not want to expend the time or the cost estimated to be $500,000 amendment to Rule 17a–4 under the
to obtain the non-reporting issuer ($100,000+$400,000) or an average of Exchange Act. The following
information and may therefore choose $5,000 for each broker-dealer. summarizes the IRFA.
not to publish priced quotes. On the We assume that non-reporting issuers, As discussed in the IRFA, the
other hand, the costs broker-dealers because they generally maintain their amendments specify the information
incur in obtaining and reviewing that a broker-dealer must gather and
financial information in compliance
information about non-reporting issuers review before publishing quotations for
with prevailing accounting standards,
may be reduced if one or more on-line covered OTC securities. The reproposed
will not incur any start-up costs to
information repositories of this Rule is intended to prevent broker-
prepare the required information in
information are established. We seek dealers from publishing quotations for
response to broker-dealers’ requests. We
comments on the reasonableness of covered OTC securities in a quotation
also believe that reporting issuers of
these estimates for annual hourly and medium without obtaining, reviewing,
covered OTC securities will not incur
dollar costs to broker-dealers. We also and retaining current information about
start-up costs as a result of the
seek comments on the extent to which the issuer. The reproposed Rule applies
amendments since such issuers already
these cost estimates will be affected by primarily to priced quotations.
the new NASD rule to limit the OTC provide the required information to the
Commission under the federal securities The amendments to the Rule would
Bulletin Board to the securities of affect all broker-dealers, including a
issuers current in their periodic filings. laws. Therefore, we believe issuers will
not incur start-up costs as a number of small broker-dealers, seeking
Although Rule 15c2–11 does not to publish quotations for covered OTC
regulate issuers, there may be some consequence of the adoption of the Rule
amendments, as reproposed. securities.99 The number of small
indirect costs imposed on issuers, broker-dealers that publish quotations
particularly non-reporting issuers, Finally, the Rule, as modified by the for covered OTC securities in quotation
because they may be contacted by amendments, could affect the liquidity mediums is not known at this time.
broker-dealers to provide the of some securities. If broker-dealers are However, we recently estimated that
information specified in the Rule. Non- unable to obtain the required issuer about 13% of all registered broker-
reporting issuers would incur the cost of information, they would have to refrain dealers would be characterized as
having to collect and provide the from publishing priced quotations in small.100 We estimate that, at any given
requested information to each that security. This could make it time, there are approximately 400
requesting broker-dealer. However, we somewhat more difficult for investors to broker-dealers, including small broker-
are assuming that non-reporting issuers determine what prices other market dealers, that submit quotations for
maintain their financial information in participants are willing to bid or offer covered OTC securities. Therefore,
compliance with prevailing accounting for the security, although they could call based on this estimate, we believe that
standards and, in most instances, would a broker-dealer publishing a name-only approximately 52 small broker-dealers
have available updated financial quotation to obtain a priced quotation. (400×13%) would be affected by the
information prepared in accordance Thus, while investors are still able to amendments. In fact, it is possible that
with generally accepted accounting obtain price information, the cost of few, if any, broker-dealers publishing
principles (GAAP). The NASD has obtaining this information may increase. quotations for covered OTC securities
informed us that financial statements However, under the reproposal, after the would be classified as a small business,
submitted with the Form 211 generally first quotation for a security is because as market makers they typically
are prepared in accordance with GAAP, published, broker-dealers could publish require more than $500,000 in capital to
and many are audited. unpriced quotes without complying support their market making activities.
Regarding start-up, operating, and with the Rule’s provisions. In addition, In the Proposing Release, we solicited
maintenance costs, we believe that broker-dealers could rely on the but did not receive any comments on
broker-dealers that collect, review, and exception that permits them to publish the number of small broker-dealers that
retain the information currently quotes representing unsolicited would be affected by the amendments.
required by the Rule, would incur only customer orders. We are again soliciting comments on the
marginal start-up, operating, and number of small broker-dealers that
maintenance costs (i.e., to expand Any effect on liquidity must be
weighed against the benefit of reducing would be affected by the amendments.
systems already in place) to comply The amendments would indirectly
with the Rule as reproposed. Further, instances of fraud or manipulation.
Greater investor access to information have an impact on those small issuers
some broker-dealers already may be that may be requested to provide the
collecting the required information for should result in more informed investor
decisions and potentially could result in information required by the Rule to
other purposes. However, we believe
that some broker-dealers may not have additional trading, and thus liquidity, 98 See 5 U.S.C. 603.
adequate systems in place to retain for covered OTC securities. We have 99 For purposes of the regulatory flexibility
issuer information and would, therefore, modified the proposals to permit broker- analysis, a broker-dealer is considered ‘‘small’’ if its
incur start-up, operating, and dealers to publish unpriced quotations total capital is less than $500,000, and is not
for OTC securities without reviewing affiliated with a broker-dealer that has $500,000 or
maintenance costs in order to comply more in total capital.
with the requirements of the the specified information (other than the 100 See Securities Exchange Act Release No.
amendments. first broker-dealer to quote the security). 40122 (June 24, 1998), 63 FR 35508 (adopting
We estimate that about 100 broker- This revision responds to the views of amendments to the definitions of ‘‘small business’’
those commenters that expressed or ‘‘small organization’’ under the Investment
dealers in the aggregate will incur start- Company Act of 1940, the Investment Advisers Act
up, operating, and maintenance costs of concerns about the Rule’s impact on of 1940, the Securities Exchange Act of 1934, and
$100,000 ($1,000×100) associated with liquidity. the Securities Act of 1933).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11139
broker-dealers publishing quotations in Therefore, having considered the VIII. Paperwork Reduction Act
those issuers’ securities. Based on foregoing alternatives in the context of
Exchange Act Rule 0–10(a), a small the amendments, we do not believe they Certain provisions of the amendments
issuer is one that on the last day of its would accomplish the stated objectives contain ‘‘collection of information’’
most recent fiscal year had total assets of the proposal. requirements within the meaning of the
of $5,000,000 or less. In the Proposing We encourage the submission of Paperwork Reduction Act of 1995
Release, we solicited but did not receive written comments regarding any aspect (PRA).101 The title for the collection of
any comments on the total number of of the IRFA. In particular, we seek information is: ‘‘Publication or
issuers of covered OTC securities; the comments on: (i) the number of small submission of quotations without
number (or percentages) of these issuers entities that would be affected by the specified information.’’ Accordingly, the
that are small issuers; and the total amendments, including the number of collection of information requirements
number (or percentage) of small issuers small broker-dealers and issuers; (ii) the contained in the Rule and the initial
of covered OTC securities that are number of small entities that are issuers proposal were submitted to the Office of
reporting and non-reporting issuers, of covered OTC securities; and (iii) the Management and Budget (OMB) for
respectively. We are again seeking number of small entities that are review, in accordance with 44 U.S.C.
comments on these issues. reporting and non-reporting issuers of 3507(d) and 5 CFR 1320.11, and were
The IRFA notes that the availability of covered securities, respectively. approved by OMB. The Rule has been
the Commission’s EDGAR system and Comments should also specify the costs assigned OMB Control No. 3235–
similar systems sponsored by federal or of compliance with the amendments, 0202.102
state authorities should assist broker- and suggest alternatives that would A. Collection of Information Under the
dealers in collecting and reviewing the meet the objectives of the amendments Amendments
reports required by the Rule. In in a more effective manner, while
addition, the prevalent use of computers imposing costs equal to or less than the As reproposed, the Rule would
and the Internet, on which access to amendments. In describing the nature of require the first broker-dealer, before
EDGAR is free, should also reduce the any impact that the amendments would initiating a priced or unpriced quotation
recordkeeping and compliance costs for have, empirical data supporting these for a covered OTC security in a
all broker-dealers by automating the views should be provided. quotation medium, to gather and review
information collection and retention For purposes of the Small Business the issuer information, and to review
process. Regulatory Enforcement Fairness Act of updated information annually if it
The IRFA recognizes that the continues to publish priced quotations.
1996, we are also requesting information
amendments indirectly affect certain This review requirement would also be
regarding the potential impact of the
issuers, particularly non-reporting imposed on any other broker-dealer
issuers. The amendments would require proposed amendments on the economy
on an annual basis. In particular, publishing a priced quotation for a
the first broker-dealer to publish any covered OTC security. Broker-dealers
quotation for a covered security to comments should address whether the
proposed changes, if adopted, would submitting priced quotations for the
review the Rule’s information.
have a $100,000,000 annual effect on security would be required to collect,
Thereafter, other broker-dealers must
the economy, cause a major increase in review, and retain the Rule’s specified
review information about the issuer
costs or prices, or have a significant information annually. Broker-dealers
when they first publish or resume
adverse effect on competition, would also have to record the sources of
publishing a priced quotation for a
investment, or innovations. Commenters their information, the date their review
covered security, and all broker-dealers
should provide empirical data to occurred, and the person responsible for
publishing priced quotations must
support their views. the review. Also, the proposals would
conduct an annual review. We are not
Comments should be submitted in require broker-dealers publishing
aware of any information repository,
electronically accessible or otherwise, triplicate to Jonathan G. Katz, Secretary, quotations for a covered OTC security to
now in existence that covers all of the Securities and Exchange Commission, collect, review, and retain more
information about non-reporting issuers 450 Fifth Street, NW, Washington, DC information than is required currently.
that broker-dealers must gather to 20549. Comments may also be Under Rule 15c2–11, the information
comply with the Rule. Consequently, submitted electronically at the following that is collected pursuant to the Rule
non-reporting issuers must collect and E-mail address: [email protected]. must be submitted to the NASD at least
provide the required information to All comment letters should refer to File three business days before any quotation
each requesting broker-dealer. We No. S7–5–99; this file number should be is published.103 Finally, the
assume that non-reporting issuers included on the subject line if E-mail is amendments would require broker-
maintain their financial information in used. Comment letters will be available dealers to provide the information
compliance with generally accepted for public inspection and copying in the specified to any customer, prospective
accounting standards and that the costs Commission’s Public Reference Room, customer, other broker-dealer or
incurred by non-reporting issuers to 450 Fifth Street, NW, Washington, DC information repository that requests it.
prepare the necessary information in 20549. Electronically submitted
response to broker-dealers’ requests comment letters will also be posted on 101 44 U.S.C. 3501 et seq.
would be minimal. the Commission’s Internet website 102 The Commission notes that a separate PRA
The IRFA discusses the kinds of (http://www.sec.gov). filing was not prepared to reflect the proposed
possible alternative proposals that we A copy of the Initial Regulatory companion changes to Rule 17a–4. The burden
hours and costs described for the Rule include and
have considered. These include, among Flexibility Analysis may be obtained by account for the anticipated burdens that may arise
others, creating differing compliance or contacting Chester A. McPherson, Office as a result of the proposed change to Rule 17a–4.
reporting requirements or timetables of Risk Management and Control, 103 The NASD has a rule requiring broker-dealers
that take into account the resources Division of Market Regulation, that initiate or resume quotations for covered equity
securities to submit verification that they have
available to small entities, and whether Securities and Exchange Commission, collected the information necessary to comply with
such entities could be exempted from 450 Fifth Street, NW, Washington, DC NASD requirements, as well as Rule 15c2–11. See
the reproposed rule, or any part thereof. 20549, at (202) 942–0772. NASD Manual, Marketplace Rules, Rule 6740.
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11140 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
B. Proposed Use of Information and if they are publishing priced estimates, we believe that, on average,
Broker-dealers must collect and quotations as of the annual review there are approximately 4.3 broker-
review the information required under requirement. The discussion below dealers publishing priced quotations for
the amendments if they publish the first estimates the collection of information each covered OTC security, and that at
quotation for a covered OTC security or burden one year after the anticipated any given time there are no more than
date of effectiveness of the amendments 400 broker-dealers that submit priced
if they publish priced quotations.
when broker-dealers that publish quotes quotations for covered OTC securities.
Moreover, the Rule requires that broker-
for covered OTC securities qualifying Finally, the reproposed Rule’s transition
dealers have a reasonable basis for
for the reproposed transition provision provision would not subject the broker-
believing that the information about the
must fully comply with the Rule’s dealers quoting the securities of the
issuer and related persons is accurate
information requirements. The estimated 8,865 potentially covered
and from reliable sources. This
discussion below also provides securities currently quoted in the OTC
information collection protects investors
estimates for the same period for issuers Bulletin Board and/or the Pink Sheets
by deterring fraudulent or manipulative
that may be contacted to provide the until the annual review requirement is
quotations for thinly-traded securities
information. In particular, the following triggered. Therefore, only those new
whose issuers are relatively unknown. applications that are submitted after the
Because information about these issuers analysis measures the cost to broker-
dealers of: (1) collecting, reviewing, reproposal becomes effective would be
is not widely disseminated and often is subject to the initial review
not current, fraudulent and recording, and retaining the required
issuer information and supplying it to requirement.
manipulative schemes are easier to Because the amendments would
perpetrate. Moreover, this collection of the NASD; (2) responding to requests for
issuer information from customers, require the first broker-dealer
information helps broker-dealers guard publishing a quotation, priced or
against becoming unwitting participants prospective customers, other broker-
dealers and information repositories; unpriced, for a particular security to
in fraudulent or manipulative schemes. collect issuer information, we believe
The Rule 15c2–11 information gathering and (3) starting up or maintaining
systems for the collection and retention that during the first year after the
requirements also serve an important amendments are effective, broker-
surveillance function for both the of issuer information. The analysis
below also addresses the indirect cost to dealers that are publishing the first
Commission and the NASD. Recently, quotations (whether priced or unpriced)
the Commission has used the Rule issuers who must furnish information to
requesting broker-dealers. for covered OTC securities in the
15c2–11 information to suspend trading aggregate would have to conduct
in the issuers’ securities pursuant to 1. Burden-Hours for Broker-Dealers approximately 1,260 initial reviews of
Section 12(k) of the Exchange Act where issuer information.105 We believe that it
Based on information provided by the
publicly available information about the will take a broker-dealer about 4 hours
NASD and NQB, we estimate that as of
issuer raised questions about the to collect, review, record, retain, and
December 31, 1998, there were
accuracy and adequacy of the issuers’ supply to the NASD the information
approximately 6,625 covered OTC
disclosures. pertaining to a reporting issuer, and
securities quoted in the OTC Bulletin
C. Respondents Board and 3,225 quoted in the Pink about 8 hours to collect, review, record,
Sheets for a total of 9,850 covered OTC retain, and supply to the NASD the
The amendments would apply to information pertaining to a non-
those broker-dealers that publish securities.104 We also believe that
approximately 10% (985) of these reporting issuer.
quotations for a covered OTC security in We therefore estimate that after the
a quotation medium as of specified securities would not be subject to the
reproposal has become effective, the
quotation events. The amendments also Rule, based on the exceptions that are
broker-dealers who are the first to
indirectly affect issuers that are asked included in this reproposing Release
publish the first quote for a covered
by broker-dealers to provide this and that approximately 8,865 securities
OTC security of a reporting issuer
information. Most of the Rule 15c2–11 would be subject to the Rule. According
(priced or unpriced) will require 3,024
information that would be required for to NASD estimates, we also believe that
hours (1,260×60%×4) to collect, review,
issuers that publicly file periodic approximately 1,400 new applications
record, retain, and supply to the NASD
reports with the Commission (reporting from broker-dealers to initiate or resume
the information required by the Rule as
issuers) is available electronically on publication of covered equity securities
reproposed. We estimate that after the
EDGAR or through the Internet. Thus, in the OTC Bulletin Board and/or the
reproposal has become effective the
the reproposal is likely to have a greater Pink Sheets or other quotation mediums
broker-dealers who are the first to
paperwork burden when broker-dealers were approved by the NASD for the publish the first quote for a covered
publish quotations for the securities of 1998 calendar year. We have estimated OTC security of a non-reporting issuer
issuers that do not participate in the that 60% of the covered OTC securities (priced or unpriced) will require 4,032
Commission’s public reporting program, were issued by reporting issuers, while hours (1,260×40%×8) to collect, review,
(i.e., non-reporting issuers) or do not file the other 40% were issued by non- record, retain, and supply to the NASD
reports with other federal or state reporting issuers. We also estimate that the information required by the Rule as
regulatory authorities. broker-dealers publish priced quotations reproposed. We therefore estimate the
for approximately 90% of the covered total annual burden hours for the first
D. Total Annual Reporting and OTC securities quoted in the OTC broker-dealers to be 7,056 hours
Recordkeeping Burden Bulletin Board and publish priced (3,024+4,032).
The amendments would require quotes for about 10% of the covered The Rule also would require an
broker-dealers to collect, review, retain, OTC securities quoted in the Pink annual review for broker-dealers
and record certain issuer and Sheets. According to NASD and NQB
supplemental information when they 104 We recognize that there may be covered OTC
105 This estimate is based on the assumption that
are the first broker-dealer to quote the the NASD will, in the first year after the reproposal
securities quoted in other quotation mediums, but becomes effective, approve 10% fewer Form 211
security; when they first publish priced at this time we do not have the empirical data to filings than the 1,400 applications approved in
quotations for a covered OTC security; include them in our estimations. 1998.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11141
publishing priced quotations for 1 hour for an issuer to provide the same be $500,000 ($100,000 + $400,000) or an
covered OTC securities. We have information to the remaining 3.3 broker- average of $5,000 for each broker-dealer.
estimated that each issuer is quoted by dealers that request the information. We assume that non-reporting issuers,
about 4.3 broker-dealers. We are Accordingly, we estimate the 3,546 non- because they maintain their financial
assuming that of the universe of reporting issuers annually will incur information in compliance with
approximately 8,865 potentially affected 31,914 hours (3,546×9×1) to comply prevailing accounting standards, will
covered OTC securities, broker-dealers with the first broker-dealer’s request for not incur any start-up costs to prepare
would publish priced quotations for information, and 11,702 hours the required information in response to
approximately 90% of the OTC Bulletin (3,546×1×3.3) to comply with the broker-dealers’ requests. We also believe
Board securities or 5,366 securities subsequent 3.3 broker-dealer requests that reporting issuers of covered OTC
((6,625×90%)×90%) and for 10% of the for an annual total of 43,616 burden securities will not incur start-up costs as
Pink Sheet securities or 290 securities hours (31,914+11,702). On average, a result of the amendments since such
(3,225×90%)×10%).106 Therefore, we therefore, each non-reporting issuer issuers already provide the required
estimate that priced quotations will be would spend approximately 12.3 information to the Commission under
published for approximately 5,656 burden hours (43,616/3,546) per year to the federal securities laws. Therefore,
(5,366+290) covered OTC securities. comply with these requests. we believe issuers will not incur start-
Given that about 60% of OTC stocks are up costs as a consequence of the
3. Total Burden-Hour Costs to Broker- adoption of the Rule amendments, as
issued by reporting issuers and the other
Dealers and Issuers reproposed.
40% by non-reporting issuers, and that
it would take a broker-dealer 4 and 8 We estimate the collection of E. General Information About the
hours, respectively, to meet the information will require approximately Collection of Information
requirements of the reproposed Rule for 186,894 burden hours annually (143,278
these issuers, we estimate the burden + 43,616) from approximately 3,946 The collection of information under
hours as follows: for reporting issuers respondents (400 broker-dealers and the amendments is mandatory and
we estimate approximately 58,375 hours 3,546 issuers). would be required at periodic intervals:
(3,394×4.3×4), and for non-reporting by the first broker-dealer to publish any
issuers we estimate approximately 4. Capital Cost to Broker-Dealers and quote for a covered OTC security, by
77,847 hours (2,263×4.3×8). Therefore, Issuers broker-dealers publishing priced quotes
we estimate the total annual paperwork thereafter, and by broker-dealers
We believe that broker-dealers that
burden hours for all broker-dealers to be publishing priced quotes at the time of
now collect, review, and retain the
143,278 hours (7,056+58,375+77,847). the annual review requirement. Broker-
information required by the current
dealers would be required to retain the
2. Burden-Hours for Issuers Rule will not incur any significant start-
information they collect for a period of
up costs to expand systems already in
Regarding the burden on issuers to not less than three years. Information
place. Further, broker-dealers that are
provide broker-dealers with the required collected under the Rule would not be
collecting the information required by
information, we believe that the 5,319 kept confidential. Any agency may not
the proposals for other purposes also
issuers of covered OTC securities (based conduct or sponsor, and a person is not
will not incur significant start-up costs.
on our estimate that 60% of the 8,865 required to respond to, a collection of
However, we believe some broker-
potentially covered OTC securities are information unless it displays a
dealers may not have adequate systems
reporting issuers) will not bear any currently valid control number.
in place to retain issuer information and
additional hourly burdens under the will incur start-up costs in order to F. Request for comments
amendments because these issuers comply with the requirements of the
already report the required information Pursuant to 44 U.S.C. 3506(c)(2)(B),
amendments. We assume that of the 400 we are soliciting comments to:
to the Commission through mandated broker-dealers that provide quotations (i) evaluate whether the reproposed
periodic filings. Further, reporting for covered OTC securities, about 100 collection of information is necessary
issuer information is widely available to broker-dealers will incur additional for the proposed performance of the
broker-dealers through a variety of start-up costs, while the remaining 300 functions of the agency, including
media. However, non-reporting issuer broker-dealers will only incur whether the information will have
information is not widely available. incremental costs. Because the practical utility;
Consequently, these issuers must information for reporting issuers will be (ii) evaluate the accuracy of our
provide the information required by the generally available on EDGAR and such estimates of the burden of the
amendments to requesting broker- availability satisfies the recordkeeping reproposed collection of information;
dealers before quotations in their requirements of the proposals, we are (iii) enhance the quality, utility, and
securities can be published. We believe assuming that the start-up costs clarity of the information to be
that the 3,546 issuers of non-reporting associated with retaining information on collected; and
covered OTC securities (based on an reporting issuers will average $1,000 per (iv) minimize the burden of collection
estimate that 40% of the 8,865 broker-dealer, whereas the same costs of information on those who are to
potentially covered OTC securities are will be $4,000 per broker-dealer for non- respond, including through the use of
non-reporting ) will spend an average of reporting issuer information. We automated collection techniques or
9 hours each to collect, prepare, and estimate that broker-dealers in the other forms of information technology.
supply the information required by the aggregate will incur start-up, operating, We seek data about quotations for
proposals to the first broker-dealer that and maintenance costs of $100,000 covered OTC securities in OTC
requests this information. Thereafter, we ($1,000 × 100) associated with reporting quotation mediums other than the OTC
estimate that it will take an average of issuer information, and $400,000 Bulletin Board and the Pink Sheets. We
106 Some securities have priced quotations
($4,000 × 100) associated with non- seek comments on our estimate of the
published in both of these quotation systems. To
reporting issuer information. Total start- number of issuers affected by the
avoid double counting, such securities are counted up, operating and maintenance cost reproposed Rule and on the time
as OTC Bulletin Board securities. burden for broker-dealers is estimated to estimates made for broker-dealers and
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11142 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
issuers to comply with the information security for publication in a quotation state electronic information system, or
collection requirements. medium, unless the broker or dealer an electronic information system
Persons desiring to submit comments complies with the provisions of this section operated by an information repository,
on the collection of information or relies on an exception contained in and you have the means to access the
paragraph (h) of this section. As used in this
requirements should direct them to the section, the term ‘‘you’’ refers to a broker or
information for the period required
Office of Management and Budget, dealer. under § 240.17a–4(b)(11);
Attention: Desk Officer for the (ii) Any significant relationship
Securities and Exchange Commission, (a) When a broker or dealer must information described in paragraph (e)
Office of Information and Regulatory comply with this section. You must of this section;
Affairs, Room 10102, New Executive comply with paragraph (b) of this (iii) The date that you reviewed the
Office Building, Washington, DC 20503, section when you publish: information described in paragraphs (c),
and should also send a copy of their (1) The first quotation for a security; (d), and (e) of this section; and
comments to Jonathan G. Katz, (2) The first quotation following the (iv) The person responsible for your
Secretary, Securities and Exchange termination of a Commission trading compliance with the requirements of
Commission, 450 Fifth Street, NW, suspension ordered pursuant to section this section; and
Washington, DC 20549, and refer to File 12(k) of the Act (15 U.S.C. 78l(k)) in any (4) Preserve the records required to be
No. S7–5–99. OMB is required to make security of the issuer of the suspended made under paragraph (b)(3) of this
a decision concerning the collections of security; section in accordance with § 240.17a–
(3) Your first quotation at a specified 4(b)(11).
information between 30 and 60 days
price for the same security after another (c) The issuer information that a
after publication of this release in the
broker or dealer publishes the first broker or dealer must review. The type
Federal Register, so a comment to OMB
quotation for a security as described in of information that is considered ‘‘issuer
is best assured of having its full effect
paragraph (a)(1) or (a)(2) of this section; information’’ and that must be reviewed
if OMB receives it within 30 days of this
(4) A quotation at a specified price for under paragraph (b) of this section
publication.
a security after a period of five or more depends on the status of the issuer.
IX. Statutory Basis and Text of consecutive business days when you (1) Issuers with a recent public
Proposed Amendments and Rule did not publish any quotations at a offering. If the issuer filed a registration
specified price for that security; statement under the Securities Act
The rule amendments are being
(5) Your first quotation at a specified (other than a registration statement on
proposed pursuant to Sections 3, 10(b),
price for a security after the date that is Form F–6 (17 CFR 239.36)) that became
15(c), 15(g), 17(a), and 23(a) of the
four months after the end of the issuer’s effective less than 90 calendar days
Securities Exchange Act of 1934, 15
fiscal year, unless the issuer is a foreign before you publish the quotation, and
U.S.C. §§ 78c, 78j(b), 78o(c), 78o(g),
private issuer; or that is not the subject of a stop order,
78q(a), and 78w(a).
(6) Your first quotation at a specified the issuer information is the prospectus
List of Subjects in 17 CFR Part 240 price for a security of a foreign private specified by section 10(a) of the
Broker-dealers, Fraud, Reporting and issuer after the date that is seven Securities Act (15 U.S.C. 77j(a)).
recordkeeping requirements, Securities. months after the end of the issuer’s (2) Issuers with a recent Regulation A
fiscal year. offering. If the issuer filed a notification
Text of Reproposed Rule (b) The steps a broker or dealer must under Regulation A under the Securities
In accordance with the foregoing, take to comply with this section. For Act (17 CFR 230.251 through 230.263)
Title 17, chapter II, part 240 of the Code each security in which you publish any and was authorized to commence the
of Federal Regulations is proposed to be of the quotations listed in paragraph (a) offering less than 40 calendar days
amended as follows: of this section, you must: before you publish a quotation, and the
(1) Review the issuer information offering circular provided for under
PART 240—GENERAL RULES AND described in paragraph (c) of this Regulation A is not the subject of a
REGULATIONS, SECURITIES section and the supplemental suspension order, the issuer information
EXCHANGE ACT OF 1934 information described in paragraph (d) is the offering circular.
of this section; (3) Certain reporting issuers. If the
1. The authority citation for part 240 (2) Determine that you have a issuer is current in filing annual or
continues to read, in part, as follows: reasonable basis under the semi-annual reports required under
Authority: 15 U.S.C. §§ 77c, 77d, 77g, 77j, circumstances for believing that the section 13 or 15(d) of the Act (15 U.S.C.
77s, 77z–2, 77eee, 77ggg, 77nnn, 77sss, 77ttt, issuer information described in 78m or 78o(d)) or section 30(a) of the
78c, 78d, 78f, 78i, 78j, 78j–1, 78k, 78k–1, 78l, paragraph (c) of this section, when Investment Company Act of 1940 (15
78m, 78n, 78o, 78p, 78q, 78s, 78u–5, 78w, considered in conjunction with the U.S.C. 80a–29(a)), the issuer information
78x, 78ll(d), 78mm, 79q, 79t, 80a–20, 80a–23, supplemental information described in is the issuer’s most recent annual or
80a–29, 80a–37, 80b–3, 80b–4 and 80b–11, paragraph (d) of this section, is accurate semi-annual report and any quarterly
unless otherwise noted.
in all material respects and was and current reports filed by the issuer
* * * * * obtained from reliable sources; after such annual or semi-annual report.
2. Section 240.15c2–11 and the (3) Make a record of: You will be considered in compliance
section heading are revised to read as (i) The issuer information described with the requirement to obtain current
follows: in paragraph (c) of this section, the reports filed by the issuer if you obtain
§ 240.15c2–11 Publication or submission
supplemental information described in all current reports filed by that issuer as
of quotations without current information. paragraph (d) of this section, and the of the date that is three business days
sources from which you obtained the before you publish the quotation.
Preliminary Note: As a means reasonably
designed to prevent fraudulent, deceptive, or
information. You will be considered to However, until the issuer has filed its
manipulative acts or practices, this section have obtained the issuer information first annual or semi-annual report, the
prevents a broker or dealer from publishing described in paragraphs (c) or (d)(1) of issuer information is:
a quotation for a security or, directly or this section if you obtained it through (i) The prospectus specified by
indirectly, submitting a quotation for a the EDGAR system, any other federal or section 10(a) of the Securities Act (15
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11143
U.S.C. 77j(a)) that was included in a (E) The total number of issuer failed or refused to provide this
registration statement filed by the issuer securityholders of record for the information;
under the Securities Act and that security as of the end of the issuer’s (xii) The following information:
became effective within the prior 15 most recent fiscal year or a more recent (A) A description of any of the
months; or date; following events involving the issuer, its
(ii) The registration statement filed by (vi) The exact title and class of the predecessor, or any of its majority-
the issuer under section 12 of the Act security to be quoted; owned subsidiaries that occurred in the
(15 U.S.C. 78l) that became effective (vii) The name, address and telephone prior two years:
within the prior 15 months (other than number of the transfer agent; (1) A change in control;
a registration statement on Form F–6 (17 (viii) A description of the issuer’s (2) An increase of 10% or more of the
CFR 239.36)), and any quarterly and business and facilities; same class of outstanding equity
current reports filed by the issuer after (ix) A description of the issuer’s securities;
the registration statement became products or services; (3) A merger, acquisition, or business
effective. (x) The full names and business combination;
(4) Certain financial institutions. If addresses of the executive officers, (4) An acquisition or disposition of
the issuer is not required to file reports directors, general partners, promoters, significant assets;
under sections 13 or 15(d) of the Act and control persons of the issuer, and (5) A bankruptcy proceeding; and
and is a bank or savings association, as the number of securities of each class of (6) The delisting of securities by any
those terms are defined in 12 U.S.C. the issuer’s securities that are securities exchange or Nasdaq; or
1813, the issuer information is the beneficially owned by each such person (B) A statement from the issuer that
issuer’s most recent annual report and as of the end of the issuer’s last fiscal the issuer, its predecessor, and its
any subsequent reports filed with the year or a more recent date; majority-owned subsidiaries have not
issuer’s appropriate Federal banking (xi) The following information: been the subject of any of the actions or
agency or State bank supervisor, as (A) A description of any of the events listed in paragraphs
those terms are defined in 12 U.S.C. following actions to which any (c)(6)(xii)(A)(1) through (6) of this
1813. executive officer, director, general section; or
(5) Certain exempted insurance partner, promoter, or control person of (C) A description of the steps you
companies. If the issuer is exempt from the issuer has been the subject during have taken to obtain from the issuer the
section 12(g) of the Act (15 U.S.C. 78l(g)) the prior five years: information needed to comply with
by complying with section 12(g)(2)(G) of (1) A conviction in a criminal paragraphs (c)(6)(xii)(A) or (c)(6)(xii)(B)
the Act (15 U.S.C. 78l(g)(2)(G)), the proceeding or named as a defendant in of this section and that the issuer failed
issuer information is the issuer’s most a pending criminal proceeding or refused to provide this information;
recent annual statement referred to in (excluding traffic violations and other and
section 12(g)(2)(G)(i) of the Act (15 minor offenses); (xiii) The financial information listed
U.S.C. 78l(g)(2)(G)(i)). (2) The entry of an order, judgment, below in paragraphs (c)(6)(xiii)(A) or
(6) Other issuers. If the issuer is not or decree, not subsequently reversed, (c)(6)(xiii)(B) and (c)(6)(xiii)(C) of this
covered by paragraphs (c)(1) through suspended or vacated, by a court of section:
(c)(5) of this section, the issuer competent jurisdiction that permanently (A) If the issuer is not a foreign
information is the information listed or temporarily enjoins, bars, suspends private issuer, the issuer’s most recent
below in paragraphs (c)(6)(i) through or otherwise limits involvement in any balance sheet, statement of cash flows,
(c)(6)(xiii) of this section. Except as type of business, securities, statement of comprehensive income,
specified in paragraph (c)(6)(xiii) of this commodities, or banking activities; and statement of operations (income),
section, this information is presumed to (3) A finding or judgment by a court prepared in accordance with U.S.
be current if it is as of a date within 12 of competent jurisdiction (in a civil generally accepted accounting
months before you publish the action), the Commission, the principles. Unless you know or have
quotation and must be the most current Commodity Futures Trading reason to know that more current
information that you know or have Commission, or a state securities information is available, this
reason to know is available: regulator of a violation of federal or state information will be presumed to be
(i) The exact name of the issuer and securities or commodities law, which current if:
any predecessor; has not been reversed, suspended, or (1) The balance sheet is as of a date
(ii) The address and telephone vacated; and that is less than 15 months before you
number of the issuer’s principal (4) The entry of an order by a self- publish the quotation;
executive offices; regulatory organization that (2) The statement of cash flows,
(iii) The state of incorporation of the permanently or temporarily bars, statement of comprehensive income,
issuer, if it is a corporation; suspends or otherwise limits and statement of operations (income)
(iv) The date on which the issuer’s involvement in any type of business or are for the 12 months preceding the date
fiscal year ends; securities activities; or of such balance sheet; and
(v) For each class of the issuer’s (B) A statement from the issuer that (3) If the balance sheet is as of a date
securities outstanding: no executive officer, director, general that is more than 6 months before you
(A) The exact title of the security; partner, promoter, or control person of publish the quotation, it must be
(B) The par or stated value of the the issuer is the subject of any of the accompanied by an additional statement
security; actions listed in paragraphs of cash flows, statement of
(C) The number of securities or total (c)(6)(xi)(A)(1) through (4) of this comprehensive income, and statement
principal amount outstanding of the section; or of operations (income) for the period
security; (C) A description of the steps you from the date of such balance sheet to
(D) The class and number of securities have taken to obtain from the issuer the a date that is less than 6 months before
issuable upon the security’s exercise, information needed to comply with you publish the quotation.
exchange or conversion, if applicable; paragraphs (c)(6)(xi)(A) or (c)(6)(xi)(B) of (B) If the issuer is a foreign private
and this section and a statement that the issuer, the issuer’s most recent balance
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11144 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
sheet and statement of operations 78l(k)) for any securities of the issuer or paragraphs (c)(5), (c)(6), (d), and (e) of
(income), and to the extent prepared by its predecessor (if any) during the 12 this section promptly available upon
the issuer, statement of cash flows, months before you publish the request to any customer, prospective
statement of comprehensive income, quotation, or a copy of the public customer, other broker or dealer, or
and statement of changes in release issued by the Commission information repository. By providing
shareholders’ equity, prepared in announcing such trading suspension this information to others under this
accordance with a comprehensive body order; and paragraph (g), you do not represent that
of accounting principles. Unless you (2) A copy or a written record of any the information is accurate; rather, you
know or have reason to know that more other material information (including represent that, as of the date recorded
current information is available, this adverse information) about the issuer under paragraph (b)(3)(iii) of this
information will be considered current that comes to your knowledge or section, you had a reasonable basis
if: possession before you publish a under the circumstances for believing
(1) The balance sheet is as of a date quotation. that the information was accurate and
that is less than 18 months before you (e) The significant relationship current in all material respects and was
publish the quotation; information that the broker or dealer obtained from reliable sources; but
(2) The statement of cash flows, must make and keep a record of. The (2) You do not need to comply with
statement of comprehensive income, type of information that is considered paragraph (g)(1) of this section to the
statement of operations (income), and ‘‘significant relationship’’ information extent that the information is reasonably
statement of changes in shareholders’ and that you must make and keep a available through EDGAR, any other
equity are for the 12 months preceding record of under paragraph (b) of this federal or state electronic information
the date of such balance sheet; and section is the following: system, or an information repository.
