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SEC Chair Speaks About Enhanced Investor Protections in the OTC Market

Technology has driven many efficiencies in our markets.  Technology can also enhance investor protection.  Today, we recognize that, as a result of technological change, information can and should be made available to over-the-counter (“OTC”) market investors in a more timely manner.

Ensuring that investors have access to material information so they can make informed investment decisions is a cornerstone of our federal securities laws.  Information about companies in the OTC market is less available than it is for issuers that are listed on a national securities exchange.  Yet, OTC securities, which include securities referred to as “penny stocks,” are primarily owned by retail investors.  One of the key SEC investor protection rules applicable in this market is Rule 15c2-11, which requires broker-dealers, as gatekeepers, to obtain and review certain information about OTC issuers before publishing quotations for their securities.  The amendments adopted today will substantially enhance investor protection by generally requiring such information to be more current and publicly available for a broker-dealer to publish quotations for an OTC issuer’s security, thereby providing greater transparency and helping prevent fraudulent and manipulative activity in the OTC market.

These amendments are long overdue—the Rule was adopted in 1971, 49 years ago, and was last substantively amended in 1991, 29 years ago.  In those days, it was much more expensive for companies to disseminate information to the public—then, internet access was limited and the mails were the primary means of disseminating disclosures—and it was much more difficult for investors, particularly individual investors, to access the information that was available.  Although the ease with which companies can share information, and investors can access such information, has vastly improved beyond what most would have expected, the Rule has not changed.

Today, while some issuers of quoted OTC securities publicly disclose current information, there is no or limited information available about many others.  Prior to today’s amendments, the Rule’s outdated exceptions, including the so-called “piggyback” exception, allowed broker-dealers to maintain a quoted market for the securities of companies that had no current and publicly available information and, in some cases, that no longer existed.  Unfortunately, experience shows the quoted markets for securities of such companies potentially can be used for fraudulent or manipulative purposes.

Under the amendments, the basic issuer information that broker-dealers must obtain and review to initiate a quoted market for the issuer’s security must be current and publicly available.  After a broker initiates a quote, issuer information also must be current and publicly available for broker-dealers to (1) maintain a quoted market in reliance on the piggyback exception and (2) rely on the unsolicited quotation exception to publish quotations on behalf of company insiders.  In short, the amendments are designed to shed more light on the OTC market and reduce the potential to misuse the securities of small issuers for fraud.

The scope of this issue is noteworthy.  There are thousands of issuers of quoted OTC securities that currently are dark, meaning that they do not disclose current information publicly.  The Commission expends substantial resources in addressing fraud related to the securities of OTC issuers, particularly issuers that do not make public disclosures on a regular basis.  These cases have involved substantial harm to investors—particularly retail investors.  Under the amendments, broker-dealers cannot maintain a quoted market for these issuers’ securities in perpetuity, and retail investors may be less susceptible to “pump-and-dump” and other manipulative schemes because quotations for such issuers’ securities would not be easily accessible to them.

This type of fraudulent activity is not limited to actors inside the United States.  The Commission has brought various actions involving these markets where the trading has originated outside the United States.  I have asked staff to examine this area and, if appropriate, produce guidance to market participants and recommendations to the Commission, as appropriate.

With respect to market efficiency and capital formation, two other pillars of our mission, I believe the amendments will improve efficiencies in the OTC market as a result of the greater transparency and—thanks to the work of the staff—their thoughtful approach to various market-specific issues.  For example, the amendments provide an exception to broker-dealers to quote actively traded and highly liquid securities of well-capitalized issuers, which are less likely to be the subject of the type of information limitations and risk of fraud or manipulation that the Rule is designed to prevent.  Without undermining the Rule’s important investor protections, this exception maintains investor access to larger and more liquid securities, including those of certain foreign issuers.  The amendments also provide several other exceptions and provisions that are designed to reduce burdens and facilitate capital formation, including for small businesses.

Finally, I would like to note that the amendments adopted today are the result of cooperative, cross-divisional efforts between the Commission’s enforcement and rulemaking teams, where the activity observed by the Division of Enforcement informed the Commission’s policy.[1]  The Commission’s Division of Enforcement and Division of Trading and Markets have long been focused on combating microcap fraud, and the amendments will make it easier to deter and prevent some of the misconduct and fraud that Commission staff sees every day.[2]  I also want to thank former Commissioners Luis Aguilar and Daniel Gallagher for their focus on these issues during their time at the Commission.  I know their remarks as Commissioners on the importance of transparency in the OTC market resonated with me, other Commissioners and the staff.

ENDNOTES

[1] I would like to acknowledge a few individuals, noting that countless members of the staff contributed to this effort:

From the Division of Trading and Markets: Brett Redfearn, Elizabeth Baird, Mark Wolfe, Josephine Tao, Elizabeth Sandoe, John Guidroz, Laura Gold, Joan Collopy, James Curley, Theresa Hajost, Samuel Litz, Patrice Pitts, Emily Russell, John Fahey, Nancy Sanow, Tyler Raimo, Randall Roy, Ajay Sutaria, Andrea Orr, and Roni Bergoffen.

From the Division of Economic and Risk Analysis: S.P. Kothari, Chyhe Becker, Narahari Phatak, Olga Itenberg, Lauren Moore, Andrew Glickman, and K. Jeremy Ko.

From the Division of Enforcement: Stephanie Avakian, Charlotte Buford, Glenn Gentry, Kerry Knowles, Melissa Hodgman, Marc Berger, Michael Paley, Jason Berkowitz, Sarah Concannon, Rachel Nonaka, Michael Brennan, Jessica Regan, Margaret Cain, Philip Koski, Keith Prive, Hane Lee Kim, Caitlyn Campbell, Mark Johnson and David Frye.

From the Office of the General Counsel: Bob Stebbins, Meridith Mitchell, Robert Teply, Janice Mitnick, and Maureen Johansen.

From the Division of Corporation Finance: Bill Hinman, Elizabeth Murphy, David Fredrickson, Jonathan Ingram, Tamara Brightwell, Adam Turk, Jennifer Zepralka, Heather Maples, Carolyn Sherman, Timothy Henseler, and Michael Coco.

From the Division of Investment Management: Dalia Blass, Sara ten Siethoff, Brian Johnson, Sara Cortes, Trace Rakestraw, Thoreau Bartmann, Brad Gude, and Joel Cavanaugh.

From the Office of Compliance Inspections and Examinations: Peter Driscoll, Daniel Kahl, Jennifer McCarthy, Carrie O’Brien, Christine Sibille, and Joseph Murphy.

From the Office of the Chief Accountant: Sagar Teotia, Peggy Kim, Jeffery Kessman, Ryan Wolfe, Natasha Guinan, Jeffery Joseph, and Jonathan Wiggins.

[2] Such risks are heightened when the identities of the underlying customer and beneficial owner are unknown to the broker-dealer, and the Divisions continue to work together to reduce fraud and misconduct in this space.

This statement was issued on September 16, 2020, by Jay Clayton, chairman of the U.S. Securities and Exchange Commission.

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