Retail investors will soon have newly added protections when trading and investing in over-the-counter (OTC) securities, according to a recent SEC rule change.
The changes apply to SEC Rule 15c2-11, the rule that governs when broker-dealers may publish electronic quotes in securities that are not traded on an exchange.
The amendments, according to the SEC, are designed to protect investors from fraud by restricting public quotes in the stock of companies that do not have up-to-date financial information available online.
Scope Of The SEC’s Amendments
There are a few different facets of the rule change. Among them:
- Companies that have not published “current” information – including financial statements from the last fiscal year and other information describing the company’s business – may not be eligible to have their securities publicly quoted by a broker-dealer. Companies can satisfy the “current” information requirements under the amended rule by meeting the requirements to be quoted on the OTCQX, OTCQB and Pink Current market tiers.
- Companies that do not provide ongoing current information and do not meet any exemption under the rule will no longer have their stock publicly quoted.
- The SEC has proposed an “Expert Market” exemption that would permit broker-dealers to electronically quote and trade these stocks, but would limit the distribution of quotes only to qualified experts such as brokers, institutions and those that qualify as accredited investors. This proposal is still pending final approval.
- The OTC Link ATS trading platform will serve as a “qualified interdealer quotation system,” allowing brokers to rely on its current information designations to initiate and maintain public quoting in lieu of submitting a Form 211 with FINRA.
- The rule narrows the “piggyback exemption” that enables broker-dealers to continue to quote an OTC security, now requiring current information, a priced quote and certain restrictions on shell companies.
“The technological advancements that have taken place since the rule was last amended enable us to require that information in the OTC market be more timely, enabling investors to make better-informed investment decisions, and reducing fraud in these markets where retail presence is significant and, unfortunately, pump-and-dump and other frauds are too common,” said former SEC Chairman, Jay Clayton.
Why The Rule Specifically Targets Retail Investors
Though there are some existing, market-based protections currently in place for investors buying and selling securities of companies without up-to-date financials — such as the warning flags that OTC Markets Group uses — the new rule goes a step further.
“The SEC’s philosophy with this rule is that when a retail investor sees activity like real-time quoting data in a security that has no information, they’re more susceptible to fraud,” said Dan Zinn, General Counsel of OTC Markets Group.
In addition to the potential Expert Market, market participants may seek exemptive or No-Action relief under the rule.
“Increasing access to information about the companies in this marketplace will make it more difficult for fraudsters to prey on retail investors,” SEC Commissioner Hester Peirce wrote.
Other Exceptions To The New Rule
The new rule will allow for broker-dealers to “rely on publicly available determinations” from FINRA or other associations, like OTC Markets, when quoting OTC securities.
“We now get to determine for brokers whether a company has met their obligations under this rule,” said Zinn. “We will publish our determination that a specific company is qualified under 15c2-11,’ and every broker can rely on that.”
The updated rule goes into effect on September 28, 2021.
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