(3) If the balance sheet is as of a date (1) Any direct or indirect affiliation (h) When a broker or dealer is not
that is more than 9 months before you between the issuer and you or between required to comply with this section.
publish the quotation, it must be the issuer and any of your associated You are not required to comply with
accompanied by an additional statement persons; this section when you publish a
of cash flows, statement of (2) Whether you are publishing the quotation for:
comprehensive income, statement of quotation on behalf of any other broker (1) A security that is listed on a
operations (income), and statement of or dealer, or any of its associated national securities exchange or Nasdaq;
changes in shareholders’ equity for the persons, and, if so, the name of such is traded on such exchange or Nasdaq
period from the date of such balance broker or dealer, or the associated on the same day as, or on the business
sheet until a date that is less than 9 person, and the terms of the day immediately before, the day you
months before you publish the arrangement; publish the quotation; and is not
quotation, if any such statements have (3) Whether you have received, or suspended, terminated, or prohibited
been prepared by the issuer. have any arrangement to receive, any from trading on such exchange or
(C) The same financial information monetary or other consideration from Nasdaq;
required by paragraph (c)(6)(xiii)(A) and any person for publishing the quotation (2) An exempted security, as defined
(B) of this section for such part of the and, if so, a description of the in section 3(a)(12) of the Act (15 U.S.C.
two preceding fiscal years as the issuer consideration and the name of the 78c(a)(12));
or any predecessor has been in existence person providing the consideration; and (3) A security where the quotation
(one year with respect to the balance (4) Whether you are publishing the represents the unsolicited order of a
sheet), prepared in accordance with U.S. quotation directly or indirectly on customer (other than a person acting as
generally accepted accounting behalf of the issuer, or any executive or for a dealer);
principles (or prepared in accordance officer, director, general partner, (4) A non-convertible debt security or
with a comprehensive body of promoter, control person, or any person, a non-participatory preferred stock;
accounting principles in the case of a who is directly or indirectly the (5) An asset-backed security that is
foreign private issuer). However, if the beneficial owner of more than 10 rated by at least one nationally
issuer has emerged from reorganization percent of the outstanding units or recognized statistical rating
pursuant to Chapter 11 of the shares of any equity security of the organization, as that term is used in
Bankruptcy Code (11 U.S.C. 1101 et issuer, and, if so, the name of such § 240.15c3–1, in one of its generic rating
seq.) and the reorganization plan has person, and the basis for any exemption categories that signifies investment
been in effect less than two years, the under the federal securities laws for any grade;
financial information required under sales of such securities on behalf of such (6) A security with a worldwide
this paragraph (c)(6)(xiii) is the court- person. average daily trading volume value of at
approved disclosure statement filed (f) The information a broker or dealer least $100,000 during each month of the
under 11 U.S.C. 1125 and the financial must submit to the NASD. At least three six full calendar months immediately
information described in this paragraph business days before you publish a before the date you publish the
(c)(6)(xiii) from the date of the entry of quotation covered by paragraph (a) of quotation;
the bankruptcy court order confirming this section, you must submit to the (7) A convertible security, if the
the issuer’s reorganization plan NASD, in accordance with NASD rules, underlying security meets the
pursuant to 11 U.S.C. 1129. the information required in paragraphs requirements of paragraph (h)(6) of this
(d) The supplemental information (c), (d), and (e) of this section. section;
that a broker or dealer must review. The (g) The broker or dealer must make (8) A security that has bid price, as
type of information that is considered certain information required by this published on a national securities
‘‘supplemental information’’ and that section available upon request. exchange, Nasdaq, or quotation
you must review under paragraph (b) of (1) If you publish a quotation for a medium, of at least $50 per share. If the
this section is the following: security in compliance with this security is a unit composed of one or
(1) A copy of any trading suspension section, you must make the issuer, more securities, the bid price of the unit
order issued by the Commission under supplemental, and significant divided by the number of shares of the
section 12(k) of the Act (15 U.S.C. relationship information specified in unit that are not warrants, options,
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11145
rights, or similar securities must be at information described in paragraph (c) (12) Quotation medium means any:
least $50; or of this section when this information is (i) System of general circulation to
(9) A security of an issuer that has net not routinely or widely made available, brokers or dealers that regularly
tangible assets in excess of $10,000,000. electronically or otherwise; and disseminates quotations of identified
(i) The steps to take to become an (ii) Is designated by the Commission brokers or dealers; or
information repository. as an information repository as (ii) Publication, alternative trading
(1) An entity seeking information described in paragraph (i) of this system, or other device that is used by
repository designation must file an section. brokers or dealers to disseminate
application with the Director of the (4) Issuer, in the case of quotations for quotations to others.
Commission’s Division of Market American Depositary Receipts, means (13) Securities Act means the
Regulation in Washington, DC. The the issuer of the deposited shares Securities Act of 1933 (15 U.S.C. 77a et
application should provide detailed represented by such American seq.).
information explaining how the entity Depositary Receipts. (k) How this section applies to
satisfies the attributes set forth in (5) NASD means the National securities for which a broker or dealer
paragraph (i)(2) of this section. The Association of Securities Dealers, Inc., is publishing quotations immediately
entity must also file any additional and its wholly owned subsidiaries before the effective date of the
information relating to the attributes set (including, but not limited to, NASD amendments. If you were publishing a
forth in paragraph (i)(2) of this section Regulation, Inc. and The Nasdaq Stock quotation for a security on the business
that the Director of the Commission’s Market, Inc.). day immediately before April 7, 1999,
Division of Market Regulation (6) Nasdaq means The Nasdaq you may continue to publish quotations
subsequently requests; National Market and The Nasdaq for the security without complying with
(2) In determining whether to SmallCap Market, both operated by The paragraph (b) of this section until you
designate an entity as an information Nasdaq Stock Market, Inc. publish a quotation described in
repository, the Commission will (7) Net tangible assets means total paragraphs (a)(2), (a)(3), (a)(4), (a)(5), or
consider whether the entity: assets less intangible assets and (a)(6) of this section.
(i) Collects information about a liabilities. For purposes of this section, (l) The Commission can grant
substantial segment of issuers of net tangible assets must be exemptions from this section. This
securities subject to this section; demonstrated by current financial section does not prohibit the
(ii) Maintains current and accurate statements, as described in paragraph publication of any quotation for a
information about such issuers; (c)(6)(xiii) of this section, and: security or a class of securities, if the
(iii) Has effective acquisition, (i) If the issuer is not a foreign private Commission, on written request or its
retrieval, and dissemination systems; issuer, the financial statements must be own motion, exempts such quotation,
(iv) Places no inappropriate limits on audited and reported on by an either unconditionally or on specified
the issuers from or about which it will independent public accountant in terms and conditions.
accept information; accordance with § 210.2–02 of this 3. Section 240.17a–4 is amended by
(v) Provides access to the documents chapter; or adding paragraph (b)(11) to read as
deposited with it to anyone willing and (ii) If the issuer is a foreign private
follows:
able to pay the applicable fees; issuer, the financial statements must be
(vi) Charges reasonable fees; and prepared in accordance with a § 240.17a–4 Records to be preserved by
(vii) In general, is so organized and comprehensive body of accounting certain exchange members, brokers and
has the capacity to be able to reasonably principles, audited in compliance with dealers.
carry out the purposes of this section. requirements of the country of * * * * *
(3) An information repository must incorporation, and reported on by an (b) * * *
notify the Director of the Commission’s accountant duly registered and in good (11) The records required to be
Division of Market Regulation of any standing in accordance with the obtained pursuant to § 240.15c2–11.
material changes that occur in the facts regulations of that jurisdiction. * * * * *
and circumstances of its application for (8) Non-participatory preferred stock Dated: February 25, 1999.
such designation; and means non-convertible capital stock, the By the Commission.
(4) In the event it is determined that holders of which are entitled to a
Margaret H. McFarland,
an information repository no longer preference in payment of dividends and
Deputy Secretary.
satisfies all of the attributes set forth in in distribution of assets on liquidation,
paragraph (i)(2) of this section, the dissolution, or winding up of the issuer, Note: This Appendix to the Preamble will
not appear in the Code of Federal
Director of the Commission’s Division of but are not entitled to participate in
Regulations.
Market Regulation may revoke such residual earnings or assets of the issuer.
designation. (9) Promoter has the same meaning Appendix
(j) The definitions applicable to this contained in § 230.405 of this chapter.
Guidance on the Scope of a Broker-Dealer’s
section. For purposes of this section, the (10) Publish means to publish a Review Under Current Rule 15c2–11 and the
following definitions apply: quotation for a security in a quotation Amendments
(1) Alternative trading system has the medium or, directly or indirectly, to
same meaning contained in § 242.300(a) submit a quotation for a security for I. Introduction
of this chapter. publication in a quotation medium. To assist broker-dealers in complying
(2) Asset backed security has the (11) Quotation means any bid or offer with Rule 15c2–11 (Rule) 1 under the
meaning contained in General at a specified price with respect to a Securities Exchange Act of 1934
Instruction I.B.5. to Form S–3 (17 CFR security, or any indication of interest by (Exchange Act),2 we are setting forth the
239.13). a broker or dealer in receiving bids or factors that they should consider in
(3) Information repository means an offers from others for a security, or any carrying out their review obligations
entity that: indication by a broker or dealer that
(i) Gathers and provides to brokers or advertises its general interest in buying 1 17 CFR 240.15c2–11.
dealers and others current issuer or selling a particular security. 2 15 U.S.C. 78a et seq.
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11146 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
under the Rule as it currently exists and in all material respects. We are giving our suspension ordered pursuant to section 12(k)
under the amendments proposed in views on the steps a broker-dealer should of the Exchange Act 11 in any security of the
Securities Exchange Act Release No. 34– take to assess the reliability of the source of issuer of the suspended security;
the required information and the accuracy of • a quotation at a specified price for a
41110.3 We are providing this guidance that information.7 security after a period of five or more
because commenters on the initial consecutive business days when it did not
proposal 4 expressed concerns about II. Quotation Events Triggering the publish any quotations at a specified price
their review obligations under its Review Requirement for that security;
provisions, particularly in light of Under the current Rule, the first broker- • its first quotation at a specified price for
elimination of the piggyback provision, dealer to publish a priced quotation must a security after the date that is four months
the addition of an annual review obtain and review the Rule’s required after the end of the issuer’s fiscal year, unless
requirement, and the obligation to information. Under the current Rule’s the issuer is a foreign private issuer; or
obtain enhanced issuer information. piggyback exception, a broker-dealer does not • its first quotation at a specified
This guidance applies, unless otherwise have to satisfy these information price for a security of a foreign private
noted, to a broker-dealer’s obligations requirements when it publishes a quotation issuer after the date that is seven
under the current Rule as well as under
for a security if it, or any other broker-dealer, months after the end of the issuer’s
is already publishing regular quotations for fiscal year.
the reproposal. the security.8 This means that the first market
Rule 15c2–11 regulates the publication of If the Rule applies, under both the current
maker publishing a quotation is the only one Rule and the amendments, the broker-dealer
quotations for OTC securities in a quotation that has to obtain the required information,
medium.5 The Rule generally prohibits must:
broker-dealers from publishing a quotation
and thereafter, any other market maker can • review the Rule’s specified information;
unless they have reviewed specified
publish quotations in the security • determine that it has a reasonable basis
indefinitely, unless there is a significant for believing that the information is accurate
information about the issuer. The kind of lapse in quotation activity.9
information depends on the nature of the in all material respects and was obtained
The amendments will restructure Rule from reliable sources;
issuer, e.g., whether the issuer is subject to
the Exchange Act’s periodic reporting
15c2–11 by setting forth more clearly the • Record the date it reviewed the specified
quotation events that trigger the Rule, the information, the sources of the information,
requirements (reporting issuer) or is an issuer requirements that the broker-dealer must
that is not subject to the Exchange Act’s and the person at the firm responsible for the
satisfy, and the nature of the information that broker-dealer’s compliance with the Rule;
reporting requirements (non-reporting the broker-dealer must review. The
issuer). Broker-dealers must also have a and
reasonable basis for believing that the issuer
amendments state that no broker-dealer, • Preserve the specified information in
directly or indirectly, may publish the accordance with Rule 17a–4.12
information, when considered in conjunction described kinds of quotations for a security We set out below in more detail the review
with any supplemental information,6 is in any quotation medium, without first obligation required of a broker-dealer before
accurate in all material respects and that it complying with the Rule’s provisions.10 it publishes a quotation for covered OTC
was obtained from a reliable source. Under the amendments, the Rule will apply securities. In general, the broker-dealer must
The Rule is precise about the kind of issuer at specified points in time, namely, when a first form a reasonable belief about the
and other information that the broker-dealer broker-dealer publishes: source’s reliability. Then the broker-dealer
must obtain and review before publishing • the first quotation for a security; should examine the materials to make sure it
quotations and about how current that • its first quotation at a specified price for has obtained all of the information required
information must be. However, some a security after another broker or dealer by the Rule, including any supplemental
commenters on the Proposing Release stated published the first quotation for the same information known by the broker-dealer. In
that they were unclear about the nature of the security. reviewing this information, the Rule requires
broker-dealer’s obligation to determine that • the first quotation following the that the broker-dealer must have a reasonable
the broker-dealer reasonably believes that the termination of a Commission trading basis under the circumstances for believing
source of the Rule 15c2–11 information is
that the issuer information described in
reliable and that the information is accurate 7 This discussion confirms and supplements
paragraph (a) [reproposed paragraph (c)] of
earlier guidance on Rule 15c2–11 issues. See the Rule,13 when considered in conjunction
3 This appendix sets forth guidance on a broker- Securities Exchange Act Release No. 29094 (April with the supplemental information described
dealer’s review obligations under the Rule as it 17, 1991), 56 FR 19148 (1991 Adopting Release);
currently exists and under the proposed Securities Exchange Act Release No. 27247
in paragraph (b) [reproposed paragraph (d)]
amendments. If the Commission takes final action (September 14, 1989), 54 FR 39194 (1989 Proposing of the Rule,14 is accurate in all material
on the proposed amendments, the Appendix will be Release).
revised to delete references to the proposal and to 8 17 CFR 240.15c2–11(f)(3). The security must 11 15 U.S.C. 78l(k).
reflect the final rule. We expect that the Appendix have been the subject of quotations on at least 12 12 17 CFR 240.17a–4.
will provide useful guidance to broker-dealers in business days during the previous 30 calendar days, 13 Currently, a broker-dealer must review and
conducting the document review required by the with no more than 4 consecutive business days maintain in its records certain issuer information,
Rule. elapsing without a quotation. Effectively, the Rule which, depending on the issuer, may include
4 Securities Exchange Act Release No. 39670 applies only to those market makers publishing prospectuses or offering circulars; certain Exchange
(February 17, 1998), 63 FR 9661 (Proposing quotations during the first 30 days of a security’s Act reports; other regulatory filings; information
Release). trading. The ability to piggyback on one’s own furnished to the Commission pursuant to Section
5 A quotation is broadly defined as any indication quotations is referred to as ‘‘self-piggybacking.’’ 12(g)(2)(G)(i) of the Exchange Act; or certain
that a broker-dealer is willing to buy or sell a 9 The piggyback exception would be eliminated financial information for non-reporting issuers. The
particular security. The reproposed Rule, however, under the proposed amendments. amendments expand the information required for
applies most directly to priced quotations. Rule 10 The current Rule applies to an interdealer issuers that do not file periodic reports with the
15c2–11 applies to broker-dealers that publish quotation system, which is a quotation medium of Commission (e.g., non-reporting issuers). In
quotations for securities traded in the OTC markets. general circulation to brokers or dealers which addition, broker-dealers would be required to make
In this appendix, ‘‘OTC stocks’’ or ‘‘OTC securities’’ regularly disseminates quotations of identified the issuer information available to anyone who
refers to securities that are not listed on a national brokers or dealers. 17 CFR 240.15c2–11(e)(2). Under requested it.
securities exchange or Nasdaq. ‘‘Covered OTC the proposed amendments, the definition of 14 In addition to a copy of any trading suspension
securities’’ refers to those OTC securities that are ‘‘interdealer quotation system’’ would be order issued by the Commission pursuant to
subject to Rule 15c2–11. Rule 15c2–11 applies to incorporated into the definition of ‘‘quotation Exchange Act Section 12(k), the broker-dealer must
securities quoted on the OTC Bulletin Board, medium.’’ Under the amendments, a ‘‘quotation record and consider any other material information
operated by the National Association of Securities medium’’ will be a system of general circulation to (including adverse information) regarding the issuer
Dealers, Inc. (NASD); the Pink Sheets operated by brokers or dealers that regularly disseminates that comes to its knowledge or possession before
the National Quotation Bureau, Inc. (NQB); and quotations of identified brokers or dealers; or publishing a quotation under the Rule. Paragraph
similar quotation systems. publication, alternative trading system, or other (b) [reproposed paragraph (d)] does not require a
6 See footnote 14 below for a description of device that is used by brokers or dealers to broker-dealer to maintain trivial information or
‘‘supplemental information.’’ disseminate quotations to others.] information from an uncertain source. Also, the
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11147
respects and was obtained from reliable dealer must obtain and review information broker-dealer typically may rely on that
sources. that is on file with the Commission, in representation as to the source. Because
In addition, we are providing numerous addition to any supplemental information. In broker-dealers frequently obtain the Rule
examples of ‘‘red flags’’ often associated with the case of a non-reporting issuer, where 15c2–11 information from these sources, the
Rule 15c2–11 documents. A red flag is there may be no information filed with a reliability of the information’s source is not
information that under the circumstances regulatory authority, the broker-dealer must often called into question.
signals that one or more of the required items obtain the required information from sources Occasionally, the broker-dealer may obtain
of information may be materially inaccurate. its deems reliable and must review this the Rule 15c2–11 information from sources
We consider these red flags to be indications information together with any supplemental not associated with the issuer, such as
that should lead a broker-dealer to inquire information. another market maker.22 In this case, the
whether it had a reasonable basis to believe The Rule does not currently specify the requesting broker-dealer should inquire
that the issuer information is accurate in all status of the person who must conduct the about the original source of the information.
material respects and that it was obtained review on the broker-dealer’s behalf. Under The broker-dealer providing the information
from a reliable source. the reproposed Rule, the broker-dealer must must make a record of the source of the
The red flags that we discuss have been make a record of the person at the firm who issuer information and can supply this
present in Commission enforcement actions, is responsible for the broker-dealer’s information to the requesting broker-dealer.
examinations conducted by our staff, and compliance with the Rule’s provisions.17 When a red flag regarding the source’s
reviews of Rule 15c2–11 conducted by the Generally, the person performing the review reliability exists, the broker-dealer must
National Association of Securities Dealers, should have sufficient experience or inquire further to reasonably determine
Inc. (NASD) submissions, but our discussion authority at the firm to make sure that the whether the information’s source is reliable.
is not meant to be exhaustive. Other Rule’s requirements are fully satisfied. To satisfy the Rule’s requirements, the
information may come into the broker- Rule 15c2–11 is intended to prevent broker-dealer must ascertain the original
dealer’s knowledge or possession that would broker-dealers from becoming involved in the source of the information, especially when a
lead it to question whether the source is fraudulent manipulation of OTC securities. broker-dealer is provided information from
reliable or whether the required information However, even if a broker-dealer technically another broker-dealer that encourages the
is accurate in all material respects. The complies with the Rule’s requirements, it publication of quotations rather than
adequacy of a broker-dealer’s review must be would be subject to liability under other responds to a request for information.23 If the
considered on a case-by-case basis. antifraud provisions of the securities laws, broker-dealer providing the information
The reproposed Rule would require a such as Rule 10b–5, if a broker-dealer refuses to substantiate that the information is
broker-dealer to obtain and review some publishes quotations as part of a fraudulent from the issuer, this refusal is a red flag that
issuer information not required by the or manipulative scheme.18 may indicate that the source is unreliable. If
current Rule, such as criminal or securities the broker-dealer is told that the issuer has
law violations and additional issuer B. Source Reliability
prepared or approved the information, the
information. Until the proposal is adopted, 1. Determining Whether a Source is Reliable broker-dealer may need to verify that
the Rule does not require the broker-dealer to The broker-dealer must first have a representation by directly contacting the
obtain and review this information. This reasonable basis for believing that Rule 15c2– issuer.
information, however, would be a red flag 11 information comes from a reliable source.
and, under the current Rule, could be 2. Examples of Unreliable Sources
In general, this means that the information
‘‘material information’’ that the broker-dealer was derived from the issuer. If the The Report of Investigation Regarding
must take into account when conducting its information is from the issuer or its officers Transactions in the Securities of Laser
review obligations. and directors, attorney, or accountant, the Arms Corporation (Laser Arms Report)
III. The Review Process broker-dealer generally can assume that the illustrates when a broker-dealer did not
source is reliable, absent red flags to the have a reasonable basis to believe that
A. Introduction contrary.19 If the information is from EDGAR
the information about a non-reporting
While the broker-dealer must obtain and or another governmental website or an
review the required information, the standard independent retrieval service 20 or standard issuer was from a reliable source.24 The
of review is based on a broker-dealer’s research sources 21 or an information Laser Arms Report noted that ‘‘inherent
arriving at a reasonable belief, not a certainty, repository contemplated under the in the requirement of paragraph (a)(5)
that the information is accurate and was reproposed Rule, the broker-dealer can [reproposed paragraph (c)(6)] is ’the
obtained from a reliable source. Although satisfy the Rule’s requirement to have a premise that the broker-dealer must at
broker-dealers often refer to their Rule 15c2– reasonable basis for believing that the source least verify that it has received the
11 files as ‘‘due diligence’’ files, the Rule’s of the information is reliable. If the broker- required information and know that
standard of review does not approach the dealer receives the information from an source of the information.’’ 25
depth of inquiry generally associated with an independent and objective source, such as a
underwriter’s obligations in a registered bank that is not a market maker in the The broker-dealer that submitted the
public offering or with a retail broker’s security, which represents that it has initial application to quote Laser Arms
obligations in recommending a security to a prepared the information or received the stock did not make any attempt to verify
customer. As discussed below, the scope of information directly from the issuer, the the source of the issuer information
review is relatively simple in the case of an contained in the Laser Arms
issuer that has just completed a public regulatory authorities for certain types of issuers, Memorandum. In fact, it was a fictitious
offering or an offering under Regulation A 15 e.g., financial institutions.
or that files periodic reports with the 17 See text of reproposed Rule 15c2–11(b)(3)(iv).
document prepared by a recidivist
Commission.16 In these cases, the broker- 18 17 CFR 240.10b–5.
securities law violator who was the
19 Because of recent microcap fraud cases
22 The proposed Rule will require a broker-dealer
broker-dealer is not required to affirmatively seek involving promoters, a broker-dealer should not
out information about the issuer beyond that presume a promoter is a reliable source of issuer to provide the information to another broker-dealer
specifically required by the Rule. However, if information. See SEC Charges 44 Stock Promoters upon request.
material information about the issuer comes to its in First Internet Securities Fraud Sweep, Press 23 See Bunker Securities, Inc., 48 S.E.C. 859
knowledge or possession (orally or in writing), the Release 98–117 (October 28, 1998) available at (1987), aff’d without opinion, 833 F.2d 303 (3d Cir.
broker-dealer must take that information into <http://www.sec.gov/news/press/98–117.txt>. 1987).
account in assessing whether the issuer information 20 Examples of an ‘‘independent retrieval service’’ 24 50 S.E.C. 489 (1991). The Laser Arms Report
is accurate and is from a reliable source. See would be the SEC’s Public Reference Room or a was issued pursuant to the investigative authority
footnote 35 below regarding how to obtain document retrieval service. granted to the Commission under Section 21(a) of
information about Commission trading suspensions. 21 Examples of ‘‘standard research sources’’ the Exchange Act (15 U.S.C. 78u(a)).
15 17 CFR 230.251–230.263.
include publications such as Standard & Poor’s 25 Laser Arms Report at 501, citing Securities
16 Under the reproposal, the broker-dealer can Standard Corporation Manual and Moody’s Exchange Act Release No. 34–29095 (April 17,
look to filings made with other federal or state Investors Service Manuals. 1991), 56 FR 19158 (1991 Proposing Release).
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11148 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
undisclosed principal of Laser Arms.26 must review the required information, reviewing the Rule’s required information for
The broker-dealer’s immediate source of together with any supplemental non-reporting issuers, the kinds of significant
the Laser Arms Memorandum was a information that comes to its attention, events that require a domestic reporting
trader at another broker-dealer whom he issuer to file a Form 8–K under the Exchange
and should be alert to red flags.
Act 32 also should be considered red flag
had known for less than one year, had Because documents filed with the
events.
seen on only a few occasions, and had Commission are subject to liability
Where no red flags appear during the
dealt with primarily by telephone. The provisions, a broker-dealer generally can
reach a reasonable belief as to the accuracy review of current and complete information,
broker-dealer did not review or attempt the broker-dealer would have a reasonable
of information contained in these
to determine the source of any part of documents.30 This also would be true for basis for believing that the Rule’s information
the information in the Laser Arms documents filed with financial institutions’ is accurate. At this point, the broker-dealer’s
Memorandum. Any attempt to contact regulatory authorities, which broker-dealers review ordinarily would end, i.e., the broker-
the issuer directly probably would have may obtain and review when publishing dealer would not be required to question the
quotes for the securities of certain banks, financial statements or any other information
led to the discovery that Laser Arms was
provided for in paragraph (c)(4) of the required to be obtained and reviewed. The
a shell corporation with no assets, Rule does not require the broker-dealer to
operations, or products.27 Under these reproposed Rule.
If a registration statement incorporates question any information unless the
circumstances, the Commission did not information contains apparent material
other documents by reference, the broker-
believe that this broker-dealer, or any of dealer may be required to obtain some of the discrepancies, or other information in the
the broker-dealers to subsequently incorporated documents to satisfy the Rule’s broker-dealer’s knowledge or possession (i.e.,
publish quotations, had a reasonable information gathering and review paragraph (b) [reproposed paragraph (d)]
basis for believing that the source of the requirements. It should not be necessary for information) reasonably indicates that the
Rule 15c2–11 information was the broker-dealer to be familiar with all paragraph (a) [reproposed paragraph (c)]
aspects of the filed documents. The broker- information is materially inaccurate.
reliable.28
dealer should focus on those sections that When red flags are present, the broker-
C. Document Review Obligations describe the items of information set forth in dealer’s efforts to satisfy itself with respect to
Rule 15c2–11(a)(5) [reproposed Rule 15c2– the accuracy of the information will vary
Once the broker-dealer has formed a with the circumstances and may require the
11(c)(6)], the issuer’s identified ‘‘risk
reasonable belief about the source’s factors,’’ 31 any recent material business broker-dealer to obtain additional
reliability, it should examine the combinations, such as the merger of a information or seek to verify existing
materials to make sure it has obtained reporting shell into a non-reporting company, information. If the broker-dealer is aware that
all of the information required by the and current financial information. the required issuer information is materially
Rule. This means that a broker-dealer In contrast to information from other kinds inaccurate, it may nevertheless publish
must not only review the information of issuers, non-reporting issuer information quotations without violating the Rule, as long
about the issuer of the security to be generally has not been filed with any as the broker-dealer can supplement that
regulatory authority. Thus, the broker-dealer information with additional information that
quoted but also consider any the broker-dealer reasonably believes is
cannot make any assumptions about the
supplemental information.29 The Rule accuracy of such information. Similarly, a accurate. If the immediate source of the
requires that the broker-dealer must broker-dealer cannot make any assumptions issuer information is unreliable, however, the
have a reasonable basis under the about the accuracy of information to broker-dealer should view that source with
circumstances for believing that the documents and other materials that are skepticism and attempt to obtain the Rule’s
issuer information described in submitted to the Commission by foreign information from another source. For
paragraph (a) [reproposed paragraph (c)] private issuers under Rule 12g3–2(b). example, a broker-dealer that is aware that
of the Rule, when considered in Although they are submitted to the the required issuer information is inaccurate
conjunction with the supplemental Commission, these documents are not ‘‘filed’’ could produce a written record reflecting the
and so are not subject to the liabilities that additional, corrected information or could
information described in paragraph (b) obtain other materials, such as a more recent
attach to reporting issuer information. These
[reproposed paragraph (d)] of the Rule, documents are prepared in accordance with Form 8–K,33 that would permit the broker-
is accurate in all material respects. the standards of the issuer’s home dealer to comply with the Rule. If the broker-
Unlike the duties of an underwriter in jurisdiction, not the standards set forth under dealer sees that the auditor’s report in an
a securities offering, Rule 15c2–11 the U.S. federal securities laws, and broker- issuer’s financial statements is qualified, the
ordinarily does not require a broker- dealers should independently assess the broker-dealer may need to contact the
dealer to conduct an independent accuracy of such information. Broker-dealers accountants about the basis for such
inquiry about the issuer of the security will also need to independently assess the qualification. If the broker-dealer learns that
to be quoted. A broker-dealer publishing accuracy of information filed with foreign an issuer’s control person has been convicted
securities regulatory authorities, based on of securities fraud, it should contact the
quotes for a covered OTC security may
considerations such as the disclosure and appropriate regulatory authority to ascertain
have no relationship with the issuer, the facts.34
liability standards under foreign law. In
and the Rule does not demand that the The Rule’s provisions are triggered by
broker-dealer develop one to obtain 30 See Sections 11 and 27 of the Securities Act, discrete quotation events. Once the broker-
information. However, the broker-dealer 15 U.S.C. 77k and 77x, and Sections 18 and 32 of dealer has complied with the Rule’s
the Exchange Act, 15 U.S.C. 78r and 78ff. See 1991 requirements with respect to a particular
26 The Laser Arms Memorandum misrepresented Adopting Release, 56 FR 19148, 19150 (1991). quotation event, there is no continuing duty
Laser Arms as a high technology weapons 31 If the issuer’s registration statement, pursuant to obtain and review the information. Of
manufacturer and the developer of a self-chilling to Item 401 of Regulation S–K, describes criminal course, when a quotation event occurs, e.g.,
beverage can. The memorandum also included or other disciplinary proceedings involving a the broker-dealer is publishing priced
forged certificates of incorporation, fictitious reporting issuer’s officer, director, general partner, quotations as of the annual review date
balance sheets, and auditor’s report which the promoter, or control person, this would be a red
signature of the accountant had been forged. flag. Reproposed Rule 15c2–11(c)(6)(xi) will require
27 Another broker-dealer who attempted to call 32 17 CFR 249.308.
broker-dealers to inquire about these types of
Laser Arms learned there was no telephone listing 33 27 CFR 249.308.
criminal or other disciplinary proceedings
for the company. This broker-dealer nevertheless involving a non-reporting issuer’s office, director, 34 Even thought he criminal and securities law
initiated a market in Laser Arms’ securities. general partner, promoter, or control person. Under violations specified in reproposed paragraph
28 See also Bunker Securities, Inc., 48 S.E.C. 859 the current Rule, however, a broker-dealer’s (c)(6)(xi) are not specified in paragraph (a)(5) of the
(1987, aff’d without opinion, 833 F.2d 303 (3d Cir. knowledge of criminal or other disciplinary current Rule, a broker-dealer’s knowledge of such
1987). proceedings involving a reporting or non-reporting information would be material adverse information
29 See footnote 14 above for a definition of issuer’s officer, director, general partner, promoter, under the current rule, and such violations would
supplemental information. or control person would be a red flag. be a red flag.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11149
required by the reproposed Rule, it must obtaining verification of information may include seeking verification from the
conduct a review of current issuer provided by the issuer. The broker-dealer issuer or soliciting the views of an
information. In this case, the review process may need to seek an opinion of an independent professional.
would be the same as described above. independent accountant or attorney to form 2. Foreign Trading Suspensions. A trading
However, the review process should be a reasonable basis to believe that the Rule’s suspension by a foreign regulator may
somewhat simpler because the broker-dealer information is accurate and from a reliable indicate that the issuer information is
would already have gained some familiarity source. In one enforcement action, a broker-
with the issuer as a result of its prior review. unreliable or inaccurate. However, a trading
dealer unreasonably relied on pre-suspension
financial statements when the Commission’s suspension in a foreign market may be
D. Scope of Review Following a Trading imposed simply because the issuer failed to
trading suspension was based upon a lack of
Suspension meet exchange listing standards. If the
accurate financial information and the
A Commission trading suspension is a issuer’s auditors indicated to the broker- broker-dealer learns of a foreign trading
material event affecting the market for an dealer that they were having problems suspension, it should attempt to determine
issuer’s securities.35 After the termination of verifying the issuer’s financial information.38 the basis for the suspension order and assess
a trading suspension, a broker-dealer may not A broker-dealer may have difficulty whether the issuer information is still
enter a quotation unless and until it has obtaining the necessary information about an accurate and whether its source is still
strictly complied with all the provisions of issuer after the expiration of a trading reliable.
the Rule. Before initiating or resuming a suspension. This difficulty, however, does 3. Concentration of ownership of the
quotation for securities subject to Rule 15c2– not relieve the broker-dealer of its
11, the broker-dealer must conduct a careful majority of outstanding, freely tradeable
responsibilities under the Rule. If any broker- stock. Concentration of ownership of freely
review in a professional manner of the basis dealer is uncertain as to what is required by
for the trading suspension to determine tradeable securities is a prominent feature of
the Rule, it should refrain from entering
whether there is a reasonable basis for the quotations relating to the securities in microcap fraud cases. When one person or
broker-dealer to believe that the information question until the Rule’s provisions have group controls the flow of freely tradeable
about the issuer is accurate and current. The been met. securities, this person or persons can have a
broker-dealer may be unable to reach a much greater ability to manipulate the stock’s
reasonable basis for relying on the questioned IV. Examples of Red Flags price than when the securities are widely
financial statements in the Commission’s If the broker-dealer discovers at any stage held. In a ‘‘pump and dump’’ scheme, retail
order even if the information otherwise of the review process any red flags in the interest is stimulated, and the price of the
satisfies the Rule’s presumption of ‘‘current’’ issuer information (whether the issuer is a securities is manipulated upward, at the
information.36 This presumption is obviated reporting or non-reporting company), it
if the broker-dealer has information to the behest or under the control of the
cannot publish a quote unless and until those manipulators who control much of the stock.
contrary.37 red flags are reasonably addressed. Material
The broker-dealer must also check the Often, other broker-dealers that are not
inconsistencies in the paragraph (a)
reliability of the source of the information, intentionally participating in improper
[reproposed paragraph (c)] information, or
particularly when the same source is material inconsistencies between that activities publish quotations in response to
providing updated information. If the broker- information and the paragraph (b) escalating demand for the security resulting
dealer seeks assurances or additional [reproposed paragraph (d)] information, are from increasing retail sales. The promoters of
information from the source (in most cases, red flags. We have set out below examples of these companies, company insiders, and
the issuer) about the matters cited in the red flags that we have noticed in microcap unscrupulous brokers make substantial
Commission trading suspension order, great profits when they sell their shares at inflated
fraud cases or in Rule 15c2–11 submissions
caution should be used before relying on the
made to the NASD. These examples, prices. When the scheme is over, the
statements or assurances from the issuer. The
however, are not comprehensive, as red flags security’s price plummets, and innocent
broker-dealer may have to test the accuracy
depend on the facts and circumstances of investors who paid a premium price are left
of the information or the source’s reliability
by conducting an independent review or each case. holding worthless shares.39
We are providing examples of red flags that 4. Large reverse stock splits. Microcap
35 See Section 12(k) of the Exchange Act.
require additional scrutiny by the broker- fraud schemes can involve the substantial
dealer to comply with Rule 15c2–11. These concentration of the publicly-traded float
Information regarding recent trading suspension
orders can be obtained by calling 800–SEC–0330. examples, however, are not exhaustive.
through a reverse stock split. The subsequent
The broker-dealer must obtain a copy of the trading Conversely, the presence of these or other red
flags is not necessarily an indication of issuance of large amounts of stock to insiders
suspension order or a copy of the Commission
release announcing the trading suspension. Copies microcap fraud or even inaccurate issuer increases their control over both the issuer
of Commission releases may be obtained through information. The red flag simply means that and trading of the stock.40
our Internet website at <http://www.sec.gov/ the broker-dealer should question whether 5. Companies in which assets are large and
enforce/tsuspend.htm> or from the Commission’s the issuer information is accurate, and in revenue is minimal without any explanation.
