[Federal Register Volume 64, Number 44 (Monday, March 8, 1999)]
[Proposed Rules]
[Pages 11124-11153]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-5299]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

Release No. 34-41110; File No. S7-5-99
RIN 3235-AH40


Publication or Submission of Quotations Without Specified 
Information

AGENCY: Securities and Exchange Commission.

ACTION: Reproposed rule.

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SUMMARY: The Securities and Exchange Commission is reproposing for 
comment amendments to Rule 15c2-11 under the Securities Exchange Act of 
1934 (Exchange Act). Rule 15c2-11 governs the publication of quotations 
for securities in a quotation medium other than a national securities 
exchange or Nasdaq. Also, we are reproposing a companion amendment to 
relocate in Rule 17a-4 under the Exchange Act the record retention 
requirement currently contained in Rule 15c2-11. The original proposal 
was issued in February 1998 in response to concerns about increased 
incidents of fraud and manipulation in over-the-counter (OTC) 
securities, which typically involve thinly-traded securities of thinly-
capitalized issuers (i.e., microcap securities).
    The reproposed amendments are more limited than the initial 
proposal and focus the Rule on those securities the Commission believes 
are more likely to be prone to fraud and manipulation. The reproposal 
is part of the Commission's continuing efforts in regulatory, 
inspections, enforcement, and investor education areas that are key to 
deterring microcap fraud.
    In addition, the reproposal will increase the information that 
broker-dealers must review before publishing quotations for non-
reporting issuers' securities, and will ease the Rule's recordkeeping 
requirements when broker-dealers have electronic access to information 
about reporting issuers. Finally, we are giving guidance to broker-
dealers on the scope of the review required by the Rule and providing 
examples of ``red flags'' that they should look for when reviewing 
issuer information.

DATES: Comments must be received on or before April 7, 1999.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, 
NW, Mail Stop 6-9, Washington, DC 20549. Comments may also be submitted

[[Page 11125]]

electronically at the following E-mail address: [email protected]. 
All comment letters should refer to File No. S7-5-99. All comments 
received will be available for public inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, NW, Washington, 
DC 20549. Electronically submitted comment letters will be posted on 
the Commission's Internet website (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Any of the following attorneys in the 
Division of Market Regulation, Securities and Exchange Commission, 450 
Fifth Street, NW, Mail Stop 10-1, Washington, DC 20549, at (202) 942-
0772: Nancy J. Sanow, Irene A. Halpin, Florence E. Harmon, Chester A. 
McPherson, or Jerome J. Roche.

SUPPLEMENTARY INFORMATION:

Table of Contents

    I. Executive Summary
    A. Overview of the microcap fraud problem and efforts to prevent 
further abuses
    B. Background of Rule 15c2-11 and recent proposed amendments
II. Overview of Reproposed Amendments
III. Discussion of Amendments
    A. Securities excluded from the Rule
    1. Securities satisfying a trading value test
    2. Securities satisfying a bid price test
    3. Securities of issuers satisfying a net tangible assets test
    4. Non-convertible debt, non-participatory preferred stock, and 
asset-backed securities
    5. Other Exceptions
    B. Quotations subject to the Rule
    1. The initial quotation for a covered OTC security
    2. Priced quotations
    3. Annual review
    C. Information required under the Rule
    1. Reporting issuers delinquent in their filings
    2. Issuers in bankruptcy
    a. Reporting issuers
    b. Non-reporting issuers emerging from bankruptcy
    3. Non-reporting foreign private issuers
    4. Other non-reporting issuers
    D. Information available upon request
    E. Information repository
    F. Definitions
    G. Preservation of documents and information
    H. Transition and exemptive authority provisions
    I. Information submitted to the NASD
    IV. General Request For Comments
    V. Effects on Efficiency, Competition, and Capital Formation
VI. Costs and Benefits of the Amendments
    A. Benefits
    B. Costs
VII. Initial Regulatory Flexibility Act
VIII. Paperwork Reduction Act
    A. Collection of information under the amendments
    B. Proposed use of information
    C. Respondents
    D. Total annual reporting and recordkeeping burden
    1. Burden-hours for broker-dealers
    2. Burden-hours for issuers
    3. Total burden-hour costs to broker-dealers and issuers
    4. Capital cost to broker-dealers and issuers
    E. General information about the collection of information
    F. Request for comments
IX. Statutory Basis and Text of Proposed Amendments and Rule

