SEC Denies Expert Market – For Now
As the compliance date for the new 15c2-11 rules looms near, on August 2, 2021, in a very short statement, the SEC shot down any near-term hope for an OTC Markets operated “expert market.” The SEC short statement indicated that a review of the proposed exemptive order that would allow the expert market is not on its agenda in the short term. The SEC continued that “[A]ccordingly, on September 28, 2021, the compliance date for the amendments to Rule 15c2-11, we expect that broker-dealers will no longer be able to publish proprietary quotations for the securities of any issuer for which there is no current and publicly available information, unless an existing exception to Rule 15c2-11 applies.”
The statement acts as a great segue for a review as to just what those exceptions may be. In addition, this blog will discuss the OTC Markets proposed expert market and finish with a broader refresher on the new 211 rules including the current public information requirements for each class of issuer. For an in-depth discussion of the amended rules, see HERE.
Also, importantly, even for companies that believe they are current in their OTC Markets Alternative Reporting requirements, OTC Markets requires that the company profile be verified through the OTCIQ system as part of the 211 compliance process. OTC Markets has indicated that profiles must be updated by August 9 to ensure their compliance team has sufficient time to confirm the availability of current public information and update company information prior to the rule’s September effective date.
As more fully described below, current information works on a 180-day timeline from the date of the end of a reporting period. Since most companies have a calendar year reporting period, the SEC picked September 28th as the compliance deadline because that is exactly 181 days from March 31st. Assuming a report is filed for the March 31st quarter end, the company will remain piggyback qualified from April 1st through September 27th inclusive. If the Company does not file its June 30th report, it will lose qualification on September 28th (the compliance date) because the company would not have current and publicly available information with respect to any reporting period that ended 180 calendar days before the publication or submission of the quotation.
Adding pressure to the thousands of companies that will be impacted by the new rules, on July 20, TD Ameritrade published a 162-page list of over 6,000 companies that do not have current public information, for which it will accept liquidating orders only, beginning mid-August. That list was reduced to 3,500 companies by August 2nd and as of today, TD Ameritrade has suspended its plans to cease trading for the time being as companies continue to get up.
- Piggyback Exception
Under the new rules, the SEC is requiring that a company’s current publicly available information be timely filed or filed within 180 calendar days from a specified date, depending on the category of company, for a broker-dealer to rely on the piggyback exemption to publish quotations. The chart below summarizes the filing requirements. The 180-day period begins on the date that a reporting period ends. Accordingly, for example, if a SEC reporting issuer has a December 31 year-end and filed a report for that period, quotations for the period January 1 – June 29 inclusive, would be covered by the piggyback exception. If the same issuer filed its quarterly reports for March 31, June 30 and September 30, the 180-day period would extend from each of those dates (until April 30 of the following year). However, if the same issuer failed to file its September 30 10Q, it would no longer be able to rely on the piggyback exception beginning December 28 (180 days following June 30) because following that date, the company would not have current and publicly available information with respect to any reporting period that ended 180 calendar days before the publication or submission of the quotation.
In making the calculation for an alternative reporting (catch-all) company, a broker-dealer must ensure that current information is dated within 12 months of the publication of the quotation and that the balance sheet is less than 16 months old. Accordingly, for example, if the alternative reporting company has a December 31 year-end, and filed its annual report for December 31, 2020 including all the required information (with a balance sheet dated after September 1, 2019 and a profit and loss for the 12 months preceding that period), a broker-dealer could continue to rely on the piggyback exception until December 31, 2021.
Of course, maintaining current information requires more than just financial statements. As further discussed below, where SEC or other regulatory requirements prescribe the information that must be reported (such as for a foreign private issuer), Rule 15c2-11 does not require different information. The Rule, however, does prescribe the information required by a catch-all company. The OTC Markets has updated its current information reporting requirements to encompass all of the information and requirements in the new Rule.