Public Reference Room in Washington, D.C. and in A red flag exists when the issuer assigns a
certain cases, from a reliable source. The
regional Commission offices. Also, Commission
releases are available form information databases more red flags that are present, the more a high value on its financial statements to
(e.g., LEXIS), and also are published in the SEC broker-dealer should scrutinize the issuer
Docket, which is available from publication services information. 39 See New Allied Development Corporation,
(e.g., Commerce Clearing House, Inc.). 1. Commission Trading Suspensions. As Securities Exchange Act Release No. 37990
36 The reproposal contains a presumption that the indicated above, Commission trading (November 26, 1996)(New Allied’s control persons
financial information of both reporting issuers and suspension orders generally raise significant had substantial stock interest in nominee accounts);
domestic and foreign non-reporting issuers is red flags as to whether the Rule 15c2–11 Douglass and Co., Inc., 46 S.E.C. 1189 (1978);
current if it is less than 15 months old. However, Gotham Securities Corporation, 46 S.E.C. 723
information is accurate and whether its
if the broker-dealer has other information that (1976). Paragraph (c)(6)(x) of the reproposed Rule
source is reliable. Broker-dealers publishing will require disclosure of the beneficial ownership
indicates that the issuer’s financial condition has
materially changed from that shown in the financial quotes once a trading suspension terminates of the issuer’s stock by its executive officers,
statements, this presumption may not apply, and must satisfy the Rule’s requirements, which directors, general partners, promoters, or control
the broker-dealer should determine whether more persons.
recent financial information is available. Financial 38 Robin Rushing and Harold Gallison, Jr., 40 Emshwiller, ‘‘Reverse Stock Splits At Many
information older than 15 months is not current and Securities Exchange Act Release No. 36910 Firms Spark Outcry.’’ The Wall Street Journal,
does not satisfy the Rule’s requirements. (February 29, 1996); see also Bagle Securities, Inc., November 20, 1998, at Cl; SEC v. Magna
37 General Bond & Share Co., 51 S.E.C. 411 (1993) Securities Exchange Act Release No. 27673 Technologies, Inc., Litigation Release No. 12227
(Commission opinion), rev’d on other grounds, (February 5, 1990); William V. Frankel & Company, (August 21, 1989) (insiders of Magna effected a 4-
General Bond & Share Co. v. SEC, 39 F.3d 1451 Securities Exchange Act Release No. 27649 (January for-1 reverse stock split, concentrated ownership in
(10th Cir. 1994); See also Robin Rushing and Harold 26, 1990); Richfield Securities, Inc., Securities themselves, and then manipulated the price of
Gallison, Jr., Securities Exchange Act Release No. Exchange Act Release No. 26129 (September 29, Magna’s stock by disseminating false and
36910 (February 29, 1996). 1988). misleading information).
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11150 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
certain assets that are often unrelated to the Rule 504 of Regulation D allows non- microcap fraud cases, the issuer’s financial
company’s business and were recently reporting companies to raise up to $1 million statements often indicate that the issuer
acquired in a non-cash transaction. In this per year in ‘‘seed capital’’ without complying acquired assets to which it assigned
situation, the company’s revenues often are with Securities Act registration requirements. substantial value in exchange for its
minimal and there appears to be no valid The freely tradable nature of securities issued essentially worthless stock.49
explanation for such large assets and in Rule 504 offerings has facilitated a number 12. Significant write-up of assets in a
minimal revenues.41 of fraudulent schemes through the OTC business combination of entities under
Also, a red flag is present when the Bulletin Board Display Service (OTC Bulletin common control.
financial statements of a development stage Board) or the Pink Sheets published by the Those persons engaged in microcap fraud
issuer list as the principal component of the National Quotation Bureau, Inc. (NQB).45 often use a business combination such as a
issuer’s net worth an asset wholly unrelated Broker-dealers should be alert to information merger as an opportunity to falsify financial
to the issuer’s line of business. For example, in the Rule 15c2–11 materials where an statements.50 We have seen microcap fraud
from a review of Rule 15c2–11 submissions, active trading market is being promoted for schemes in which unscrupulous issuers use
art collections or other collectibles that are securities issued solely in a Rule 504 purchase method accounting 51 to write up
unrelated to the issuer’s business apparently transaction. the historical value of an asset to an
have been overvalued on the financial 8. A registered or unregistered offering artificially high value in situations when the
statements of some issuers.42 While assets raises proceeds that are used to repay a entities involved in the business combination
that are unrelated to the business of the bridge loan made or arranged by the are under common control or otherwise have
issuer are not always an indication of underwriter where: a high degree of common ownership. For
potential microcap fraud, some unscrupulous • The bridge loan was made at a high example, Generally Accepted Accounting
issuers have overvalued these types of assets interest rate for a short period; Principles (GAAP) requires that the
in an effort to inflate their balance sheets. • The underwriter received securities at acquisition of one entity by another entity be
6. Shell corporation’s acquisition of private below-market rates prior to the offering; and accounted for at historical cost in a manner
company. A shell corporation is • The issuer has no apparent business similar to that in ‘‘pooling of interests’’
characterized by no business operations and purpose for the bridge loan. accounting when these entities are under
little or no assets. In a fraud scheme, a Broker-dealers have given small issuers common control.52
reporting company with a large number of bridge loans at a high interest rate for a short 13. Unusual auditing issues.
shares controlled by one person or a small time period.46 In exchange for this bridge • Auditors refuse to certify financial
number of persons often merges with a non- loan, the broker-dealer receives a significant statements or they issue a qualified opinion;
reporting company having some business number of shares of the issuer’s common or
operations. The new public company is then stock at a price that is substantially below • There has been a change of
used as the vehicle for ‘‘pump and dump’’ market rates. The broker-dealer then engages accountants.53
and other fraudulent schemes. Broker-dealers in a scheme to manipulate the stock’s price
placing quotes for these issuers’ securities and ultimately benefits when it dumps the 49 See New Allied Development Corporation,
should be mindful of the potential for stock at an artificially high price.47 Securities Exchange Act Release No. 37990
abuse.43 9. Significant write-up of assets upon a (November 26, 1996) (the respondents obtained new
company obtaining a patent or trademark for Allied, a public shell, which was a dormant
7. Offerings under Rule 504 of Regulation
a product. The significant write-up of assets uranium mining company with no assets, in a
D where one or more of the following factors transaction which resulted in insiders controlling
are present: upon the issuer’s obtaining a patent or
52.4% of New Allied’s stock; New Allied then
• Little capital is raised in the Rule 504 trademark for a product is a technique used
acquired an interest in real estate associated with
offering and there appears to be no business by issuers engaged in microcap fraud to worthless gambling concerns in exchange for New
purpose except to provide some shareholders inflate their balance sheets.48 Allied stock); Douglass and Co., Inc., 46 S.E.C. 1189
with free-trading shares; 10. Significant asset consists of OTC (1978).
• The Rule 504 offering is preceded by an Bulletin Board or Pink Sheet companies. We 50 See New Allied Development corporation,
unregistered offering to insiders or others for have noticed that some microcap fraud Securities Exchange Act Release No. 37990
services rendered at prices well below the schemes involve issuers whose major assets (November 26, 1996) (the respondents disseminated
are substantial amounts of shares in other materially false documents to market makers,
price in the subsequent offering; including unaudit financial statements, that valued
• Sales immediately following the Rule OTC Bulletin Board or Pink Sheet
companies. new Allied’s medical and consumer products at
504 offering are at substantially higher prices $2,150,000 although their historical costs were
than those paid in the Rule 504 offering; or 11. Assets acquired for shares of stock
approximately $17,000); A.J. Carno Co., 1976 SEC
when the stock has no market value. In
• A shell company and an operating LEXIS 2764 (February 23, 1976) (Initial Decision),
company merge, which results in the order dismissing proceeding and withdrawing
45 See Securities Act Release No. 33–7644 broker-dealer registration, Securities Exchange Act
operating entity becoming the surviving
(February 19, 1999) in which we adopted Release No. 14647 (April 10, 1978) (Management
entity. The surviving entity goes ‘‘public’’ by
amendments to Rule 504 of Regulation D that limit Dynamics, Inc.’s (MD) founding officer and director
issuing shares pursuant to Rule 504.44 the circumstances where general solicitation is wrote MD shareholders to recommend the
permitted and ‘‘freely tradeable’’ securities may be acquisition of the assets of a real estate developer.
41 New Allied Development Corporation, issued in reliance on Rule 504 to transactions (1) Press releases and shareholder letters reinforced the
Securities Exchange Act Release No. 37990 registered under state law requiring public filing misleading impression that the transaction was
(November 26, 1996). and delivery of a disclosure document to investors certain to generate substantial income for MD).
42 See In the Matter of Rom N. De Guzman, before sale, or (2) exempted under state law 51 When two companies merge, compliance with
Securities Exchange Act Release No. 37747 permitting general solicitation and general Generally Accepted Accounting Principles requires
(September 30, 1996). advertising so long as sales are made only to that the combination be accounted for as either the
43 See New Allied Development Corporation, ‘‘accredited investors.’’ ‘‘pooling method’’ or ‘‘purchase method.’’ With the
46 Emshwiller, ‘‘NASD Quietly Takes Aim at IPO pooing method, the historical costs of the two
Securities Exchange Act Release No. 37990
(November 26, 1996); Stylex Homes, Inc., Securities Bridge-Loan Trend,’’ The Wall Street Journal, companies are added together. With purchase
Exchange Act Release No. 36299 (September 29, January 20, 1998, at Cl. method accounting, the company being acquired
1995); Bunker Securities, Inc., 48 S.E.C. 859 (1987), 47 See Memory Metals, Inc., Securities Act Release writes up its assets to fair market value, which
aff’d without opinion, 833 F. 2d 303 (3d Cir. 1987); No. 6820 (February 22, 1989). generally are greater than the historical costs.
Butcher & Singer, Inc., 48 S.E.C,. 640, aff’d without 48 New Allied Development corporation, 52 Ronald Effren, Securities Act Release No.
opinion, 833 F. 2d 303 (ed Cir. 1987); Douglass and Securities Exchange Act Release No. 37990 7256, Securities Exchange Act Release No. 36713
Co., Inc., 46 S.E.C. 1189 (1978); A.J. Carno Co., 1976 (November 26, 1996); see also Frederick R. Grant, (January 16, 1996); see also Martin Halpern,
SEC LEXIS 2764 (February 23, 1976) (initial Securities Exchange Release No. 38239 (February 5, Securities Exchange Act Release No. 34727
decision), order dismissing proceeding and 1997); Atlantis Group, Inc., securities Exchange Act (September 27, 1994).
withdrawing broker-dealer registration, Securities Release No. 37932 (November 8, 1996); Eli 53 See Securities Exchange Act Form 8–K, Item
Exchange Act Release No. 14647 (April 10, 1978); Buchalter, Securities Exchange Act Release No. 4; Merle S. Finkel, Securities Act Release No. 7401
Gotham Securities Corporation, 46 S.E.C. 723 37702 (September 19, 1996); Milton Mermelstein, (March 12, 1997) (original auditors notified systems
(1976). Securities Exchange Act Release No. 37222 (May of Excellence that purported registration statement
44 See example ι6, above. 16, 1996). on Form S–8 had not been filed and that other
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11151
Rule 15c2–11 does not contemplate that an arbitrary one designed to make assets and promoter, or control person’s involvement in
the broker-dealer scrutinize the issuer’s liabilities balance out.57 any type of business, securities,
financial statements with the expertise of an In addition, issuer information that is commodities, or banking activities;
accountant. The above red flags, however, do altered on its face raises red flags that, at a • Adjudication by civil court of competent
not require an expertise in accounting minimum, require the broker-dealer to jurisdiction, the Commission, the Commodity
matters and have appeared in several contact the issuer.58 Futures Trading Commission or a state
microcap fraud schemes. In one case, the 16. Broker-dealer receives substantially securities regulator to have violated federal
respondents stated in the Form 211 similar offering documents from different or state securities or commodities law; or
submissions to the NASD that they relied on issuers with the following characteristics: • Order by a self-regulatory organization
audited financial statements. However, the • The same attorney is involved; permanently or temporarily barring,
auditors orally advised the associated • The same officers and directors are suspending or otherwise limiting
persons of the broker-dealer before they listed; and/or involvement in any type of business or
submitted the Form 211 that the auditor’s • The same shareholders are listed. securities activities.62
opinion attached to the pro forma financial It is not uncommon for the same Many microcap fraud cases involve
statement was qualified because of the individuals to be involved in multiple recidivist securities law violators.63 If a
auditor’s inability to verify the issuer’s microcap frauds. If a broker-dealer realizes broker-dealer has information or could
after reviewing the information for several
financial information.54 reasonably discover information about the
issuers that the same individuals are
An accountant’s resignation or dismissal is above types of violations, it should question
involved with these entities, the broker-
a characteristic found in some microcap whether it has a reasonable basis to believe
dealer should make further inquiries to
fraud cases. If a broker-dealer sees any of that the issuer’s information is accurate and
determine whether it has a reasonable basis
these red flags, it should confirm the complete in these circumstances.
to believe that the issuer information is
auditor’s credentials with the appropriate accurate. 20. Significant events involving an issuer
state licensing authority, question the 17. Extraordinary gains in year-to-year or its predecessor, or any of its majority
circumstances of the change in accountants, operations. In microcap fraud cases, the owned subsidiaries.
and carefully scrutinize the Rule’s required issuer may show extraordinary gains in its The following types of significant events
information. year-to-year operations. This may be should prompt further investigation by a
14. Extraordinary items in notes to the accomplished through assigning an broker-dealer:
financial statements, e.g., unusual related artificially high value to certain assets or • Change in control of the issuer; 64
party transactions. Unusual related party through other manipulative devices that are • Substantial increase in equity securities;
transactions are sometimes found in red flags, such as the significant write-up of • Merger, acquisition, or business
microcap fraud schemes. For example, an assets upon merger or acquisition.59 combination;
issuer’s financial statements may show a 18. Reporting company fails to file an • Acquisition or disposition of significant
related party transaction between two annual report. The fact that a reporting assets; 65
companies, which later merge and inflate the company has not filed an annual report Bankruptcy proceedings; 66 or
worth of their assets by using purchase suggests that there is a potential problem Delisting from any securities exchange or
method accounting.55 with the company.60 the Nasdaq Stock Market.67
15. Suspicious documents. 19. Disciplinary actions against an issuer’s While not necessarily problematic, these
• Inconsistent financial statements; officers, directors, general partners, are material events involving the issuer. The
• Altered financial statements; or promoters, or control persons. change in control of the issuer, merger,
• Altered certificates of incorporation. The following types of disciplinary actions acquisition, or business combination,
Altered or facially inconsistent issuer should trigger further investigation by a acquisition or disposition of significant assets
documents have been present in various broker-dealer: can provide unscrupulous issuers an
microcap fraud schemes. For example, • Indictment or conviction in a criminal opportunity to artificially overvalue the
Polaris Mining Co. was a shell corporation proceeding; 61 issuer’s assets to support an upward
with no meaningful assets and no trading • Order permanently or temporarily manipulation of the issuer’s worthless
market for its stock.56 Douglass and Co., Inc., enjoining, barring, suspending or otherwise
a broker-dealer, published quotations for limiting an officer, director, general partner, 62 The reproposed text of Rule 15c2–
Polaris in the Pink Sheets in violation of Rule 11(c)(6)(xi)(A)(2) requires the broker-dealer to
15c2–11 because the Polaris financial 57 See also Butcher & Singer, Inc., 48 S.E.C. 640, review these factors for non-reporting issuers.
information upon which Douglass and Co., aff’d without opinion, 833 F.2d 303 (3d Cir. 1987) Otherwise, under the reproposed text of Rule 15c2–
Inc. relied was deficient and contradictory on (a salesman and later an officer of Butcher & Singer 11(c)(6)(xi)(B) or (C), the broker-dealer must obtain
its face: two balance sheets for the same years apparently obtained some blank stock certificates a statement from the issuer that none of these
contained blatant disparities. Both balance and forged former officers’ signatures as well as the events has occurred or must record the steps taken
certificates’ amounts and purported dates of to obtain this information and that the issuer
sheets valued certain mined but unprocessed refused or failed to provide it. Even though the
issuance to himself and his family members; the
ores at the estimated eventual selling price broker-dealer, Butcher & Singer, failed to review the current Rule does not require the broker-dealer to
even though significant processing work Rule’s required information; Butcher & Singer might obtain and review this information, we consider
remained to be done. One statement did not have noticed red flags that would have led to the such information to be red flags under the Rule if
list property location. One statement had an discovery of the underlying fraud if it had reviewed it comes to the broker-dealer’s attention.
item for capitalized expenses and the other the Rule’s required information). 63 See SEC v. I-Net Providers, Litigation Release
statement for the same year did not. The 5 See United States v. Marshall Zolp, Litigation No. 15219 (January 17, 1997); New Allied
former statement showed no retained Release Nos. 11494 (July 23, 1987) and 11236 Development Corporation, Securities Exchange Act
earnings or accumulated deficit, suggesting (October 2, 1986)(fictitious certificates of Release No. 37990 (November 26, 1996).
that the figure for capitalized expenses was incorporation and fictitious financial statements on 64 See Exchange Act Form 8–K, Item 1.
which the name of another company had been 65 See Exchange Act Form 8–K, Item 2.
whited out and the name of Laser Arms filled in). 66 See Exchange Act Form 8–K, Item 3.
irregularities exist in connection with issuance of 59 See, e.g., A. J. Carno Co., 1976 SEC LEXIS 2764 67 The proposed text of Rule 15c2–11(c)(6)(xii)(A)
this stock; thereafter, Systems of Excellence (February 23, 1976)(Initial Decision), order requires the broker-dealer to review these factors.
retained new auditor who issued materially false or dismissing proceedings and withdrawing broker- Otherwise, under the proposed text of Rule 15c2–
inaccurate audit reports. dealer registration, Securities Exchange Act Release 11(c)(6)(xii)(B) or (C), the broker-dealer must obtain
54 See Robin Rushing and Harold Gallison, Jr., No. 14647 (April 10, 1978). a statement from the issuer that none of these
Securities Exchange Act Release No. 36910 60 See Combined Companies International Corp.,
events has occurred or must record the steps taken
(February 29, 1996). In this case, the SEC also had Securities Exchange Act Release No. 38653 (May to obtain this information and that the issuer
entered a trading suspension for lack of accurate 19, 1997); Robin Rushing and Harold Gallison, Jr., refused or failed to provide it. Even though the
financial information. Securities Exchange Act Release No. 36910 current Rule does not require the broker-dealer to
55 See Ronald Effren, Securities Exchange Act (February 29, 1996). obtain and review this information, we consider
Release No. 36713 (January 16, 1996). 61 Stylex Homes, Inc., Securities Exchange Act such information to be red flags under the Rule if
56 Douglass and Co., Inc., 46 S.E.C. 1189 (1978). Release No. 36299 (September 29, 1995). it comes to the broker-dealer’s attention.
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11152 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
stock.68 An increase in the issuer’s equity 23. Regulation S transactions of domestic ‘‘employees’’ who act as conduits by selling
securities provides the securities necessary issuers. Regulation S 75 provides a safe harbor the securities to the public and remitting the
for such manipulation. Bankruptcy from the registration requirements of the proceeds (or their economic benefit) to the
proceedings or a delisting from an exchange Securities Act of 1933 for offers and sales of issuer.81 This public sale of securities by the
or the Nasdaq Stock Market may also indicate securities by both foreign and domestic issuer has not been registered, although the
problems with an issuer that could lead the issuers that are made outside the United Securities Act requires registration. The
broker-dealer to conclude that it does not States. We recently adopted amendments to failure to register this sale of securities
have a reasonable basis to believe that the Regulation S that are designed to prevent the deprives public investors of the protections
issuer’s financial information is accurate.69 abuses that relate to offshore offerings of afforded by the Securities Act.
21. Request to publish both bid and ask equity securities of domestic issuers.76 Prior To prevent these abuses, Form S–8 and
quotes on behalf of a customer for the same to the recent amendments, Regulation S related rules impose certain restrictions on
stock. The highly unusual request from a transactions involving large amounts of the the use of the form for the sale of securities
customer for the broker-dealer to publish securities of U.S. issuers were particularly to certain consultants and advisors.82 We are
both bid and ask quotes is a red flag ‘‘that vulnerable to fraud and manipulation.77 The also proposing additional amendments to
calls for appropriate inquiry on [the broker- perpetrators of the fraud sold the securities Form S–8.83 Although these amendments
dealer’s] part.’’ 70 to U.S. investors after the 40-day holding should deter microcap abuses, broker-dealers
22. Issuer or promoter offers to pay a ‘‘due period expired, and little information was nevertheless should be aware of the prior
diligence’’ fee. If a market maker receives an available to investors about the issuers. abuses of Form S–8 in microcap fraud cases.
offer from an issuer to pay a ‘‘due diligence’’ Under the amendments, equity securities 25. ‘‘Hot industry’’ microcap stocks.
fee in connection with making a market in of U.S. issuers that are sold offshore under Another characteristic of microcap fraud
the issuer’s security, this is not solely a red Regulation S are classified as ‘‘restricted cases is that they often involve stocks that are
flag.71 It is a violation of NASD Rule 2460 for securities’’ within the meaning of Rule 144 in vogue.84 In the past, oil and gas ventures
the broker-dealer to accept this offer.72 If the under the Securities Act, and the period and mining operations, as well as stocks of
broker-dealer receives any consideration in during which these securities cannot be issuers with purportedly innovative
connection with publishing a quotation, the distributed in the United States is lengthened products, have been popular in frauds
reproposed Rule requires the broker-dealer to from 40 days to one year. These amendments involving low-priced stocks.
disclose any such compensation, as well as make Regulation S abuses less likely, but 26. Unusual activity in brokerage accounts
any other significant relationship information broker-dealers should be alert to any of issuer affiliates, especially involving
between the issuer and the broker-dealer questionable activities once the one-year ‘‘related’’ shareholders. Many microcap
publishing the quotation or any of its holding period expires. frauds begin with the deposit and sale of
associated persons.73 In Douglass and Co., 24. Form S–8 stock. Form S–8 is the short- large blocks of an obscure stock by a new and
Inc., a registered representative said he form registration statement for offers and unfamiliar customer who often is affiliated
would try to get the broker-dealer to initiate sales of a company’s securities to its with an issuer.85 At the same time, the
a market in the stock of Polaris Mining Co., employees, including consultants and broker-dealer is encouraged to make a market
but that it would cost the issuer about $1,500 advisors.78 The form has been abused by in the stock by the issuer.
to cover ‘‘expenses.’’ The registered unscrupulous issuers to register on Form S– 27. Companies that frequently change
representative later agreed to accept Polaris 8 securities nominally offered and sold to names. Frequent name changes are another
stock (some of which he kept himself) employees or, more commonly, to so-called
instead of the $1,500.74 characteristic that we have seen in microcap
consultants and advisors. These persons then fraud cases. For example, Twenty First
resell the securities in the public markets, at Century Health (TFCH) was originally a
68 See New Allied Development Corporation,
the direction of the issuer or a promoter.79 In company called Big Valley Energy, Inc. Big
Securities Exchange Act Release No. 37990 a typical pattern, an issuer registers on Form
(November 26, 1996); A. J. Carno Co., 1976 SEC Valley then changed its name to Biotronic
S–8 securities underlying options issued to Energy Engineering, Inc., then to The
LEXIS 2764 (February 23, 1976)(Initial Decision),
order dismissing proceedings and withdrawing so-called consultants where, by Sonoron Group, then to Zorro International,
broker-dealer registration, Securities Exchange Act prearrangement, the issuer directs the Inc., then to Health & Wealth, Inc., and
Release No. 14647 (April 10, 1978); see also Bion consultants’ exercise of the options and finally became TFCH in 1995. At the
Environmental Technologies, Inc., Securities resale of the underlying securities in the promoter’s request, TFCH issued false
Exchange Act Release No. 36111 (August 16, 1995). public market. The consultants then either
69 See B.J. Thomas, Securities Exchange Act
audited financial statements that recorded
remit to the issuer the proceeds from the sale material, nonexistent assets.86
Release No. 38727 (June 10, 1997); SEC v. Magna of the underlying shares, or apply the
Technologies, Inc., Litigation Release No. 12227 28. Companies that frequently change their
proceeds to pay debts of the issuer that are line of business. Besides companies that
(August 21, 1989); see e.g., Milton Mermelstein,
Securities Exchange Act Release No. 37222 (May not related to any services provided by the frequently change their names, we also see
16, 1996). consultants.80 In some cases, these
70 Alessandrini & Co., Inc., 45 S.E.C. 399 (1971), consultants perform little or no other service 81 See S.E.C. v. Charles O. Huttoe, Litigation
citing D.H. Blair & Co., 44 S.E.C. 320 (1970). for the issuer. In other microcap frauds, the
Release Nos. 15153 (November 7, 1996); 15185
71 Butcher & Singer, Inc., 48 SEC 640, aff’d issuer uses Form S–8 to sell securities to (December 12, 1996)(unregistered public offering
without opinion, 833 F.2d 303 (3d Cir. 1987)(a purporting to use Form S–8).
salesman received 400,000 shares of an obscure 75 17 CFR 230.901–230.905 and Preliminary 82 Securities Act Release No. 33–7646 (February
penny stock for helping to develop and maintain a Notes. 19, 1999).
market in the stock); see Brent Duane Green, 76 Securities Act Release No. 7505 (February 17, 83 Securities Act Release No. 33–7647 (February
Securities Exchange Act Release No. 39210 (October
7, 1997); Steven Ira Wertman, Securities Exchange 1998), 63 FR 9632. We also adopted amendments 19, 1999).
Act Release No. 38751 (June 20, 1997); Christopher that would affect applicable reporting requirements 84 See Douglass and Co., Inc., 46 S.E.C. 1189
D. Jennings, Securities Exchange Act Release No. along with other amendments intended to prevent (1978) (November 26, 1996)(mining operation); see
38696 (May 30, 1997). abuses of Regulation S. Since January 1, 1999, also S.E.C. v. Bradley J. Simmons and American
72 NASD Rule 2460, Payments for Market Making, Regulation S transactions are required to be Energy Group, Ltd, Litigation Release No. 15353
prohibits any payment by an issuer or the issuer’s reported quarterly on Forms 10–Q and 10–K. (April 29, 1997)(oil and gas company).
77 See Frederick R. Grant, Securities Exchange 85 Laser Arms Report, 50 S.E.C. 489, 503; see also
affiliates and promoters, directly or indirectly, to a
member for publishing a quotation, acting as a Release No. 38239 (February 5, 1997); S.E.C. v. Butcher & Singer, Inc., 48 S.E.C. 640, aff’d without
market maker, or submitting an application. Enviromint Holdings, Inc., Litigation Release No. opinion, 833 F.2d 303 (3d Cir. 1987); Gotham
73 See reproposed Rule 15c2–11(e); see also 14683 (October 6, 1995). Securities Corporation, 46 S.E.C. 723 (1976) (the
78 Form S–8 under the Securities Act of 1933 (15
current Rule 15c2–11(a)(5)(xvi). family of the broker-dealer’s principal owned a
74 Douglass and Co., Inc., 46 S.E.C. 1189 (1978); U.S.C. 77a et seq.). significant amount of the stock of Marcon
79 See S.E.C. v. Enviromint Holdings, Inc., Electronics Corp., which was a shell corporation
see also See Robin Rushing and Harold Gallison, Jr.,
Securities Exchange Act Release No. 36910 Litigation Release No. 14683 (October 6, 1995). with no assets; the family benefited when the
(February 29, 1996); General Bond & Share Co., 51 80 See, e.g., Spectrum Information Technologies, broker-dealer manipulated upward the price of the
S.E.C. 411 (1993)(Commission opinion), rev’d on Inc., Securities Act Release No. 7426 (June 25, Marcon stock).
other grounds, General Bond & Share Co. v. SEC, 1997); SEC v. Hollywood Trenz, Inc., Litigation 86 Merle S. Finkel, Securities Act Release No.
39 F.3d 1451 (10th Cir. 1994). Release No. 15730. 7401 (March 12, 1997).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11153
companies that frequently change their line a dormant public shell with no assets.87 New stock. Next, New Allied became a vehicle to
of business in microcap fraud cases. For Allied then acquired the rights to medical enter the gaming business purportedly to
example, New Allied Development started products in exchange for its overvalued build a casino.
out as a uranium mining company that was
87 New Allied Development Corporation, [FR Doc. 99–5299 Filed 3–5–99; 8:45 am]
Securities Exchange Act Release No. 37990 BILLING CODE 8010–01–P
(November 26, 1996).OCR text (327,657c · gpumon-ocr-api · 90% conf)
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11124 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
Act and all materials required by section unless, immediately before filing the SECURITIES AND EXCHANGE
14(a) or 14(c) of the Exchange Act (15 registration statement, the registrant: COMMISSION
U.S.C. 78n(a) or 78n(c)) required to be (i) Is subject to the reporting
filed during the 12 months immediately 17 CFR Part 240
requirements of Sections 13(a) or 15(d)
before filing a registration statement on of the Securities Exchange Act of 1934
this form (or for such shorter period that Release No. 34–41110; File No. S7–5–
(the ‘‘Exchange Act’’) (15 U.S.C. 78m(a) 99
the registrant was required to file such
or 78o(d));
reports and materials); and RIN 3235–AH40
(iii) Has filed on a timely basis all (ii) Has filed all reports required by
reports required by section 13(a) or Section 13(a) or 15(d) of the Exchange Publication or Submission of
15(d) of the Exchange Act during the 12 Act and all materials required by Quotations Without Specified
calendar months and any portion of a Section 14(a) or 14(c) of the Exchange Information
month immediately preceding the filing Act (15 U.S.C. 78n(a) or 78n(c)) required AGENCY: Securities and Exchange
of the registration statement (or for such to be filed during the 12 months Commission.
shorter period that the registrant was immediately before filing a registration ACTION: Reproposed rule.
required to file such reports). If during statement on this form (or for such
that time the registrant has used shorter period that the registrant was SUMMARY: The Securities and Exchange
§ 240.12b–25 of this chapter with required to file such reports and Commission is reproposing for comment
respect to a report or a part of a report, materials); and amendments to Rule 15c2–11 under the
that material must have been filed Securities Exchange Act of 1934
within the time prescribed by that (iii) Has filed on a timely basis all
(Exchange Act). Rule 15c2–11 governs
section. reports required by Section 13(a) or
the publication of quotations for
(2) If the registrant is an entity formed 15(d) of the Exchange Act during the 12
securities in a quotation medium other
by the merger between: calendar months and any portion of a than a national securities exchange or
(i) An entity subject to the Exchange month immediately preceding the filing Nasdaq. Also, we are reproposing a
Act reporting requirements that had of the registration statement (or for such companion amendment to relocate in
only nominal assets at the time of the shorter period that the registrant was Rule 17a–4 under the Exchange Act the
merger; and required to file such reports). If during record retention requirement currently
(ii) An entity that was not subject to that time the registrant has used Rule contained in Rule 15c2–11. The original
the Exchange Act reporting 12b–25 (§ 240.12b–25 of this chapter) proposal was issued in February 1998 in
requirements at the time of the merger, under the Exchange Act with respect to response to concerns about increased
the registrant may not file a registration a report or a part of a report, that incidents of fraud and manipulation in
statement on this form until it has filed material must have been filed within the over-the-counter (OTC) securities,
an annual report on Form 10–K or Form time prescribed by that rule. which typically involve thinly-traded
10–KSB (§ 249.310 or § 249.310b of this securities of thinly-capitalized issuers
chapter) containing audited financial (b) If the registrant is an entity formed
by the merger between: (i.e., microcap securities).
statements for a fiscal year ending after The reproposed amendments are more
consummation of the merger. (i) An entity subject to the Exchange limited than the initial proposal and
(b) A registrant may use this form for Act reporting requirements that had focus the Rule on those securities the
registration under the Act of the only nominal assets at the time of the Commission believes are more likely to
following securities: merger; and be prone to fraud and manipulation.
* * * * * (ii) An entity that was not subject to The reproposal is part of the
3. By amending Form S–8 (referenced the Exchange Act reporting Commission’s continuing efforts in
in § 239.16b) in General Instruction A to requirements at the time of the merger, regulatory, inspections, enforcement,
redesignate paragraphs 1.(a) and 1.(b) as the registrant may not file a registration and investor education areas that are
paragraphs 1.(d) and 1.(e); revise the key to deterring microcap fraud.
statement on this form until it has filed
introductory text of paragraph 1.; and In addition, the reproposal will
an annual report on Form 10–K or Form
add new paragraphs 1.(a) and 1.(b) to increase the information that broker-
10–KSB (§ 249.310 or § 249.310b of this
read as follows: dealers must review before publishing
chapter) containing audited financial
Note: The text of Form S–8 does not, and quotations for non-reporting issuers’
statements for a fiscal year ending after securities, and will ease the Rule’s
this amendment will not, appear in the Code
of Federal Regulations.
consummation of the merger. recordkeeping requirements when
* * * * * broker-dealers have electronic access to
Form S–8 Registration Statement Under Dated: February 25, 1999. information about reporting issuers.
the Securities Act of 1933
By the Commission. Finally, we are giving guidance to
* * * * * Margaret H. McFarland, broker-dealers on the scope of the
General Instructions Deputy Secretary.
review required by the Rule and
providing examples of ‘‘red flags’’ that
[FR Doc. 99–5298 Filed 3–5–99; 8:45 am]
A. Rule as to Use of Form S–8 they should look for when reviewing
BILLING CODE 8010–01–P
1. A registrant may use this form for issuer information.
registration under the Securities Act of DATES: Comments must be received on
1933 of the securities listed in or before April 7, 1999.
paragraph 1.(d) and 1.(e) of this section ADDRESSES: Comments should be
if the registrant satisfies the submitted in triplicate to Jonathan G.
requirements of paragraph 1.(a) and Katz, Secretary, Securities and Exchange
1.(b) of this section: Commission, 450 Fifth Street, NW, Mail
(a) A registrant may not file a Stop 6–9, Washington, DC 20549.
registration statement on this form Comments may also be submitted
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11125
electronically at the following E-mail D. Total annual reporting and using high pressure sales tactics and a
address: [email protected]. All recordkeeping burden supply of securities under the firm’s
comment letters should refer to File No. 1. Burden-hours for broker-dealers control. The fraudsters create interest in
2. Burden-hours for issuers
S7–5–99. All comments received will be 3. Total burden-hour costs to broker-
the security by disseminating false or
available for public inspection and dealers and issuers misleading information about the issuer
copying in the Commission’s Public 4. Capital cost to broker-dealers and issuers through, for example, oral statements,
Reference Room, 450 Fifth Street, NW, E. General information about the collection press releases, or the Internet. To further
Washington, DC 20549. Electronically of information the manipulative scheme, the retail
submitted comment letters will be F. Request for comments broker frequently acts as a market maker
posted on the Commission’s Internet IX. Statutory Basis and Text of Proposed in the security or, either on its own or
website (http://www.sec.gov). Amendments and Rule through the issuer’s promoter, induces
FOR FURTHER INFORMATION CONTACT: Any Appendix other firms to act as market makers.
of the following attorneys in the I. Introduction By publishing quotations, the market
Division of Market Regulation, II. Quotation Events Triggering the Review maker raises the profile of the security,
Securities and Exchange Commission, Requirement even though the market maker is not an
450 Fifth Street, NW, Mail Stop 10–1, III. The Review Process active participant in the fraud and
A. Introduction publishes quotations solely in response
Washington, DC 20549, at (202) 942–
B. Source reliability
0772: Nancy J. Sanow, Irene A. Halpin, to increased demand for the security.