Appendix

I. Introduction
II. Quotation Events Triggering the Review Requirement
III. The Review Process
    A. Introduction
    B. Source reliability
    1. Determining whether a source is reliable
    2. Examples of unreliable sources
    C. Document review obligations
    D. Scope of review following a trading suspension
IV. Examples of Red Flags

I. Executive Summary

A. Overview of the Microcap Fraud Problem and Efforts to Prevent 
Further Abuses

    Because incidents of fraud and manipulation involving microcap 
securities are a serious concern, the Commission, along with other 
regulators, has made combating microcap fraud one of its top 
priorities. Microcap securities generally are characterized by low 
share prices and little or no analyst coverage.\1\ The issuers of 
microcap securities typically are thinly-capitalized and information 
about them often is limited, particularly when they are not subject to 
the Commission's periodic disclosure requirements. Securities of 
microcap companies usually are quoted on the OTC Bulletin Board 
operated by the National Association of Securities Dealers, Inc. 
(NASD), or in the Pink Sheets published by the National Quotation 
Bureau, Inc. (NQB), but they are not exclusive to these quotation 
mediums.\2\
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    \1\ The term microcap securities is not defined under the 
federal securities laws or regulations. The use of the term 
``microcap securities'' in this release, however, should be 
distinguished from its use in the mutual fund context. For example, 
Lipper Analytical Services, a mutual fund rating organization, 
generally categorizes microcap companies as companies with market 
capitalization of less than $300 million. Lipper-Directors' 
Analytical Data, Investment Objective Key, 2d ed. 1997.
    \2\ Microcap securities can also be listed on securities 
exchanges or Nasdaq or quoted in alternative trading systems.
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    Microcap fraud often involves schemes such as ``pump and dump'' 
operations, in which unscrupulous brokers sell the securities of less-
seasoned issuers to retail customers by using high pressure sales 
tactics and a supply of securities under the firm's control. The 
fraudsters create interest in the security by disseminating false or 
misleading information about the issuer through, for example, oral 
statements, press releases, or the Internet. To further the 
manipulative scheme, the retail broker frequently acts as a market 
maker in the security or, either on its own or through the issuer's 
promoter, induces other firms to act as market makers.
    By publishing quotations, the market maker raises the profile of 
the security, even though the market maker is not an active participant 
in the fraud and publishes quotations solely in response to increased 
demand for the security. The broker, promoter, or others orchestrating 
the fraud can point to quotations for the security to ``validate'' its 
worth. The perpetrators of the fraud then dispose of their stake at an 
inflated price. Once they no longer need to stimulate interest in the 
security, the market for it collapses and innocent investors are left 
holding stock with little or no value.
    The defrauded victims of microcap fraud activities are not the only 
ones harmed. When other investors become reluctant or unwilling to 
invest in the kinds of securities they perceive as prone to fraud, 
liquidity for those securities can be impaired. As a result, existing 
shareholders can face difficulty in disposing of their holdings and 
legitimate issuers of lower-priced stocks can find it hard to raise 
capital to start up or expand operations or services. In short, 
continuing incidents of microcap fraud are detrimental to the integrity 
of our nation's capital markets.
    To combat microcap abuses, we have initiated several enforcement, 
examination, education, and regulatory measures. These actions include 
the following:
     In September 1998, we filed 13 enforcement actions against 
41 defendants for their involvement in fraudulent microcap schemes that 
bilked investors of more than $25 million.\3\
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    \3\ For a summary of these cases, see Fight Against Microcap 
Fraud ``Paying Dividends'', Press Release No. 98-92 (September 24, 
1998), available through our Internet website at <http://
www.sec.gov/news/micronew.htm>.
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     We conducted a nationwide sweep to combat fraud through 
the Internet, which resulted in 23 enforcement actions against 44 stock 
promoters of microcap stocks in October 1998.\4\
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    \4\ For a summary of these cases, see Purveyors of Fraudulent 
Spam, Online Newsletters, Message Board Postings, and Websites 
Caught, Press Release No. 98-117 (October 28, 1998), available 
through our Internet website at <http://www.sec.gov/news/
netfraud.htm>.