The amended rule adds a 15-day conditional grace period from the date of a publicly available determination that a company no longer has current information within the 180-day specified period as set forth in the chart below, for a broker-dealer to continue to quote the particular security. The purpose of the grace period is to give the markets notice that the company is in danger of no longer being quoted and provide investors with an opportunity to liquidate positions. In order to use the grace period, three conditions must be met: (i) OTC Markets or FINRA must make a public determination that current public information is no longer available within 4 business days of the information no longer being available (i.e., expiration of the time periods in the chart); this could be by, for example, a tag on the quote page or added letter to the ticker symbol; (ii) all other conditions for reliance on the piggyback exception must be effective (such as a one way quote); and (iii) the grace period ended on the earliest of the company once again making current information publicly available or the 14th calendar day after OTC Markets or FINRA makes the public determination in (i) above. I note that once OTC Markets has made a publicly available determination that a broker-dealer may rely on the piggyback exception, it has an affirmative duty to make a publicly available determination that the same company no longer has publicly available current information as required by the rule.
The SEC does not include a delinquent reporting issuer in the “catch-all” category for purposes of qualification for the piggyback exception; rather, the amended rule provides for a grace period for Exchange Act reporting companies that are delinquent in their reporting obligations. A broker-dealer can continue to rely on the piggyback exception for quotations for a period of 180 days following the end of the reporting period. Since most OTC Markets companies are not accelerated filers, the due date for an annual Form 10-K is 90 days from fiscal year end and for a quarterly Form 10-Q it is 45 days from quarter-end. Accordingly, a company can be delinquent up to 90 days on the filing of its Form 10-K or 135 days on its Form 10-Q before losing piggyback eligibility. Regulation A and Regulation Crowdfunding reporting companies are not provided with a grace period, but rather must timely file their reports to maintain piggyback eligibility.
To reduce some of the added burdens of the rule change, the SEC allows a broker-dealer to rely on either OTC Markets or FINRA’s publicly announced determination that the requirements of the piggyback exception have been met. To be able to properly keep track of piggyback exception eligibility, OTC Markets will need to establish, maintain, and enforce reasonably designed written policies and procedures to determine, on an ongoing basis, whether the documents and information are, depending on the type of company, filed within the prescribed time periods.
The following chart summarizes the time frames for which 15c2-11 information must be current and publicly available, timely filed, or filed within 180 calendar days from the specified period, for purposes of piggyback eligibility:
|Category of Company||15c2-11 Current Information|
|Exchange Act reporting company||Filed within 180 days following end of a reporting period.|
|Regulation A reporting company||Filed within 120 days of fiscal year-end and 90 days of semi-annual period end|
|Regulation Crowdfunding filer||Filed within 120 days of fiscal year-end.|
|Foreign Private Issuer||Since first day of most recent completed fiscal year, has filed information required to be filed by the laws of home country or principal exchange traded on.|
|Catch-all company||Current and publicly available annually, except the most recent balance sheet must be dated less than 16 months before submission of a quote and profit and loss and retained earnings statements for the 12 months preceding the date of the balance sheet.
Note that compliance with the requirement to include financial information for the 2 preceding years does not take effect until 2 years after the effective date (i.e., approximately 2 years and 2 months). A catch-all company would still need to provide all other current information set forth in the rule, to qualify for the piggyback exception, beginning on the compliance date.
In addition to the current publicly available information requirement, to rely on the piggyback exception, the new rules require: (i) at least a one-way priced quotation at a specified price (either bid or ask); and (ii) that no more than 4 days in succession have elapsed without a quotation (frequency of quotation requirement). Although the priced quotation must be at a specified price, there is no minimum threshold (for example, it does not have to be above $0.01). For a broker-dealer to rely on the piggyback exception, a quoted OTC security of an issuer would need to be the subject of a bid or offer quotation, at a specified price, with no more than four business days in succession without such a quotation.
The initial rule proposal contained a provision that would have eliminated the piggyback exception altogether for shell companies. This provision received significant pushback and would have had a huge chilling effect on reverse merger transactions in the OTC Markets. In response to the pushback, the final rule allows for broker-dealers to rely on the piggyback exception to publish quotations for shell companies for a period of 18 months following the initial priced quotation on OTC Markets. In essence, a shell company is being granted 18 months to complete a reverse merger with an operating business, or in the alternative, to organically begin operations itself. The amended rules only allow the piggyback exception for a period of 18 months following the initial quotation. The first 18-month period for a shell company will begin on September 18, the compliance date for the new rules. If a company remains a shell at the end of the 18-month period, it will lose piggyback eligibility and a new 211 compliance review would be necessary.