1. Determining whether a source is reliable
Florence E. Harmon, Chester A. 2. Examples of unreliable sources The broker, promoter, or others
McPherson, or Jerome J. Roche. C. Document review obligations orchestrating the fraud can point to
SUPPLEMENTARY INFORMATION: D. Scope of review following a trading quotations for the security to ‘‘validate’’
suspension its worth. The perpetrators of the fraud
Table of Contents IV. Examples of Red Flags then dispose of their stake at an inflated
I. Executive Summary price. Once they no longer need to
A. Overview of the microcap fraud I. Executive Summary
stimulate interest in the security, the
problem and efforts to prevent further A. Overview of the Microcap Fraud
abuses
market for it collapses and innocent
Problem and Efforts to Prevent Further investors are left holding stock with
B. Background of Rule 15c2–11 and recent
proposed amendments
Abuses little or no value.
II. Overview of Reproposed Amendments Because incidents of fraud and The defrauded victims of microcap
III. Discussion of Amendments manipulation involving microcap fraud activities are not the only ones
A. Securities excluded from the Rule securities are a serious concern, the harmed. When other investors become
1. Securities satisfying a trading value test Commission, along with other reluctant or unwilling to invest in the
2. Securities satisfying a bid price test kinds of securities they perceive as
3. Securities of issuers satisfying a net
regulators, has made combating
tangible assets test microcap fraud one of its top priorities. prone to fraud, liquidity for those
4. Non-convertible debt, non-participatory Microcap securities generally are securities can be impaired. As a result,
preferred stock, and asset-backed characterized by low share prices and existing shareholders can face difficulty
securities little or no analyst coverage.1 The in disposing of their holdings and
5. Other Exceptions issuers of microcap securities typically legitimate issuers of lower-priced stocks
B. Quotations subject to the Rule are thinly-capitalized and information can find it hard to raise capital to start
1. The initial quotation for a covered OTC about them often is limited, particularly up or expand operations or services. In
security when they are not subject to the short, continuing incidents of microcap
2. Priced quotations
3. Annual review
Commission’s periodic disclosure fraud are detrimental to the integrity of
C. Information required under the Rule requirements. Securities of microcap our nation’s capital markets.
1. Reporting issuers delinquent in their companies usually are quoted on the To combat microcap abuses, we have
filings OTC Bulletin Board operated by the initiated several enforcement,
2. Issuers in bankruptcy National Association of Securities examination, education, and regulatory
a. Reporting issuers Dealers, Inc. (NASD), or in the Pink measures. These actions include the
b. Non-reporting issuers emerging from Sheets published by the National following:
bankruptcy Quotation Bureau, Inc. (NQB), but they • In September 1998, we filed 13
3. Non-reporting foreign private issuers are not exclusive to these quotation
4. Other non-reporting issuers
enforcement actions against 41
D. Information available upon request mediums.2 defendants for their involvement in
E. Information repository Microcap fraud often involves fraudulent microcap schemes that
F. Definitions schemes such as ‘‘pump and dump’’ bilked investors of more than $25
G. Preservation of documents and operations, in which unscrupulous million.3
information brokers sell the securities of less- • We conducted a nationwide sweep
H. Transition and exemptive authority seasoned issuers to retail customers by to combat fraud through the Internet,
provisions which resulted in 23 enforcement
I. Information submitted to the NASD 1 The term microcap securities is not defined
IV. General Request For Comments
actions against 44 stock promoters of
under the federal securities laws or regulations. The
V. Effects on Efficiency, Competition, and use of the term ‘‘microcap securities’’ in this microcap stocks in October 1998.4
Capital Formation release, however, should be distinguished from its
VI. Costs and Benefits of the Amendments use in the mutual fund context. For example, 3 For a summary of these cases, see Fight Against
A. Benefits Lipper Analytical Services, a mutual fund rating Microcap Fraud ‘‘Paying Dividends’’, Press Release
organization, generally categorizes microcap No. 98–92 (September 24, 1998), available through
B. Costs
companies as companies with market capitalization our Internet website at <http://www.sec.gov/news/
VII. Initial Regulatory Flexibility Act of less than $300 million. Lipper-Directors’ micronew.htm>.
VIII. Paperwork Reduction Act Analytical Data, Investment Objective Key, 2d ed. 4 For a summary of these cases, see Purveyors of
A. Collection of information under the 1997. Fraudulent Spam, Online Newsletters, Message
amendments 2 Microcap securities can also be listed on Board Postings, and Websites Caught, Press Release
B. Proposed use of information securities exchanges or Nasdaq or quoted in No. 98–117 (October 28, 1998), available through
C. Respondents alternative trading systems. Continued
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11126 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
• We initiated examination sweeps of our rule that governs the quotations by broker-dealer is able to ‘‘piggyback’’ on
several firms that are active in the broker-dealers for OTC securities.12 either its own or other broker-dealers’
microcap market. Our examination staff Rule 15c2–11 is intended to prevent previously published quotations. This
conducted complex and resource- broker-dealers from becoming involved exception assumes that regular and
intensive reviews of these firms’ records in the fraudulent manipulation of OTC frequent quotations for a security
for evidence of the hallmarks of securities. However, even if a broker- generally reflect market supply and
microcap fraud, such as patterns of ‘‘bait dealer technically complies with the demand and are based on independent,
and switch’’ sales techniques, Rule’s requirements, it would be subject informed pricing decisions. However, as
misrepresentations and exaggerated to liability under other antifraud a result of the piggyback provision, the
claims, unauthorized trading and provisions of the securities laws, such Rule’s application is essentially limited
refusals to sell securities, market as Rule 10b–5, if it publishes quotations to just the first broker-dealer publishing
manipulation, and lax or nonexistent as part of a fraudulent or manipulative quotes.
supervision. scheme.13 In February 1998, the Commission
• We have held numerous investors’ published for comment amendments to
town meetings across the country to B. Background of Rule 15c2–11 and the Rule that were designed to curb
educate people about investing wisely, Recent Proposed Amendments fraud in microcap securities.17 This
and we have put together several Rule 15c2–11 contains requirements proposal would have eliminated the
brochures to assist investors.5 that are intended to deter broker-dealers piggyback provision by requiring all
• We are cooperating with self- from initiating or resuming quotations broker-dealers to review current issuer
regulatory organizations (SROs) to for covered OTC securities that may information before publishing their first
improve supervision and regulation of facilitate a fraudulent or manipulative quotation for a covered OTC security,
the OTC securities market. For example, scheme. The Rule currently prohibits a without regard to whether the quotation
we recently approved NASD rule broker-dealer from publishing (or was priced or unpriced, and to
changes that limit quotations on the submitting for publication) a quotation thereafter review current issuer
OTC Bulletin Board to the securities of for a covered OTC security in a information annually if they published
issuers that are current in their reports quotation medium unless it has priced quotations. With limited
filed with the Commission or other obtained and reviewed current exceptions, the proposal would have
regulatory authority.6 information about the issuer.14 The applied to any security quoted in a
• We have taken steps to strengthen broker-dealer must also have a quotation medium other than a national
our regulations and close loopholes to reasonable basis for believing that the securities exchange or Nasdaq. The
help reduce incidents of microcap issuer information, when considered proposal would also have expanded the
fraud. along with any supplemental information required for issuers that do
Today, we are taking action on several information, is accurate and is from a not file periodic reports with the
additional regulatory measures aimed at reliable source.15 Commission (e.g., non-reporting
preventing further incidents of microcap The Rule currently contains several issuers). In addition, broker-dealers
fraud. In addition to adopting exceptions to its prohibitions. Under the would have been required to make the
amendments to Form S–8 7 under the ‘‘piggyback’’ exception, the Rule’s issuer information available to anyone
Securities Act of 1933 (Securities Act) 8 information requirements do not apply who requested it.
and adopting amendments to Regulation when a broker-dealer publishes, in an In response to the Proposing Release,
D,9 we are reproposing amendments to interdealer quotation system, a we received 199 comment letters from
Rule 15c2–11 10 under the Securities quotation for a covered OTC security 193 commenters.18 The majority of
Exchange Act of 1934 (Exchange Act),11 that was already the subject of regular commenters, which included broker-
and frequent quotations in the same dealers, issuers, attorneys, and
our Internet website at <http://www.sec.gov/news/ interdealer quotation system.16 A individuals, opposed many of the
netfraud.htm>. proposed changes. Broker-dealers were
5 See, e.g., ‘‘Microcap Stock: A Guide for 12 In this release, ‘‘OTC stocks’’ or OTC securities especially concerned that they would be
Investors’’ (providing a variety of tips on how to refers to securities that are not listed on a national
detect and avoid microcap fraud); ‘‘Cold Calling
exposed to potential liability in civil
securities exchange or Nasdaq. ‘‘Covered OTC
Alert’’ (describing the cold calling rules and securities’’ refers to those OTC securities that are
actions as a result of their increased
instructing investors how to avoid telephone subject to Rule 15c2–11. The Rule applies to review obligations under the proposal.
scams); ‘‘Internet Fraud’’ (describing common securities quoted on the OTC Bulletin Board Commenters also expressed views about
frauds including on-line newsletter and bulletin operated by the NASD, the Pink Sheets operated by
board posting scams); and ‘‘Ask Questions’’ (listing
the possibility of: reduced liquidity in
the NQB, and similar quotation mediums. For
questions that investors should ask about their further discussion of quotation mediums, see Part
covered OTC securities if broker-dealers
investments and their investment professionals). III.F. below stopped making markets; less
All of these publications are available for free from 13 17 CFR 240.10b–5. transparent markets if broker-dealers
our toll-free publications line at (800) 732–0330 and 14 Rule 15c2–11 defines quotation as any bid or did not publish priced quotes to avoid
can be downloaded through our Internet website at
<http://www.sec.gov>.
offer at a specified price with respect to a security, the annual review requirement; less
6 Securities Exchange Act Release No. 40878
or any indication of interest by a broker or dealer competitive pricing for covered OTC
in receiving bids or offers from others for a security,
(January 4, 1999), 64 FR 1255 (OTC Bulletin Board or any indication by a broker or dealer that securities; impaired access to capital by
Release). advertises its general interest in buying or selling
7 Securities Act Release No. 33–7646 (February
a particular security. For the purposes of this medium.’’ See Part III.F. below for a discussion of
19, 1999). The amendments to Form S–8 restrict the release, a ‘‘priced quotation’’ is a bid or offer at a the term ‘‘quotation medium.’’
use of Form S–8 for the sale of securities to specified price. 17 Securities Exchange Act Release No. 39670
consultants and advisors, among other things. 15 See Part III.C. below for a description of the (February 17, 1998), 63 FR 9661 (Proposing
8 15 U.S.C. 77a et seq.
required issuer and supplemental information. Release).
9 Securities Act Release No. 33–7644 (February 16 An interdealer quotation system is a quotation 18 This total includes virtually identical comment
19, 1999). The amendments limit the circumstances medium of general circulation to brokers or dealers letters from 68 issuers. All comment letters are
where freely tradable securities may be issued in which regularly disseminates quotations of available in File No. S7–3–98 at our Public
reliance on, and general solicitation is permitted identified brokers or dealers. 17 CFR 240.15c2– Reference Room, 450 Fifth Street, NW, Washington,
under, Rule 504 of Regulation D. 11(e)(2). Under the proposed amendments, the DC 20549. Comment letters that were submitted
10 17 CFR 240.15c2–11.
definition of ‘‘interdealer quotation system’’ would electronically are available through our Internet
11 15 U.S.C. 78a et seq. be incorporated into the definition of ‘‘quotation website at <http://www.sec.gov/rules/s7398.htm>.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11127
issuers; and increased compliance costs should take and ‘‘red flags’’ they should amendments also reorganize and
for broker-dealers. In addition, some consider when reviewing the Rule’s simplify the Rule’s provisions
commenters pointed out that the required information. In response to consistent with the Commission’s Plain
proposal would not cover Nasdaq commenters’ concerns about broker- English program.
SmallCap securities, which, they noted, dealer liability, we stress that broker-
III. Discussion of Amendments
have also been the subject of abusive dealers will have no obligation to
activities. Some commenters also continuously update their Rule 15c2–11 The amendments restructure Rule
remarked that the proposal would not materials. The broker-dealer’s review 15c2–11 by setting forth more clearly
stop microcap fraud, which, in their obligations under the Rule occur only at the quotation events that trigger the
view, is really a sales abuse problem. the specific times identified in the Rule. Rule, the requirements that the broker-
Several commenters, principally state In general, the amendments would: dealer must satisfy, and the nature of
securities regulators and their national • Limit the Rule primarily to priced the information that the broker-dealer
association, supported the proposal. quotations; 19 must review. The amendments state that
They believed that microcap fraud • Eliminate the Rule’s piggyback no broker-dealer, directly or indirectly,
would be deterred if broker-dealers are provision and require all broker-dealers may publish the described kinds of
required to review issuer information to review current issuer information quotations for a security in any
and make their own independent and before publishing priced quotations for quotation medium, without first
substantiated determinations before a security; complying with the Rule’s provisions.
publishing quotations. Further, • Require broker-dealers publishing The Rule will only apply at specified
commenters favoring the proposal stated priced quotations for a security to points in time, namely, when a broker-
that the availability of information via review current information about the dealer publishes:
EDGAR and the speed of issuer annually and upon the • The first quotation for a security;
communication via the Internet would occurrence of specified events; • Its first quotation at a specified
ease any increased burden on broker- • Expand the information required for price for a security after another broker
dealers created by the Rule certain non-reporting issuers; or dealer published the first quotation
amendments. Finally, a number of • Require documentation of the for the same security;
commenters were more neutral in their broker-dealer’s compliance with the • The first quotation following the
approach and offered views or Rule; and termination of a Commission trading
suggestions on specific provisions. • Require broker-dealers publishing suspension ordered pursuant to section
quotes in compliance with the Rule to 12(k) of the Exchange Act 20 in any
II. Overview of Reproposed
provide the issuer information upon security of the issuer of the suspended
Amendments
request to customers, prospective security;
The Commission is issuing a revised customers, information repositories, and • A quotation at a specified price for
proposal to amend Rule 15c2–11 to help other broker-dealers. a security after a period of five or more
curtail abuses in the offer, sale and In addition, the amendments would consecutive business days when it did
trading of microcap securities. Because exclude from the Rule’s coverage: not publish any quotations at a specified
these amendments will significantly • Securities with a worldwide price for that security;
change the Rule’s scope, we are average daily trading volume value of at • Its first quotation at a specified
publishing them to give interested least $100,000 during each month of the price for a security after the date that is
persons an opportunity to provide us six full calendar months immediately four months after the end of the issuer’s
with their comments and views. preceding the date of publication of a fiscal year, unless the issuer is a foreign
The amendments are intended to have quotation, and convertible securities private issuer; or
broker-dealers ‘‘stop, look and listen’’ where the underlying security satisfies • Its first quotation at a specified
before they begin to quote a covered this threshold; price for a security of a foreign private
OTC security in a quotation medium • Securities with a bid price of at issuer after the date that is seven
other than a national securities least $50 per share; months after the end of the issuer’s
exchange or Nasdaq. However, the • Securities of issuers with net fiscal year.
amendments reflect commenters’ tangible assets in excess of $10,000,000, The broker-dealer’s information
concerns about the earlier proposal by as demonstrated by audited financial gathering and review requirements are
limiting the scope of the Rule statements; substantially the same as the initial
principally to priced quotations and to • Non-convertible debt and non- proposal.21 If the Rule applies, the
those securities that the Commission participatory preferred stock; and broker-dealer must:
believes are more likely to be the subject • Asset-backed securities that are • Review the Rule’s specified
of improper activities. Under these rated as investment grade by at least one information;
amendments, the Rule will no longer nationally recognized statistical rating • Determine that it has a reasonable
apply to securities of larger issuers, or organization. basis for believing that the information
to securities that have a substantial These amendments are intended to is accurate in all material respects and
trading price or that meet a minimum enhance the integrity of quotations for was obtained from reliable sources;
dollar value of average daily trading securities in this market sector, to • Record the date it reviewed the
volume. In addition, the Rule will only improve the quality of information specified information, the sources of the
cover priced quotations, except in the about smaller, lesser-known issuers, and information, and the person at the firm
case of the first quotation for a covered to foster greater access to this responsible for the broker-dealer’s
OTC security. The provisions relating to information by investors. The compliance with the Rule; and
the broker-dealer’s obligations under the
20 15 U.S.C. 781(k).
Rule and the issuer information that the 19 The amendments, however, will prohibit the
broker-dealer must review are little first broker-dealer from publishing a priced or 21 However, we are narrowing the scope of the
unpriced quotation for a covered OTC security requirement contained in the Proposing Release
changed from the initial proposal. unless it complies with the Rule. For a discussion that broker-dealers provide the Rule 15c2–11
We also are providing guidance of the requirements concerning the initial quotation information to others upon their request. See Part
regarding the steps broker-dealers for a covered OTC security, see Part III.B.1. below. II.D. below.
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11128 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
• Preserve the specified information 1. Securities Satisfying a Trading Value reasonable and verifiable method may
in accordance with Rule 17a–4.22 Test be used.28 For example, it may be
Commenters on the Proposing Release To tailor the Rule to transactions that derived from multiplying the number of
did not object to the standards set forth we believe are most likely to involve shares by the price in each trade. The
in these review and documentation microcap fraud, the amendments NASD may also be able to assist broker-
requirements. Rather, they expressed exclude securities with a value of dealers in determining whether a
worldwide ADTV of at least $100,000 particular security is eligible for the
concerns about the scope of a broker-
during each month of the six full exclusion.
dealer’s review obligations under the Q1. Should the dollar value of ADTV
earlier proposal, particularly as some of calendar months immediately preceding
the date of publication of a quotation.26 for this exclusion be higher than
them misconstrued the proposal to $100,000, e.g., $500,000 or $1 million,
require continuous updating of Convertible securities will also be
excluded when the underlying security or should it be a lower amount, e.g.,
information. To assist broker-dealers $50,000? Commenters should provide
publishing quotations for covered OTC satisfies this threshold.
The majority of OTC stocks of U.S. data and analysis to support suggested
securities, we are giving guidance in an revisions to this proposed threshold.
companies that are not listed on an
appendix to this release about the Q2. Should the dollar value of ADTV
exchange or Nasdaq trade infrequently
nature of the review we expect broker- measuring period be longer than six
and will not satisfy for a test based on
dealers to conduct under both the months, e.g., twelve months, or be
a value of ADTV of $100,000 or more
current Rule and the proposed during each month over a six month shorter, e.g., three months? Should the
amendments. measuring period. However, there are a length of the measuring period depend
number of non-reporting issuers having on the amount of the value of ADTV
A. Securities Excluded From the Rule threshold, i.e., should a lower value of
securities with significant trading levels,
Several commenters suggested that particularly larger foreign issuers with ADTV threshold be allowed but require
the Rule should cover only those actively traded securities in their home a longer measuring period?
securities that have the characteristics Q3. Should the exclusion based on
markets. We think that it is appropriate
ADTV value also incorporate a value of
that have led to abuses in the microcap to take this trading activity into account
public float test, like Regulation M
market.23 These commenters noted that, in applying the value of ADTV test.
The price of a microcap security that does? If so, should the public float value
while the earlier proposal was intended
is the subject of a fraud often is be $25 million or some higher or lower
to focus on microcap abuses, it covered amount? Would public float information
quotations for a number of non- manipulated upward rapidly so that
those involved in the manipulation can be easy or difficult to obtain for non-
reporting foreign and domestic issuers’ reporting issuers? 29
securities that are unlikely to be the quickly sell stock at a significant profit,
to the detriment of innocent investors. Q4. Rule 101 under the Commission’s
targets of microcap schemes. They Regulation M excludes from that rule’s
suggested that the amendments be Microcap securities involved in such
manipulations often are thinly traded, trading prohibitions securities with a
crafted to cover only those equity value of ADTV of $1 million or more,
securities most likely to be prone to and the daily trading volume for such
securities rarely reaches a value of using a two month measuring period, if
abusive activities. the issuer has a public float value of at
$100,000 over an extended period of
We agree that applying the Rule to the time. We believe that measuring the least $150 million. Should Rule 15c2–
securities of larger issuers, more liquid value of the security’s ADTV over a six 11’s exclusion parallel the terms of this
securities, and certain fixed-income month period is a way to ensure that the exclusion?
debt securities is not directly related to securities qualifying for this exclusion 2. Securities Satisfying a Bid Price Test
microcap fraud concerns.24 We are not involved in the type of short-
therefore are proposing to exclude from To limit the Rule to transactions that
term price manipulations frequently the Commission believes are most likely
Rule 15c2–11 those securities satisfying seen in microcap schemes. to involve microcap fraud, we are
any one of three alternative tests based A broker-dealer should determine the
proposing an amendment to exclude
on: the value of the security’s average value of a security’s ADTV from
securities with a bid price of at least $50
daily trading volume (ADTV); the information that is publicly available
per share at the time the quotation is
security’s bid price; or the issuer’s net and that the broker-dealer has a
published in the quotation medium.30
tangible assets.25 We are also proposing reasonable basis for believing that the
While the vast majority of OTC stocks
to exclude debt securities, non- information is reliable.27 In calculating
are quoted at lower prices and will not
participatory preferred stock, and the value of ADTV in U.S. dollars, any
typically satisfy for a test based on a bid
investment grade asset-backed
price of at least $50 per share, there are
securities. 26 We have used an ADTV value of $100,000 in
another, but related, context. Rules 101 and 102 of
28 This is comparable to the calculation of value
Regulation M, 17 CFR 242.101 and 102, provide for
22 17 CFR 240.17a–4.
a one business day restricted period for securities of ADTV under Regulation M. See Securities
23 See, e.g., Letter from Securities Industry Exchange Act Release No. 38067 (December 20,
with an ADTV value of at least $100,000 (as
Association (April 28, 1998) (SIA Comment Letter). measured over a 60 day period), if the issuer has 1996), 62 FR 520, 537.
24 Of course the general antifraud provisions of a public float value of at least $25 million. These 29 See id.
the federal securities laws, including Rule 10b–5 rules are intended to prevent manipulative 30 Most of the Commission’s recent trading
(17 CFR 240.10b–5), apply to transactions in all activities during a distribution. suspension orders issued under Section 12(k) of the
securities, whether or not excluded from Rule 27 A broker-dealer will be able to rely on trading Exchange Act, 15 U.S.C. 781(k), have involved
15c2–11. volume as reported by SROs or comparable entities, securities quoted on the OTC Bulletin Board or the
25 We estimate that at least 10% of covered OTC or any other source believed to be reliable. Pink Sheets. Our staff’s analysis of these trading
securities will be excluded from the Rule under Electronic information systems that provide suspension orders, issued between April 1, 1994
these tests. We estimate that approximately 5% of information regarding securities in markets around and January 1, 1998, showed that the suspended
the OTC securities of U.S. companies, 10% of the the world could provide an easy means to OTC securities had an average bid price of
OTC securities of foreign issuers (excluding ADRs), determine worldwide trading volume in a particular approximately $5, with a median bid price of
and 66% of OTC American Depositary Receipts security. Worldwide trading volume includes all approximately $3. These securities had bid prices
(ADRs) will satisfy any one of these three markets, domestic or foreign, where an OTC that ranged from a low of approximately $0.50 to
alternative tests. security is traded. a high of approximately $18.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11129
securities of closely-held issuers that are incorporation, and reported on by an Q12. Should the use of financial
quoted at significant share prices. The accountant duly registered and in good statements of a foreign private that are
broker-dealer publishing the quotation standing under the regulations of that not prepared in accordance with U.S.
can use its own bona fide quotation to jurisdiction.34 If audited financial GAAP be limited to financial statements
satisfy the test. The broker-dealer cannot statements are unavailable, the broker- prepared in accordance with the
use its own or another broker-dealer’s dealer may not rely on this exception. accounting standards promulgated by
unpriced quotation to rely on this test, Some commenters suggested that we the International Accounting Standards
even if the broker-dealer publishing a look to the current definition of ‘‘penny Committee (IASC)?37
name-only quotation provides a bid stock’’ in assessing the scope of Rule Commenters are invited to provide us
price of at least $50 per share upon 15c2–11. Exchange Act Rule 3a51–1 with their views on the alternative tests
inquiry. If a security is a unit composed excludes from the definition of penny for an exclusion from Rule 15c2–11, as
of one or more securities, the bid price stock a security of an issuer having net described above.
of the unit, when divided by the number tangible assets in excess of $2 million, Q13. Should all three of the tests
of shares of the unit that are not if the issuer has been in continuous based on value of ADTV, bid price, and
warrants, options, rights, or similar operation for at least 3 years, or $5 net tangible assets be incorporated into
securities, must be at least $50 to be million, if the issuer has been in Rule 15c2–11?
excepted from the Rule.31 continuous operation for less than three Q14. Should the proposed exclusions
Q5. Should this exclusion be based on years.35 We preliminarily believe that, from the Rule be limited to those
a bid price higher than $50 per share, for purposes of an exclusion from the securities that satisfy at least two of the
e.g., $100 per share or lower, e.g., $20 Rule, the net tangible assets amount three tests?
per share? Commenters should provide should be higher, and, unlike the Q15. Are there other tests that are
data and analysis to support suggested definition of penny stock, the threshold more appropriate to exclude the
alternatives to the proposed threshold. need not distinguish between newer and securities of larger, more seasoned
Q6. Should this exclusion be available more seasoned issuers. issuers from Rule 15c2–11? For
only if the security has a bid price of Q8. Should the threshold amount for example, should a security that has no
$50 over a specified period of time? this net tangible assets test be higher or very minimal trading volume be
Q7. Should this test be based instead than $10 million, e.g., $20 million? excluded from the Rule’s requirements?
on the security’s last sale price? If so, Under what circumstances would it be What would be an appropriate low
should there be a time limit added to appropriate to permit a lower threshold volume threshold? If trading volume
such a test so that a stale last sale price amount? Commenters should provide suddenly exceeded the low volume
cannot be used? data and analysis to support their views threshold, would broker-dealers
on whether the threshold amount publishing quotes find it easy or
3. Securities of Issuers Satisfying a Net should be raised or lowered. difficult to have to obtain and review
Tangible Assets Test Q9. For ease of compliance with both information before continuing to
Microcap fraud schemes generally Commission and NASD rules, should publish priced quotations?
involve issuers with limited assets.32 this exclusion parallel the exclusion
4. Non-Convertible Debt, Non-
We are therefore proposing to exclude contained in the NASD’s proposed rule
Participatory Preferred Stock, and Asset-
securities of issuers having net tangible that would require broker-dealers to
Backed Securities
assets in excess of $10,000,000, as review current information about the
issuer of an OTC security before We are proposing to exclude non-
determined by audited financial
recommending a transaction in the convertible debt securities, non-
statements.
security?36 The NASD proposal would participatory preferred stock,38 and
If the issuer is not a foreign private
exclude the securities of issuers having asset-backed securities that are rated by
issuer, a broker-dealer should make this
total assets of at least $100 million and at least one nationally recognized
determination using the most recent
shareholders’ equity of at least $10 statistical rating organization, as that
financial statements for the issuer that
million, based on audited financial term is used in Rule 15c3–1 under the
have been audited and reported on by
statements. Exchange Act,39 in one of its generic
an independent public accountant in
Q10. Will there be sufficient rating categories that signifies
accordance with the provisions of Rule
information in financial statements, investment grade.40 Commenters on this
2–02 of Regulation S–X.33 If the issuer
is a foreign private issuer, a broker- particularly those of non-reporting
37 IASC’s accounting standards are summarized
dealer should make this determination issuers, to permit broker-dealers to make
on, and may be ordered through, the IASC’s Internet
using the most recent financial the net tangible assets calculation? website at <http://www.iasc.org.uk>.
Q11. Should the use of financial
statements for the issuer (dated less than 38 Non-participatory preferred stock means non-
statements of a foreign private issuer be convertible capital stock, the holders of which are
18 months prior to the date of the
limited to financial statements prepared entitled to a preference in payment of dividends
publication of the quotation) that are and in distribution of assets on liquidation,
in accordance with U.S. generally
prepared in accordance with a dissolution, or winding up of the issuer, but are not
accepted accounting principles (GAAP)?
comprehensive body of accounting entitled to participate in residual earnings or assets
principles, audited in compliance with of the issuer. See paragraph (j)(8) of the Rule
34 These financial statements may be found in proposal, which is based upon a definition
requirements of the country of filings with the Commission on Forms 20–F or 6– contained in Rule 902(a)(1) of Regulations S (17
K, or in submissions under Rule 12g3–2(b) under CFR 230.902(a)(1)).
31 This is comparable to the provisions excluding the Exchange Act (17 CFR 240.12g3–2(b)), or 39 17 CFR 240.15c3–1 (net capital requirements
equity securities priced at $5 or more from the elsewhere. for broker-dealers).
definition of ‘‘penny stock’’ contained in 17 CFR 35 17 CFR 240.3a51–1. 40 The Commission’s staff is engaged in a project
240.3a51–1(d)(2). 36 See proposed NASD Rule 2315, which the to consider the development of disclosure and
32 Analysis of OTC securities that were the subject
Commission recently issued for public comment. registration requirements specifically related to
of recent Commission-ordered trading suspensions Securities Exchange Act Release No. 41075 asset-backed securities. As part of that project, the
showed the issuers on average had approximately (February 19, 1999). The proposed rule will be staff intends to examine further the role of ratings
$3,500,000 in net tangible assets, with a median of available through the NASD Regulation Internet with respect to asset-backed securities. Therefore,
approximately $225,000 is such assets. website at <http://www.nasdr.com> and our we consider it appropriate to limit the proposed
33 17 CFR 210.2–02. Internet website at <http://www.sec.gov>. Continued
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11130 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
issue generally supported excluding obtained and reviewed specified microcap activities, and, if so, whether
fixed-income securities from the Rule. information about the issuer and the the Rule should cover all initial
The fraud and manipulation that we security. Further, this information will quotations.
have observed in the microcap need to be submitted to the NASD, in
3. Annual Review
securities have not been evident in the accordance with the NASD’s rules, at
fixed-income market. In addition, non- least three business days before the The amendments require a broker-
convertible debt securities, non- quotation is published.42 There is one dealer to review the specified
participatory preferred stock, and situation that ‘‘restarts’’ the Rule’s information annually if the broker-
investment grade asset-backed securities requirements: following the termination dealer publishes priced quotations for
generally trade at prices and in of a Commission trading suspension the security. The date by which the
denominations that make them less ordered pursuant to Exchange Act annual review must be performed
likely targets for manipulation. Further, Section 12(k),43 the broker-dealer depends on whether the issuer is a
the type of issuer information required publishing the first quote, whether it is domestic or a foreign company:
by the Rule is much less relevant to the priced or unpriced, must comply with • Domestic Issuers: The annual
pricing and trading of these types of Rule 15c2–11. In essence, this is the review must occur prior to the first
securities. way the Rule currently works. priced quotation that is more than four
Q16. Should this exclusion apply to We believe that the Rule should cover months after the end of the issuer’s
all asset-backed securities or should the the first quotation as a means to assure fiscal year.
exclusion apply only to asset-backed that there is basic information about the • Foreign Private Issuers: The annual
securities that are rated investment issuer available to the marketplace review must occur prior to the first
grade on the basis that those securities before trading in the security begins and priced quotation that is more than seven
are even less likely to be subject to to alert regulators that trading in the months following the end of the issuer’s
fraudulent activities? security will be starting. The NASD uses fiscal year.
Q17. Should the Rule exclude all non- Rule 15c2–11 submissions for The purpose of this requirement is to
convertible debt and non-participatory surveillance and enforcement purposes make sure that the broker-dealer
preferred stock or should the exclusion and routinely provides copies of this periodically reviews fundamental
apply only to non-convertible debt and information to the Commission. information about the issuer if the
non-participatory preferred stock that broker-dealer continues to publish
2. Priced Quotations priced quotations. The broker-dealer
are rated investment grade?
While the first broker-dealer must should know if no current information
5. Other Exceptions obtain the required information for the about the issuer exists or if current
The exceptions relating to quotations initial quotation (priced or unpriced) for information reflects a significant change
for exchange-listed and Nasdaq a covered OTC security as discussed in the issuer’s ownership, operations, or
securities, quotations representing a above, thereafter the Rule will only financial condition.
customer’s unsolicited order, and apply to broker-dealers submitting their While we originally proposed two
quotations for exempted securities first priced quotations. The Rule’s alternative dates for conducting the
remain substantively the same as review requirements are also triggered annual review, to simplify the Rule we
currently in the Rule. As we indicated when a broker-dealer first publishes a are reproposing only one date for each
in the Proposing Release, the priced quotation following the lapse of type of security.44 Four months after the
unsolicited status of the customer orders five or more business days of its priced end of the issuer’s fiscal year, a broker-
would be called into question if a quotations for the security. In addition, dealer publishing priced quotes for a
broker-dealer repeatedly publishes as discussed below, a broker-dealer covered OTC security of a domestic
quotations on the basis of the must satisfy the Rule’s requirements if issuer must have conducted the annual
unsolicited customer order exception.41 it publishes a priced quotation as of a review. In the case of a foreign private
Q18. Should unsolicited customer specific date following the end of the issuer’s security, the annual review
orders be required to be identified as issuer’s fiscal year. must occur before the broker-dealer
such in the quotation medium? Is it We propose to focus the Rule’s publishes a priced quote following the
feasible for quotation mediums to show requirements after publication of the date that is seven months after the
that the quote represents an unsolicited first quote on priced quotations, because issuer’s fiscal year end. We believe that
customer order? recent microcap manipulation schemes these time periods give a broker-dealer
have primarily involved priced sufficient time to obtain and review
B. Quotations Subject to the Rule updated issuer information for both
quotations. In addition, priced quotes
1. The Initial Quotation for a Covered are used as indicia of value for a variety reporting and non-reporting issuers.
OTC Security of purposes (e.g., bank loans or pledges Some commenters opposed the
of securities). This revision also annual review requirement because of
As indicated above, the Rule’s potential recordkeeping burdens, the
requirements will apply at the time of responds to the concerns of several
commenters that the earlier proposal perceived difficulty of obtaining the
discrete quotation events. Subject to the required information, and the loss of
Rule’s exceptions, the amendments will could have resulted in some broker-
dealers being precluded from publishing liquidity that could potentially occur if
prohibit the first broker-dealer from broker-dealers could not publish priced
publishing a priced or unpriced any quotations if they could not obtain
the Rule’s required information. We quotes because current issuer
quotation for a covered OTC security in information was unavailable.45
a quotation medium unless it has solicit commenters’ views, however, on
whether unpriced indications of interest 44 The initial proposal would have permitted a
exclusion to investment grade asset-backed will be used more often in unlawful broker-dealer to conduct the annual review as of the
securities at this time. anniversary date of the initial quotation.