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[[Page 11126]]

     We initiated examination sweeps of several firms that are 
active in the microcap market. Our examination staff conducted complex 
and resource-intensive reviews of these firms' records for evidence of 
the hallmarks of microcap fraud, such as patterns of ``bait and 
switch'' sales techniques, misrepresentations and exaggerated claims, 
unauthorized trading and refusals to sell securities, market 
manipulation, and lax or nonexistent supervision.
     We have held numerous investors' town meetings across the 
country to educate people about investing wisely, and we have put 
together several brochures to assist investors.\5\
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    \5\ See, e.g., ``Microcap Stock: A Guide for Investors'' 
(providing a variety of tips on how to detect and avoid microcap 
fraud); ``Cold Calling Alert'' (describing the cold calling rules 
and instructing investors how to avoid telephone scams); ``Internet 
Fraud'' (describing common frauds including on-line newsletter and 
bulletin board posting scams); and ``Ask Questions'' (listing 
questions that investors should ask about their investments and 
their investment professionals). All of these publications are 
available for free from our toll-free publications line at (800) 
732-0330 and can be downloaded through our Internet website at 
<http://www.sec.gov>.
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     We are cooperating with self-regulatory organizations 
(SROs) to improve supervision and regulation of the OTC securities 
market. For example, we recently approved NASD rule changes that limit 
quotations on the OTC Bulletin Board to the securities of issuers that 
are current in their reports filed with the Commission or other 
regulatory authority.\6\
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    \6\ Securities Exchange Act Release No. 40878 (January 4, 1999), 
64 FR 1255 (OTC Bulletin Board Release).
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     We have taken steps to strengthen our regulations and 
close loopholes to help reduce incidents of microcap fraud.
    Today, we are taking action on several additional regulatory 
measures aimed at preventing further incidents of microcap fraud. In 
addition to adopting amendments to Form S-8 \7\ under the Securities 
Act of 1933 (Securities Act) \8\ and adopting amendments to Regulation 
D,\9\ we are reproposing amendments to Rule 15c2-11 \10\ under the 
Securities Exchange Act of 1934 (Exchange Act),\11\ our rule that 
governs the quotations by broker-dealers for OTC securities.\12\ Rule 
15c2-11 is intended to prevent broker-dealers from becoming involved in 
the fraudulent manipulation of OTC securities. However, even if a 
broker-dealer technically complies with the Rule's requirements, it 
would be subject to liability under other antifraud provisions of the 
securities laws, such as Rule 10b-5, if it publishes quotations as part 
of a fraudulent or manipulative scheme.\13\
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    \7\ Securities Act Release No. 33-7646 (February 19, 1999). The 
amendments to Form S-8 restrict the use of Form S-8 for the sale of 
securities to consultants and advisors, among other things.
    \8\ 15 U.S.C. 77a et seq.
    \9\ Securities Act Release No. 33-7644 (February 19, 1999). The 
amendments limit the circumstances where freely tradable securities 
may be issued in reliance on, and general solicitation is permitted 
under, Rule 504 of Regulation D.
    \10\ 17 CFR 240.15c2-11.
    \11\ 15 U.S.C. 78a et seq.
    \12\ In this release, ``OTC stocks'' or OTC securities refers to 
securities that are not listed on a national securities exchange or 
Nasdaq. ``Covered OTC securities'' refers to those OTC securities 
that are subject to Rule 15c2-11. The Rule applies to securities 
quoted on the OTC Bulletin Board operated by the NASD, the Pink 
Sheets operated by the NQB, and similar quotation mediums. For 
further discussion of quotation mediums, see Part III.F. below
    \13\ 17 CFR 240.10b-5.
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B. Background of Rule 15c2-11 and Recent Proposed Amendments