The rule adopts a definition of shell company that tracks Securities Act Rules 405 and 144 and Exchange Act Rule 12b-2, but also adds a “reasonable basis” qualifier to help broker-dealers and OTC Markets make determinations. A shell company is defined as any issuer, other than a business combination related shell company as defined in Rule 405 or asset backed issuer, that has: (i) no or nominal operations; and (ii) either no or nominal assets or assets consisting solely of cash or cash equivalents. A company will not be considered a shell simply because it is a start-up or has limited operating history. To have a reasonable basis for its shell company determination, a broker-dealer or the OTC Markets can review public filings, financial statements, business descriptions, etc.
In addition, a broker-dealer may not rely on the piggyback exception during the first 60 calendar days after the termination of a SEC trading suspension under Section 12(k) of the Exchange Act.
Understanding the dramatic change and impact the new rules will have on the OTC Market place, the SEC will consider requests from market participants, including issuers, investors, or broker-dealers, for exemptive relief from the amended Rule for OTC securities that are currently eligible for the piggyback exception yet may lose piggyback eligibility due to the amendments to the Rule. In a request for relief, the SEC will consider all facts and circumstances including whether based on information provided, the issuer or securities are less susceptible to fraud or manipulation. The SEC may consider securities that have an established prior history of regular quoting and trading activity; companies that do not have an adverse regulatory history; companies that have complied with any applicable state or local disclosure regulations that require that the company provide its financial information to its shareholders on a regular basis, such as annually; companies that have complied with any tax obligations as of the most recent tax year; companies that have recently made material disclosures as part of a reverse merger; or facts and circumstances that present other features that are consistent with the goals of the amended Rule of enhancing protections for investors. At the time of the rule release, the SEC suggested that requests for relief be submitted as soon as possible to prevent a quotation interruption prior to the rule’s implementation. At the time of publication of this blog, I am unsure if the SEC could entertain such a request prior to the September 28 deadline.
- Unsolicited Quotation Exception
Rule 15c2-11 has an unsolicited quotation exception. That is, a broker-dealer may issue a quote where such quotation represents unsolicited customer orders. The Rule requires a broker-dealer that is presented with an unsolicited quotation to determine whether there is current publicly available information. If no current available information exists, the unsolicited quotation exception is not available for company insiders or affiliates. The Rule defines “affiliate” using the same language as Rule 144 and in particular “[A]n affiliate of an issuer is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, such issuer.” This definition encompasses officers and directors and presumptively covers shareholders owning 10% or more of the outstanding securities.
A broker-dealer may rely on a written representation from a customer’s broker that such customer is not a company insider or an affiliate. The written representation must be received before and on the day of a quotation. Also, the broker-dealer must have a reasonable basis for believing the customer’s broker is a reliable source including, for example, obtaining information on what due diligence the broker conducted. Like the piggyback exception, a broker-dealer will be able to rely on a qualified IDQS (OTC Markets) or a national securities association (FINRA) determination that there is current publicly available information.
- ADTV and Asset Test Exception
Rule 15c2-11 has an ADTV and asset test exception for securities that are considered lower-risk. To rely on this exception, the security must satisfy a two-pronged test involving (i) the security’s average daily trading volume (“ADTV”) value during a specified measuring period (the “ADTV test”); and (ii) the company’s total assets and unaffiliated shareholders’ equity (the “asset test”).
The ADTV test requires that the security have a worldwide reported ADTV value of at least $100,000 during the 60 calendar days immediately prior to the date of publishing a quotation. To satisfy the final ADTV test, a broker-dealer would be able to determine the value of a security’s ADTV from information that is publicly available and that the broker-dealer has a reasonable basis for believing is reliable. Generally, any reasonable and verifiable method may be used (e.g., ADTV value could be derived from multiplying the number of shares by the price in each trade)
The asset test requires that the company have at least $50 million in total assets and stockholders’ equity of at least $10 million as reflected on the company’s publicly available audited balance sheet issued within six months of the end of its most recent fiscal year-end. This would cover both domestic and foreign issuers.