41 Proposing Release, 63 FR at 9669. Also, we are 42 For a discussion of the requirements under the 45 See Letter from A.G. Edwards & Sons, Inc.,
combining into a single provision the current reproposed amendments concerning the submission (April 27, 1998) (A.G. Edwards Comment Letter);
exceptions for exchange-listed and Nasdaq of information to the NASD, see Part III.I. below. and Letter from National Quotation Bureau, LLC,
securities. 43 15 U.S.C. 781(k). (April 27, 1998) (NQB Comment Letter).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11131
Commenters stated that the Rule’s securities? How would such a proposal The broker-dealer also must obtain
review requirements represented a shift help reduce instances of microcap and review the supplemental
from the Commission and the SROs to fraud? information contained in paragraph (d)
broker-dealers of the burdens of Q22. Is the Rule text sufficiently clear of the reproposed Rule. A broker-dealer
overseeing issuer compliance with in identifying the quotation events that must review a copy of any trading
regulatory requirements.46 Some are subject to the Rule’s provisions? Are suspension order issued under Section
commenters wrote that the annual there other quotation events that should 12(k) for any of the issuer’s securities
review is only appropriate for certain be covered by the Rule? during the 12 months preceding the
non-reporting companies or issuers for Q23. Should the provision pertaining publication of the quotation, as well as
which only limited information is to a lapse in quotations of five any other material information,
available. Other commenters stated that consecutive business days or more including adverse information, that
the annual review should not apply to provide for a longer time period, e.g., comes to the broker-dealer’s knowledge
issuers that are current in their reporting ten consecutive business days without a or possession before publication of the
requirements because this information priced quotation, or a shorter time quotation. A broker-dealer must
is available on EDGAR.47 A number of period, e.g., three consecutive business consider this supplemental information,
commenters, however, generally days without a priced quotation? along with the issuer information, when
supported some sort of required annual Q24. Should the Rule give broker- it determines whether it has a
review for broker-dealers publishing dealers the option to conduct the annual reasonable basis for believing that the
priced quotations, although they review as of the anniversary date of the issuer information is accurate and from
differed as to the securities that should initial quotation by the broker-dealer? reliable sources. While we are not
be subject to this provision.48 including a requirement that the broker-
The amendments will apply the C. Information Required Under the Rule
dealer obtain and review any trading
annual review requirement to priced The amendments are substantially suspension for a foreign security that
quotations for both reporting and non- identical to the earlier proposal with was issued by a foreign financial
reporting issuers’ securities. We believe respect to the issuer information that a regulatory authority, this information
that an annual review requirement for broker-dealer must review before must be taken into account by the
both reporting and non-reporting publishing a quotation for a covered broker-dealer if it comes to the broker-
issuers’ securities fulfills the objectives OTC security. Under the reproposal, a dealer’s knowledge or possession at the
of the Rule without imposing significant broker-dealer subject to the Rule must time that a review is required.
burdens on broker-dealers. This is gather, review, and maintain in its In addition, the broker-dealer must
especially so because we are revising records the following issuer make a record of the significant
the Rule to cover only those securities information: relationship information contained in
that, in our view, are most likely to be • For an issuer that has conducted a paragraph (e) of the reproposed Rule,
the subject of microcap fraud schemes recent public offering either registered which is unchanged from the Proposing
and are also limiting the scope of the under the Securities Act of 1933 Release. Under this provision, a broker-
annual review to priced quotations. We (Securities Act) or effected pursuant to dealer would have to document
also note that because information about Regulation A under the Securities Act, specified information such as whether
reporting issuers is available on the a copy of the prospectus or offering the broker-dealer has any affiliation
Commission’s website, the review of circular; with the issuer or arrangements to
information about these issuers can be • For an issuer that files reports with receive any consideration to publish the
accomplished quite easily. the Commission pursuant to Sections 13 quote, and whether the quote is being
Commenters are requested to provide or 15(d) of the Exchange Act49 published on behalf of another broker-
us with their views on the reproposal’s (reporting issuer), the issuer’s most dealer or the issuer, any of its insiders,
focus on priced quotations. recent annual or semi-annual report and or any large shareholder.
Q19. Should the Rule cover all broker- any subsequent quarterly and current Commenters generally did not object
dealers’ initial quotations, whether reports; to the issuer, significant relationship,
priced or unpriced, as the earlier • For an issuer that is an insurance and supplemental information
proposal would have? Will the company of the kind specified in requirements; in fact, some commenters
reproposal cause broker-dealers to Section 12(g)(2)(G) of the Exchange favored the enhanced information
publish unpriced quotes to avoid Act,50 the issuer’s most recent annual requirements for non-reporting
complying with the Rule? statement referred to in Section issuers.51 Therefore, we are reproposing
Q20. Should the Rule apply 12(g)(2)(G)(i); these requirements without any
exclusively to priced quotes, i.e., the • For an issuer that is not required to substantive changes, other than
Rule would not cover any unpriced file reports pursuant to Sections 13 or revisions relating to financial statements
quotes? 15(d) of the Exchange Act and that is a for non-reporting issuers, as discussed
Q21. Are there other approaches that bank or savings association, the issuer’s
would be more appropriate, e.g., to most recent annual report and any 51 In response to the 78 comment letters that we
cover any initial quote for a covered received from issuers of securities quoted on the
subsequent reports filed with its OTC Bulletin Board who were concerned about
OTC security by a broker-dealer, appropriate federal or state banking continued liquidity for their securities, we note that
whether priced or unpriced, but not to authority; and 33 of these issuers are reporting companies. Also,
apply the Rule or at least the annual • For any other issuer, the under recently approved amendments to NASD
review requirement to reporting issuers’ information, including certain financial Rules 6530 and 6540, all of these issuers ultimately
will need to be reporting companies current in their
information, specified in proposed reporting obligations in order for their securities to
46 See, e.g., A.G. Edwards Comment Letter.
paragraph (c)(6) of the Rule, which must remain on the OTC Bulletin Board. See note 6 above
47 See, e.g., NQB Comment Letter.
be reasonably current in relation to the and accompanying text. There should be no
48 See Letter from NASD Regulation, Inc., (July burdens on reporting issuers to provide information
17, 1998) (NASD Comment Letter); Letter from
day a quotation is submitted. to broker-dealers wishing to publish quotations
North American Securities Administrators because the issuer information should be available
49 15 U.S.C. 78m and 78o(d).
Association, Inc., (April 27, 1998) (NASAA on EDGAR, as long as the issuers are current in
Comment Letter); and SIA Comment Letter. 50 15 U.S.C. 78l(g)(2)(G). their reporting obligations.
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11132 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
below in Part III.C.4. We are addressing Chapter 11 reorganization when current satisfy Rule 15c2–11 because this
below specific points that a few Exchange Act reports were unavailable. financial report usually contains only
commenters raised about the One commenter also suggested that the information about issuer receipts and
information requirements and other Commission permit delinquent disbursements. Where a reporting issuer
provisions. Commenters are welcome to reporting companies that experience a receives this type of no-action position,
provide their views on the information 51% ownership change as a result of a a broker-dealer would not be able to
requirements for the various categories confirmed plan of reorganization to obtain the issuer information required
of issuers and should consult the begin reporting from the effective date by the Rule until the debtor’s
Proposing Release for a more detailed of the reorganization plan with a filing reorganization plan becomes effective,
description of these provisions.52 with the Commission, attaching the and the debtor files a Form 8–K, which
court-approved disclosure statement instead of attaching the Rule 2015
1. Reporting Issuers Delinquent in Their
together with a certified audited balance bankruptcy reports, now includes the
Filings
sheet as of the effective date.56 issuer’s audited balance sheet. Under
In the case of an issuer delinquent in The reproposal will require a broker- Rule 15c2–11, broker-dealers could
its reporting obligations, a broker-dealer dealer publishing quotations for a review this 8–K, which contains an
will not be able to publish an initial reporting issuer’s securities to obtain the issuer’s audited balance sheet, and then
priced quotation, or continue to publish issuer’s Exchange Act reports, even if publish priced quotations. From then
priced quotations after the annual the reporting issuer has filed for Chapter on, the issuer must file its Exchange Act
review date, because it will not be able 11 reorganization. Thus, if a reporting periodic reports for all periods that
to obtain the specified reports. A few issuer that has filed for Chapter 11 begin after the plan becomes effective.60
commenters indicated concern about reorganization becomes delinquent in The publication of quotations by a
the possible adverse implications for the its reporting obligations, a broker-dealer broker-dealer indicates that a market
market for delinquent issuers’ securities will not be able to publish priced exists for the issuer’s securities. It
if broker-dealers could not publish quotations covered by the Rule. For would be inconsistent with the premise
quotes when current issuer information example, a broker-dealer could not of the no-action position (i.e., that there
was unavailable.53 As noted above, we continue to publish priced quotations as is no trading in the issuer’s securities)
are revising the Rule to permit broker- of the annual review date for a covered if a broker-dealer were able to stimulate
dealers to publish unpriced quotations, security of a reporting debtor that has trading by publishing quotations
even in the absence of current issuer become delinquent in its reporting without having the issuer’s Exchange
information (except in the case of the obligations.57 Act reports.
first quotation for the security). The bankruptcy court filings for an Q25. Are there circumstances in
issuer undergoing reorganization under which a broker-dealer should be
2. Issuers in Bankruptcy Chapter 11 are not adequate to satisfy permitted to publish priced quotations
a. Reporting Issuers the Rule’s requirements. These Rule for the securities of delinquent reporting
A few commenters urged us to permit 2015 bankruptcy reports ordinarily issuers in bankruptcy? Please describe
broker-dealers to continue to quote the contain only data about issuer receipts these circumstances. Should the Rule
securities of reporting issuers that had and disbursements and not the type of prohibit broker-dealers from publishing
filed for reorganization under federal issuer financial information unpriced quotes for the securities of
bankruptcy law because it would contemplated by Rule 15c2–11.58 In these issuers?
provide liquidity for these securities.54 some cases, our Division of Corporation
Finance may grant issuers in bankruptcy b. Non-Reporting Issuers Emerging From
They noted that it was often Bankruptcy
burdensome for small companies that no-action relief with respect to
had filed for reorganization under Exchange Act filing requirements.59 The Proposing Release contained
Chapter 11 of the Bankruptcy Code 55 to These no-action positions, however, are amendments to permit broker-dealers
produce audited financial statements to predicated on little or no trading that quote the securities of non-
comply with Exchange Act reporting occurring in the debtor’s securities. The reporting companies emerging from
requirements. Rule 2015 bankruptcy reports that the bankruptcy to review the bankruptcy
Commenters suggested that broker- Division of Corporation Finance accepts court-approved disclosure statement
dealers could satisfy the Rule’s under its no-action position do not and issuer financial information
requirements by reviewing bankruptcy required by the Rule from the date that
56 Demers Comment Letter; see also 11 U.S.C.
court filings made by an issuer in the bankruptcy court confirms the
1125. The disclosure statement includes, among
other things, a description of the issuer’s business
reorganization plan.61 The commenters
52 See Part II.A.4. of the Proposing Release at 63 plan, a description of any securities to be issued, who addressed this issue supported the
FR 9661, 9664–9669. and financial information. proposal to limit a broker-dealer’s
53 See, e.g., NASAA Comment Letter. 57 Broker-dealers would be able to continue to
review to the post-reorganization
54 See, e.g., Letter from Daniel J. Demers (March publish unpriced quotations. information.62 The amendments are
27, 1998) (Demers Comment Letter); Letter from 58 See Federal Rule of Bankruptcy Procedure 2015
Robotti & Company, Inc., (April 27, 1998) (Robotti (Rule 2015 bankruptcy reports).
unchanged from the original proposal.
Comment Letter); and NQB Comment Letter. In 59 See Staff Legal Bulletin No. 2 (April 15, 1997)
60 See Staff Legal Bulletin No. 2.
1989, we sought comment on whether there were (CF) (Staff Legal Bulletin No. 2), which is available
situations, such as bankruptcy, that should be through our Internet website at <http:// 61 See 11 U.S.C. 1125. The disclosure statement
addressed if the piggyback provision were revised. www.sec.gov/rules/othern/slbcf2.txt>. Under Staff includes, among other things, a description of the
See Securities Exchange Act Release No. 27247 Legal Bulletin No. 2, our Division of Corporation issuer’s business plan, a description of any
(September 14, 1989), 54 FR 39194 (1989 Release). Finance has granted no-action relief permitting an securities to be issued, and financial information.
Commenters on the 1989 Release argued that it was issuer in Chapter 11 reorganization to satisfy its 62 See Letter from Florida Division of Securities
appropriate to permit broker-dealers to continue Exchange Act reporting obligations by filing the (April 27, 1998) (Florida Comment Letter); NQB
quoting the securities of issuers that had filed for Rule 2015 bankruptcy reports on Exchange Act Comment Letter; Demers Comment Letter; and
bankruptcy because it provided liquidity for these Form 8–K. See 17 CFR 249.308. Under Staff Legal Robotti Comment Letter. Mr. Demers suggested that
securities and suggested that issuers in bankruptcy Bulletin No. 2, the staff has allowed a company to the required financial information for non-reporting
be identified in the quotation system by using a substitute its Rule 2015 bankruptcy reports for its issuers emerging from bankruptcy be from the
special indicator. Exchange Act periodic reports when there is little ‘‘effective date’’ of the plan, instead of the
55 11 U.S.C. 1101 et seq. or no trading in the debtor’s securities. ‘‘confirmation date’’ of the plan. We are retaining
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11133
3. Non-Reporting Foreign Private Issuers recognize the foreign status of these quotations for such an issuer greater
In the case of a foreign private issuer issuers.66 By eliminating the provision understanding of the issuer’s operations
that relies on an exemption from for Rule 12g3–2(b) issuers, all non- and a better indication of whether
registration under Section 12(g) 63 of the reporting foreign private issuers will be potential or actual fraud or
Exchange Act by complying with treated similarly under Rule 15c2–11. manipulation may be present.
Exchange Act Rule 12g3–2(b), Rule Commenters were divided on whether Several commenters supported the
15c2–11 specifies that a broker-dealer we should amend the provisions of the requirement for a broker-dealer to
must review the information submitted Rule governing the review of review the disciplinary information
to the Commission under Rule 12g3– information for non-reporting foreign about the insiders of non-reporting
2(b).64 To qualify for the registration private issuers.67 Because the issuers. One commenter believed that if
exemption, the issuer must furnish to reproposal excludes the securities of broker-dealers are allowed to publish
the Commission information that the many larger foreign issuers from Rule quotations without obtaining this
issuer has made or is required to make 15c2–11 and also distinguishes between disciplinary information, it would
public under the law of the country in U.S. and foreign accounting standards create a loophole for issuers to avoid
which the foreign private issuer is for those foreign issuers that continue to disclosing information that would be of
domiciled or incorporated; has filed or be covered, many of the reasons for utmost importance and would thereby
is required to file with a stock exchange permitting broker-dealers to rely on defeat the goal of the Commission.68
on which the securities are traded and Rule 12g3–2(b) information have been While no commenters directly opposed
which the exchange has made public; or addressed. the requirement to obtain disciplinary
Q26. Should broker-dealers be information, several commenters
has distributed or is required to
required to obtain and review the same objected to the enhanced information
distribute to its securityholders. For
type of issuer information with respect requirements in general as too difficult
foreign private issuers that do not
to non-reporting foreign private issuers and burdensome, especially when
furnish the Commission with
providing information under Rule 12g3– issuers are unwilling to volunteer
information under Rule 12g3–2(b), the
2(b) as they must for other non-reporting information.69
Rule currently requires broker-dealers to
foreign issuers? Are there reasons to Q28. Should the Rule require the
obtain and review the same kind of
retain a special provision in Rule 15c2– disciplinary history information for the
information, including financial
11 for foreign issuers furnishing insiders of all issuers of covered OTC
information, as required for non-
information under Rule 12g3–2(b)? securities, and not just insiders of non-
reporting domestic issuers.
We note that Rule 12g3–2(b) contains Q27. What is the experience of broker- reporting issuers, on the basis that
no specific requirements governing the dealers under the Rule when the foreign microcap fraud can involve issuers
categories of information the issuer issuer has not furnished information to whose insiders have histories of prior
must furnish to the Commission under the Commission under Rule 12g3–2(b)? misconduct?
How difficult or easy will it be for We are proposing to amend the
the exemption. As a result, there is no
broker-dealers to obtain the paragraph financial information that a broker-
assurance that broker-dealers publishing
(c)(6) information for a non-reporting dealer must review when publishing
quotes will obtain the same type of
foreign private issuer? quotations of both domestic and foreign
information for each foreign private
non-reporting issuers. The reproposal
issuer that claims the Rule 12g3–2(b) 4. Other Non-Reporting Issuers lists the financial statements required
exemption as they must for other non-
The amendments parallel the for a domestic issuer, which must be
reporting foreign private issuers. This
Proposing Release in their treatment of prepared in accordance with U.S.
can be problematic since a number of
non-reporting issuers (i.e., those non- GAAP, and sets forth when these
issuers claiming the Rule 12g3–2(b)
reporting issuers that are not financial financial statements will be presumed
exemption are foreign microcap
institutions covered by paragraph ‘‘current’’ under the Rule. Absent
companies that can potentially be
(c)(4)), except for the new exclusions contrary information, a domestic
subject to the same kinds of abusive
discussed in Part III.A. above and the issuer’s balance sheet will be considered
practices as their U.S. counterparts.
Therefore, we are proposing to change revisions to the required financial current if it is as of a date that is less
Rule 15c2–11 requirements with respect information for non-reporting issuers. than 15 months before the quotation is
to quotations for the securities of foreign As in the Proposing Release, the Rule published, rather than less than16
issuers complying with Rule 12g3–2(b). will require broker-dealers to review months as now specified in the Rule.70
more information than currently This revision comports with existing
Broker-dealers publishing quotations for
required about the issuer’s outstanding Exchange Act requirements regarding
the securities of Rule 12g3–2(b) issuers
securities; the issuer’s insiders, when a domestic reporting issuer’s
will have to obtain and review the
including their disciplinary history; and financial statements are considered
information specified in paragraph (c)(6)
of the reproposed Rule.65 However, as certain significant events involving the
described in more detail below, we issuer, among other items. This 68 See NASAA Comment Letter.
69 See, e.g., Letter from David B. Schneider (April
propose to revise the financial information will provide a broker-dealer
21, 1998).
statements that must be reviewed for that is considering whether to publish 70 This provision is a presumption that financial
non-reporting foreign private issuers to information that is less than 15 months old is
66 See Part III.C.4. below.
current. However, if the broker-dealer has other
67 For example, some commenters stated that we information that indicates that the issuer’s financial
this amendment from the confirmation date because should delete the reference to Rule 12g3–2(b) and condition has materially changed from that shown
adequate information is available about the non- require broker-dealers to review the same in the financial statements, this presumption may
reporting issuer at this point for Rule 15c2–11 information as required for all other foreign non- not apply, and the broker-dealer should determine
purposes. reporting issuers whose securities are subject to whether more recent financial information is
63 15 U.S.C. 78l(g).
Rule 15c2–11. See, e.g., Florida Comment Letter. available. Financial information older than 15
64 17 CFR § 240.12g3–2(b).
Other commenters, however, indicated that we months is not current and does not satisfy the
65 Some of the paragraph (c)(6) information that should continue to require broker-dealers to review Rule’s requirements. The presumption for non-
broker-dealers will have to obtain and review may only the home country information that certain financial information is that this information is
be present in the foreign issuer’s Rule 12g3–2(b) foreign issuers submit to the Commission under considered current if it is as of a date within 12
materials. Rule 12g3–2(b). See, e.g., SIA Comment Letter. months of publication of the quotation.
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11134 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
current. The reproposal also will require entities to which a broker-dealer must having a data base of information about
broker-dealers to review the specified provide the information.72 The the non-reporting issuers of covered
financial information for such part of amendments require a broker-dealer to OTC securities.76 Such a data base also
the two preceding fiscal years (in the provide information upon request to any would enhance the availability of
case of the balance sheet, the preceding current customer, prospective customer, information about little-known issuers
fiscal year) that the issuer (or any information repository, or other broker- to investors, other professionals, and
predecessor) has been in existence. dealer. regulators. The consensus among the
The reproposal also will revise the A few commenters asserted that commenters who specifically addressed
requirements with respect to the broker-dealers should not be required to this issue was that the creation of a
financial statements that broker-dealers provide information that already is repository would foster access to
must review when publishing a generally available to the public from information about issuers that do not
quotation for a non-reporting foreign other sources (e.g., information for participate in the public disclosure
private issuer’s security. The reproposal reporting companies that is available on system.77 For these reasons, we
lists the financial statements that the EDGAR).73 We are addressing these encourage the development of one or
broker-dealer must review, which must concerns in the amendments by more repositories of Rule 15c2–11
be prepared in accordance with a requiring broker-dealers to provide the information, but we note that the
comprehensive body of accounting required information that is not existence of a repository will not be
principles, and sets forth when these accessible through EDGAR, any other necessary for broker-dealers to comply
financial statements will be considered federal or state electronic information with the Rule.
current under the Rule. For a non- system, or an information repository. The amendments establish that the
reporting foreign private issuer, its Further, most commenters responding Commission may, upon written
balance sheet will be presumed current to this issue were concerned about the application, designate an entity as an
if it is as of a date less than 18 months cost of providing information to others information repository.78 In determining
before the quotation is published.71 upon request.74 We believe that the cost whether to grant or deny such a
Also, if the balance sheet is as of a date of requiring broker-dealers to make the designation, the Commission will
more than 9 months before the information available (including to consider whether an entity:
quotation is published, the broker- other broker-dealers) upon request is • Collects information about a
dealer must obtain more current minimal.75 substantial segment of issuers of
financial information only to the extent The amendments retain in substantial securities subject to the Rule;
that the issuer has prepared it. The form the clause that providing • Maintains current and accurate
broker-dealer must obtain the specified information to others does not information about such issuers;
constitute a representation by the • Has effective acquisition, retrieval,
financial information for the two
broker-dealer that the information is and dissemination systems;
preceding fiscal years (one year with • Places no inappropriate limits on
respect to the balance sheet) that the accurate. Rather, providing the
information to others constitutes a the issuers from or about which it will
issuer has been in existence. accept or request information;
Q29. Are the financial statement representation that the information is
current in relation to the date the • Provides access to the documents
requirements, including the deposited with it to anyone willing and
presumption regarding when the information was reviewed, and that the
broker-dealer has a reasonable basis for able to pay the applicable fees; and
information is considered current, clear • Charges reasonable fees.
and capable of being complied with by believing that the information was
accurate as of the date recorded and was In general, the Commission will
broker-dealers publishing quotations? consider whether an entity wishing to
Should there be longer time periods for obtained from reliable sources.
Q31. Should we require broker- act as an information repository is so
the presumption regarding when the organized and has the capacity to be
dealers to make the information
financial statements for a non-reporting able reasonably to obtain and provide to
available to anyone who requests it,
foreign private issuer are considered others current information required by
particularly if broker-dealers are
current? If so, what time periods would the Rule. An information repository will
permitted to charge reasonable fees?
be appropriate? be required to notify the Commission of
Should broker-dealers be required to
Q30. Are there any information any material changes in the facts and
provide information to fewer classes of
requirements for non-reporting issuers circumstances of their application for
persons?
that should be added or removed from designation as an information
reproposed paragraph (c)(6)? E. Information Repository repository. In the event that an
D. Information Available Upon Request The amendments, as in the Proposing information repository no longer
Release, eliminate the piggyback satisfies these attributes, we may
We believe that some microcap frauds withdraw such designation.
provision of the Rule. The elimination
could be prevented if there were greater
of the piggyback provision and the
investor access to information about 76 We note that, for reporting issuers, information
potential for increased costs of
those securities and their issuers. repositories already exist. Broker-dealers are able to
compliance suggest the desirability of
Accordingly, we are reproposing, with access and review the required information on our
some revisions, the requirement that a EDGAR system, available through our Internet
72 See, e.g., Letter from Security Traders
website at <http://www.sec.gov>. In addition,
broker-dealer publishing quotations for Association (April 28, 1998) (STA Comment Letter). broker-dealers may consult federal or state
any covered OTC security make the We originally proposed that the information be electronic information systems for information
information promptly available upon made available to anyone upon request. about issuers of covered OTC securities.
73 See e.g., Letter from Richard P. Ryder, Esq. 77 See e.g., Letter from Singer Frumento
request. In response to the Proposing
(May 12, 1998). Sichenzia, LLP, (April 13, 1998).
Release, several commenters suggested 74 See e.g., Letter from The Bond Market 78 This authority will be delegated to the Director
that we restrict the types of persons and Association Comment Letter (April 27, 1998); NQB of the Commission’s Division of Market Regulation.
Comment Letter; and Florida Comment Letter. We propose to amend Rule 200.30–3, which
71 This presumption will operate in the same 75 A broker-dealer may charge for the reasonable provides for delegation of authority to the Director,
manner as for domestic issuers. See footnote 70 expenses it incurs in producing and forwarding to include the designation of information
above. copies of the Rule 15c2–11 information. repositories. See 17 CFR 200.30–3.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11135
Some commenters suggested that the only to the broker-dealers that submit Net tangible assets. We are proposing
Commission assume the task of serving quotations for publication by the ATS, to add a definition to the Rule to assist
as the Rule 15c2–11 information and not to the ATS functioning as the broker-dealers in assessing whether or
repository.79 Because the issuers that quotation medium for them. The Rule not a security can meet the proposed
would be the focus of any information will apply to an ATS only if, as a exception to the Rule for securities of
repository generally would not be registered broker-dealer, it displays its issuers with net tangible assets
required to file periodic reports with the own orders in the ATS. exceeding $10 million. Net tangible
Commission, this is not a function that An issue has also been raised about assets means total assets less intangible
we can assume at this time. The NASD whether Rule 15c2–11 applies to broker- assets and liabilities and this
has also advised us preliminarily that it dealers submitting orders through an determination must be based on the
is unable to undertake the responsibility ATS. We understand that some broker- issuer’s current financial statements,
of serving as an information repository dealers have taken the position that which must be audited.
at the present time. Therefore, we compliance with Rule 15c2–11 is not
necessary when they submit an order G. Preservation of Documents and
encourage private sector initiatives for
through an ATS.83 They have viewed Information
the creation of one or more Rule 15c2–
11 information repositories. such an order for the security as not To facilitate compliance with the
Q32. Are there other criteria that constituting a quotation within the Rule’s recordkeeping requirements, we
should be used to determine the meaning of Rule 15c2–11. These orders believe that it is appropriate to codify
information repository designation? may represent transactions for the the Rule’s record preservation
broker-dealer’s own account. The Rule’s requirements in Rule 17a–4,86 rather
F. Definitions than in Rule 15c2–11. Rule 17a–4
definition of quotation makes clear that
Reproposed paragraph (j) of the Rule the Rule covers any indication of obligates broker-dealers to preserve
sets forth the definitions applicable to interest by a broker or dealer in documents and information that they
all provisions of the Rule. Most of the receiving bids or offers from others for must compile pursuant to Commission
definitions are unchanged from the a security, or any indication by a broker rules for the time period and in the
Proposing Release, but a few definitions or dealer that it wishes to advertise its manner specified in the various
are revised to respond to commenters’ general interest in buying or selling a provisions of Rule 17a–4. As in the
suggestions or to add clarity to the particular security. Thus, broker-dealers Proposing Release, Rule 17a–4 would be
amendments. are subject to the Rule when they place amended to add the information
Quotation Medium. The current any indication of interest in any specified in reproposed paragraphs (c),
definition of ‘‘interdealer quotation quotation medium, including an ATS, (d), and (e) of Rule 15c2–11 to the other
system’’ will be incorporated into the that they wish to receive bids or offers information that broker-dealers are
definition of ‘‘quotation medium’’ in in a covered OTC security, unless they already required to preserve under Rule
paragraph (j)(12).80 This definition of can rely on one of the Rule’s 17a–4.87
quotation medium is quite inclusive: it exceptions.84 With regard to issuer information that
covers any publication, alternative Also, we are clarifying the Rule’s is accessible to broker-dealers through
trading system (ATS), or other device application to broker-dealers that our EDGAR system, any other federal or
that is used by brokers or dealers to publish quotations in multiple state electronic information system,88 or
make known to others their interest in quotation mediums or move their an information repository, the
transactions in any security, including quotations from one quotation medium amendments provide different
offers to buy or sell at a stated price or to another. If the broker-dealer complies requirements. If broker-dealers obtain
otherwise, or invitations of offers to buy with the Rule’s provisions, based upon and review the information contained
or sell.81 A few ATSs expressed concern a review of information, it may publish on such systems, they will not need to
about whether they would have to quotations in one or more quotation preserve such information separately, as
comply with the Rule’s information mediums.85 long as they document the review and
review requirements with regard to any the information is accessible on such
covered OTC security that is traded on 83 For example, some broker-dealers have claimed system for the same period of time that
their systems by broker-dealer to submit customer ‘‘orders’’ in quotations mediums
subscribers to such ATSs.82 ATSs are following the termination of a Commission trading 86 17 CFR 240.17a–4. We will add new paragraph
suspension issued under Exchange Act Section (b)(11).
included in the definition of ‘‘quotation 12(k). 87 This proposed recordkeeping requirement was
medium’’ if they display subscriber 84 To rely on the exception for an unsolicited
discussed by few commenters and generally was
orders to any person other than ATS customer order, the order must represent an viewed favorably. See e.g., NASAA Comment
employees. The Rule’s information unsolicited indication of interest of a customer Letter.
review requirements, however, apply (other than a person acting as or for a dealer) of the 88 Broker-dealers publishing quotes for securities
broker-dealer submitting the order to the ATS. of exempt financial institutions may obtain the
85 We have previously interpreted the Rule to
79 See, e.g., STA Comment Letter. regulatory reports from the financial institution by
require a broker-dealer that was publishing contacting their primary bank regulatory agency.
80 Under the current Rule, interdealer quotation
quotations in a particular interdealer quotation Broker-dealers can access the Federal Reserve
system is defined as any system of general system to review issuer information before System’s National Information Center of Banking
circulation to brokers or dealers which regularly publishing quotations in another interdealer Information Internet website at <http://
disseminates quotations of identified brokers or quotation system unless it relied upon an www.ffiec.gov/NIC>, the Office of the Comptroller
dealers. A separate definition of ‘‘interdealer exemption. See Letter re: OTC Bulletin Board of the Currency’s Internet website at <http://
quotation system’’ is no longer necessary because of Display Service (December 20, 1993) (conditional www.occ.treas.gov>, which has information about
the proposed elimination of the piggyback exemption permitting broker-dealers that are individual nationally chartered banks, or the
provision and the revision that the information be currently publishing quotations in an interdealer Federal Deposit Insurance Corporation’s (FDIC)
furnished to the NASD in accordance with NASD quotation system to publish quotations in the OTC Internet website at <http://www.fdic.gov>, which
rules, rather than to interdealer quotation systems. Bulletin Board without reviewing issuer provides the most recent Call Reports for all FDIC
81 We are using the term ‘‘alternative trading
information under the Rule); and Letter re: OTC insured banks. Broker-dealers that access exempt
system,’’ which encompasses the term ‘‘electronic Bulletin Board; Modification of Exemption financial institution information through these
communications network.’’ See Securities Exchange (December 1, 1998) (modifying the exemption websites would be able to satisfy the Rule’s
Act Release No. 40760 (December 8, 1998), 63 FR granted in 1993). Upon adoption of the reproposed requirements by recording their review and
70844. amendments, we will rescind this interpretation preserving the information in the same manner as
82 See e.g., Letter from Instinet (April 22, 1998). and related exemptions. for EDGAR information discussed above.
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11136 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
the broker-dealers are obligated to well as on any other matter that might excluding unpriced quotations from the
preserve such information pursuant to have an impact on the reproposal Rule, anti-competitive burdens will be
Rule 17a–4. discussed above. In particular, we seek reduced because broker-dealers that
comment on the whether the reproposal cannot, or do not want to, obtain the
H. Transition and Exemptive Authority
will help focus the Rule on those specified information can still advertise
Provisions
securities and quotations most likely to their interest in buying or selling a
We are reproposing the transition be involved in microcap fraud. particular OTC security in a quotation
provision covering quotations by broker- Commenters are requested to address medium. Finally, the reproposal should
dealers that were initiated prior to the whether there are other ways to amend have a beneficial impact on capital
effective date of the proposed the Rule that would help reduce fraud formation because microcap fraud
amendments and, with a slight and manipulation in the OTC market. ultimately increases the costs of raising
modification, the provision giving the Commenters also are invited to address capital for legitimate smaller issuers.
Commission the authority to grant whether the Rule’s text is sufficiently Investors may be less willing to commit
exemptions from the Rule.89 These clear and understandable, or whether it their resources if they are concerned
proposed provisions were viewed as can be simplified without sacrificing its about fraudulent activities in OTC
adequate by the few commenters who purposes. We also request commenters securities.
discussed them.90 to provide us with their views regarding We request comments on the benefits,
I. Information submitted to the NASD whether the original proposal, or as well as the adverse consequences,
aspects of it, are preferable to the that may result with respect to
Rule 15c2–11 currently requires any reproposal. efficiency, competition and capital
broker-dealer covered by the Rule to We encourage commenters to focus on formation, if the reproposal is adopted.
submit the information required under the various provisions of the reproposal
paragraph (a)(5) (i.e., for non-reporting and bring to our attention any VI. Costs and Benefits of the
issuers) to the interdealer quotation compliance or other specific issues that Amendments
system, in the form prescribed by the they may encounter if the reproposal is We request commenters to evaluate
system, at least three business days adopted. Commenters are urged to the costs and benefits associated with
before submitting a quotation for provide us with their views as the amendments to Rule 15c2–11. We
publication. We intend to amend this expeditiously as possible so that we can have identified certain costs and
obligation by requiring broker-dealers to complete our review of Rule 15c2–11. benefits relating to the reproposal,
submit the information that they must which are discussed below, and
review only to the NASD, in accordance V. Effects on Efficiency, Competition,
and Capital Formation encourage commenters to discuss any
with the NASD’s rules.
additional costs or benefits. In
The amendments are substantially the Section 23(a)(2) of the Exchange Act
same as originally proposed, except for particular, we request comments on the
requires the Commission, in adopting potential costs for any necessary
one change. Under the Proposing rules under the Exchange Act, to
Release, a broker-dealer would be in modifications to information gathering,
consider the anti-competitive effects of management, and reporting systems or
compliance with the requirement to any rules it adopts thereunder, and to
obtain current reports filed by a procedures that would be necessary to
not adopt any rule that would impose a implement the amendments, as well as
reporting issuer, if the broker-dealer burden on competition not necessary or
obtained all current reports filed with any potential benefits resulting from the
appropriate in the public interest.91 reproposal for issuers, investors, broker-
the Commission by an issuer as of a date Furthermore, Section 3(f) of the
up to three business days before the dealers, securities industry
Exchange Act 92 requires the professionals, regulators or others.
earlier of the date the broker-dealer Commission, when engaged in
submitted the quotations to the Commenters should provide analysis
rulemaking, to consider or determine and data to support their views on the
quotation medium and the date the whether an action is necessary or
broker-dealer submitted information to costs and benefits associated with the
appropriate in the public interest, and amendments.
the NASD. To reduce the chance that a whether the action will promote
broker-dealer would overlook a recently efficiency, competition, and capital A. Benefits
filed report containing material issuer formation. Incidents of microcap fraud
information, we are proposing to We preliminarily believe that the frequently involve issuers for which
eliminate the reference to the date the reproposal would not have any anti- public information is limited.93 Without
information was submitted to the competitive effects that are not information, it is difficult for investors,
NASD. This means that a broker-dealer necessary or appropriate in the public securities professionals, and others to
would be required to obtain current interest. By applying the Rule to the first evaluate the risks presented by these
reports filed by a reporting issuer after broker-dealer publishing any quotations securities. Consequently, many
the broker-dealer had submitted for a security in a quotation medium investors fall prey to persons who make
information to the NASD, if such reports and to other broker-dealers publishing false representations and unrealistic
were filed more than three business priced quotations thereafter, the predictions about these securities. The
days in advance of the publication of availability of information about issuers publication of quotations by broker-
the quotation. of covered OTC securities should be dealers can facilitate the fraudulent
IV. General Request for Comments increased. This should help improve the promotion of microcap securities.
level of competition among broker- In our view, the reproposal generally
We solicit comment on all aspects of dealers publishing priced quotations
the amendments to Rule 15c2–11, as would improve the quality of the
and enhance the extent of information markets for securities subject to Rule
89 The reproposal would provide the Commission
about OTC issuers that is available to 15c2–11 and would help protect
with the authority to grant an exemption from the the investing public. Moreover, by
Rule for any quotation for a security or any class 93 See, e.g., SEC v. Global Financial Traders, Ltd.,
of security. 91 15 U.S.C. 78w(a)(2).
