Proposal to Amend Rule 15c2-11 and De-listing of OTC Non-Reporting and Shell Companies

The Securities and Exchange Commission recently released a sweeping proposal to amend Rule 15c2-11 and provide a pathway to de-list currently trading OTC securities that are delinquent in their financial reporting or are shell companies. This new rule will modernize the existing Rule, updating several areas including rules about issuers’ current information, the piggyback exception, reducing regulatory burdens on broker dealers and more. In further detail, these proposals include the following:

Availability of Current Information
  • Greater transparency provided to investors and the market by requiring that information about the issuer be made current and publicly available.  This includes financial reporting requirements be made current to OTC and/or the SEC.  
  • Piggyback exception would require each broker to ensure issuer information be current and publicly available.
Limit Exceptions to Better Protect Investors
  • Set piggyback limits only on those securities that contain bid and ask quotations that are published at specified prices.
  • Remove the piggyback exception during the first 60 days after the termination of an SEC trading suspension.
  • Eliminate the piggyback exception for shell companies, which would eliminate trading on any shell companies.
  • Limitations to be set as to how many unsolicited orders on behalf of company insiders can be executed.
Reduce Burdens on Broker-Dealers Where Fraud is Less of a Concern
  • If the registration statement or offering circular names an underwriter and that underwriter is the broker-dealer publishing the quotation.
  • Well-capitalized issuers with significant trading volume and assets are proposed to be exempt from new availability of current information requirements.
  • A regulated third-party (attorney, etc) performs the 15c2-11 Rule review and let’s others know about the quotation of a broker-dealer relying on the exception.
  • Any IDQS (Interdealer Quotation System) that also mirrors the role of an ATS (Alternative Trading System), be allowed to conduct reviews on the accuracy of information.

Drawbacks of the Proposal to Amend Rule 15c2-11

The proposal would eliminate the market trading of securities that have insufficient public information (non-reporting entities) and all shell companies. This poses a high risk for numerous companies and investors. 

Hundreds of retail investors work with experienced financial advisers, whom some have forewarned against this amendment, asserting that, “this proposal would hamper the value of legitimate companies’ shares… and even the notion alone that something like this may happen, a large wave of selling could occur that would crush the value of stock of a lot of these companies” (Ron Lefton, financial advisor).

In a precautionary statement, OTC Markets has reacted quickly to this amendment, desiring to protect existing companies’ and investor securities, suggesting that the implementation of an “Expert Market” where advanced investors (with proper licensing) can still have access to the market trading of securities that would otherwise be prohibited by the new rule while still protecting retail investors. Additionally, OTC Markets would like to compromise with the SEC to ensure bankruptcies, financial restructurings, dark companies, cash shells, and liquidation remain profitable and trading, at a minimum, for savvy fundamental investors.

Although there are benefits of providing greater transparency and protection to investors, these proposals would, utmost, destroy shareholder value in hundreds of micro-cap stocks and massive losses to hundreds of thousands of investors.  Additional damages will include those to the shell company community, one which has been scrutinized in the past.  Shell companies are typically used as publicly traded vehicles for reverse merger candidates that help create valid public companies and contribute to a revenue earning economy.  If shell companies aren’t allowed to trade, the value of maintaining a shell company would diminish.  The extinction of shell companies would most likely cause capital formation in the public markets to retail investors to decline including reverse mergers.  Capital formation is the single most important driver in our economy’s growth and to new jobs.  To further reduce capital formation in the form of shell companies without adding any viable replacement to the equation reduces job growth and economic expansion.

Benefits of the Proposal to Amend Rule 15c2-11

This proposal is intended to provide greater protection for market participants, who can more confidently make an educated investment.

Stephanie Avakian, Co-Director of the Division of SEC Enforcement, said, “This proposal is the result of a multi-year cooperative effort between our Division and the Division of Trading and Markets to prevent the type of microcap fraud that our Enforcement staff sees every day.”  

SEC’s Proposed Rule and Concept Release states that 150 pump-and-dump manipulation cases between 2002 and 2015 were found and that 86 percent of these cases involved OTC securities. Through amending Rule 15c2-11, the SEC hopes to diminish this number.

Many comments have been made by the Commission emphasizing market security and the rights investors must have to make well-informed decisions “so that investors don’t lose their hard-earned money.”

Suggestions for Improvement

Refinements of the proposal suggested by various third-parties including our staff include:

  • Erecting additional disclosure requirements and trading restrictions to protect investors, so that the public trading in dark companies and shells can remain a viable option and be preserved.
  • Streamlining FINRA’s role in the Form 211 process, so that broker-dealers can more easily quote securities that have up-to-date information.
  • Providing additional regulatory guidance of the proposal to ensure market competition and capital formation is not hampered.
  • Provide an “expert market” for experienced traders that can still trade non-reporting and shell securities.
  • Provide reasonable grace periods and guidelines for issuers that go delinquent in their reporting.
  • If shell company trading is halted, create guidelines and a pathway for shell companies to be relisted easily with defined financial thresholds to encourage market makers to more easily assist in this process.
  • For companies that have undergone an SEC trading suspension, provide an easier pathway for relisting once the company resolves its SEC comments.
  • Provide a capital formation friendly and regulated ‘shell exchange’ to facilitate the reverse merger market and exchange of entities between parties.  This would help the SEC better regulate such deals and prevent losses to existing investors of shell companies.

Affected Issuers Must Take Action Before Final Rules are Issued

Issuers that are delinquent in their SEC reporting will likely be de-listed once the final rules are released, making it very difficult for the company to ever get relisted due to the current stringent 211 requirements.  It is unlikely that a market maker would be willing to risk the liability and extended effort required, based on recent samplings from around the market.

Issuers should immediately focus on getting current in their SEC reporting and if they are a shell company, transition to an operating status. To help with this process, Colonial’s EDGAR filing and transfer agent teams can assist you with getting your filings current and assist you with any questions regarding your shell company.

Dan Carter
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