The rule also creates an exception for a company who has another security concurrently being quoted on a national securities exchange. For example, some companies quote their warrants or rights on OTC Markets following a unit IPO offering onto a national exchange.
Like the piggyback exception, the SEC allows a broker-dealer to rely on either OTC Markets or FINRA’s publicly announced determination that the requirements of the ADTV and asset test or the exchange-traded security exception have been met. Conversely, if OTC Markets or FINRA is publishing the availability of an exception, they will also need to publish when such exception is no longer available.
- Underwritten Offering Exception
The Rule has an exception to allow a broker-dealer to publish a quotation of a security without conducting the required information review, for an issuer with an offering that was underwritten by that broker-dealer and only if (i) the registration statement for the offering became effective less than 90 days prior to the date the broker-dealer publishes a quotation; or (iii) the Regulation A offering circular became qualified less than 40 days prior to the date the broker-dealer publishes a quotation. This change may potentially expedite the availability of securities to retail investors in the OTC market following an underwritten offering, which may facilitate capital formation. This exception requires that the broker-dealer have the 211 current information in its possession and have a reasonable basis for believing the information is accurate and the sources of information are reliable.
OTC Markets Request for Exemptive Order for Expert Market
OTC Markets requested an exemptive order with the SEC to permit broker-dealers to publish or submit proprietary quotations for securities, on a continuous basis, in a market where the distribution of such quotations is restricted to sophisticated or professional investors, without complying with the information review and recordkeeping requirements of amended Rule 15c2-11. The SEC published the proposed exemptive order and requested public comment.
OTC Markets currently maintains an expert market which allows broker-dealer subscribers to, among other things, find price transparency in certain securities that may not be eligible or suitable for retail investors. The request for exemptive relief would modify that expert market to provide greater access to certain retail investors. An expanded expert market is intended to provide a marketplace, limited to sophisticated or professional investors, for grey market securities or small companies seeking growth opportunities that might prefer to be quoted in a more limited market.
Under the proposed conditional exemptive order, OTC Markets Group would authorize market data distributors, including Subscribers, to be eligible to receive quotations published or submitted on the Expert Market and to distribute such data to Subscribers who comply with certain obligations and restrictions on data access set forth in a Market Data Distribution Agreement (“MDDA”). The MDDA would, among other things, restrict end users and the distribution to any third parties that do not qualify as a permitted recipient, and would require that the distributor or subscriber report all end users to OTC Markets.
Permitted recipients (“Qualified Experts”) or expert market users would include: (i) any qualified institutional buyer as defined in Rule 144A (generally must own and invest $100 million in securities); (ii) any accredited investor as defined in Rule 501(a) (see HERE); and (iii) any qualified purchaser as defined in Section 2 of the Investment Company Act of 1940 (generally have $5 million or more in securities).
Qualified securities on the expert market would include: (i) companies that are currently quoted under the piggyback exception and lose qualification on the compliance date for the amended rules (September 28); (ii) companies that lose 211 compliance in the future due to a lack of current public information, shell status or failure to meet the frequency of quotation requirement; and (iii) any security that is issued in conjunction with a Chapter 11 bankruptcy plan under Section 1145 of the Bankruptcy Code. Securities that had been subject to a registration revocation or defunct companies would not be able to be quoted.
In operating the expert market under the proposed exemptive relief, OTC Markets would establish, maintain, and enforce written policies and procedures that are reasonably designed to allow only permitted recipients to view, and to prevent the general public from viewing, quotations published or submitted on the expert market. OTC Markets would also establish procedures to surveil the use of the expert market to ensure compliance with the MDDA.
As noted at the beginning of this blog, the SEC has taken any action on this Order off the table, at least in the near term.
