Big Changes in Capital Markets Related to Low Priced Securities




Posted by on November 12, 2018

Big Changes in Capital Markets Related to Low Priced Securities- Today is the continuation of a LawCast series talking about changes in capital markets related to low priced securities. In the last LawCast in this series I went over the definition of a penny stock. In reading the definition of a penny stock, it mainly includes those stocks that do not trade on a national exchange or rather those that do trade on the OTC Markets. Both the Nasdaq and NYSE American have initial listing standards that generally fit within the exclusion from the definition of a penny stock; however, the continued listing requirements would allow a company to fail to meet the net tangible assets and revenue tests or otherwise fail to fall within one of the Rule 3a51-1 exclusions. Nasdaq actually publishes a daily list of those companies that it believes are considered a penny stock and subject to the Penny Stock Act.

Which leaves OTC Markets. The SEC has been unfavorable to OTC Markets in the past, which is somewhat understandable as it has undeniably been a forum for fraud, but it is also undeniably a venture and growth market for solid companies seeking to access capital markets. OTC Markets and its management group have been working hard to gain favor with the SEC and initiate regulatory changes that would help reduce micro-cap fraud.

The SEC has always publicly fought a battle against micro-cap fraud and back in December 2016, it published an antagonistic white paper detailing the risks associated with investing in OTC Markets securities. I blogged about the white paper at the time, including my issues with its framework, lack of understanding of the multiple tiers of trading on OTC Markets including the OTC Pink, OTCQB and OTCQX, and data sources which were limited to SEC enforcement actions. Furthermore, the SEC was the impetus behind FINRA’s withdrawal of its request to delete the OTCBB and later proposal to expand its operations, though as of today, this proposal remains just that: a proposal. Despite some temporary negative publicity, the white paper did not appear to impact the OTC Markets’ business.

Both before and after the white paper, the OTC Markets has continued to make self-regulating changes to its marketplace, including adding various “flags” such as the “shell risk” and “stock promotion” flags. The “shell risk” designation indicates that a company displays characteristics common to shell companies. This designation is made at OTC Markets’ sole and absolute discretion based on an analysis of the company’s annual financial data and may differ from a company’s self-reported shell classifications in their own public filings.

Moreover, OTC Markets has added quantitative and qualitative listing requirements for both the OTCQB and OTCQX, such as a minimum number of shareholders and public float, IPO listing standards and change of control re-application procedures. Effective January 1, 2019 OTC Markets is also requiring all OTCQB and OTCQX companies to provide verified share data directly to OTC Markets through a transfer agent that participates in its Transfer Agent Verified Shares Program.

In March of this year, OTC Markets made a presentation to the SEC’s Investor Advisory Committee as part of a panel on “Discussion of Regulatory Approaches to Combat Retail Investor Fraud.” During the meeting, Mr. Coulson discussed the most serious market risks and presented a list of 14 OTC Markets regulatory recommendations to improve disclosure and combat these market risks. The recommendations include items that could increase the liquidity and facilitate capital formation, but also include recommendations to improve regulatory responsiveness and reduce fraud. In an upcoming Lawcast series I will go over those recommendations.

Also, on September 26, 2018, OTC Markets took part in the SEC’s Roundtable on Regulatory Approaches to Combating Retail Investor Fraud hosted by the SEC Division of Trading and Markets, at which Cromwell Coulson and OTC Markets General Counsel Dan Zinn both sat on panels focused on combating fraud and stock manipulation.