    Rule 15c2-11 contains requirements that are intended to deter 
broker-dealers from initiating or resuming quotations for covered OTC 
securities that may facilitate a fraudulent or manipulative scheme. The 
Rule currently prohibits a broker-dealer from publishing (or submitting 
for publication) a quotation for a covered OTC security in a quotation 
medium unless it has obtained and reviewed current information about 
the issuer.\14\ The broker-dealer must also have a reasonable basis for 
believing that the issuer information, when considered along with any 
supplemental information, is accurate and is from a reliable 
source.\15\
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    \14\ Rule 15c2-11 defines quotation as any bid or offer at a 
specified price with respect to a security, or any indication of 
interest by a broker or dealer in receiving bids or offers from 
others for a security, or any indication by a broker or dealer that 
advertises its general interest in buying or selling a particular 
security. For the purposes of this release, a ``priced quotation'' 
is a bid or offer at a specified price.
    \15\ See Part III.C. below for a description of the required 
issuer and supplemental information.
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    The Rule currently contains several exceptions to its prohibitions. 
Under the ``piggyback'' exception, the Rule's information requirements 
do not apply when a broker-dealer publishes, in an interdealer 
quotation system, a quotation for a covered OTC security that was 
already the subject of regular and frequent quotations in the same 
interdealer quotation system.\16\ A broker-dealer is able to 
``piggyback'' on either its own or other broker-dealers' previously 
published quotations. This exception assumes that regular and frequent 
quotations for a security generally reflect market supply and demand 
and are based on independent, informed pricing decisions. However, as a 
result of the piggyback provision, the Rule's application is 
essentially limited to just the first broker-dealer publishing quotes.
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    \16\ An interdealer quotation system is a quotation medium of 
general circulation to brokers or dealers which regularly 
disseminates quotations of identified brokers or dealers. 17 CFR 
240.15c2-11(e)(2). Under the proposed amendments, the definition of 
``interdealer quotation system'' would be incorporated into the 
definition of ``quotation medium.'' See Part III.F. below for a 
discussion of the term ``quotation medium.''
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    In February 1998, the Commission published for comment amendments 
to the Rule that were designed to curb fraud in microcap 
securities.\17\ This proposal would have eliminated the piggyback 
provision by requiring all broker-dealers to review current issuer 
information before publishing their first quotation for a covered OTC 
security, without regard to whether the quotation was priced or 
unpriced, and to thereafter review current issuer information annually 
if they published priced quotations. With limited exceptions, the 
proposal would have applied to any security quoted in a quotation 
medium other than a national securities exchange or Nasdaq. The 
proposal would also have expanded the information required for issuers 
that do not file periodic reports with the Commission (e.g., non-
reporting issuers). In addition, broker-dealers would have been 
required to make the issuer information available to anyone who 
requested it.
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    \17\ Securities Exchange Act Release No. 39670 (February 17, 
1998), 63 FR 9661 (Proposing Release).
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    In response to the Proposing Release, we received 199 comment 
letters from 193 commenters.\18\ The majority of commenters, which 
included broker-dealers, issuers, attorneys, and individuals, opposed 
many of the proposed changes. Broker-dealers were especially concerned 
that they would be exposed to potential liability in civil actions as a 
result of their increased review obligations under the proposal. 
Commenters also expressed views about the possibility of: reduced 
liquidity in covered OTC securities if broker-dealers stopped making 
markets; less transparent markets if broker-dealers did not publish 
priced quotes to avoid the annual review requirement; less competitive 
pricing for covered OTC securities; impaired access to capital by

[[Page 11127]]

issuers; and increased compliance costs for broker-dealers. In 
addition, some commenters pointed out that the proposal would not cover 
Nasdaq SmallCap securities, which, they noted, have also been the 
subject of abusive activities. Some commenters also remarked that the 
proposal would not stop microcap fraud, which, in their view, is really 
a sales abuse problem.
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    \18\ This total includes virtually identical comment letters 
from 68 issuers. All comment letters are available in File No. S7-3-
98 at our Public Reference Room, 450 Fifth Street, NW, Washington, 
DC 20549. Comment letters that were submitted electronically are 
available through our Internet website at <http://www.sec.gov/rules/
s7398.htm>.
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    Several commenters, principally state securities regulators and 
their national association, supported the proposal. They believed that 
microcap fraud would be deterred if broker-dealers are required to 
review issuer information and make their own independent and 
substantiated determinations before publishing quotations. Further, 
commenters favoring the proposal stated that the availability of 
information via EDGAR and the speed of communication via the Internet 
would ease any increased burden on broker-dealers created by the Rule 
amendments. Finally, a number of commenters were more neutral in their 
approach and offered views or suggestions on specific provisions.

