SEC Adopts Final Amendments to Rule 15C2-11; Attorney Laura Anthony Sees Changes for OTC Companies

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Oct 15, 2020, 08:31 ET

WEST PALM BEACH, Fla., Oct. 15, 2020 /PRNewswire/ -- Despite an unusual abundance of comments and pushback, on September 16, 2020, one year after issuing proposed rules, the SEC has adopted final rules amending Securities Exchange Act ("Exchange Act") Rule 15c2-11. The primary purpose of the rule amendment is to enhance retail protection where there is little or no current and publicly available information about a company and as such, it is difficult for an investor or other market participant to evaluate the company and the risks involved in purchasing or selling its securities. The SEC believes the final amendments will preserve the integrity of the OTC market, and promote capital formation for issuers that provide current and publicly available information to investors.

From a high level, the amended rule will require that a company have current and publicly available information as a precondition for a broker-dealer to either initiate or continue to quote its securities; will narrow reliance on certain of the rules exceptions, including the piggyback exception; will add new exceptions for lower risk securities; and add the ability of OTC Markets itself to confirm that the requirements of Rule 15c2-11 or an exception have been met, and allow for broker-dealer to rely on that confirmation. Importantly, the new rule will not require OTC Markets to submit a Form 211 application or otherwise have FINRA review its determination that a broker-dealer can quote a security, prior to the quotation by a broker-dealer.

The final rule release contains an in-depth discussion of the numerous comments received (I was one of the many comment writers), especially related to the piggyback exception. As part of the comment process, the OTC Markets, and many of its supporters, suggested the creation of a new "expert market" which would allow the trading of securities with no or limited information, by institutions and other qualified individual traders. In rejecting the proposal, the SEC indicated that there was not enough detail and information around how such a market would operate, but that it was open to considering such a segregated expert qualified marketplace in the future following the appropriate groundwork.

The final rules entail a complete overhaul of the current rule structure and, as such, will require the development of a new infrastructure, compliance procedures and written supervisory procedures at OTC Markets, new compliance procedures and written supervisory procedures at broker-dealers that quote OTC Markets securities, and similar changes within FINRA to adapt to and accommodate the new system. I expect a period of somewhat chaos in the beginning with rapid execution adjustments to work out the kinks.

The final rule release contains a section on guidance related to the rules implementation and use. The guidance includes information on determining the reliability of information sources, conducting information reviews, and red flags that may heighten a review requirement.

The effective date of the rule is 60 days following publication in the federal register. The rule will be published any day now. Compliance with the majority of the rule is required nine months after the effective date. However, compliance with the provision requiring a catch-all category of company to have current information for the preceding two years in order to qualify for the piggyback exception is not until two years from the effective date. As discussed more fully below, a catch-all company is generally an alternatively reporting company on OTC Markets.

Background

Rule 15c2-11 was enacted in 1971 to ensure that proper information was available to a broker and its clients prior to quoting a security in an effort to prevent micro-cap fraud. The last substantive amendment was in 1991. At the time of enactment of the rule, the Internet was not available for access to information. In reality, a broker-dealer never provides the information to investors, FINRA does not make or require the information to be made public, and the broker-dealer never updates information, even after years and years. Since the enactment of the rules, the Internet has created a whole new disclosure possibility and OTC Markets itself has enacted disclosure requirements, processes and procedures. The current system does not satisfy the intended goals or legislative intent and is unnecessarily cumbersome at the beginning of a company's quotation life with no follow-through.

I've written about 15c2-11 many times, including HERE and HERE. In the former blog I discussed OTC Markets' comment letter to FINRA related to Rule 6432 and the operation of 15c2-11. FINRA Rule 6432 requires that all broker-dealers have and maintain certain information on a non-exchange-traded company security prior to resuming or initiating a quotation of that security. Generally, a non-exchange-traded security is quoted on the OTC Markets. Compliance with the rule is demonstrated by filing a Form 211 with FINRA.

The specific information required to be maintained by the broker-dealer when it initiates a quotation is delineated in Exchange Act Rule 15c2-11. The core principle behind Rule 15c2-11 is that adequate current information be available when a security enters the marketplace. The information required by the Rule includes either: (i) a prospectus filed under the Securities Act of 1933, such as a Form S-1, which went effective less than 90 days prior; (ii) a qualified Regulation A offering circular that was qualified less than 40 days prior; (iii) the company's most recent annual reported filed under Section 13 or 15(d) of the Exchange Act or Regulation A under wand quarterly reports to date; (iv) information published pursuant to Rule 12g3-2(b) for foreign issuers; or (v) specified information that is similar to what would be included in items (i) through (iv).

In addition, a broker-dealer must have a reasonable basis under the circumstances to believe that the information is accurate in all material respects and from a reliable source. This reasonable basis requirement has altered the initial quotation process dramatically over the last ten years. In particular, FINRA uses this requirement to conduct a deep dive into the due diligence and background of a company when processing a 211 Application.

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Attorney Laura Anthony

Laura Anthony, Esq. is the founding partner of Anthony, L.G., PLLC, a national corporate, securities and business transactions law firm. For more than two decades Ms. Anthony has focused her law practice on small and mid-cap private and public companies, capital markets, NASDAQ, NYSE American, the OTC markets, going public transactions, mergers and acquisitions, registered public and exempt private offerings and corporate finance transactions, Regulation A/A+, securities token offerings, Exchange Act and other regulatory reporting requirements, FINRA requirements, state and federal securities laws, general corporate law and complex business transactions. The Anthony, L.G. PLLC team has represented issuers, buyers, sellers, underwriters, placement agents, investors, and shareholders in mergers, acquisitions and corporate finance transactions valued in excess of $1 billion. ALG has represented in excess of 200 companies in reverse merger, initial public offering and direct public offering transactions. Palm Beach Attorney Laura Anthony is also the creator and author of SecuritiesLawBlog.com, the host of LawCast™, Corporate Finance in Focus and a contributor to The Huffington Post and Law360.