Litigation Release Nos. 15291 (March 14, 1997), and
90 See, e.g., Florida Comment Letter. 92 15 U.S.C. 78c. 15338 (April 17, 1997).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11137
investors from fraudulent schemes of securities on the OTC Bulletin Board information required by the reproposed
involving these securities. The and Pink Sheets are issued by reporting Rule from the Commission’s EDGAR
reproposal is focused on the OTC- companies, whose reports are included system and therefore should incur
quoted securities of smaller issuers. on EDGAR, a significant recordkeeping minimal costs to comply with the Rule.
Absent the amendments, we believe that cost savings to broker-dealers should We believe that it will take a broker-
some broker-dealers would submit result. dealer a maximum of 4 hours to collect,
quotations without regard to basic We do not have the data to quantify review, record, retain, and supply to the
information about relatively unknown the value of the benefits described NASD the information pertaining to a
issuers. In our view, when broker- above. We seek comments on the value reporting issuer, and a maximum of 8
dealers must review specified issuer of these benefits and on any benefits, hours to collect, review, record, retain,
information before publishing priced not already identified, that may result and supply to the NASD the information
quotations, they are less likely to from the adoption of the amendments. pertaining to a non-reporting issuer.95
become unwitting participants in B. Costs We estimate that it will cost a broker-
unlawful schemes of unscrupulous dealer an average cost of $40 per hour
broker-dealers or promoters. Market We anticipate that the elimination of (based on a blended compensation rate
makers in the securities of legitimate the piggyback provision will create the for clerical and supervisory compliance
microcap issuers, as well as the issuers most significant costs that the industry staff) to obtain and review the necessary
themselves, also would benefit from will incur. Currently, only those broker- information required by the Rule.96
improving the integrity of this market dealers that publish quotations during We recently approved changes to
sector. One benefit of the reproposal is the first 30 days of the security’s trading NASD Rules 6539 and 6540 to limit the
that the scope of the Rule will be are required to obtain and review the quotations on the OTC Bulletin Board to
revised so that broker-dealers will not specified information before they securities of issuers that are current in
have to obtain information about those initiate quotations. As reproposed, the their reports filed with us or other
securities that satisfy any one the Rule will continue to require the first regulatory authority, and to prohibit
proposed alternative tests. broker-dealer, before initiating a priced NASD members from quoting a security
We also believe that the amendments or unpriced quotation for a covered OTC on the OTC Bulletin Board unless the
will serve an important surveillance security in a quotation medium, to issuer has made current filings with
function. Currently, only the first review the specified information. us.97 While these NASD Rule changes
broker-dealer quoting a security in a Thereafter, the reproposed Rule will may result in more issuers choosing to
quotation medium must gather, review, impose the review requirement only on become reporting issuers in order to
and preserve the information. The broker-dealers publishing priced continue to qualify for quotation on the
amendments will require the first quotations, including in connection OTC Bulletin Board, we are at this time
broker-dealer initiating any quotation with the annual review requirement. Of unable to adequately quantify the cost
and all broker-dealers initiating priced course, if the Commission suspends impact or burden that the reproposal
quotations thereafter to satisfy the trading under Exchange Act Section imposes in relation to these rule
Rule’s information review requirements. 12(k) for any of the issuer’s securities, changes. However, we believe that,
Moreover, under NASD Rule 6740,94 the Rule’s requirements are triggered. generally, any increase in the number of
broker-dealers demonstrate their The first broker-dealer, before reporting issuers subject to the Rule will
compliance with that rule by filing the initiating any quotation for a covered cause a reduction in the number of the
Rule 15c2–11 information with the OTC security, is currently required to burden hours and associated costs. We
NASD. Recently, the review of Forms incur the cost of having to gather and are of the view that because reporting
211 filed with the NASD has resulted in review the issuer information. As a issuer information is readily available
a number of Commission trading result of the amendments, that broker- from the Commission’s EDGAR system
suspensions and other enforcement dealer will incur the cost to update that and, because we estimate that broker-
actions. information annually if it continues to dealers only have to spend 4 hours
The amendments require broker- publish priced quotations. Thereafter, reviewing reporting issuer information,
dealers publishing quotes in compliance any broker-dealer publishing priced instead of the estimated 8 hours to
with the Rule to provide the information quotations for a covered OTC security review non-reporting issuer
upon request to any customer, will incur costs when it first publishes information, the reduced time spent
prospective customer, other broker- a priced quotation and when it conducts reviewing issuer information will result
dealers, or information repository unless the required annual review. To the in lower costs to broker-dealers.
the information is available through a extent a broker-dealer does not already However, broker-dealers publishing
government sponsored database. This have the required information, it will priced quotations for the OTC securities
amendment will help make information incur costs for the collection and review of non-reporting issuers are likely to
about non-reporting issuers more widely of this information. Moreover, a broker- incur greater costs in complying with
available to the public. dealer also will incur costs associated
We also believe that the amendments with creating the records required by 95 We computed these cost estimates after
will ease significantly the Rule’s the Rule and retaining the Rule’s reviewing, among other sources, responses to a
survey of broker-dealers conducted by the NQB
recordkeeping requirement because required information for the specified about issues raised in the Proposing Release. The
broker-dealers will not have to retain period of time under the amendment to results of the NQB’s survey are available in File No.
information that is available on the Rule 17a–4. S7–3–98 at the Commission’s Public Reference
Commission’s EDGAR system or on the We estimate that approximately 60% Room, 450 Fifth Street N.W., Washington, D.C.
20549.
information systems of other federal or of the issuers of OTC stocks are 96 The cost estimate assumes that clerical staff are
state authorities. Access to EDGAR and reporting issuers, while the remaining paid at an average rate of $15 per hour and
similar government-sponsored 40% are non-reporting issuers. Based on supervisory compliance staff are paid at an average
information systems is free on the this assumption, broker-dealers rate of $100 per hour. The blended compensation
rate assumes that 70% of the time is clerical and
Internet. Given that approximately 60% publishing priced quotations for the 30% is supervisory compliance [(0.7 × $15) + (0.3
OTC securities of reporting issuers × $100) = $40].
94 NASD Manual, Marketplace Rules, Rule 6740. should be able to obtain the prescribed 97 See OTC Bulletin Board Release.
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11138 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
the Rule. For purposes of the Paperwork reporting issuer information, and VII. Initial Regulatory Flexibility Act
Reduction Act, we estimate the total $400,000 ($4,000×100) associated with We have prepared an Initial
burden hours for all broker-dealers to be non-reporting issuer information. Total Regulatory Flexibility Analysis (IRFA) 98
143,278 hours and the total cost to be start-up, operating and maintenance regarding the amendments to Rule
$5,731,120. Some broker-dealers may cost burden for broker-dealers is 15c2–11 and the reproposed companion
not want to expend the time or the cost estimated to be $500,000 amendment to Rule 17a–4 under the
to obtain the non-reporting issuer ($100,000+$400,000) or an average of Exchange Act. The following
information and may therefore choose $5,000 for each broker-dealer. summarizes the IRFA.
not to publish priced quotes. On the We assume that non-reporting issuers, As discussed in the IRFA, the
other hand, the costs broker-dealers because they generally maintain their amendments specify the information
incur in obtaining and reviewing that a broker-dealer must gather and
financial information in compliance
information about non-reporting issuers review before publishing quotations for
with prevailing accounting standards,
may be reduced if one or more on-line covered OTC securities. The reproposed
will not incur any start-up costs to
information repositories of this Rule is intended to prevent broker-
prepare the required information in
information are established. We seek dealers from publishing quotations for
response to broker-dealers’ requests. We
comments on the reasonableness of covered OTC securities in a quotation
also believe that reporting issuers of
these estimates for annual hourly and medium without obtaining, reviewing,
covered OTC securities will not incur
dollar costs to broker-dealers. We also and retaining current information about
start-up costs as a result of the
seek comments on the extent to which the issuer. The reproposed Rule applies
amendments since such issuers already
these cost estimates will be affected by primarily to priced quotations.
the new NASD rule to limit the OTC provide the required information to the
Commission under the federal securities The amendments to the Rule would
Bulletin Board to the securities of affect all broker-dealers, including a
issuers current in their periodic filings. laws. Therefore, we believe issuers will
not incur start-up costs as a number of small broker-dealers, seeking
Although Rule 15c2–11 does not to publish quotations for covered OTC
regulate issuers, there may be some consequence of the adoption of the Rule
amendments, as reproposed. securities.99 The number of small
indirect costs imposed on issuers, broker-dealers that publish quotations
particularly non-reporting issuers, Finally, the Rule, as modified by the for covered OTC securities in quotation
because they may be contacted by amendments, could affect the liquidity mediums is not known at this time.
broker-dealers to provide the of some securities. If broker-dealers are However, we recently estimated that
information specified in the Rule. Non- unable to obtain the required issuer about 13% of all registered broker-
reporting issuers would incur the cost of information, they would have to refrain dealers would be characterized as
having to collect and provide the from publishing priced quotations in small.100 We estimate that, at any given
requested information to each that security. This could make it time, there are approximately 400
requesting broker-dealer. However, we somewhat more difficult for investors to broker-dealers, including small broker-
are assuming that non-reporting issuers determine what prices other market dealers, that submit quotations for
maintain their financial information in participants are willing to bid or offer covered OTC securities. Therefore,
compliance with prevailing accounting for the security, although they could call based on this estimate, we believe that
standards and, in most instances, would a broker-dealer publishing a name-only approximately 52 small broker-dealers
have available updated financial quotation to obtain a priced quotation. (400×13%) would be affected by the
information prepared in accordance Thus, while investors are still able to amendments. In fact, it is possible that
with generally accepted accounting obtain price information, the cost of few, if any, broker-dealers publishing
principles (GAAP). The NASD has obtaining this information may increase. quotations for covered OTC securities
informed us that financial statements However, under the reproposal, after the would be classified as a small business,
submitted with the Form 211 generally first quotation for a security is because as market makers they typically
are prepared in accordance with GAAP, published, broker-dealers could publish require more than $500,000 in capital to
and many are audited. unpriced quotes without complying support their market making activities.
Regarding start-up, operating, and with the Rule’s provisions. In addition, In the Proposing Release, we solicited
maintenance costs, we believe that broker-dealers could rely on the but did not receive any comments on
broker-dealers that collect, review, and exception that permits them to publish the number of small broker-dealers that
retain the information currently quotes representing unsolicited would be affected by the amendments.
required by the Rule, would incur only customer orders. We are again soliciting comments on the
marginal start-up, operating, and number of small broker-dealers that
maintenance costs (i.e., to expand Any effect on liquidity must be
weighed against the benefit of reducing would be affected by the amendments.
systems already in place) to comply The amendments would indirectly
with the Rule as reproposed. Further, instances of fraud or manipulation.
Greater investor access to information have an impact on those small issuers
some broker-dealers already may be that may be requested to provide the
collecting the required information for should result in more informed investor
decisions and potentially could result in information required by the Rule to
other purposes. However, we believe
that some broker-dealers may not have additional trading, and thus liquidity, 98 See 5 U.S.C. 603.
adequate systems in place to retain for covered OTC securities. We have 99 For purposes of the regulatory flexibility
issuer information and would, therefore, modified the proposals to permit broker- analysis, a broker-dealer is considered ‘‘small’’ if its
incur start-up, operating, and dealers to publish unpriced quotations total capital is less than $500,000, and is not
for OTC securities without reviewing affiliated with a broker-dealer that has $500,000 or
maintenance costs in order to comply more in total capital.
with the requirements of the the specified information (other than the 100 See Securities Exchange Act Release No.
amendments. first broker-dealer to quote the security). 40122 (June 24, 1998), 63 FR 35508 (adopting
We estimate that about 100 broker- This revision responds to the views of amendments to the definitions of ‘‘small business’’
those commenters that expressed or ‘‘small organization’’ under the Investment
dealers in the aggregate will incur start- Company Act of 1940, the Investment Advisers Act
up, operating, and maintenance costs of concerns about the Rule’s impact on of 1940, the Securities Exchange Act of 1934, and
$100,000 ($1,000×100) associated with liquidity. the Securities Act of 1933).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11139
broker-dealers publishing quotations in Therefore, having considered the VIII. Paperwork Reduction Act
those issuers’ securities. Based on foregoing alternatives in the context of
Exchange Act Rule 0–10(a), a small the amendments, we do not believe they Certain provisions of the amendments
issuer is one that on the last day of its would accomplish the stated objectives contain ‘‘collection of information’’
most recent fiscal year had total assets of the proposal. requirements within the meaning of the
of $5,000,000 or less. In the Proposing We encourage the submission of Paperwork Reduction Act of 1995
Release, we solicited but did not receive written comments regarding any aspect (PRA).101 The title for the collection of
any comments on the total number of of the IRFA. In particular, we seek information is: ‘‘Publication or
issuers of covered OTC securities; the comments on: (i) the number of small submission of quotations without
number (or percentages) of these issuers entities that would be affected by the specified information.’’ Accordingly, the
that are small issuers; and the total amendments, including the number of collection of information requirements
number (or percentage) of small issuers small broker-dealers and issuers; (ii) the contained in the Rule and the initial
of covered OTC securities that are number of small entities that are issuers proposal were submitted to the Office of
reporting and non-reporting issuers, of covered OTC securities; and (iii) the Management and Budget (OMB) for
respectively. We are again seeking number of small entities that are review, in accordance with 44 U.S.C.
comments on these issues. reporting and non-reporting issuers of 3507(d) and 5 CFR 1320.11, and were
The IRFA notes that the availability of covered securities, respectively. approved by OMB. The Rule has been
the Commission’s EDGAR system and Comments should also specify the costs assigned OMB Control No. 3235–
similar systems sponsored by federal or of compliance with the amendments, 0202.102
state authorities should assist broker- and suggest alternatives that would A. Collection of Information Under the
dealers in collecting and reviewing the meet the objectives of the amendments Amendments
reports required by the Rule. In in a more effective manner, while
addition, the prevalent use of computers imposing costs equal to or less than the As reproposed, the Rule would
and the Internet, on which access to amendments. In describing the nature of require the first broker-dealer, before
EDGAR is free, should also reduce the any impact that the amendments would initiating a priced or unpriced quotation
recordkeeping and compliance costs for have, empirical data supporting these for a covered OTC security in a
all broker-dealers by automating the views should be provided. quotation medium, to gather and review
information collection and retention For purposes of the Small Business the issuer information, and to review
process. Regulatory Enforcement Fairness Act of updated information annually if it
The IRFA recognizes that the continues to publish priced quotations.
1996, we are also requesting information
amendments indirectly affect certain This review requirement would also be
regarding the potential impact of the
issuers, particularly non-reporting imposed on any other broker-dealer
issuers. The amendments would require proposed amendments on the economy
on an annual basis. In particular, publishing a priced quotation for a
the first broker-dealer to publish any covered OTC security. Broker-dealers
quotation for a covered security to comments should address whether the
proposed changes, if adopted, would submitting priced quotations for the
review the Rule’s information.
have a $100,000,000 annual effect on security would be required to collect,
Thereafter, other broker-dealers must
the economy, cause a major increase in review, and retain the Rule’s specified
review information about the issuer
costs or prices, or have a significant information annually. Broker-dealers
when they first publish or resume
adverse effect on competition, would also have to record the sources of
publishing a priced quotation for a
investment, or innovations. Commenters their information, the date their review
covered security, and all broker-dealers
should provide empirical data to occurred, and the person responsible for
publishing priced quotations must
support their views. the review. Also, the proposals would
conduct an annual review. We are not
Comments should be submitted in require broker-dealers publishing
aware of any information repository,
electronically accessible or otherwise, triplicate to Jonathan G. Katz, Secretary, quotations for a covered OTC security to
now in existence that covers all of the Securities and Exchange Commission, collect, review, and retain more
information about non-reporting issuers 450 Fifth Street, NW, Washington, DC information than is required currently.
that broker-dealers must gather to 20549. Comments may also be Under Rule 15c2–11, the information
comply with the Rule. Consequently, submitted electronically at the following that is collected pursuant to the Rule
non-reporting issuers must collect and E-mail address: [email protected]. must be submitted to the NASD at least
provide the required information to All comment letters should refer to File three business days before any quotation
each requesting broker-dealer. We No. S7–5–99; this file number should be is published.103 Finally, the
assume that non-reporting issuers included on the subject line if E-mail is amendments would require broker-
maintain their financial information in used. Comment letters will be available dealers to provide the information
compliance with generally accepted for public inspection and copying in the specified to any customer, prospective
accounting standards and that the costs Commission’s Public Reference Room, customer, other broker-dealer or
incurred by non-reporting issuers to 450 Fifth Street, NW, Washington, DC information repository that requests it.
prepare the necessary information in 20549. Electronically submitted
response to broker-dealers’ requests comment letters will also be posted on 101 44 U.S.C. 3501 et seq.
would be minimal. the Commission’s Internet website 102 The Commission notes that a separate PRA
The IRFA discusses the kinds of (http://www.sec.gov). filing was not prepared to reflect the proposed
possible alternative proposals that we A copy of the Initial Regulatory companion changes to Rule 17a–4. The burden
hours and costs described for the Rule include and
have considered. These include, among Flexibility Analysis may be obtained by account for the anticipated burdens that may arise
others, creating differing compliance or contacting Chester A. McPherson, Office as a result of the proposed change to Rule 17a–4.
reporting requirements or timetables of Risk Management and Control, 103 The NASD has a rule requiring broker-dealers
that take into account the resources Division of Market Regulation, that initiate or resume quotations for covered equity
securities to submit verification that they have
available to small entities, and whether Securities and Exchange Commission, collected the information necessary to comply with
such entities could be exempted from 450 Fifth Street, NW, Washington, DC NASD requirements, as well as Rule 15c2–11. See
the reproposed rule, or any part thereof. 20549, at (202) 942–0772. NASD Manual, Marketplace Rules, Rule 6740.
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11140 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
B. Proposed Use of Information and if they are publishing priced estimates, we believe that, on average,
Broker-dealers must collect and quotations as of the annual review there are approximately 4.3 broker-
review the information required under requirement. The discussion below dealers publishing priced quotations for
the amendments if they publish the first estimates the collection of information each covered OTC security, and that at
quotation for a covered OTC security or burden one year after the anticipated any given time there are no more than
date of effectiveness of the amendments 400 broker-dealers that submit priced
if they publish priced quotations.
when broker-dealers that publish quotes quotations for covered OTC securities.
Moreover, the Rule requires that broker-
for covered OTC securities qualifying Finally, the reproposed Rule’s transition
dealers have a reasonable basis for
for the reproposed transition provision provision would not subject the broker-
believing that the information about the
must fully comply with the Rule’s dealers quoting the securities of the
issuer and related persons is accurate
information requirements. The estimated 8,865 potentially covered
and from reliable sources. This
discussion below also provides securities currently quoted in the OTC
information collection protects investors
estimates for the same period for issuers Bulletin Board and/or the Pink Sheets
by deterring fraudulent or manipulative
that may be contacted to provide the until the annual review requirement is
quotations for thinly-traded securities
information. In particular, the following triggered. Therefore, only those new
whose issuers are relatively unknown. applications that are submitted after the
Because information about these issuers analysis measures the cost to broker-
dealers of: (1) collecting, reviewing, reproposal becomes effective would be
is not widely disseminated and often is subject to the initial review
not current, fraudulent and recording, and retaining the required
issuer information and supplying it to requirement.
manipulative schemes are easier to Because the amendments would
perpetrate. Moreover, this collection of the NASD; (2) responding to requests for
issuer information from customers, require the first broker-dealer
information helps broker-dealers guard publishing a quotation, priced or
against becoming unwitting participants prospective customers, other broker-
dealers and information repositories; unpriced, for a particular security to
in fraudulent or manipulative schemes. collect issuer information, we believe
The Rule 15c2–11 information gathering and (3) starting up or maintaining
systems for the collection and retention that during the first year after the
requirements also serve an important amendments are effective, broker-
surveillance function for both the of issuer information. The analysis
below also addresses the indirect cost to dealers that are publishing the first
Commission and the NASD. Recently, quotations (whether priced or unpriced)
the Commission has used the Rule issuers who must furnish information to
requesting broker-dealers. for covered OTC securities in the
15c2–11 information to suspend trading aggregate would have to conduct
in the issuers’ securities pursuant to 1. Burden-Hours for Broker-Dealers approximately 1,260 initial reviews of
Section 12(k) of the Exchange Act where issuer information.105 We believe that it
Based on information provided by the
publicly available information about the will take a broker-dealer about 4 hours
NASD and NQB, we estimate that as of
issuer raised questions about the to collect, review, record, retain, and
December 31, 1998, there were
accuracy and adequacy of the issuers’ supply to the NASD the information
approximately 6,625 covered OTC
disclosures. pertaining to a reporting issuer, and
securities quoted in the OTC Bulletin
C. Respondents Board and 3,225 quoted in the Pink about 8 hours to collect, review, record,
Sheets for a total of 9,850 covered OTC retain, and supply to the NASD the
The amendments would apply to information pertaining to a non-
those broker-dealers that publish securities.104 We also believe that
approximately 10% (985) of these reporting issuer.
quotations for a covered OTC security in We therefore estimate that after the
a quotation medium as of specified securities would not be subject to the
reproposal has become effective, the
quotation events. The amendments also Rule, based on the exceptions that are
broker-dealers who are the first to
indirectly affect issuers that are asked included in this reproposing Release
publish the first quote for a covered
by broker-dealers to provide this and that approximately 8,865 securities
OTC security of a reporting issuer
information. Most of the Rule 15c2–11 would be subject to the Rule. According
(priced or unpriced) will require 3,024
information that would be required for to NASD estimates, we also believe that
hours (1,260×60%×4) to collect, review,
issuers that publicly file periodic approximately 1,400 new applications
record, retain, and supply to the NASD
reports with the Commission (reporting from broker-dealers to initiate or resume
the information required by the Rule as
issuers) is available electronically on publication of covered equity securities
reproposed. We estimate that after the
EDGAR or through the Internet. Thus, in the OTC Bulletin Board and/or the
reproposal has become effective the
the reproposal is likely to have a greater Pink Sheets or other quotation mediums
broker-dealers who are the first to
paperwork burden when broker-dealers were approved by the NASD for the publish the first quote for a covered
publish quotations for the securities of 1998 calendar year. We have estimated OTC security of a non-reporting issuer
issuers that do not participate in the that 60% of the covered OTC securities (priced or unpriced) will require 4,032
Commission’s public reporting program, were issued by reporting issuers, while hours (1,260×40%×8) to collect, review,
(i.e., non-reporting issuers) or do not file the other 40% were issued by non- record, retain, and supply to the NASD
reports with other federal or state reporting issuers. We also estimate that the information required by the Rule as
regulatory authorities. broker-dealers publish priced quotations reproposed. We therefore estimate the
for approximately 90% of the covered total annual burden hours for the first
D. Total Annual Reporting and OTC securities quoted in the OTC broker-dealers to be 7,056 hours
Recordkeeping Burden Bulletin Board and publish priced (3,024+4,032).
The amendments would require quotes for about 10% of the covered The Rule also would require an
broker-dealers to collect, review, retain, OTC securities quoted in the Pink annual review for broker-dealers
and record certain issuer and Sheets. According to NASD and NQB
supplemental information when they 104 We recognize that there may be covered OTC
105 This estimate is based on the assumption that
are the first broker-dealer to quote the the NASD will, in the first year after the reproposal
securities quoted in other quotation mediums, but becomes effective, approve 10% fewer Form 211
security; when they first publish priced at this time we do not have the empirical data to filings than the 1,400 applications approved in
quotations for a covered OTC security; include them in our estimations. 1998.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11141
publishing priced quotations for 1 hour for an issuer to provide the same be $500,000 ($100,000 + $400,000) or an
covered OTC securities. We have information to the remaining 3.3 broker- average of $5,000 for each broker-dealer.
estimated that each issuer is quoted by dealers that request the information. We assume that non-reporting issuers,
about 4.3 broker-dealers. We are Accordingly, we estimate the 3,546 non- because they maintain their financial
assuming that of the universe of reporting issuers annually will incur information in compliance with
approximately 8,865 potentially affected 31,914 hours (3,546×9×1) to comply prevailing accounting standards, will
covered OTC securities, broker-dealers with the first broker-dealer’s request for not incur any start-up costs to prepare
would publish priced quotations for information, and 11,702 hours the required information in response to
approximately 90% of the OTC Bulletin (3,546×1×3.3) to comply with the broker-dealers’ requests. We also believe
Board securities or 5,366 securities subsequent 3.3 broker-dealer requests that reporting issuers of covered OTC
((6,625×90%)×90%) and for 10% of the for an annual total of 43,616 burden securities will not incur start-up costs as
Pink Sheet securities or 290 securities hours (31,914+11,702). On average, a result of the amendments since such
(3,225×90%)×10%).106 Therefore, we therefore, each non-reporting issuer issuers already provide the required
estimate that priced quotations will be would spend approximately 12.3 information to the Commission under
published for approximately 5,656 burden hours (43,616/3,546) per year to the federal securities laws. Therefore,
(5,366+290) covered OTC securities. comply with these requests. we believe issuers will not incur start-
Given that about 60% of OTC stocks are up costs as a consequence of the
3. Total Burden-Hour Costs to Broker- adoption of the Rule amendments, as
issued by reporting issuers and the other
Dealers and Issuers reproposed.
40% by non-reporting issuers, and that
it would take a broker-dealer 4 and 8 We estimate the collection of E. General Information About the
hours, respectively, to meet the information will require approximately Collection of Information
requirements of the reproposed Rule for 186,894 burden hours annually (143,278
these issuers, we estimate the burden + 43,616) from approximately 3,946 The collection of information under
hours as follows: for reporting issuers respondents (400 broker-dealers and the amendments is mandatory and
we estimate approximately 58,375 hours 3,546 issuers). would be required at periodic intervals:
(3,394×4.3×4), and for non-reporting by the first broker-dealer to publish any
issuers we estimate approximately 4. Capital Cost to Broker-Dealers and quote for a covered OTC security, by
77,847 hours (2,263×4.3×8). Therefore, Issuers broker-dealers publishing priced quotes
we estimate the total annual paperwork thereafter, and by broker-dealers
We believe that broker-dealers that
burden hours for all broker-dealers to be publishing priced quotes at the time of
now collect, review, and retain the
143,278 hours (7,056+58,375+77,847). the annual review requirement. Broker-
information required by the current
dealers would be required to retain the
2. Burden-Hours for Issuers Rule will not incur any significant start-
information they collect for a period of
up costs to expand systems already in
Regarding the burden on issuers to not less than three years. Information
place. Further, broker-dealers that are
provide broker-dealers with the required collected under the Rule would not be
collecting the information required by
information, we believe that the 5,319 kept confidential. Any agency may not
the proposals for other purposes also
issuers of covered OTC securities (based conduct or sponsor, and a person is not
will not incur significant start-up costs.
on our estimate that 60% of the 8,865 required to respond to, a collection of
However, we believe some broker-
potentially covered OTC securities are information unless it displays a
dealers may not have adequate systems
reporting issuers) will not bear any currently valid control number.
in place to retain issuer information and
additional hourly burdens under the will incur start-up costs in order to F. Request for comments
amendments because these issuers comply with the requirements of the
already report the required information Pursuant to 44 U.S.C. 3506(c)(2)(B),
amendments. We assume that of the 400 we are soliciting comments to:
to the Commission through mandated broker-dealers that provide quotations (i) evaluate whether the reproposed
periodic filings. Further, reporting for covered OTC securities, about 100 collection of information is necessary
issuer information is widely available to broker-dealers will incur additional for the proposed performance of the
broker-dealers through a variety of start-up costs, while the remaining 300 functions of the agency, including
media. However, non-reporting issuer broker-dealers will only incur whether the information will have
information is not widely available. incremental costs. Because the practical utility;
Consequently, these issuers must information for reporting issuers will be (ii) evaluate the accuracy of our
provide the information required by the generally available on EDGAR and such estimates of the burden of the
amendments to requesting broker- availability satisfies the recordkeeping reproposed collection of information;
dealers before quotations in their requirements of the proposals, we are (iii) enhance the quality, utility, and
securities can be published. We believe assuming that the start-up costs clarity of the information to be
that the 3,546 issuers of non-reporting associated with retaining information on collected; and
covered OTC securities (based on an reporting issuers will average $1,000 per (iv) minimize the burden of collection
estimate that 40% of the 8,865 broker-dealer, whereas the same costs of information on those who are to
potentially covered OTC securities are will be $4,000 per broker-dealer for non- respond, including through the use of
non-reporting ) will spend an average of reporting issuer information. We automated collection techniques or
9 hours each to collect, prepare, and estimate that broker-dealers in the other forms of information technology.
supply the information required by the aggregate will incur start-up, operating, We seek data about quotations for
proposals to the first broker-dealer that and maintenance costs of $100,000 covered OTC securities in OTC
requests this information. Thereafter, we ($1,000 × 100) associated with reporting quotation mediums other than the OTC
estimate that it will take an average of issuer information, and $400,000 Bulletin Board and the Pink Sheets. We
106 Some securities have priced quotations
($4,000 × 100) associated with non- seek comments on our estimate of the
published in both of these quotation systems. To
reporting issuer information. Total start- number of issuers affected by the
avoid double counting, such securities are counted up, operating and maintenance cost reproposed Rule and on the time
as OTC Bulletin Board securities. burden for broker-dealers is estimated to estimates made for broker-dealers and
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11142 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
issuers to comply with the information security for publication in a quotation state electronic information system, or
collection requirements. medium, unless the broker or dealer an electronic information system
Persons desiring to submit comments complies with the provisions of this section operated by an information repository,
on the collection of information or relies on an exception contained in and you have the means to access the
paragraph (h) of this section. As used in this
requirements should direct them to the section, the term ‘‘you’’ refers to a broker or
information for the period required
Office of Management and Budget, dealer. under § 240.17a–4(b)(11);
Attention: Desk Officer for the (ii) Any significant relationship
Securities and Exchange Commission, (a) When a broker or dealer must information described in paragraph (e)
Office of Information and Regulatory comply with this section. You must of this section;
Affairs, Room 10102, New Executive comply with paragraph (b) of this (iii) The date that you reviewed the
Office Building, Washington, DC 20503, section when you publish: information described in paragraphs (c),
and should also send a copy of their (1) The first quotation for a security; (d), and (e) of this section; and
comments to Jonathan G. Katz, (2) The first quotation following the (iv) The person responsible for your
Secretary, Securities and Exchange termination of a Commission trading compliance with the requirements of
Commission, 450 Fifth Street, NW, suspension ordered pursuant to section this section; and
Washington, DC 20549, and refer to File 12(k) of the Act (15 U.S.C. 78l(k)) in any (4) Preserve the records required to be
No. S7–5–99. OMB is required to make security of the issuer of the suspended made under paragraph (b)(3) of this
a decision concerning the collections of security; section in accordance with § 240.17a–
(3) Your first quotation at a specified 4(b)(11).
information between 30 and 60 days
price for the same security after another (c) The issuer information that a
after publication of this release in the
broker or dealer publishes the first broker or dealer must review. The type
Federal Register, so a comment to OMB
quotation for a security as described in of information that is considered ‘‘issuer
is best assured of having its full effect
paragraph (a)(1) or (a)(2) of this section; information’’ and that must be reviewed
if OMB receives it within 30 days of this
(4) A quotation at a specified price for under paragraph (b) of this section
publication.
a security after a period of five or more depends on the status of the issuer.
IX. Statutory Basis and Text of consecutive business days when you (1) Issuers with a recent public
Proposed Amendments and Rule did not publish any quotations at a offering. If the issuer filed a registration
specified price for that security; statement under the Securities Act
The rule amendments are being
(5) Your first quotation at a specified (other than a registration statement on
proposed pursuant to Sections 3, 10(b),
price for a security after the date that is Form F–6 (17 CFR 239.36)) that became
15(c), 15(g), 17(a), and 23(a) of the
four months after the end of the issuer’s effective less than 90 calendar days
Securities Exchange Act of 1934, 15
fiscal year, unless the issuer is a foreign before you publish the quotation, and
U.S.C. §§ 78c, 78j(b), 78o(c), 78o(g),
private issuer; or that is not the subject of a stop order,
78q(a), and 78w(a).
(6) Your first quotation at a specified the issuer information is the prospectus
List of Subjects in 17 CFR Part 240 price for a security of a foreign private specified by section 10(a) of the
Broker-dealers, Fraud, Reporting and issuer after the date that is seven Securities Act (15 U.S.C. 77j(a)).
recordkeeping requirements, Securities. months after the end of the issuer’s (2) Issuers with a recent Regulation A
fiscal year. offering. If the issuer filed a notification
Text of Reproposed Rule (b) The steps a broker or dealer must under Regulation A under the Securities
In accordance with the foregoing, take to comply with this section. For Act (17 CFR 230.251 through 230.263)
Title 17, chapter II, part 240 of the Code each security in which you publish any and was authorized to commence the
of Federal Regulations is proposed to be of the quotations listed in paragraph (a) offering less than 40 calendar days
amended as follows: of this section, you must: before you publish a quotation, and the
(1) Review the issuer information offering circular provided for under
PART 240—GENERAL RULES AND described in paragraph (c) of this Regulation A is not the subject of a
REGULATIONS, SECURITIES section and the supplemental suspension order, the issuer information
EXCHANGE ACT OF 1934 information described in paragraph (d) is the offering circular.
of this section; (3) Certain reporting issuers. If the
1. The authority citation for part 240 (2) Determine that you have a issuer is current in filing annual or
continues to read, in part, as follows: reasonable basis under the semi-annual reports required under
Authority: 15 U.S.C. §§ 77c, 77d, 77g, 77j, circumstances for believing that the section 13 or 15(d) of the Act (15 U.S.C.
77s, 77z–2, 77eee, 77ggg, 77nnn, 77sss, 77ttt, issuer information described in 78m or 78o(d)) or section 30(a) of the
78c, 78d, 78f, 78i, 78j, 78j–1, 78k, 78k–1, 78l, paragraph (c) of this section, when Investment Company Act of 1940 (15
78m, 78n, 78o, 78p, 78q, 78s, 78u–5, 78w, considered in conjunction with the U.S.C. 80a–29(a)), the issuer information
78x, 78ll(d), 78mm, 79q, 79t, 80a–20, 80a–23, supplemental information described in is the issuer’s most recent annual or
80a–29, 80a–37, 80b–3, 80b–4 and 80b–11, paragraph (d) of this section, is accurate semi-annual report and any quarterly
unless otherwise noted.
in all material respects and was and current reports filed by the issuer
* * * * * obtained from reliable sources; after such annual or semi-annual report.
2. Section 240.15c2–11 and the (3) Make a record of: You will be considered in compliance
section heading are revised to read as (i) The issuer information described with the requirement to obtain current
follows: in paragraph (c) of this section, the reports filed by the issuer if you obtain
§ 240.15c2–11 Publication or submission
supplemental information described in all current reports filed by that issuer as
of quotations without current information. paragraph (d) of this section, and the of the date that is three business days
sources from which you obtained the before you publish the quotation.