II. Overview of Reproposed Amendments

    The Commission is issuing a revised proposal to amend Rule 15c2-11 
to help curtail abuses in the offer, sale and trading of microcap 
securities. Because these amendments will significantly change the 
Rule's scope, we are publishing them to give interested persons an 
opportunity to provide us with their comments and views.
    The amendments are intended to have broker-dealers ``stop, look and 
listen'' before they begin to quote a covered OTC security in a 
quotation medium other than a national securities exchange or Nasdaq. 
However, the amendments reflect commenters' concerns about the earlier 
proposal by limiting the scope of the Rule principally to priced 
quotations and to those securities that the Commission believes are 
more likely to be the subject of improper activities. Under these 
amendments, the Rule will no longer apply to securities of larger 
issuers, or to securities that have a substantial trading price or that 
meet a minimum dollar value of average daily trading volume. In 
addition, the Rule will only cover priced quotations, except in the 
case of the first quotation for a covered OTC security. The provisions 
relating to the broker-dealer's obligations under the Rule and the 
issuer information that the broker-dealer must review are little 
changed from the initial proposal.
    We also are providing guidance regarding the steps broker-dealers 
should take and ``red flags'' they should consider when reviewing the 
Rule's required information. In response to commenters' concerns about 
broker-dealer liability, we stress that broker-dealers will have no 
obligation to continuously update their Rule 15c2-11 materials. The 
broker-dealer's review obligations under the Rule occur only at the 
specific times identified in the Rule.
    In general, the amendments would:
     Limit the Rule primarily to priced quotations; \19\
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    \19\ The amendments, however, will prohibit the first broker-
dealer from publishing a priced or unpriced quotation for a covered 
OTC security unless it complies with the Rule. For a discussion of 
the requirements concerning the initial quotation for a covered OTC 
security, see Part III.B.1. below.
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     Eliminate the Rule's piggyback provision and require all 
broker-dealers to review current issuer information before publishing 
priced quotations for a security;
     Require broker-dealers publishing priced quotations for a 
security to review current information about the issuer annually and 
upon the occurrence of specified events;
     Expand the information required for certain non-reporting 
issuers;
     Require documentation of the broker-dealer's compliance 
with the Rule; and
     Require broker-dealers publishing quotes in compliance 
with the Rule to provide the issuer information upon request to 
customers, prospective customers, information repositories, and other 
broker-dealers.
    In addition, the amendments would exclude from the Rule's coverage:
     Securities with a worldwide average daily trading volume 
value of at least $100,000 during each month of the six full calendar 
months immediately preceding the date of publication of a quotation, 
and convertible securities where the underlying security satisfies this 
threshold;
     Securities with a bid price of at least $50 per share;
     Securities of issuers with net tangible assets in excess 
of $10,000,000, as demonstrated by audited financial statements;
     Non-convertible debt and non-participatory preferred 
stock; and
     Asset-backed securities that are rated as investment grade 
by at least one nationally recognized statistical rating organization.
    These amendments are intended to enhance the integrity of 
quotations for securities in this market sector, to improve the quality 
of information about smaller, lesser-known issuers, and to foster 
greater access to this information by investors. The amendments also 
reorganize and simplify the Rule's provisions consistent with the 
Commission's Plain English program.

III. Discussion of Amendments

    The amendments restructure Rule 15c2-11 by setting forth more 
clearly the quotation events that trigger the Rule, the requirements 
that the broker-dealer must satisfy, and the nature of the information 
that the broker-dealer must review. The amendments state that no 
broker-dealer, directly or indirectly, may publish the described kinds 
of quotations for a security in any quotation medium, without first 
complying with the Rule's provisions. The Rule will only apply at 
specified points in time, namely, when a broker-dealer publishes:
     The first quotation for a security;
     Its first quotation at a specified price for a security 
after another broker or dealer published the first quotation for the 
same security;
     The first quotation following the termination of a 
Commission trading suspension ordered pursuant to section 12(k) of the 
Exchange Act \20\ in any security of the issuer of the suspended 
security;
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    \20\ 15 U.S.C. 781(k).
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     A quotation at a specified price for a security after a 
period of five or more consecutive business days when it did not 
publish any quotations at a specified price for that security;
     Its first quotation at a specified price for a security 
after the date that is four months after the end of the issuer's fiscal 
year, unless the issuer is a foreign private issuer; or
     Its first quotation at a specified price for a security of 
a foreign private issuer after the date that is seven months after the 
end of the issuer's fiscal year.
    The broker-dealer's information gathering and review requirements 
are substantially the same as the initial proposal.\21\ If the Rule 
applies, the broker-dealer must:
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    \21\ However, we are narrowing the scope of the requirement 
contained in the Proposing Release that broker-dealers provide the 
Rule 15c2-11 information to others upon their request. See Part 
II.D. below.
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     Review the Rule's specified information;
     Determine that it has a reasonable basis for believing 
that the information is accurate in all material respects and was 
obtained from reliable sources;
     Record the date it reviewed the specified information, the 
sources of the information, and the person at the firm responsible for 
the broker-dealer's compliance with the Rule; and

[[Page 11128]]

     Preserve the specified information in accordance with Rule 
17a-4.\22\
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    \22\ 17 CFR 240.17a-4.
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    Commenters on the Proposing Release did not object to the standards 
set forth in these review and documentation requirements. Rather, they 
expressed concerns about the scope of a broker-dealer's review 
obligations under the earlier proposal, particularly as some of them 
misconstrued the proposal to require continuous updating of 
information. To assist broker-dealers publishing quotations for covered 
OTC securities, we are giving guidance in an appendix to this release 
about the nature of the review we expect broker-dealers to conduct 
under both the current Rule and the proposed amendments.

