OTC Markets Regulatory Recommendations

Posted by on November 19, 2018

OTC Markets Regulatory Recommendations- Today is the first in 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. A review of OTC Markets website on November 6, 2018 shows 10,495 traded securities and approximately $1.1 billion volume of trades. In his remarks to the IAC, Mr. Coulson points out that 98% of the traded dollar volume of companies on OTC Markets make current information available. Echoing the SEC’s “Main Street investor” focus, he states that “[W]e have many stocks on our markets that are completely appropriate to be part of a diversified, long term, investment portfolio, of a main street investor; we also have speculative securities that are only appropriate for risk tolerant trader.”

However, certainly the trading in all equity securities, and especially small-cap securities, has risk. Mr. Coulson identifies what he believes are the three biggest risks to retail investors. In particular: (i) manipulative online promotion, including fraudulent and misleading information; (ii) share dilution, including through equity line financings, toxic convertible instruments and illegal share distributions; and (iii) bad actors, with a suggestion to allow for a speedy trading freeze to prevent ongoing frauds. I note that in its recent comment letters to FINRA related to the 15c2-11 process, OTC Markets suggested that it be given the power to institute short-term trading halts in response to improper activity and/or a lack of proper disclosure.

As part of OTC Markets’ recently adopted stock promotion policy and best practices guidelines to improve investor transparency OTC Markets conducted an investigative initiative to track promotion activities. Coulson indicates that data reveals that 70% of dollar volume of securities impacted by promotional activities are listed and trade on national exchanges. Moreover, promoted securities usually have significant share dilution and are rarely suspended by the SEC. Although OTC Markets stock promotion policies are helpful, Mr. Coulson suggests that regulatory modernization is also needed to require increased disclosure of online paid stock promotion and the people behind such promotions.

Coulson also addressed the issue of short selling. Internet-based forums, especially anonymous forums that are used for stock manipulation, misinformation and fraudulent promotions, proclaim that short selling in small-cap securities is rampant and the cause of downward pricing pressure. The reality is that short selling in small-cap securities is generally minimal due to the high cost of borrow interest and coverage requirements. Most short selling is small companies is completed by market makers with a requirement to close out within 2 days. Coulson actually suggests that in addition to greater transparency and reporting of short selling activity, regulatory changes should be made to encourage heathy short selling and price stabilization efforts by market makers.

In the next LawCast in this series I will continue to highlight Mr. Coulson’s presentation and then go over the 14 regulatory recommendations for change.