Preliminary Note: As a means reasonably
designed to prevent fraudulent, deceptive, or
information. You will be considered to However, until the issuer has filed its
manipulative acts or practices, this section have obtained the issuer information first annual or semi-annual report, the
prevents a broker or dealer from publishing described in paragraphs (c) or (d)(1) of issuer information is:
a quotation for a security or, directly or this section if you obtained it through (i) The prospectus specified by
indirectly, submitting a quotation for a the EDGAR system, any other federal or section 10(a) of the Securities Act (15
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11143
U.S.C. 77j(a)) that was included in a (E) The total number of issuer failed or refused to provide this
registration statement filed by the issuer securityholders of record for the information;
under the Securities Act and that security as of the end of the issuer’s (xii) The following information:
became effective within the prior 15 most recent fiscal year or a more recent (A) A description of any of the
months; or date; following events involving the issuer, its
(ii) The registration statement filed by (vi) The exact title and class of the predecessor, or any of its majority-
the issuer under section 12 of the Act security to be quoted; owned subsidiaries that occurred in the
(15 U.S.C. 78l) that became effective (vii) The name, address and telephone prior two years:
within the prior 15 months (other than number of the transfer agent; (1) A change in control;
a registration statement on Form F–6 (17 (viii) A description of the issuer’s (2) An increase of 10% or more of the
CFR 239.36)), and any quarterly and business and facilities; same class of outstanding equity
current reports filed by the issuer after (ix) A description of the issuer’s securities;
the registration statement became products or services; (3) A merger, acquisition, or business
effective. (x) The full names and business combination;
(4) Certain financial institutions. If addresses of the executive officers, (4) An acquisition or disposition of
the issuer is not required to file reports directors, general partners, promoters, significant assets;
under sections 13 or 15(d) of the Act and control persons of the issuer, and (5) A bankruptcy proceeding; and
and is a bank or savings association, as the number of securities of each class of (6) The delisting of securities by any
those terms are defined in 12 U.S.C. the issuer’s securities that are securities exchange or Nasdaq; or
1813, the issuer information is the beneficially owned by each such person (B) A statement from the issuer that
issuer’s most recent annual report and as of the end of the issuer’s last fiscal the issuer, its predecessor, and its
any subsequent reports filed with the year or a more recent date; majority-owned subsidiaries have not
issuer’s appropriate Federal banking (xi) The following information: been the subject of any of the actions or
agency or State bank supervisor, as (A) A description of any of the events listed in paragraphs
those terms are defined in 12 U.S.C. following actions to which any (c)(6)(xii)(A)(1) through (6) of this
1813. executive officer, director, general section; or
(5) Certain exempted insurance partner, promoter, or control person of (C) A description of the steps you
companies. If the issuer is exempt from the issuer has been the subject during have taken to obtain from the issuer the
section 12(g) of the Act (15 U.S.C. 78l(g)) the prior five years: information needed to comply with
by complying with section 12(g)(2)(G) of (1) A conviction in a criminal paragraphs (c)(6)(xii)(A) or (c)(6)(xii)(B)
the Act (15 U.S.C. 78l(g)(2)(G)), the proceeding or named as a defendant in of this section and that the issuer failed
issuer information is the issuer’s most a pending criminal proceeding or refused to provide this information;
recent annual statement referred to in (excluding traffic violations and other and
section 12(g)(2)(G)(i) of the Act (15 minor offenses); (xiii) The financial information listed
U.S.C. 78l(g)(2)(G)(i)). (2) The entry of an order, judgment, below in paragraphs (c)(6)(xiii)(A) or
(6) Other issuers. If the issuer is not or decree, not subsequently reversed, (c)(6)(xiii)(B) and (c)(6)(xiii)(C) of this
covered by paragraphs (c)(1) through suspended or vacated, by a court of section:
(c)(5) of this section, the issuer competent jurisdiction that permanently (A) If the issuer is not a foreign
information is the information listed or temporarily enjoins, bars, suspends private issuer, the issuer’s most recent
below in paragraphs (c)(6)(i) through or otherwise limits involvement in any balance sheet, statement of cash flows,
(c)(6)(xiii) of this section. Except as type of business, securities, statement of comprehensive income,
specified in paragraph (c)(6)(xiii) of this commodities, or banking activities; and statement of operations (income),
section, this information is presumed to (3) A finding or judgment by a court prepared in accordance with U.S.
be current if it is as of a date within 12 of competent jurisdiction (in a civil generally accepted accounting
months before you publish the action), the Commission, the principles. Unless you know or have
quotation and must be the most current Commodity Futures Trading reason to know that more current
information that you know or have Commission, or a state securities information is available, this
reason to know is available: regulator of a violation of federal or state information will be presumed to be
(i) The exact name of the issuer and securities or commodities law, which current if:
any predecessor; has not been reversed, suspended, or (1) The balance sheet is as of a date
(ii) The address and telephone vacated; and that is less than 15 months before you
number of the issuer’s principal (4) The entry of an order by a self- publish the quotation;
executive offices; regulatory organization that (2) The statement of cash flows,
(iii) The state of incorporation of the permanently or temporarily bars, statement of comprehensive income,
issuer, if it is a corporation; suspends or otherwise limits and statement of operations (income)
(iv) The date on which the issuer’s involvement in any type of business or are for the 12 months preceding the date
fiscal year ends; securities activities; or of such balance sheet; and
(v) For each class of the issuer’s (B) A statement from the issuer that (3) If the balance sheet is as of a date
securities outstanding: no executive officer, director, general that is more than 6 months before you
(A) The exact title of the security; partner, promoter, or control person of publish the quotation, it must be
(B) The par or stated value of the the issuer is the subject of any of the accompanied by an additional statement
security; actions listed in paragraphs of cash flows, statement of
(C) The number of securities or total (c)(6)(xi)(A)(1) through (4) of this comprehensive income, and statement
principal amount outstanding of the section; or of operations (income) for the period
security; (C) A description of the steps you from the date of such balance sheet to
(D) The class and number of securities have taken to obtain from the issuer the a date that is less than 6 months before
issuable upon the security’s exercise, information needed to comply with you publish the quotation.
exchange or conversion, if applicable; paragraphs (c)(6)(xi)(A) or (c)(6)(xi)(B) of (B) If the issuer is a foreign private
and this section and a statement that the issuer, the issuer’s most recent balance
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11144 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
sheet and statement of operations 78l(k)) for any securities of the issuer or paragraphs (c)(5), (c)(6), (d), and (e) of
(income), and to the extent prepared by its predecessor (if any) during the 12 this section promptly available upon
the issuer, statement of cash flows, months before you publish the request to any customer, prospective
statement of comprehensive income, quotation, or a copy of the public customer, other broker or dealer, or
and statement of changes in release issued by the Commission information repository. By providing
shareholders’ equity, prepared in announcing such trading suspension this information to others under this
accordance with a comprehensive body order; and paragraph (g), you do not represent that
of accounting principles. Unless you (2) A copy or a written record of any the information is accurate; rather, you
know or have reason to know that more other material information (including represent that, as of the date recorded
current information is available, this adverse information) about the issuer under paragraph (b)(3)(iii) of this
information will be considered current that comes to your knowledge or section, you had a reasonable basis
if: possession before you publish a under the circumstances for believing
(1) The balance sheet is as of a date quotation. that the information was accurate and
that is less than 18 months before you (e) The significant relationship current in all material respects and was
publish the quotation; information that the broker or dealer obtained from reliable sources; but
(2) The statement of cash flows, must make and keep a record of. The (2) You do not need to comply with
statement of comprehensive income, type of information that is considered paragraph (g)(1) of this section to the
statement of operations (income), and ‘‘significant relationship’’ information extent that the information is reasonably
statement of changes in shareholders’ and that you must make and keep a available through EDGAR, any other
equity are for the 12 months preceding record of under paragraph (b) of this federal or state electronic information
the date of such balance sheet; and section is the following: system, or an information repository.
(3) If the balance sheet is as of a date (1) Any direct or indirect affiliation (h) When a broker or dealer is not
that is more than 9 months before you between the issuer and you or between required to comply with this section.
publish the quotation, it must be the issuer and any of your associated You are not required to comply with
accompanied by an additional statement persons; this section when you publish a
of cash flows, statement of (2) Whether you are publishing the quotation for:
comprehensive income, statement of quotation on behalf of any other broker (1) A security that is listed on a
operations (income), and statement of or dealer, or any of its associated national securities exchange or Nasdaq;
changes in shareholders’ equity for the persons, and, if so, the name of such is traded on such exchange or Nasdaq
period from the date of such balance broker or dealer, or the associated on the same day as, or on the business
sheet until a date that is less than 9 person, and the terms of the day immediately before, the day you
months before you publish the arrangement; publish the quotation; and is not
quotation, if any such statements have (3) Whether you have received, or suspended, terminated, or prohibited
been prepared by the issuer. have any arrangement to receive, any from trading on such exchange or
(C) The same financial information monetary or other consideration from Nasdaq;
required by paragraph (c)(6)(xiii)(A) and any person for publishing the quotation (2) An exempted security, as defined
(B) of this section for such part of the and, if so, a description of the in section 3(a)(12) of the Act (15 U.S.C.
two preceding fiscal years as the issuer consideration and the name of the 78c(a)(12));
or any predecessor has been in existence person providing the consideration; and (3) A security where the quotation
(one year with respect to the balance (4) Whether you are publishing the represents the unsolicited order of a
sheet), prepared in accordance with U.S. quotation directly or indirectly on customer (other than a person acting as
generally accepted accounting behalf of the issuer, or any executive or for a dealer);
principles (or prepared in accordance officer, director, general partner, (4) A non-convertible debt security or
with a comprehensive body of promoter, control person, or any person, a non-participatory preferred stock;
accounting principles in the case of a who is directly or indirectly the (5) An asset-backed security that is
foreign private issuer). However, if the beneficial owner of more than 10 rated by at least one nationally
issuer has emerged from reorganization percent of the outstanding units or recognized statistical rating
pursuant to Chapter 11 of the shares of any equity security of the organization, as that term is used in
Bankruptcy Code (11 U.S.C. 1101 et issuer, and, if so, the name of such § 240.15c3–1, in one of its generic rating
seq.) and the reorganization plan has person, and the basis for any exemption categories that signifies investment
been in effect less than two years, the under the federal securities laws for any grade;
financial information required under sales of such securities on behalf of such (6) A security with a worldwide
this paragraph (c)(6)(xiii) is the court- person. average daily trading volume value of at
approved disclosure statement filed (f) The information a broker or dealer least $100,000 during each month of the
under 11 U.S.C. 1125 and the financial must submit to the NASD. At least three six full calendar months immediately
information described in this paragraph business days before you publish a before the date you publish the
(c)(6)(xiii) from the date of the entry of quotation covered by paragraph (a) of quotation;
the bankruptcy court order confirming this section, you must submit to the (7) A convertible security, if the
the issuer’s reorganization plan NASD, in accordance with NASD rules, underlying security meets the
pursuant to 11 U.S.C. 1129. the information required in paragraphs requirements of paragraph (h)(6) of this
(d) The supplemental information (c), (d), and (e) of this section. section;
that a broker or dealer must review. The (g) The broker or dealer must make (8) A security that has bid price, as
type of information that is considered certain information required by this published on a national securities
‘‘supplemental information’’ and that section available upon request. exchange, Nasdaq, or quotation
you must review under paragraph (b) of (1) If you publish a quotation for a medium, of at least $50 per share. If the
this section is the following: security in compliance with this security is a unit composed of one or
(1) A copy of any trading suspension section, you must make the issuer, more securities, the bid price of the unit
order issued by the Commission under supplemental, and significant divided by the number of shares of the
section 12(k) of the Act (15 U.S.C. relationship information specified in unit that are not warrants, options,
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11145
rights, or similar securities must be at information described in paragraph (c) (12) Quotation medium means any:
least $50; or of this section when this information is (i) System of general circulation to
(9) A security of an issuer that has net not routinely or widely made available, brokers or dealers that regularly
tangible assets in excess of $10,000,000. electronically or otherwise; and disseminates quotations of identified
(i) The steps to take to become an (ii) Is designated by the Commission brokers or dealers; or
information repository. as an information repository as (ii) Publication, alternative trading
(1) An entity seeking information described in paragraph (i) of this system, or other device that is used by
repository designation must file an section. brokers or dealers to disseminate
application with the Director of the (4) Issuer, in the case of quotations for quotations to others.
Commission’s Division of Market American Depositary Receipts, means (13) Securities Act means the
Regulation in Washington, DC. The the issuer of the deposited shares Securities Act of 1933 (15 U.S.C. 77a et
application should provide detailed represented by such American seq.).
information explaining how the entity Depositary Receipts. (k) How this section applies to
satisfies the attributes set forth in (5) NASD means the National securities for which a broker or dealer
paragraph (i)(2) of this section. The Association of Securities Dealers, Inc., is publishing quotations immediately
entity must also file any additional and its wholly owned subsidiaries before the effective date of the
information relating to the attributes set (including, but not limited to, NASD amendments. If you were publishing a
forth in paragraph (i)(2) of this section Regulation, Inc. and The Nasdaq Stock quotation for a security on the business
that the Director of the Commission’s Market, Inc.). day immediately before April 7, 1999,
Division of Market Regulation (6) Nasdaq means The Nasdaq you may continue to publish quotations
subsequently requests; National Market and The Nasdaq for the security without complying with
(2) In determining whether to SmallCap Market, both operated by The paragraph (b) of this section until you
designate an entity as an information Nasdaq Stock Market, Inc. publish a quotation described in
repository, the Commission will (7) Net tangible assets means total paragraphs (a)(2), (a)(3), (a)(4), (a)(5), or
consider whether the entity: assets less intangible assets and (a)(6) of this section.
(i) Collects information about a liabilities. For purposes of this section, (l) The Commission can grant
substantial segment of issuers of net tangible assets must be exemptions from this section. This
securities subject to this section; demonstrated by current financial section does not prohibit the
(ii) Maintains current and accurate statements, as described in paragraph publication of any quotation for a
information about such issuers; (c)(6)(xiii) of this section, and: security or a class of securities, if the
(iii) Has effective acquisition, (i) If the issuer is not a foreign private Commission, on written request or its
retrieval, and dissemination systems; issuer, the financial statements must be own motion, exempts such quotation,
(iv) Places no inappropriate limits on audited and reported on by an either unconditionally or on specified
the issuers from or about which it will independent public accountant in terms and conditions.
accept information; accordance with § 210.2–02 of this 3. Section 240.17a–4 is amended by
(v) Provides access to the documents chapter; or adding paragraph (b)(11) to read as
deposited with it to anyone willing and (ii) If the issuer is a foreign private
follows:
able to pay the applicable fees; issuer, the financial statements must be
(vi) Charges reasonable fees; and prepared in accordance with a § 240.17a–4 Records to be preserved by
(vii) In general, is so organized and comprehensive body of accounting certain exchange members, brokers and
has the capacity to be able to reasonably principles, audited in compliance with dealers.
carry out the purposes of this section. requirements of the country of * * * * *
(3) An information repository must incorporation, and reported on by an (b) * * *
notify the Director of the Commission’s accountant duly registered and in good (11) The records required to be
Division of Market Regulation of any standing in accordance with the obtained pursuant to § 240.15c2–11.
material changes that occur in the facts regulations of that jurisdiction. * * * * *
and circumstances of its application for (8) Non-participatory preferred stock Dated: February 25, 1999.
such designation; and means non-convertible capital stock, the By the Commission.
(4) In the event it is determined that holders of which are entitled to a
Margaret H. McFarland,
an information repository no longer preference in payment of dividends and
Deputy Secretary.
satisfies all of the attributes set forth in in distribution of assets on liquidation,
paragraph (i)(2) of this section, the dissolution, or winding up of the issuer, Note: This Appendix to the Preamble will
not appear in the Code of Federal
Director of the Commission’s Division of but are not entitled to participate in
Regulations.
Market Regulation may revoke such residual earnings or assets of the issuer.
designation. (9) Promoter has the same meaning Appendix
(j) The definitions applicable to this contained in § 230.405 of this chapter.
Guidance on the Scope of a Broker-Dealer’s
section. For purposes of this section, the (10) Publish means to publish a Review Under Current Rule 15c2–11 and the
following definitions apply: quotation for a security in a quotation Amendments
(1) Alternative trading system has the medium or, directly or indirectly, to
same meaning contained in § 242.300(a) submit a quotation for a security for I. Introduction
of this chapter. publication in a quotation medium. To assist broker-dealers in complying
(2) Asset backed security has the (11) Quotation means any bid or offer with Rule 15c2–11 (Rule) 1 under the
meaning contained in General at a specified price with respect to a Securities Exchange Act of 1934
Instruction I.B.5. to Form S–3 (17 CFR security, or any indication of interest by (Exchange Act),2 we are setting forth the
239.13). a broker or dealer in receiving bids or factors that they should consider in
(3) Information repository means an offers from others for a security, or any carrying out their review obligations
entity that: indication by a broker or dealer that
(i) Gathers and provides to brokers or advertises its general interest in buying 1 17 CFR 240.15c2–11.
dealers and others current issuer or selling a particular security. 2 15 U.S.C. 78a et seq.
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11146 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
under the Rule as it currently exists and in all material respects. We are giving our suspension ordered pursuant to section 12(k)
under the amendments proposed in views on the steps a broker-dealer should of the Exchange Act 11 in any security of the
Securities Exchange Act Release No. 34– take to assess the reliability of the source of issuer of the suspended security;
the required information and the accuracy of • a quotation at a specified price for a
41110.3 We are providing this guidance that information.7 security after a period of five or more
because commenters on the initial consecutive business days when it did not
proposal 4 expressed concerns about II. Quotation Events Triggering the publish any quotations at a specified price
their review obligations under its Review Requirement for that security;
provisions, particularly in light of Under the current Rule, the first broker- • its first quotation at a specified price for
elimination of the piggyback provision, dealer to publish a priced quotation must a security after the date that is four months
the addition of an annual review obtain and review the Rule’s required after the end of the issuer’s fiscal year, unless
requirement, and the obligation to information. Under the current Rule’s the issuer is a foreign private issuer; or
obtain enhanced issuer information. piggyback exception, a broker-dealer does not • its first quotation at a specified
This guidance applies, unless otherwise have to satisfy these information price for a security of a foreign private
noted, to a broker-dealer’s obligations requirements when it publishes a quotation issuer after the date that is seven
under the current Rule as well as under
for a security if it, or any other broker-dealer, months after the end of the issuer’s
is already publishing regular quotations for fiscal year.
the reproposal. the security.8 This means that the first market
Rule 15c2–11 regulates the publication of If the Rule applies, under both the current
maker publishing a quotation is the only one Rule and the amendments, the broker-dealer
quotations for OTC securities in a quotation that has to obtain the required information,
medium.5 The Rule generally prohibits must:
broker-dealers from publishing a quotation
and thereafter, any other market maker can • review the Rule’s specified information;
unless they have reviewed specified
publish quotations in the security • determine that it has a reasonable basis
indefinitely, unless there is a significant for believing that the information is accurate
information about the issuer. The kind of lapse in quotation activity.9
information depends on the nature of the in all material respects and was obtained
The amendments will restructure Rule from reliable sources;
issuer, e.g., whether the issuer is subject to
the Exchange Act’s periodic reporting
15c2–11 by setting forth more clearly the • Record the date it reviewed the specified
quotation events that trigger the Rule, the information, the sources of the information,
requirements (reporting issuer) or is an issuer requirements that the broker-dealer must
that is not subject to the Exchange Act’s and the person at the firm responsible for the
satisfy, and the nature of the information that broker-dealer’s compliance with the Rule;
reporting requirements (non-reporting the broker-dealer must review. The
issuer). Broker-dealers must also have a and
reasonable basis for believing that the issuer
amendments state that no broker-dealer, • Preserve the specified information in
directly or indirectly, may publish the accordance with Rule 17a–4.12
information, when considered in conjunction described kinds of quotations for a security We set out below in more detail the review
with any supplemental information,6 is in any quotation medium, without first obligation required of a broker-dealer before
accurate in all material respects and that it complying with the Rule’s provisions.10 it publishes a quotation for covered OTC
was obtained from a reliable source. Under the amendments, the Rule will apply securities. In general, the broker-dealer must
The Rule is precise about the kind of issuer at specified points in time, namely, when a first form a reasonable belief about the
and other information that the broker-dealer broker-dealer publishes: source’s reliability. Then the broker-dealer
must obtain and review before publishing • the first quotation for a security; should examine the materials to make sure it
quotations and about how current that • its first quotation at a specified price for has obtained all of the information required
information must be. However, some a security after another broker or dealer by the Rule, including any supplemental
commenters on the Proposing Release stated published the first quotation for the same information known by the broker-dealer. In
that they were unclear about the nature of the security. reviewing this information, the Rule requires
broker-dealer’s obligation to determine that • the first quotation following the that the broker-dealer must have a reasonable
the broker-dealer reasonably believes that the termination of a Commission trading basis under the circumstances for believing
source of the Rule 15c2–11 information is
that the issuer information described in
reliable and that the information is accurate 7 This discussion confirms and supplements
paragraph (a) [reproposed paragraph (c)] of
earlier guidance on Rule 15c2–11 issues. See the Rule,13 when considered in conjunction
3 This appendix sets forth guidance on a broker- Securities Exchange Act Release No. 29094 (April with the supplemental information described
dealer’s review obligations under the Rule as it 17, 1991), 56 FR 19148 (1991 Adopting Release);
currently exists and under the proposed Securities Exchange Act Release No. 27247
in paragraph (b) [reproposed paragraph (d)]
amendments. If the Commission takes final action (September 14, 1989), 54 FR 39194 (1989 Proposing of the Rule,14 is accurate in all material
on the proposed amendments, the Appendix will be Release).
revised to delete references to the proposal and to 8 17 CFR 240.15c2–11(f)(3). The security must 11 15 U.S.C. 78l(k).
reflect the final rule. We expect that the Appendix have been the subject of quotations on at least 12 12 17 CFR 240.17a–4.
will provide useful guidance to broker-dealers in business days during the previous 30 calendar days, 13 Currently, a broker-dealer must review and
conducting the document review required by the with no more than 4 consecutive business days maintain in its records certain issuer information,
Rule. elapsing without a quotation. Effectively, the Rule which, depending on the issuer, may include
4 Securities Exchange Act Release No. 39670 applies only to those market makers publishing prospectuses or offering circulars; certain Exchange
(February 17, 1998), 63 FR 9661 (Proposing quotations during the first 30 days of a security’s Act reports; other regulatory filings; information
Release). trading. The ability to piggyback on one’s own furnished to the Commission pursuant to Section
5 A quotation is broadly defined as any indication quotations is referred to as ‘‘self-piggybacking.’’ 12(g)(2)(G)(i) of the Exchange Act; or certain
that a broker-dealer is willing to buy or sell a 9 The piggyback exception would be eliminated financial information for non-reporting issuers. The
particular security. The reproposed Rule, however, under the proposed amendments. amendments expand the information required for
applies most directly to priced quotations. Rule 10 The current Rule applies to an interdealer issuers that do not file periodic reports with the
15c2–11 applies to broker-dealers that publish quotation system, which is a quotation medium of Commission (e.g., non-reporting issuers). In
quotations for securities traded in the OTC markets. general circulation to brokers or dealers which addition, broker-dealers would be required to make
In this appendix, ‘‘OTC stocks’’ or ‘‘OTC securities’’ regularly disseminates quotations of identified the issuer information available to anyone who
refers to securities that are not listed on a national brokers or dealers. 17 CFR 240.15c2–11(e)(2). Under requested it.
securities exchange or Nasdaq. ‘‘Covered OTC the proposed amendments, the definition of 14 In addition to a copy of any trading suspension
securities’’ refers to those OTC securities that are ‘‘interdealer quotation system’’ would be order issued by the Commission pursuant to
subject to Rule 15c2–11. Rule 15c2–11 applies to incorporated into the definition of ‘‘quotation Exchange Act Section 12(k), the broker-dealer must
securities quoted on the OTC Bulletin Board, medium.’’ Under the amendments, a ‘‘quotation record and consider any other material information
operated by the National Association of Securities medium’’ will be a system of general circulation to (including adverse information) regarding the issuer
Dealers, Inc. (NASD); the Pink Sheets operated by brokers or dealers that regularly disseminates that comes to its knowledge or possession before
the National Quotation Bureau, Inc. (NQB); and quotations of identified brokers or dealers; or publishing a quotation under the Rule. Paragraph
similar quotation systems. publication, alternative trading system, or other (b) [reproposed paragraph (d)] does not require a
6 See footnote 14 below for a description of device that is used by brokers or dealers to broker-dealer to maintain trivial information or
‘‘supplemental information.’’ disseminate quotations to others.] information from an uncertain source. Also, the
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11147
respects and was obtained from reliable dealer must obtain and review information broker-dealer typically may rely on that
sources. that is on file with the Commission, in representation as to the source. Because
In addition, we are providing numerous addition to any supplemental information. In broker-dealers frequently obtain the Rule
examples of ‘‘red flags’’ often associated with the case of a non-reporting issuer, where 15c2–11 information from these sources, the
Rule 15c2–11 documents. A red flag is there may be no information filed with a reliability of the information’s source is not
information that under the circumstances regulatory authority, the broker-dealer must often called into question.
signals that one or more of the required items obtain the required information from sources Occasionally, the broker-dealer may obtain
of information may be materially inaccurate. its deems reliable and must review this the Rule 15c2–11 information from sources
We consider these red flags to be indications information together with any supplemental not associated with the issuer, such as
that should lead a broker-dealer to inquire information. another market maker.22 In this case, the
whether it had a reasonable basis to believe The Rule does not currently specify the requesting broker-dealer should inquire
that the issuer information is accurate in all status of the person who must conduct the about the original source of the information.
material respects and that it was obtained review on the broker-dealer’s behalf. Under The broker-dealer providing the information
from a reliable source. the reproposed Rule, the broker-dealer must must make a record of the source of the
The red flags that we discuss have been make a record of the person at the firm who issuer information and can supply this
present in Commission enforcement actions, is responsible for the broker-dealer’s information to the requesting broker-dealer.
examinations conducted by our staff, and compliance with the Rule’s provisions.17 When a red flag regarding the source’s
reviews of Rule 15c2–11 conducted by the Generally, the person performing the review reliability exists, the broker-dealer must
National Association of Securities Dealers, should have sufficient experience or inquire further to reasonably determine
Inc. (NASD) submissions, but our discussion authority at the firm to make sure that the whether the information’s source is reliable.
is not meant to be exhaustive. Other Rule’s requirements are fully satisfied. To satisfy the Rule’s requirements, the
information may come into the broker- Rule 15c2–11 is intended to prevent broker-dealer must ascertain the original
dealer’s knowledge or possession that would broker-dealers from becoming involved in the source of the information, especially when a
lead it to question whether the source is fraudulent manipulation of OTC securities. broker-dealer is provided information from
reliable or whether the required information However, even if a broker-dealer technically another broker-dealer that encourages the
is accurate in all material respects. The complies with the Rule’s requirements, it publication of quotations rather than
adequacy of a broker-dealer’s review must be would be subject to liability under other responds to a request for information.23 If the
considered on a case-by-case basis. antifraud provisions of the securities laws, broker-dealer providing the information
The reproposed Rule would require a such as Rule 10b–5, if a broker-dealer refuses to substantiate that the information is
broker-dealer to obtain and review some publishes quotations as part of a fraudulent from the issuer, this refusal is a red flag that
issuer information not required by the or manipulative scheme.18 may indicate that the source is unreliable. If
current Rule, such as criminal or securities the broker-dealer is told that the issuer has
law violations and additional issuer B. Source Reliability
prepared or approved the information, the
information. Until the proposal is adopted, 1. Determining Whether a Source is Reliable broker-dealer may need to verify that
the Rule does not require the broker-dealer to The broker-dealer must first have a representation by directly contacting the
obtain and review this information. This reasonable basis for believing that Rule 15c2– issuer.
information, however, would be a red flag 11 information comes from a reliable source.
and, under the current Rule, could be 2. Examples of Unreliable Sources
In general, this means that the information
‘‘material information’’ that the broker-dealer was derived from the issuer. If the The Report of Investigation Regarding
must take into account when conducting its information is from the issuer or its officers Transactions in the Securities of Laser
review obligations. and directors, attorney, or accountant, the Arms Corporation (Laser Arms Report)
III. The Review Process broker-dealer generally can assume that the illustrates when a broker-dealer did not
source is reliable, absent red flags to the have a reasonable basis to believe that
A. Introduction contrary.19 If the information is from EDGAR
the information about a non-reporting
While the broker-dealer must obtain and or another governmental website or an
review the required information, the standard independent retrieval service 20 or standard issuer was from a reliable source.24 The
of review is based on a broker-dealer’s research sources 21 or an information Laser Arms Report noted that ‘‘inherent
arriving at a reasonable belief, not a certainty, repository contemplated under the in the requirement of paragraph (a)(5)
that the information is accurate and was reproposed Rule, the broker-dealer can [reproposed paragraph (c)(6)] is ’the
obtained from a reliable source. Although satisfy the Rule’s requirement to have a premise that the broker-dealer must at
broker-dealers often refer to their Rule 15c2– reasonable basis for believing that the source least verify that it has received the
11 files as ‘‘due diligence’’ files, the Rule’s of the information is reliable. If the broker- required information and know that
standard of review does not approach the dealer receives the information from an source of the information.’’ 25
depth of inquiry generally associated with an independent and objective source, such as a
underwriter’s obligations in a registered bank that is not a market maker in the The broker-dealer that submitted the
public offering or with a retail broker’s security, which represents that it has initial application to quote Laser Arms
obligations in recommending a security to a prepared the information or received the stock did not make any attempt to verify
customer. As discussed below, the scope of information directly from the issuer, the the source of the issuer information
review is relatively simple in the case of an contained in the Laser Arms
issuer that has just completed a public regulatory authorities for certain types of issuers, Memorandum. In fact, it was a fictitious
offering or an offering under Regulation A 15 e.g., financial institutions.
or that files periodic reports with the 17 See text of reproposed Rule 15c2–11(b)(3)(iv).
document prepared by a recidivist
Commission.16 In these cases, the broker- 18 17 CFR 240.10b–5.
securities law violator who was the
19 Because of recent microcap fraud cases
22 The proposed Rule will require a broker-dealer
broker-dealer is not required to affirmatively seek involving promoters, a broker-dealer should not
out information about the issuer beyond that presume a promoter is a reliable source of issuer to provide the information to another broker-dealer
specifically required by the Rule. However, if information. See SEC Charges 44 Stock Promoters upon request.
material information about the issuer comes to its in First Internet Securities Fraud Sweep, Press 23 See Bunker Securities, Inc., 48 S.E.C. 859
knowledge or possession (orally or in writing), the Release 98–117 (October 28, 1998) available at (1987), aff’d without opinion, 833 F.2d 303 (3d Cir.
broker-dealer must take that information into <http://www.sec.gov/news/press/98–117.txt>. 1987).
account in assessing whether the issuer information 20 Examples of an ‘‘independent retrieval service’’ 24 50 S.E.C. 489 (1991). The Laser Arms Report
is accurate and is from a reliable source. See would be the SEC’s Public Reference Room or a was issued pursuant to the investigative authority
footnote 35 below regarding how to obtain document retrieval service. granted to the Commission under Section 21(a) of
information about Commission trading suspensions. 21 Examples of ‘‘standard research sources’’ the Exchange Act (15 U.S.C. 78u(a)).
15 17 CFR 230.251–230.263.
include publications such as Standard & Poor’s 25 Laser Arms Report at 501, citing Securities
16 Under the reproposal, the broker-dealer can Standard Corporation Manual and Moody’s Exchange Act Release No. 34–29095 (April 17,
look to filings made with other federal or state Investors Service Manuals. 1991), 56 FR 19158 (1991 Proposing Release).
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11148 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
undisclosed principal of Laser Arms.26 must review the required information, reviewing the Rule’s required information for
The broker-dealer’s immediate source of together with any supplemental non-reporting issuers, the kinds of significant
the Laser Arms Memorandum was a information that comes to its attention, events that require a domestic reporting
trader at another broker-dealer whom he issuer to file a Form 8–K under the Exchange
and should be alert to red flags.
Act 32 also should be considered red flag
had known for less than one year, had Because documents filed with the
events.
seen on only a few occasions, and had Commission are subject to liability
Where no red flags appear during the
dealt with primarily by telephone. The provisions, a broker-dealer generally can
reach a reasonable belief as to the accuracy review of current and complete information,
broker-dealer did not review or attempt the broker-dealer would have a reasonable
of information contained in these
to determine the source of any part of documents.30 This also would be true for basis for believing that the Rule’s information
the information in the Laser Arms documents filed with financial institutions’ is accurate. At this point, the broker-dealer’s
Memorandum. Any attempt to contact regulatory authorities, which broker-dealers review ordinarily would end, i.e., the broker-
the issuer directly probably would have may obtain and review when publishing dealer would not be required to question the
quotes for the securities of certain banks, financial statements or any other information
led to the discovery that Laser Arms was
provided for in paragraph (c)(4) of the required to be obtained and reviewed. The
a shell corporation with no assets, Rule does not require the broker-dealer to
operations, or products.27 Under these reproposed Rule.
If a registration statement incorporates question any information unless the
circumstances, the Commission did not information contains apparent material
other documents by reference, the broker-
believe that this broker-dealer, or any of dealer may be required to obtain some of the discrepancies, or other information in the
the broker-dealers to subsequently incorporated documents to satisfy the Rule’s broker-dealer’s knowledge or possession (i.e.,
publish quotations, had a reasonable information gathering and review paragraph (b) [reproposed paragraph (d)]
basis for believing that the source of the requirements. It should not be necessary for information) reasonably indicates that the
Rule 15c2–11 information was the broker-dealer to be familiar with all paragraph (a) [reproposed paragraph (c)]
aspects of the filed documents. The broker- information is materially inaccurate.
reliable.28
dealer should focus on those sections that When red flags are present, the broker-
C. Document Review Obligations describe the items of information set forth in dealer’s efforts to satisfy itself with respect to
Rule 15c2–11(a)(5) [reproposed Rule 15c2– the accuracy of the information will vary
Once the broker-dealer has formed a with the circumstances and may require the
11(c)(6)], the issuer’s identified ‘‘risk
reasonable belief about the source’s factors,’’ 31 any recent material business broker-dealer to obtain additional
reliability, it should examine the combinations, such as the merger of a information or seek to verify existing
materials to make sure it has obtained reporting shell into a non-reporting company, information. If the broker-dealer is aware that
all of the information required by the and current financial information. the required issuer information is materially
Rule. This means that a broker-dealer In contrast to information from other kinds inaccurate, it may nevertheless publish
must not only review the information of issuers, non-reporting issuer information quotations without violating the Rule, as long
about the issuer of the security to be generally has not been filed with any as the broker-dealer can supplement that
regulatory authority. Thus, the broker-dealer information with additional information that
quoted but also consider any the broker-dealer reasonably believes is
cannot make any assumptions about the
supplemental information.29 The Rule accuracy of such information. Similarly, a accurate. If the immediate source of the
requires that the broker-dealer must broker-dealer cannot make any assumptions issuer information is unreliable, however, the
have a reasonable basis under the about the accuracy of information to broker-dealer should view that source with
circumstances for believing that the documents and other materials that are skepticism and attempt to obtain the Rule’s
issuer information described in submitted to the Commission by foreign information from another source. For
paragraph (a) [reproposed paragraph (c)] private issuers under Rule 12g3–2(b). example, a broker-dealer that is aware that
of the Rule, when considered in Although they are submitted to the the required issuer information is inaccurate
conjunction with the supplemental Commission, these documents are not ‘‘filed’’ could produce a written record reflecting the
and so are not subject to the liabilities that additional, corrected information or could
information described in paragraph (b) obtain other materials, such as a more recent
attach to reporting issuer information. These
[reproposed paragraph (d)] of the Rule, documents are prepared in accordance with Form 8–K,33 that would permit the broker-
is accurate in all material respects. the standards of the issuer’s home dealer to comply with the Rule. If the broker-
Unlike the duties of an underwriter in jurisdiction, not the standards set forth under dealer sees that the auditor’s report in an
a securities offering, Rule 15c2–11 the U.S. federal securities laws, and broker- issuer’s financial statements is qualified, the
ordinarily does not require a broker- dealers should independently assess the broker-dealer may need to contact the
dealer to conduct an independent accuracy of such information. Broker-dealers accountants about the basis for such
inquiry about the issuer of the security will also need to independently assess the qualification. If the broker-dealer learns that
to be quoted. A broker-dealer publishing accuracy of information filed with foreign an issuer’s control person has been convicted
securities regulatory authorities, based on of securities fraud, it should contact the
quotes for a covered OTC security may
considerations such as the disclosure and appropriate regulatory authority to ascertain
have no relationship with the issuer, the facts.34
liability standards under foreign law. In
and the Rule does not demand that the The Rule’s provisions are triggered by
broker-dealer develop one to obtain 30 See Sections 11 and 27 of the Securities Act, discrete quotation events. Once the broker-
information. However, the broker-dealer 15 U.S.C. 77k and 77x, and Sections 18 and 32 of dealer has complied with the Rule’s
the Exchange Act, 15 U.S.C. 78r and 78ff. See 1991 requirements with respect to a particular
26 The Laser Arms Memorandum misrepresented Adopting Release, 56 FR 19148, 19150 (1991). quotation event, there is no continuing duty
Laser Arms as a high technology weapons 31 If the issuer’s registration statement, pursuant to obtain and review the information. Of
manufacturer and the developer of a self-chilling to Item 401 of Regulation S–K, describes criminal course, when a quotation event occurs, e.g.,
beverage can. The memorandum also included or other disciplinary proceedings involving a the broker-dealer is publishing priced
forged certificates of incorporation, fictitious reporting issuer’s officer, director, general partner, quotations as of the annual review date
balance sheets, and auditor’s report which the promoter, or control person, this would be a red
signature of the accountant had been forged. flag. Reproposed Rule 15c2–11(c)(6)(xi) will require
27 Another broker-dealer who attempted to call 32 17 CFR 249.308.
broker-dealers to inquire about these types of
Laser Arms learned there was no telephone listing 33 27 CFR 249.308.
criminal or other disciplinary proceedings
for the company. This broker-dealer nevertheless involving a non-reporting issuer’s office, director, 34 Even thought he criminal and securities law
initiated a market in Laser Arms’ securities. general partner, promoter, or control person. Under violations specified in reproposed paragraph
28 See also Bunker Securities, Inc., 48 S.E.C. 859 the current Rule, however, a broker-dealer’s (c)(6)(xi) are not specified in paragraph (a)(5) of the
(1987, aff’d without opinion, 833 F.2d 303 (3d Cir. knowledge of criminal or other disciplinary current Rule, a broker-dealer’s knowledge of such
1987). proceedings involving a reporting or non-reporting information would be material adverse information
29 See footnote 14 above for a definition of issuer’s officer, director, general partner, promoter, under the current rule, and such violations would
supplemental information. or control person would be a red flag. be a red flag.