A. Securities Excluded From the Rule

    Several commenters suggested that the Rule should cover only those 
securities that have the characteristics that have led to abuses in the 
microcap market.\23\ These commenters noted that, while the earlier 
proposal was intended to focus on microcap abuses, it covered 
quotations for a number of non-reporting foreign and domestic issuers' 
securities that are unlikely to be the targets of microcap schemes. 
They suggested that the amendments be crafted to cover only those 
equity securities most likely to be prone to abusive activities.
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    \23\ See, e.g., Letter from Securities Industry Association 
(April 28, 1998) (SIA Comment Letter).
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    We agree that applying the Rule to the securities of larger 
issuers, more liquid securities, and certain fixed-income debt 
securities is not directly related to microcap fraud concerns.\24\ We 
therefore are proposing to exclude from Rule 15c2-11 those securities 
satisfying any one of three alternative tests based on: the value of 
the security's average daily trading volume (ADTV); the security's bid 
price; or the issuer's net tangible assets.\25\ We are also proposing 
to exclude debt securities, non-participatory preferred stock, and 
investment grade asset-backed securities.
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    \24\ Of course the general antifraud provisions of the federal 
securities laws, including Rule 10b-5 (17 CFR 240.10b-5), apply to 
transactions in all securities, whether or not excluded from Rule 
15c2-11.
    \25\ We estimate that at least 10% of covered OTC securities 
will be excluded from the Rule under these tests. We estimate that 
approximately 5% of the OTC securities of U.S. companies, 10% of the 
OTC securities of foreign issuers (excluding ADRs), and 66% of OTC 
American Depositary Receipts (ADRs) will satisfy any one of these 
three alternative tests.
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1. Securities Satisfying a Trading Value Test
    To tailor the Rule to transactions that we believe are most likely 
to involve microcap fraud, the amendments exclude securities with a 
value of worldwide ADTV of at least $100,000 during each month of the 
six full calendar months immediately preceding the date of publication 
of a quotation.\26\ Convertible securities will also be excluded when 
the underlying security satisfies this threshold.
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    \26\ We have used an ADTV value of $100,000 in another, but 
related, context. Rules 101 and 102 of Regulation M, 17 CFR 242.101 
and 102, provide for a one business day restricted period for 
securities with an ADTV value of at least $100,000 (as measured over 
a 60 day period), if the issuer has a public float value of at least 
$25 million. These rules are intended to prevent manipulative 
activities during a distribution.
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    The majority of OTC stocks of U.S. companies that are not listed on 
an exchange or Nasdaq trade infrequently and will not satisfy for a 
test based on a value of ADTV of $100,000 or more during each month 
over a six month measuring period. However, there are a number of non-
reporting issuers having securities with significant trading levels, 
particularly larger foreign issuers with actively traded securities in 
their home markets. We think that it is appropriate to take this 
trading activity into account in applying the value of ADTV test.
    The price of a microcap security that is the subject of a fraud 
often is manipulated upward rapidly so that those involved in the 
manipulation can quickly sell stock at a significant profit, to the 
detriment of innocent investors. Microcap securities involved in such 
manipulations often are thinly traded, and the daily trading volume for 
such securities rarely reaches a value of $100,000 over an extended 
period of time. We believe that measuring the value of the security's 
ADTV over a six month period is a way to ensure that the securities 
qualifying for this exclusion are not involved in the type of short-
term price manipulations frequently seen in microcap schemes.
    A broker-dealer should 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 that the information is 
reliable.\27\ In calculating the value of ADTV in U.S. dollars, any 
reasonable and verifiable method may be used.\28\ For example, it may 
be derived from multiplying the number of shares by the price in each 
trade. The NASD may also be able to assist broker-dealers in 
determining whether a particular security is eligible for the 
exclusion.
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    \27\ A broker-dealer will be able to rely on trading volume as 
reported by SROs or comparable entities, or any other source 
believed to be reliable. Electronic information systems that provide 
information regarding securities in markets around the world could 
provide an easy means to determine worldwide trading volume in a 
particular security. Worldwide trading volume includes all markets, 
domestic or foreign, where an OTC security is traded.
    \28\ This is comparable to the calculation of value of ADTV 
under Regulation M. See Securities Exchange Act Release No. 38067 
(December 20, 1996), 62 FR 520, 537.
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    Q1. Should the dollar value of ADTV for this exclusion be higher 
than $100,000, e.g., $500,000 or $1 million, or should it be a lower 
amount, e.g., $50,000? Commenters should provide data and analysis to 
support suggested revisions to this proposed threshold.
    Q2. Should the dollar value of ADTV measuring period be longer than 
six months, e.g., twelve months, or be shorter, e.g., three months? 
Should the length of the measuring period depend on the amount of the 
value of ADTV threshold, i.e., should a lower value of ADTV threshold 
be allowed but require a longer measuring period?
    Q3. Should the exclusion based on ADTV value also incorporate a 
value of public float test, like Regulation M does? If so, should the 
public float value be $25 million or some higher or lower amount? Would 
public float information be easy or difficult to obtain for non-
reporting issuers? \29\
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    \29\ See id.
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    Q4. Rule 101 under the Commission's Regulation M excludes from that 
rule's trading prohibitions securities with a value of ADTV of $1 
million or more, using a two month measuring period, if the issuer has 
a public float value of at least $150 million. Should Rule 15c2-11's 
exclusion parallel the terms of this exclusion?
2. Securities Satisfying a Bid Price Test
    To limit the Rule to transactions that the Commission believes are 
most likely to involve microcap fraud, we are proposing an amendment to 
exclude securities with a bid price of at least $50 per share at the 
time the quotation is published in the quotation medium.\30\ While the 
vast majority of OTC stocks are quoted at lower prices and will not 
typically satisfy for a test based on a bid price of at least $50 per 
share, there are