More on Amended Rule 15c2-11
Amended Rule 15c2-11: (i) requires that information about the company and the security be current and publicly available in order to initiate or continue to quote a security; (ii) limits certain exceptions to the rule including the piggyback exception where a company’s information becomes unavailable to the public or is no longer current; (iii) reduces regulatory burdens to quote securities that may be less susceptible to potential fraud and manipulation; (iv) allows OTC Markets itself to evaluate and confirm eligibility to rely on the rule; and (v) streamlines the rule and eliminate obsolete provisions.
The amended Rule adds the ability for new “market participants” to conduct the review process and allows broker-dealers to rely on that review process and the determination from certain third parties that an exception is available for a security. The rule release uses the terms “qualified IDQS that meets the definition of an ATS” and “national securities association” throughout. The only relevant qualified IDQS is OTC Markets itself and the only national securities association in the United States is FINRA. However, if new IDQS platforms or national securities associations develop, they would also be covered by the Rule.
A broker-dealer can rely on the OTC Markets determination of the availability of the rule or an exception to quote a security without conducting an independent review. Keeping the rule’s current 3-business-day requirement, a broker-dealer’s quotation must be published or submitted within 3 business days after the qualified IDQS (OTC Markets) makes a publicly available determination.
Importantly, the new rule specifically does not require that OTC Markets comply with FINRA Rule 6432 and does not require OTC Markets or broker-dealers relying on OTC Markets’ publicly available determination that an exception applies to file Forms 211 with FINRA. I believe that the system will evolve such that OTC Markets completes the vast majority of 211 compliance reviews.
Current Public Information Requirements
The amended Rule (i) requires that the documents and information that a broker-dealer must have to quote an OTC security be current and publicly available; (ii) permits additional market participants to perform the required review (i.e., OTC Markets); and (iii) expands some categories of information required to be reviewed.
To initiate or resume a quotation, a broker-dealer or OTC Markets, must review information up to three days prior to the quotation. The information that a broker-dealer needs to review depends on the category of company, and in particular: (i) a company subject to the periodic reporting requirements of the Exchange Act, Regulation A or Regulation Crowdfunding (Regulation Crowdfunding was not included in the proposed rule but was added in the final); (i) a company with a registration statement that became effective less than 90 days prior to the date the broker-dealer publishes a quotation; (iii) a company with a Regulation A offering circular that goes effective less than 40 days prior to the date the broker-dealer publishes a quotation; (iv) an exempt foreign private issuer with information available under 12(g)3-2(b) and (v) all others (catch-all category) which information must be as of a date within 12 months prior to the publication or submission of a quotation.
The catch-all category encompasses companies that alternatively report on OTC Markets, as well as companies that are delinquent in their SEC reporting obligations – provided, however, that companies delinquent in their SEC reporting companies can only satisfy the catch-all requirements for a broker-dealer to quote an initial or resume quotation of its securities, not for the piggyback exception.
For companies relying on the catch-all category, the information required to rely on Rule 15c2-11 includes the type of information that would be available for a reporting company, including financial information for the two preceding years that the company or its predecessor has been in existence. The information requirements were expanded from the proposed rule to also include (i) the address of the company’s principal place of business; (ii) state of incorporation of each of the company’s predecessors (if any); (iii) the ticker symbol (if assigned); (iv) the title of each “company insider” as defined in the rule; (v) a balance sheet as of a date less than 16 months before the publication or submission of a broker-dealers quotation; and (vi) a profit and loss and retained earnings statement for the 12 months preceding the date of the most recent balance sheet.
Certain supplemental information is also required in determining whether the information required by Rule 15c2-11 is satisfied. In particular, a broker-dealer or OTC Markets, must always determine the identity of the person on whose behalf a quotation is made, including whether that person is an insider of the company and whether the company has been subject to a recent trading suspension. The requirement to review this supplemental information only applies when a broker-dealer is initiating or resuming a quotation for a company, and not when relying on an exception, such as the piggyback exception, for continued quotations.