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11149
required by the reproposed Rule, it must obtaining verification of information may include seeking verification from the
conduct a review of current issuer provided by the issuer. The broker-dealer issuer or soliciting the views of an
information. In this case, the review process may need to seek an opinion of an independent professional.
would be the same as described above. independent accountant or attorney to form 2. Foreign Trading Suspensions. A trading
However, the review process should be a reasonable basis to believe that the Rule’s suspension by a foreign regulator may
somewhat simpler because the broker-dealer information is accurate and from a reliable indicate that the issuer information is
would already have gained some familiarity source. In one enforcement action, a broker-
with the issuer as a result of its prior review. unreliable or inaccurate. However, a trading
dealer unreasonably relied on pre-suspension
financial statements when the Commission’s suspension in a foreign market may be
D. Scope of Review Following a Trading imposed simply because the issuer failed to
trading suspension was based upon a lack of
Suspension meet exchange listing standards. If the
accurate financial information and the
A Commission trading suspension is a issuer’s auditors indicated to the broker- broker-dealer learns of a foreign trading
material event affecting the market for an dealer that they were having problems suspension, it should attempt to determine
issuer’s securities.35 After the termination of verifying the issuer’s financial information.38 the basis for the suspension order and assess
a trading suspension, a broker-dealer may not A broker-dealer may have difficulty whether the issuer information is still
enter a quotation unless and until it has obtaining the necessary information about an accurate and whether its source is still
strictly complied with all the provisions of issuer after the expiration of a trading reliable.
the Rule. Before initiating or resuming a suspension. This difficulty, however, does 3. Concentration of ownership of the
quotation for securities subject to Rule 15c2– not relieve the broker-dealer of its
11, the broker-dealer must conduct a careful majority of outstanding, freely tradeable
responsibilities under the Rule. If any broker- stock. Concentration of ownership of freely
review in a professional manner of the basis dealer is uncertain as to what is required by
for the trading suspension to determine tradeable securities is a prominent feature of
the Rule, it should refrain from entering
whether there is a reasonable basis for the quotations relating to the securities in microcap fraud cases. When one person or
broker-dealer to believe that the information question until the Rule’s provisions have group controls the flow of freely tradeable
about the issuer is accurate and current. The been met. securities, this person or persons can have a
broker-dealer may be unable to reach a much greater ability to manipulate the stock’s
reasonable basis for relying on the questioned IV. Examples of Red Flags price than when the securities are widely
financial statements in the Commission’s If the broker-dealer discovers at any stage held. In a ‘‘pump and dump’’ scheme, retail
order even if the information otherwise of the review process any red flags in the interest is stimulated, and the price of the
satisfies the Rule’s presumption of ‘‘current’’ issuer information (whether the issuer is a securities is manipulated upward, at the
information.36 This presumption is obviated reporting or non-reporting company), it
if the broker-dealer has information to the behest or under the control of the
cannot publish a quote unless and until those manipulators who control much of the stock.
contrary.37 red flags are reasonably addressed. Material
The broker-dealer must also check the Often, other broker-dealers that are not
inconsistencies in the paragraph (a)
reliability of the source of the information, intentionally participating in improper
[reproposed paragraph (c)] information, or
particularly when the same source is material inconsistencies between that activities publish quotations in response to
providing updated information. If the broker- information and the paragraph (b) escalating demand for the security resulting
dealer seeks assurances or additional [reproposed paragraph (d)] information, are from increasing retail sales. The promoters of
information from the source (in most cases, red flags. We have set out below examples of these companies, company insiders, and
the issuer) about the matters cited in the red flags that we have noticed in microcap unscrupulous brokers make substantial
Commission trading suspension order, great profits when they sell their shares at inflated
fraud cases or in Rule 15c2–11 submissions
caution should be used before relying on the
made to the NASD. These examples, prices. When the scheme is over, the
statements or assurances from the issuer. The
however, are not comprehensive, as red flags security’s price plummets, and innocent
broker-dealer may have to test the accuracy
depend on the facts and circumstances of investors who paid a premium price are left
of the information or the source’s reliability
by conducting an independent review or each case. holding worthless shares.39
We are providing examples of red flags that 4. Large reverse stock splits. Microcap
35 See Section 12(k) of the Exchange Act.
require additional scrutiny by the broker- fraud schemes can involve the substantial
dealer to comply with Rule 15c2–11. These concentration of the publicly-traded float
Information regarding recent trading suspension
orders can be obtained by calling 800–SEC–0330. examples, however, are not exhaustive.
through a reverse stock split. The subsequent
The broker-dealer must obtain a copy of the trading Conversely, the presence of these or other red
flags is not necessarily an indication of issuance of large amounts of stock to insiders
suspension order or a copy of the Commission
release announcing the trading suspension. Copies microcap fraud or even inaccurate issuer increases their control over both the issuer
of Commission releases may be obtained through information. The red flag simply means that and trading of the stock.40
our Internet website at <http://www.sec.gov/ the broker-dealer should question whether 5. Companies in which assets are large and
enforce/tsuspend.htm> or from the Commission’s the issuer information is accurate, and in revenue is minimal without any explanation.
Public Reference Room in Washington, D.C. and in A red flag exists when the issuer assigns a
certain cases, from a reliable source. The
regional Commission offices. Also, Commission
releases are available form information databases more red flags that are present, the more a high value on its financial statements to
(e.g., LEXIS), and also are published in the SEC broker-dealer should scrutinize the issuer
Docket, which is available from publication services information. 39 See New Allied Development Corporation,
(e.g., Commerce Clearing House, Inc.). 1. Commission Trading Suspensions. As Securities Exchange Act Release No. 37990
36 The reproposal contains a presumption that the indicated above, Commission trading (November 26, 1996)(New Allied’s control persons
financial information of both reporting issuers and suspension orders generally raise significant had substantial stock interest in nominee accounts);
domestic and foreign non-reporting issuers is red flags as to whether the Rule 15c2–11 Douglass and Co., Inc., 46 S.E.C. 1189 (1978);
current if it is less than 15 months old. However, Gotham Securities Corporation, 46 S.E.C. 723
information is accurate and whether its
if the broker-dealer has other information that (1976). Paragraph (c)(6)(x) of the reproposed Rule
source is reliable. Broker-dealers publishing will require disclosure of the beneficial ownership
indicates that the issuer’s financial condition has
materially changed from that shown in the financial quotes once a trading suspension terminates of the issuer’s stock by its executive officers,
statements, this presumption may not apply, and must satisfy the Rule’s requirements, which directors, general partners, promoters, or control
the broker-dealer should determine whether more persons.
recent financial information is available. Financial 38 Robin Rushing and Harold Gallison, Jr., 40 Emshwiller, ‘‘Reverse Stock Splits At Many
information older than 15 months is not current and Securities Exchange Act Release No. 36910 Firms Spark Outcry.’’ The Wall Street Journal,
does not satisfy the Rule’s requirements. (February 29, 1996); see also Bagle Securities, Inc., November 20, 1998, at Cl; SEC v. Magna
37 General Bond & Share Co., 51 S.E.C. 411 (1993) Securities Exchange Act Release No. 27673 Technologies, Inc., Litigation Release No. 12227
(Commission opinion), rev’d on other grounds, (February 5, 1990); William V. Frankel & Company, (August 21, 1989) (insiders of Magna effected a 4-
General Bond & Share Co. v. SEC, 39 F.3d 1451 Securities Exchange Act Release No. 27649 (January for-1 reverse stock split, concentrated ownership in
(10th Cir. 1994); See also Robin Rushing and Harold 26, 1990); Richfield Securities, Inc., Securities themselves, and then manipulated the price of
Gallison, Jr., Securities Exchange Act Release No. Exchange Act Release No. 26129 (September 29, Magna’s stock by disseminating false and
36910 (February 29, 1996). 1988). misleading information).
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11150 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
certain assets that are often unrelated to the Rule 504 of Regulation D allows non- microcap fraud cases, the issuer’s financial
company’s business and were recently reporting companies to raise up to $1 million statements often indicate that the issuer
acquired in a non-cash transaction. In this per year in ‘‘seed capital’’ without complying acquired assets to which it assigned
situation, the company’s revenues often are with Securities Act registration requirements. substantial value in exchange for its
minimal and there appears to be no valid The freely tradable nature of securities issued essentially worthless stock.49
explanation for such large assets and in Rule 504 offerings has facilitated a number 12. Significant write-up of assets in a
minimal revenues.41 of fraudulent schemes through the OTC business combination of entities under
Also, a red flag is present when the Bulletin Board Display Service (OTC Bulletin common control.
financial statements of a development stage Board) or the Pink Sheets published by the Those persons engaged in microcap fraud
issuer list as the principal component of the National Quotation Bureau, Inc. (NQB).45 often use a business combination such as a
issuer’s net worth an asset wholly unrelated Broker-dealers should be alert to information merger as an opportunity to falsify financial
to the issuer’s line of business. For example, in the Rule 15c2–11 materials where an statements.50 We have seen microcap fraud
from a review of Rule 15c2–11 submissions, active trading market is being promoted for schemes in which unscrupulous issuers use
art collections or other collectibles that are securities issued solely in a Rule 504 purchase method accounting 51 to write up
unrelated to the issuer’s business apparently transaction. the historical value of an asset to an
have been overvalued on the financial 8. A registered or unregistered offering artificially high value in situations when the
statements of some issuers.42 While assets raises proceeds that are used to repay a entities involved in the business combination
that are unrelated to the business of the bridge loan made or arranged by the are under common control or otherwise have
issuer are not always an indication of underwriter where: a high degree of common ownership. For
potential microcap fraud, some unscrupulous • The bridge loan was made at a high example, Generally Accepted Accounting
issuers have overvalued these types of assets interest rate for a short period; Principles (GAAP) requires that the
in an effort to inflate their balance sheets. • The underwriter received securities at acquisition of one entity by another entity be
6. Shell corporation’s acquisition of private below-market rates prior to the offering; and accounted for at historical cost in a manner
company. A shell corporation is • The issuer has no apparent business similar to that in ‘‘pooling of interests’’
characterized by no business operations and purpose for the bridge loan. accounting when these entities are under
little or no assets. In a fraud scheme, a Broker-dealers have given small issuers common control.52
reporting company with a large number of bridge loans at a high interest rate for a short 13. Unusual auditing issues.
shares controlled by one person or a small time period.46 In exchange for this bridge • Auditors refuse to certify financial
number of persons often merges with a non- loan, the broker-dealer receives a significant statements or they issue a qualified opinion;
reporting company having some business number of shares of the issuer’s common or
operations. The new public company is then stock at a price that is substantially below • There has been a change of
used as the vehicle for ‘‘pump and dump’’ market rates. The broker-dealer then engages accountants.53
and other fraudulent schemes. Broker-dealers in a scheme to manipulate the stock’s price
placing quotes for these issuers’ securities and ultimately benefits when it dumps the 49 See New Allied Development Corporation,
should be mindful of the potential for stock at an artificially high price.47 Securities Exchange Act Release No. 37990
abuse.43 9. Significant write-up of assets upon a (November 26, 1996) (the respondents obtained new
company obtaining a patent or trademark for Allied, a public shell, which was a dormant
7. Offerings under Rule 504 of Regulation
a product. The significant write-up of assets uranium mining company with no assets, in a
D where one or more of the following factors transaction which resulted in insiders controlling
are present: upon the issuer’s obtaining a patent or
52.4% of New Allied’s stock; New Allied then
• Little capital is raised in the Rule 504 trademark for a product is a technique used
acquired an interest in real estate associated with
offering and there appears to be no business by issuers engaged in microcap fraud to worthless gambling concerns in exchange for New
purpose except to provide some shareholders inflate their balance sheets.48 Allied stock); Douglass and Co., Inc., 46 S.E.C. 1189
with free-trading shares; 10. Significant asset consists of OTC (1978).
• The Rule 504 offering is preceded by an Bulletin Board or Pink Sheet companies. We 50 See New Allied Development corporation,
unregistered offering to insiders or others for have noticed that some microcap fraud Securities Exchange Act Release No. 37990
services rendered at prices well below the schemes involve issuers whose major assets (November 26, 1996) (the respondents disseminated
are substantial amounts of shares in other materially false documents to market makers,
price in the subsequent offering; including unaudit financial statements, that valued
• Sales immediately following the Rule OTC Bulletin Board or Pink Sheet
companies. new Allied’s medical and consumer products at
504 offering are at substantially higher prices $2,150,000 although their historical costs were
than those paid in the Rule 504 offering; or 11. Assets acquired for shares of stock
approximately $17,000); A.J. Carno Co., 1976 SEC
when the stock has no market value. In
• A shell company and an operating LEXIS 2764 (February 23, 1976) (Initial Decision),
company merge, which results in the order dismissing proceeding and withdrawing
45 See Securities Act Release No. 33–7644 broker-dealer registration, Securities Exchange Act
operating entity becoming the surviving
(February 19, 1999) in which we adopted Release No. 14647 (April 10, 1978) (Management
entity. The surviving entity goes ‘‘public’’ by
amendments to Rule 504 of Regulation D that limit Dynamics, Inc.’s (MD) founding officer and director
issuing shares pursuant to Rule 504.44 the circumstances where general solicitation is wrote MD shareholders to recommend the
permitted and ‘‘freely tradeable’’ securities may be acquisition of the assets of a real estate developer.
41 New Allied Development Corporation, issued in reliance on Rule 504 to transactions (1) Press releases and shareholder letters reinforced the
Securities Exchange Act Release No. 37990 registered under state law requiring public filing misleading impression that the transaction was
(November 26, 1996). and delivery of a disclosure document to investors certain to generate substantial income for MD).
42 See In the Matter of Rom N. De Guzman, before sale, or (2) exempted under state law 51 When two companies merge, compliance with
Securities Exchange Act Release No. 37747 permitting general solicitation and general Generally Accepted Accounting Principles requires
(September 30, 1996). advertising so long as sales are made only to that the combination be accounted for as either the
43 See New Allied Development Corporation, ‘‘accredited investors.’’ ‘‘pooling method’’ or ‘‘purchase method.’’ With the
46 Emshwiller, ‘‘NASD Quietly Takes Aim at IPO pooing method, the historical costs of the two
Securities Exchange Act Release No. 37990
(November 26, 1996); Stylex Homes, Inc., Securities Bridge-Loan Trend,’’ The Wall Street Journal, companies are added together. With purchase
Exchange Act Release No. 36299 (September 29, January 20, 1998, at Cl. method accounting, the company being acquired
1995); Bunker Securities, Inc., 48 S.E.C. 859 (1987), 47 See Memory Metals, Inc., Securities Act Release writes up its assets to fair market value, which
aff’d without opinion, 833 F. 2d 303 (3d Cir. 1987); No. 6820 (February 22, 1989). generally are greater than the historical costs.
Butcher & Singer, Inc., 48 S.E.C,. 640, aff’d without 48 New Allied Development corporation, 52 Ronald Effren, Securities Act Release No.
opinion, 833 F. 2d 303 (ed Cir. 1987); Douglass and Securities Exchange Act Release No. 37990 7256, Securities Exchange Act Release No. 36713
Co., Inc., 46 S.E.C. 1189 (1978); A.J. Carno Co., 1976 (November 26, 1996); see also Frederick R. Grant, (January 16, 1996); see also Martin Halpern,
SEC LEXIS 2764 (February 23, 1976) (initial Securities Exchange Release No. 38239 (February 5, Securities Exchange Act Release No. 34727
decision), order dismissing proceeding and 1997); Atlantis Group, Inc., securities Exchange Act (September 27, 1994).
withdrawing broker-dealer registration, Securities Release No. 37932 (November 8, 1996); Eli 53 See Securities Exchange Act Form 8–K, Item
Exchange Act Release No. 14647 (April 10, 1978); Buchalter, Securities Exchange Act Release No. 4; Merle S. Finkel, Securities Act Release No. 7401
Gotham Securities Corporation, 46 S.E.C. 723 37702 (September 19, 1996); Milton Mermelstein, (March 12, 1997) (original auditors notified systems
(1976). Securities Exchange Act Release No. 37222 (May of Excellence that purported registration statement
44 See example ι6, above. 16, 1996). on Form S–8 had not been filed and that other
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11151
Rule 15c2–11 does not contemplate that an arbitrary one designed to make assets and promoter, or control person’s involvement in
the broker-dealer scrutinize the issuer’s liabilities balance out.57 any type of business, securities,
financial statements with the expertise of an In addition, issuer information that is commodities, or banking activities;
accountant. The above red flags, however, do altered on its face raises red flags that, at a • Adjudication by civil court of competent
not require an expertise in accounting minimum, require the broker-dealer to jurisdiction, the Commission, the Commodity
matters and have appeared in several contact the issuer.58 Futures Trading Commission or a state
microcap fraud schemes. In one case, the 16. Broker-dealer receives substantially securities regulator to have violated federal
respondents stated in the Form 211 similar offering documents from different or state securities or commodities law; or
submissions to the NASD that they relied on issuers with the following characteristics: • Order by a self-regulatory organization
audited financial statements. However, the • The same attorney is involved; permanently or temporarily barring,
auditors orally advised the associated • The same officers and directors are suspending or otherwise limiting
persons of the broker-dealer before they listed; and/or involvement in any type of business or
submitted the Form 211 that the auditor’s • The same shareholders are listed. securities activities.62
opinion attached to the pro forma financial It is not uncommon for the same Many microcap fraud cases involve
statement was qualified because of the individuals to be involved in multiple recidivist securities law violators.63 If a
auditor’s inability to verify the issuer’s microcap frauds. If a broker-dealer realizes broker-dealer has information or could
after reviewing the information for several
financial information.54 reasonably discover information about the
issuers that the same individuals are
An accountant’s resignation or dismissal is above types of violations, it should question
involved with these entities, the broker-
a characteristic found in some microcap whether it has a reasonable basis to believe
dealer should make further inquiries to
fraud cases. If a broker-dealer sees any of that the issuer’s information is accurate and
determine whether it has a reasonable basis
these red flags, it should confirm the complete in these circumstances.
to believe that the issuer information is
auditor’s credentials with the appropriate accurate. 20. Significant events involving an issuer
state licensing authority, question the 17. Extraordinary gains in year-to-year or its predecessor, or any of its majority
circumstances of the change in accountants, operations. In microcap fraud cases, the owned subsidiaries.
and carefully scrutinize the Rule’s required issuer may show extraordinary gains in its The following types of significant events
information. year-to-year operations. This may be should prompt further investigation by a
14. Extraordinary items in notes to the accomplished through assigning an broker-dealer:
financial statements, e.g., unusual related artificially high value to certain assets or • Change in control of the issuer; 64
party transactions. Unusual related party through other manipulative devices that are • Substantial increase in equity securities;
transactions are sometimes found in red flags, such as the significant write-up of • Merger, acquisition, or business
microcap fraud schemes. For example, an assets upon merger or acquisition.59 combination;
issuer’s financial statements may show a 18. Reporting company fails to file an • Acquisition or disposition of significant
related party transaction between two annual report. The fact that a reporting assets; 65
companies, which later merge and inflate the company has not filed an annual report Bankruptcy proceedings; 66 or
worth of their assets by using purchase suggests that there is a potential problem Delisting from any securities exchange or
method accounting.55 with the company.60 the Nasdaq Stock Market.67
15. Suspicious documents. 19. Disciplinary actions against an issuer’s While not necessarily problematic, these
• Inconsistent financial statements; officers, directors, general partners, are material events involving the issuer. The
• Altered financial statements; or promoters, or control persons. change in control of the issuer, merger,
• Altered certificates of incorporation. The following types of disciplinary actions acquisition, or business combination,
Altered or facially inconsistent issuer should trigger further investigation by a acquisition or disposition of significant assets
documents have been present in various broker-dealer: can provide unscrupulous issuers an
microcap fraud schemes. For example, • Indictment or conviction in a criminal opportunity to artificially overvalue the
Polaris Mining Co. was a shell corporation proceeding; 61 issuer’s assets to support an upward
with no meaningful assets and no trading • Order permanently or temporarily manipulation of the issuer’s worthless
market for its stock.56 Douglass and Co., Inc., enjoining, barring, suspending or otherwise
a broker-dealer, published quotations for limiting an officer, director, general partner, 62 The reproposed text of Rule 15c2–
Polaris in the Pink Sheets in violation of Rule 11(c)(6)(xi)(A)(2) requires the broker-dealer to
15c2–11 because the Polaris financial 57 See also Butcher & Singer, Inc., 48 S.E.C. 640, review these factors for non-reporting issuers.
information upon which Douglass and Co., aff’d without opinion, 833 F.2d 303 (3d Cir. 1987) Otherwise, under the reproposed text of Rule 15c2–
Inc. relied was deficient and contradictory on (a salesman and later an officer of Butcher & Singer 11(c)(6)(xi)(B) or (C), the broker-dealer must obtain
its face: two balance sheets for the same years apparently obtained some blank stock certificates a statement from the issuer that none of these
contained blatant disparities. Both balance and forged former officers’ signatures as well as the events has occurred or must record the steps taken
certificates’ amounts and purported dates of to obtain this information and that the issuer
sheets valued certain mined but unprocessed refused or failed to provide it. Even though the
issuance to himself and his family members; the
ores at the estimated eventual selling price broker-dealer, Butcher & Singer, failed to review the current Rule does not require the broker-dealer to
even though significant processing work Rule’s required information; Butcher & Singer might obtain and review this information, we consider
remained to be done. One statement did not have noticed red flags that would have led to the such information to be red flags under the Rule if
list property location. One statement had an discovery of the underlying fraud if it had reviewed it comes to the broker-dealer’s attention.
item for capitalized expenses and the other the Rule’s required information). 63 See SEC v. I-Net Providers, Litigation Release
statement for the same year did not. The 5 See United States v. Marshall Zolp, Litigation No. 15219 (January 17, 1997); New Allied
former statement showed no retained Release Nos. 11494 (July 23, 1987) and 11236 Development Corporation, Securities Exchange Act
earnings or accumulated deficit, suggesting (October 2, 1986)(fictitious certificates of Release No. 37990 (November 26, 1996).
that the figure for capitalized expenses was incorporation and fictitious financial statements on 64 See Exchange Act Form 8–K, Item 1.
which the name of another company had been 65 See Exchange Act Form 8–K, Item 2.
whited out and the name of Laser Arms filled in). 66 See Exchange Act Form 8–K, Item 3.
irregularities exist in connection with issuance of 59 See, e.g., A. J. Carno Co., 1976 SEC LEXIS 2764 67 The proposed text of Rule 15c2–11(c)(6)(xii)(A)
this stock; thereafter, Systems of Excellence (February 23, 1976)(Initial Decision), order requires the broker-dealer to review these factors.
retained new auditor who issued materially false or dismissing proceedings and withdrawing broker- Otherwise, under the proposed text of Rule 15c2–
inaccurate audit reports. dealer registration, Securities Exchange Act Release 11(c)(6)(xii)(B) or (C), the broker-dealer must obtain
54 See Robin Rushing and Harold Gallison, Jr., No. 14647 (April 10, 1978). a statement from the issuer that none of these
Securities Exchange Act Release No. 36910 60 See Combined Companies International Corp.,
events has occurred or must record the steps taken
(February 29, 1996). In this case, the SEC also had Securities Exchange Act Release No. 38653 (May to obtain this information and that the issuer
entered a trading suspension for lack of accurate 19, 1997); Robin Rushing and Harold Gallison, Jr., refused or failed to provide it. Even though the
financial information. Securities Exchange Act Release No. 36910 current Rule does not require the broker-dealer to
55 See Ronald Effren, Securities Exchange Act (February 29, 1996). obtain and review this information, we consider
Release No. 36713 (January 16, 1996). 61 Stylex Homes, Inc., Securities Exchange Act such information to be red flags under the Rule if
56 Douglass and Co., Inc., 46 S.E.C. 1189 (1978). Release No. 36299 (September 29, 1995). it comes to the broker-dealer’s attention.
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11152 Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules
stock.68 An increase in the issuer’s equity 23. Regulation S transactions of domestic ‘‘employees’’ who act as conduits by selling
securities provides the securities necessary issuers. Regulation S 75 provides a safe harbor the securities to the public and remitting the
for such manipulation. Bankruptcy from the registration requirements of the proceeds (or their economic benefit) to the
proceedings or a delisting from an exchange Securities Act of 1933 for offers and sales of issuer.81 This public sale of securities by the
or the Nasdaq Stock Market may also indicate securities by both foreign and domestic issuer has not been registered, although the
problems with an issuer that could lead the issuers that are made outside the United Securities Act requires registration. The
broker-dealer to conclude that it does not States. We recently adopted amendments to failure to register this sale of securities
have a reasonable basis to believe that the Regulation S that are designed to prevent the deprives public investors of the protections
issuer’s financial information is accurate.69 abuses that relate to offshore offerings of afforded by the Securities Act.
21. Request to publish both bid and ask equity securities of domestic issuers.76 Prior To prevent these abuses, Form S–8 and
quotes on behalf of a customer for the same to the recent amendments, Regulation S related rules impose certain restrictions on
stock. The highly unusual request from a transactions involving large amounts of the the use of the form for the sale of securities
customer for the broker-dealer to publish securities of U.S. issuers were particularly to certain consultants and advisors.82 We are
both bid and ask quotes is a red flag ‘‘that vulnerable to fraud and manipulation.77 The also proposing additional amendments to
calls for appropriate inquiry on [the broker- perpetrators of the fraud sold the securities Form S–8.83 Although these amendments
dealer’s] part.’’ 70 to U.S. investors after the 40-day holding should deter microcap abuses, broker-dealers
22. Issuer or promoter offers to pay a ‘‘due period expired, and little information was nevertheless should be aware of the prior
diligence’’ fee. If a market maker receives an available to investors about the issuers. abuses of Form S–8 in microcap fraud cases.
offer from an issuer to pay a ‘‘due diligence’’ Under the amendments, equity securities 25. ‘‘Hot industry’’ microcap stocks.
fee in connection with making a market in of U.S. issuers that are sold offshore under Another characteristic of microcap fraud
the issuer’s security, this is not solely a red Regulation S are classified as ‘‘restricted cases is that they often involve stocks that are
flag.71 It is a violation of NASD Rule 2460 for securities’’ within the meaning of Rule 144 in vogue.84 In the past, oil and gas ventures
the broker-dealer to accept this offer.72 If the under the Securities Act, and the period and mining operations, as well as stocks of
broker-dealer receives any consideration in during which these securities cannot be issuers with purportedly innovative
connection with publishing a quotation, the distributed in the United States is lengthened products, have been popular in frauds
reproposed Rule requires the broker-dealer to from 40 days to one year. These amendments involving low-priced stocks.
disclose any such compensation, as well as make Regulation S abuses less likely, but 26. Unusual activity in brokerage accounts
any other significant relationship information broker-dealers should be alert to any of issuer affiliates, especially involving
between the issuer and the broker-dealer questionable activities once the one-year ‘‘related’’ shareholders. Many microcap
publishing the quotation or any of its holding period expires. frauds begin with the deposit and sale of
associated persons.73 In Douglass and Co., 24. Form S–8 stock. Form S–8 is the short- large blocks of an obscure stock by a new and
Inc., a registered representative said he form registration statement for offers and unfamiliar customer who often is affiliated
would try to get the broker-dealer to initiate sales of a company’s securities to its with an issuer.85 At the same time, the
a market in the stock of Polaris Mining Co., employees, including consultants and broker-dealer is encouraged to make a market
but that it would cost the issuer about $1,500 advisors.78 The form has been abused by in the stock by the issuer.
to cover ‘‘expenses.’’ The registered unscrupulous issuers to register on Form S– 27. Companies that frequently change
representative later agreed to accept Polaris 8 securities nominally offered and sold to names. Frequent name changes are another
stock (some of which he kept himself) employees or, more commonly, to so-called
instead of the $1,500.74 characteristic that we have seen in microcap
consultants and advisors. These persons then fraud cases. For example, Twenty First
resell the securities in the public markets, at Century Health (TFCH) was originally a
68 See New Allied Development Corporation,
the direction of the issuer or a promoter.79 In company called Big Valley Energy, Inc. Big
Securities Exchange Act Release No. 37990 a typical pattern, an issuer registers on Form
(November 26, 1996); A. J. Carno Co., 1976 SEC Valley then changed its name to Biotronic
S–8 securities underlying options issued to Energy Engineering, Inc., then to The
LEXIS 2764 (February 23, 1976)(Initial Decision),
order dismissing proceedings and withdrawing so-called consultants where, by Sonoron Group, then to Zorro International,
broker-dealer registration, Securities Exchange Act prearrangement, the issuer directs the Inc., then to Health & Wealth, Inc., and
Release No. 14647 (April 10, 1978); see also Bion consultants’ exercise of the options and finally became TFCH in 1995. At the
Environmental Technologies, Inc., Securities resale of the underlying securities in the promoter’s request, TFCH issued false
Exchange Act Release No. 36111 (August 16, 1995). public market. The consultants then either
69 See B.J. Thomas, Securities Exchange Act
audited financial statements that recorded
remit to the issuer the proceeds from the sale material, nonexistent assets.86
Release No. 38727 (June 10, 1997); SEC v. Magna of the underlying shares, or apply the
Technologies, Inc., Litigation Release No. 12227 28. Companies that frequently change their
proceeds to pay debts of the issuer that are line of business. Besides companies that
(August 21, 1989); see e.g., Milton Mermelstein,
Securities Exchange Act Release No. 37222 (May not related to any services provided by the frequently change their names, we also see
16, 1996). consultants.80 In some cases, these
70 Alessandrini & Co., Inc., 45 S.E.C. 399 (1971), consultants perform little or no other service 81 See S.E.C. v. Charles O. Huttoe, Litigation
citing D.H. Blair & Co., 44 S.E.C. 320 (1970). for the issuer. In other microcap frauds, the
Release Nos. 15153 (November 7, 1996); 15185
71 Butcher & Singer, Inc., 48 SEC 640, aff’d issuer uses Form S–8 to sell securities to (December 12, 1996)(unregistered public offering
without opinion, 833 F.2d 303 (3d Cir. 1987)(a purporting to use Form S–8).
salesman received 400,000 shares of an obscure 75 17 CFR 230.901–230.905 and Preliminary 82 Securities Act Release No. 33–7646 (February
penny stock for helping to develop and maintain a Notes. 19, 1999).
market in the stock); see Brent Duane Green, 76 Securities Act Release No. 7505 (February 17, 83 Securities Act Release No. 33–7647 (February
Securities Exchange Act Release No. 39210 (October
7, 1997); Steven Ira Wertman, Securities Exchange 1998), 63 FR 9632. We also adopted amendments 19, 1999).
Act Release No. 38751 (June 20, 1997); Christopher that would affect applicable reporting requirements 84 See Douglass and Co., Inc., 46 S.E.C. 1189
D. Jennings, Securities Exchange Act Release No. along with other amendments intended to prevent (1978) (November 26, 1996)(mining operation); see
38696 (May 30, 1997). abuses of Regulation S. Since January 1, 1999, also S.E.C. v. Bradley J. Simmons and American
72 NASD Rule 2460, Payments for Market Making, Regulation S transactions are required to be Energy Group, Ltd, Litigation Release No. 15353
prohibits any payment by an issuer or the issuer’s reported quarterly on Forms 10–Q and 10–K. (April 29, 1997)(oil and gas company).
77 See Frederick R. Grant, Securities Exchange 85 Laser Arms Report, 50 S.E.C. 489, 503; see also
affiliates and promoters, directly or indirectly, to a
member for publishing a quotation, acting as a Release No. 38239 (February 5, 1997); S.E.C. v. Butcher & Singer, Inc., 48 S.E.C. 640, aff’d without
market maker, or submitting an application. Enviromint Holdings, Inc., Litigation Release No. opinion, 833 F.2d 303 (3d Cir. 1987); Gotham
73 See reproposed Rule 15c2–11(e); see also 14683 (October 6, 1995). Securities Corporation, 46 S.E.C. 723 (1976) (the
78 Form S–8 under the Securities Act of 1933 (15
current Rule 15c2–11(a)(5)(xvi). family of the broker-dealer’s principal owned a
74 Douglass and Co., Inc., 46 S.E.C. 1189 (1978); U.S.C. 77a et seq.). significant amount of the stock of Marcon
79 See S.E.C. v. Enviromint Holdings, Inc., Electronics Corp., which was a shell corporation
see also See Robin Rushing and Harold Gallison, Jr.,
Securities Exchange Act Release No. 36910 Litigation Release No. 14683 (October 6, 1995). with no assets; the family benefited when the
(February 29, 1996); General Bond & Share Co., 51 80 See, e.g., Spectrum Information Technologies, broker-dealer manipulated upward the price of the
S.E.C. 411 (1993)(Commission opinion), rev’d on Inc., Securities Act Release No. 7426 (June 25, Marcon stock).
other grounds, General Bond & Share Co. v. SEC, 1997); SEC v. Hollywood Trenz, Inc., Litigation 86 Merle S. Finkel, Securities Act Release No.
39 F.3d 1451 (10th Cir. 1994). Release No. 15730. 7401 (March 12, 1997).
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Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Proposed Rules 11153
companies that frequently change their line a dormant public shell with no assets.87 New stock. Next, New Allied became a vehicle to
of business in microcap fraud cases. For Allied then acquired the rights to medical enter the gaming business purportedly to
example, New Allied Development started products in exchange for its overvalued build a casino.
out as a uranium mining company that was
87 New Allied Development Corporation, [FR Doc. 99–5299 Filed 3–5–99; 8:45 am]
Securities Exchange Act Release No. 37990 BILLING CODE 8010–01–P
(November 26, 1996).