Apr 04, 2018

OTC Markets Group Believes FINRA and SEC Rules Hurt Capital Formation By Small Issuers

Securities Attorneys (Exchange Act) By Lahdan Rahmati

On January 8, 2018, the OTC Markets Group issued a response letter to FINRA’s request for comments in which OTC Markets Group states that the “cumbersome operational processes around Rule 6432, and the related Rule 15c2-11 under the Securities Exchange Act of 1934 (SEA) unnecessarily impede capital formation by small issuers.”  The OTC Markets Group goes on to say that Rule 6432 and Rule 15c2-11 present the added burdens of negatively impacting capital raising by smaller U.S. companies, prevent U.S. investors from investing in well-respected foreign companies that might help them to better diversify their investment portfolios and do not help regulators prevent and detect fraud.

In April 2017, FINRA issued Regulatory Notice 17-14 to request comments on FINRA Rules Impacting Capital Formation.  The request for comments was catalyzed by FINRA360,  an initiative launched by FINRA to self-evaluate and improve the organizations’ rules, operations and administrative processes for effectiveness and efficiency in an attempt to enhance FINRA’s mission.

The comment period officially ended on May 30, 2017 and it is unclear whether FINRA will consider the response letter issued by OTC Markets Group.  The seventeen (17) page response letter urges FINRA to reevaluate Rule 6432 to provide more efficient and better quality secondary market trading for small cap issuers that have freely tradable securities in addition to transparent order handling and trade executions for investors.  The highlights are summarized below.

How Does Rule 6432 Relate To Rule 15c2-11?

Rule 15c2-11 governs the submission and publication of quotations to an Interdealer Quotation System, or IDQS, by broker-dealers in securities not listed on a national securities exchange. The rule requires broker-dealers to review and maintain specified information about the issuer of a security before publishing a quotation for that security in any IDQS.

Rule 6432 is intended to ensure broker-dealer compliance with Rule 15c2-11. Under Rule 6432, a FINRA member firm must file with FINRA a Form 211 that contains the information required under Rule 15c2-11, as well as the price at which the broker intends to initiate quotations and the basis upon which such price was determined.

What Is Wrong With The Way FINRA Currently Administers Rule 6432 And Rule 15c2-11 According To The OTC Markets Group?

Rule 15c2-11 is meant to act as a disclosure rule and embody the famous quote by Justice Brandeis “sunlight is said to be the best of disinfectants; electric light the most efficient policemen” but it falls short.  Rule 15c2-11 only requires broker-dealers to gather a lot of information about an issuer to prepare and file a Form 211, however, broker-dealers have no requirement to share that information with the investing public.

  1. Rule 15c2-11 was introduced 45 years ago – that was before the internet existed and a time when investors and brokers often struggled to access company disclosure. Times have changed and so must the way this rule is administered.
  2. FINRA’s involvement in the Form 211 process reaches beyond the scope of Rule 6432 and has become a practical impediment to small companies seeking to access secondary market liquidity. It routinely takes weeks or longer from the time of filing before a FINRA member firm may submit a quotation when in practice it should only take three (3) days.
  3. The process of filing a Form 211 should be more transparent and efficient. The current regime does not make public markets more attractive to smaller companies.
  4. Market operators do not have enough authority to initiate trading halts which is an issue since the market must be empowered to respond to indications of fraud in a timely manner.
  5. FINRA Rule 5250 does not permit broker-dealers to accept compensation from issuers for the preparation and filing of a Form 211. You know what they say – you get what you pay for.
  6. Only the sponsoring broker-dealer may publish quotations for the first thirty (30) days after a Form 211 is cleared instead of the preferred practice of allowing multiple market makers to quote a security immediately upon clearing a Form 211.

How Can These Problems Be Fixed According To The OTC Markets Group?

  1. Make the Form 211 Review Process More Objective and Efficient: Broker-dealers should be able to submit a quotation three (3) days after filing a Form 211, whether or not FINRA has provided a response, and FINRA should be an industry regulator ensuring that the filing broker-dealer has complied with the objective information criteria required under Rule 15c2-11. For example, securities issued under Regulation A, although immediately freely tradable under the SEC’s regulation, cannot be quoted by broker-dealers until and unless a Form 211 is submitted and approved by FINRA, which routinely takes several months instead of three (3) days. This kind of delay inhibits small company capital raising.
  2. Form 211 Materials Should be Made Public and Issuers Should be Liable for Any Misrepresentations: All information submitted in connection with a Form 211 should be made publicly available and the ultimate responsibility for the accuracy of information provided should lie with the issuer, not the broker dealer.
  3. Outsource Form 211 Processes to IDQSs: The filing broker-dealer should send a Form 211 directly to the IQDS on which it plans to quote the security.  The IDQS should review the filing for completeness and submit the Form 211 to FINRA within three (3) days.  An IQDS that is a FINRA member should be permitted for file a Form 211 for quotations on its own system of issuers that meet recognized standards.
  4. Allow IDQSs to Monitor Disclosure and Institute Trading Halts: FINRA member IDQSs should be responsible for developing a regime that monitors the ongoing disclosure of securities quoted and FINRA should give authority to market operators to initiate trading halts. This makes sense because a majority of the fraudulent activity in microcap securities occurs after a Form 211 has been cleared and the security starts trading.
  5. Allow Broker Dealer Compensation for Form 211 Filing: FINRA Rule 5250 should be amended to permit broker-dealers to accept compensation from issuers for the preparation and filing of a Form 211, provided that the relationship is disclosed pursuance to SEA Rule 17(b). The process of information gathering cannot be performed without cost and the quality of the process would be improved if the sponsoring broker-dealer could be paid for these services.
  6. Allow Multiple Market Makers to Quote a Security after a Form 211 is cleared: This would replace the current practice where only the sponsoring broker-dealer may publish quotations for the first thirty (30) days after a Form 211 is cleared.

If you are interested in learning more about the subject matter discussed in this blog, please contact me at (202) 869-0888 (ext. 107) or Lou Bevilacqua at (202) 869-0888 (ext. 100).  We would be happy to discuss. You can also contact us by email at

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