[[Page 11129]]

securities of closely-held issuers that are quoted at significant share 
prices. The broker-dealer publishing the quotation can use its own bona 
fide quotation to satisfy the test. The broker-dealer cannot use its 
own or another broker-dealer's unpriced quotation to rely on this test, 
even if the broker-dealer publishing a name-only quotation provides a 
bid price of at least $50 per share upon inquiry. If a security is a 
unit composed of one or more securities, the bid price of the unit, 
when divided by the number of shares of the unit that are not warrants, 
options, rights, or similar securities, must be at least $50 to be 
excepted from the Rule.\31\
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    \30\ Most of the Commission's recent trading suspension orders 
issued under Section 12(k) of the Exchange Act, 15 U.S.C. 781(k), 
have involved securities quoted on the OTC Bulletin Board or the 
Pink Sheets. Our staff's analysis of these trading suspension 
orders, issued between April 1, 1994 and January 1, 1998, showed 
that the suspended OTC securities had an average bid price of 
approximately $5, with a median bid price of approximately $3. These 
securities had bid prices that ranged from a low of approximately 
$0.50 to a high of approximately $18.
    \31\ This is comparable to the provisions excluding equity 
securities priced at $5 or more from the definition of ``penny 
stock'' contained in 17 CFR 240.3a51-1(d)(2).
---------------------------------------------------------------------------

    Q5. Should this exclusion be based on a bid price higher than $50 
per share, e.g., $100 per share or lower, e.g., $20 per share? 
Commenters should provide data and analysis to support suggested 
alternatives to the proposed threshold.
    Q6. Should this exclusion be available only if the security has a 
bid price of $50 over a specified period of time?
    Q7. Should this test be based instead on the security's last sale 
price? If so, should there be a time limit added to such a test so that 
a stale last sale price cannot be used?
3. Securities of Issuers Satisfying a Net Tangible Assets Test
    Microcap fraud schemes generally involve issuers with limited 
assets.\32\ We are therefore proposing to exclude securities of issuers 
having net tangible assets in excess of $10,000,000, as determined by 
audited financial statements.
---------------------------------------------------------------------------

    \32\ Analysis of OTC securities that were the subject of recent 
Commission-ordered trading suspensions showed the issuers on average 
had approximately $3,500,000 in net tangible assets, with a median 
of approximately $225,000 is such assets.
---------------------------------------------------------------------------

