OTC Markets Regulatory Recommendations To Improve Disclosure

Posted by on January 09, 2019

OTC Markets Regulatory Recommendations To Improve Disclosure- Today is the continuation of a LawCast series talking about OTC Markets regulatory recommendations to improve disclosure and combat micro-cap fraud. On March 8, 2018, Cromwell Coulson, CEO of OTC Markets Group, made a presentation to the SEC’s Investor Advisory Committee (“IAC”) 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 Market’s regulatory recommendations to improve disclosure and combat these market risks. I started going through these risks in the last Lawcast in this series.
A topic of concern and interest involves the illegal issuance of securities and affiliate trading. Mr. Coulson suggests transparency and information can help this issue. In particular, Coulson advocates for increasing the role of transfer agents as record keepers. I note that he did not use the words “gate keepers” and it is unclear from the transcript if that implication was there. On December 22, 2015, the SEC issued an advance notice of proposed rulemaking and concept release on proposed new requirements for transfer agents and requesting public comment. No further action has been taken since that time, and rules related to transfer agents have been moved from the SEC short-term agenda to long-term actions.

Also to further transparency related to illegal issuances and affiliate trading, Coulson suggests ending anonymous Objecting Beneficial Owner (OBO) accounts for affiliates of issuers. Likewise, Coulson suggests adding a reporting requirement similar to Forms 3, 4 and 5 under Section 16 for non-SEC reporting companies.

To help combat fraud and provide a deterrent to bad actors, Coulson supports increased cooperation and communication between market operators, such as OTC Markets, and regulators. Using the analogy of real-time monitoring for credit card fraud, Coulson suggests real-time monitoring and responses by market operators to red flags and indicia of fraud. In order to make preventative responses feasible, there would have to be a system to allow for a relatively quick investigation and re-onboarding of trading for affected companies.

Coulson notes that much of the fraud in smaller public company trading emanates from unregulated intermediaries that have acquired shares in the private financing markets and are seeking to
stimulate investor buying interest, so they can sell their shares. Although Coulson does not talk about regulating finders as a response to this problem, he does talk about stimulating financing options for smaller companies. I am a champion of a workable regulatory regime for finders.

To stimulate financing options, Coulson suggests allowing SEC reporting companies to utilize Regulation A+ and increasing shelf registration options. I’ve written many times about my support for an amendment to Regulation A+ to allow SEC reporting companies to complete offerings.

Coulson completed his presentation by talking about another topic that has been oft debated and for which I have strong opinions, and that is venture exchanges. The OTC Markets has worked hard to position itself as a venture exchange, but unfortunately has not received legislative support. In fact, OTC Markets does not always receive due regard at all from the SEC and Wall Street. Back in December 2016, the SEC issued a white paper on penny stocks in which it inaccurately, albeit implicitly, lumped all OTC Markets securities together as penny stocks and as providing limited disclosure. To the contrary, one of the requirements to trade on the OTCQX tier of OTC Markets is that the security not be a penny stock. Both the OTCQB and OTCQX require fairly robust disclosure, including audited financial statements. OTC Markets also has a flag which appears on a company’s quote page to identify if a particular security is exempt from the definition of a penny stock.

Mr. Coulson points out that in 2017, 61 companies graduated from the OTC Markets to a national exchange, illustrating the venture function of OTC Markets. Furthermore, realizing the need for legislation, Coulson states that any venture legislation should follow the European SME growth market model, be disclosure-driven, and include exchanges and ATS’s that already serve smaller companies (such as OTC Markets).

Coulson rightfully adds, “[E]xchange listing is not a clear solution to solving the problems at hand. We need a more holistic approach, focusing on better investor information, rather than the hard-and-fast assertion that every exchange-traded security is safe, while all other securities are risky.”