Regardless of the category of company, the broker-dealer or OTC Markets, must have a reasonable basis under the circumstances to believe that the information is accurate in all material respects and from a reliable source. In order to satisfy this obligation, the information and its sources must be reviewed and if any red flags are present such as material inconsistencies in the public information or between the public information and information the reviewer has knowledge of, the reviewer should request supplemental information. Other red flags could include a qualified audit opinion resulting from failure to provide financial information, companies that list the principal component of its net worth an asset wholly unrelated to the issuer’s lines of business, or companies with bad-actor disclosures or disqualifications.
The existing rule only requires that SEC filings for reporting or Regulation A companies be publicly available and in practice, there is often a deep-dive of due diligence information that is not, and is never made, publicly available. Under the final rule, all information other than some limited exceptions, and the basis for any exemption, will need to be current and publicly available for a broker-dealer to initiate or resume a quotation in the security. The information required to be current and publicly available will also include supplemental information that the broker-dealer, or other market participant, has reviewed about the company and its officer, directors, shareholders, and related parties.
Interestingly, the SEC release specifies that a deep-dive due diligence is not necessary in the absence of red flags and that FINRA, OTC Markets or a broker-dealer can rely solely on the publicly available information, again, unless a red flag is present. Currently, the broker-dealer that submits the majority of Form 211 applications does a complete a deep-dive due diligence, and FINRA then does so as well upon submittal of the application. I suspect that upon implementation of the new rule, OTC Markets itself will complete the vast majority of 15c2-11 rule compliance reviews and broker-dealers will rely on that review rather than submitting a Form 211 application to FINRA and separately complying with the information review requirements.
Information will be deemed publicly available if it is posted on: (i) the EDGAR database; (ii) the OTC Markets (or other qualified IDQS) website; (iii) a national securities association (i.e., FINRA) website; (iv) the company’s website; (v) a registered broker-dealer’s website; (vi) a state or federal agency’s website; or (vii) an electronic delivery system that is generally available to the public in the primary trading market of a foreign private issuer. The posted information must not be password-protected or otherwise user-restricted. A broker-dealer will have the requirement to either provide the information to an investor that requests it or direct them to the electronic publicly available information.
Information will be current if it is filed, published or disclosed in accordance with each subparagraph’s listed time frame as laid out in the chart above. The rule has a catch-all whereby unless otherwise specified information is current if it is dated within 12 months of a quotation. A broker-dealer must continue to obtain current information through 3 days prior to the quotation of a security.
The final rule adds specifics as to the date of financial statements for all categories of companies, other than the “catch-all” category. A balance sheet must be less than 16 months from the date of quotation and a profit and loss statement and retained earnings statement must cover the 12 months prior to the balance sheet. However, if the balance sheet is not dated within 6 months of quotation, it will need to be accompanied by a profit-and-loss and retained-earnings statement for a period from the date of the balance sheet to a date less than six months before the publication of a quotation. A catch-all category company, including a company that is delinquent in its SEC reporting obligations, does not have the 6 month requirement for financial statements but a balance sheet must be dated no more than 16 months prior to quotation publication and the profit and loss must be for the 12 months preceding the date of the balance sheet.
The categories of information required to be reviewed will also expand. For instance, a broker-dealer or the OTC Markets will be required to identify company officers, 10%-or-greater shareholders and related parties to the company, its officers, and directors. In addition, records must be reviewed, and disclosure made if the person for whom quotation is being published is the company, CEO, member of the board of directors, or 10%-or-greater shareholder. As discussed below, the unsolicited quotation exception will no longer be available for officers, directors, affiliates or 10%-or-greater shareholders unless the company has current publicly available information.
The rule will not require that the qualified IDQS – i.e., OTC Markets – separately review the information to publish the quote of a broker-dealer on its system, unless the broker-dealer is relying on the new exception allowing it to quote securities after a 211 information review has been completed by OTC Markets. In other words, if a broker-dealer completes the 211 review and clears a Form 211 with FINRA, OTC Markets can allow the broker-dealer to quote on its system. If OTC Markets completes the 211 review, the broker-dealer, upon confirming that the 211 information is current and publicly available, is excepted from performing a separate review and can proceed to quote that security.