15c2-11 Reforms - The Bradshaw Law Group Blog

In September of last year, the Securities and Exchange Commission (the “SEC”) adopted a new amendment to Rule 15c2-11 of the Securities and Exchange Act of 1934. The changes to Rule 15c2-11 are primarily concerned with the way companies traded Over the Counter (“OTC”) and are able to continuously be quoted by brokers using the “Piggyback Exemption” after they become delinquent with their public filings or go defunct. On September 28, 2021, the amendment will go into effect and will bring the greatest reform to OTC trading in decades. 

Under these changes, broker/dealers will no longer be able to continue quotations of the stock in issuers that do not have any publicly available information and disclosures with either the SEC or a qualified Inter Dealer Quotation System (“IDQS”) such as provided by OTC Markets Group (“OTC Markets”) or by the OTC Bulletin Board (“OTCBB”) which is a quotation system maintained by the Financial Industry Regulatory Authority (“FINRA”). For companies currently trading on the OTC Markets, the changes are good and bad news. Some companies who were not up to date on SEC rule changes are scrambling to get in compliance with the new rules at the last minute or face a liquidity crisis for their stock. 

What is the Piggyback Exemption?

Under 15c-211, a broker/dealer can quote a price for the stock newly public corporations if it satisfies the due diligence requirements and files a Form 211 on behalf of the issuer. Once this form has been filed other brokers can “Piggyback” off the initial quotation of the security and quote their own bid and ask spread for the stock. With the Piggyback Exemption, there are no due diligence standards for subsequent quotes, and the stock can continuously be quoted so long as there is a broker providing quotes. This exemption can continue even when the issuer stops reporting and goes defunct. 

Before the recent changes to 15c-211, the current information provided to the broker filing the Form 211 was not required to be publicly available and the obligations to continuously provide current information beyond the registration statement by the issuer could easily be sidestepped since their securities would still be freely trading regardless of reporting compliance. This has led to systemic problems with fraud in the OTC markets. Now OTC issuers will have to provide current information to the public before their securities are quoted.

The Good: Why the Change Can Benefit OTC Issuers

The average layperson mistakenly refers to all OTC stocks as, “the Pinks” or the “Pink Sheets,” but such terms are more specific to the OTCPink or OTCBB listings. The IDQS of OTC Markets, LLC, which quotes nearly all modern OTC listings, consists of three tiers, OTCQX, OTCQB, and OTCPink. Each tier has its own listing and reporting standard standards. The changes to Rule 15c2-11 could increase the legitimacy of the OTC markets and give greater investor confidence in the trading of stocks listed on either the OTCQX or OTCQB which already require a company to be fully SEC reporting (i.e., filing form 10-Q, 10-K, and 8-K when required to do so). The changes to 15c2-11 essentially have no negative impact on companies traded on the OTCQX and OTCQB tiers.

The Bad: Why the Change Can Harm OTC Issuers

Not all companies have the resources to provide the necessary periodic disclosures and audits to the public. Those companies that trade on the OTCPink tier or the OTCBB commonly do not have any current information, or their information is extremely limited and almost universally unaudited. The continual problem for the SEC and investors with companies quoted on the OTCPink or OTCBB is that many are nothing but public shells that are being used as a vehicle to perpetuate a pump and dump scheme. Other schemes involve hijacking a dark, defunct, or abandoned shell through the state court systems to be used for fraud or as a reverse merger vehicle to bypass the required disclosures in a new public offering. Such widespread fraud problems are likely the driving forces behind the SEC’s amendments to 15c2-11 that unfortunately will harm some legitimate companies (albeit struggling or early-stage) as collateral damage.

Keep in mind that not all OTCPink or OTCBB companies are non-reporting or small penny stocks you have never heard of. Sometimes a foreign company that is a household brand will list their American Depository Receipts (“ADR”) on the various tiers of the OTC securities market. However, the important disclosures with US regulators concerning those ADRs might be more limited than a domestic stock and you may have to look up filings on the foreign stock exchange on which they are primarily listed. There are also convenience and cost savings factors to being traded on the OTC because listing on a major exchange is essentially adding another regulator for your compliance team that also charges hefty fees.

The Alternative Reporting

As mentioned in the previous section, a foreign company might satisfy some of its disclosure and reporting requirements for ADRs on its domestic stock exchange, provided the disclosures are publicly available to American investors and are adequate. Domestic OTCPink (but not OTCBB) companies will also have their own alternative that may be a cheaper way to remain in compliance with the new 15c2-11 requirements instead of filing with the SEC. 

OTC Markets will provide an alternative reporting standard on their OTC Link ATS (“Link”). The link will satisfy the SEC standard for a qualified IDQS and will be an alternative way to maintain compliance. That means that an issuer will be able to file periodic disclosures with OTC Markets to satisfy their disclosures instead of the SEC’s EDGAR system. Filing under Link will also remove the need to have a broker/dealer file a Form 211 for an issuer before being publicly quoted which can be a huge roadblock to liquidity for some issuers, as the broker assumes some liability when filing a 211.

The reporting standard on Link will not be as stringent as the periodic and annual reports with the SEC but they offer a way for investors to have at least some crucial information available before they submit a buy order with their broker. It should be noted, any individual security is already a high-risk investment compared to something such as a professionally managed index fund (which themselves are not free of risk), and those individual securities traded under an alternative reporting standard are even riskier and more speculative. Our firm encourages the issuers we represent to be fully reporting on EDGAR, but welcome a less cumbersome alternative for those that truly need it.

What Happens to the Issuers That Don’t Report?

OTC Markets will be relegating certain issuers who do not report to its Expert Market. They have publicly communicated that such securities will be quoted on an unsolicited basis to “broker-dealers, institution, and other sophisticated investors.” Our firm interprets that language as meaning individuals will need to be an Accredited Investor as defined under Rule 501 of Regulation D of the Securities Act of 1933 to buy Expert Market securities.

The securities of other non-reporting issuers quoted via the OTCBB or who do not meet the requirements of the Expert Market will essentially become illiquid assets on the grey market. Essentially grey market securities have no market-making activities provided by broker/dealers, and for all intents and purposes are no longer “public” even though they may have an underlying registration statement. Broker/dealers will no longer be able to rely on the previous Piggyback Exemption to provide public quotes of these non-reporting securities. If you have grey market stock in your brokerage account after September 28, 2021, you should contact your broker to explore your options.

The Bradshaw Law Group is experienced in all securities issues and transactions, so you can rest assured that your securities matters will be handled professionally and accurately.

Contact us today for a free consultation: https://bradshawlawgroup.com/location/contact/

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