    If the issuer is not a foreign private issuer, a broker-dealer 
should make this determination using the most recent financial 
statements for the issuer that have been audited and reported on by an 
independent public accountant in accordance with the provisions of Rule 
2-02 of Regulation S-X.\33\ If the issuer is a foreign private issuer, 
a broker-dealer should make this determination using the most recent 
financial statements for the issuer (dated less than 18 months prior to 
the date of the publication of the quotation) that are prepared in 
accordance with a comprehensive body of accounting principles, audited 
in compliance with requirements of the country of incorporation, and 
reported on by an accountant duly registered and in good standing under 
the regulations of that jurisdiction.\34\ If audited financial 
statements are unavailable, the broker-dealer may not rely on this 
exception.
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    \33\ 17 CFR 210.2-02.
    \34\ These financial statements may be found in filings with the 
Commission on Forms 20-F or 6-K, or in submissions under Rule 12g3-
2(b) under the Exchange Act (17 CFR 240.12g3-2(b)), or elsewhere.
---------------------------------------------------------------------------

    Some commenters suggested that we look to the current definition of 
``penny stock'' in assessing the scope of Rule 15c2-11. Exchange Act 
Rule 3a51-1 excludes from the definition of penny stock a security of 
an issuer having net tangible assets in excess of $2 million, if the 
issuer has been in continuous operation for at least 3 years, or $5 
million, if the issuer has been in continuous operation for less than 
three years.\35\ We preliminarily believe that, for purposes of an 
exclusion from the Rule, the net tangible assets amount should be 
higher, and, unlike the definition of penny stock, the threshold need 
not distinguish between newer and more seasoned issuers.
---------------------------------------------------------------------------

    \35\ 17 CFR 240.3a51-1.
---------------------------------------------------------------------------

    Q8. Should the threshold amount for this net tangible assets test 
be higher than $10 million, e.g., $20 million? Under what circumstances 
would it be appropriate to permit a lower threshold amount? Commenters 
should provide data and analysis to support their views on whether the 
threshold amount should be raised or lowered.
    Q9. For ease of compliance with both Commission and NASD rules, 
should this exclusion parallel the exclusion contained in the NASD's 
proposed rule that would require broker-dealers to review current 
information about the issuer of an OTC security before recommending a 
transaction in the security?\36\ The NASD proposal would exclude the 
securities of issuers having total assets of at least $100 million and 
shareholders' equity of at least $10 million, based on audited 
financial statements.
---------------------------------------------------------------------------

    \36\ See proposed NASD Rule 2315, which the Commission recently 
issued for public comment. Securities Exchange Act Release No. 41075 
(February 19, 1999). The proposed rule will be available through the 
NASD Regulation Internet website at <http://www.nasdr.com> and our 
Internet website at <http://www.sec.gov>.
---------------------------------------------------------------------------

    Q10. Will there be sufficient information in financial statements, 
particularly those of non-reporting issuers, to permit broker-dealers 
to make the net tangible assets calculation?
    Q11. Should the use of financial statements of a foreign private 
issuer be limited to financial statements prepared in accordance with 
U.S. generally accepted accounting principles (GAAP)?
    Q12. Should the use of financial statements of a foreign private 
that are not prepared in accordance with U.S. GAAP be limited to 
financial statements prepared in accordance with the accounting 
standards promulgated by the International Accounting Standards 
Committee (IASC)?\37\
---------------------------------------------------------------------------

    \37\ IASC's accounting standards are summarized on, and may be 
ordered through, the IASC's Internet website at <http://
www.iasc.org.uk>.
---------------------------------------------------------------------------

    Commenters are invited to provide us with their views on the 
alternative tests for an exclusion from Rule 15c2-11, as described 
above.
    Q13. Should all three of the tests based on value of ADTV, bid 
price, and net tangible assets be incorporated into Rule 15c2-11?
    Q14. Should the proposed exclusions from the Rule be limited to 
those securities that satisfy at least two of the three tests?
    Q15. Are there other tests that are more appropriate to exclude the 
securities of larger, more seasoned issuers from Rule 15c2-11? For 
example, should a security that has no or very minimal trading volume 
be excluded from the Rule's requirements? What would be an appropriate 
low volume threshold? If trading volume suddenly exceeded the low 
volume threshold, would broker-dealers publishing quotes find it easy 
or difficult to have to obtain and review information before continuing 
to publish priced quotations?
4. Non-Convertible Debt, Non-Participatory Preferred Stock, and Asset-
Backed Securities
    We are proposing to exclude non-convertible debt securities, non-
participatory preferred stock,\38\ and asset-backed securities that are 
rated by at least one nationally recognized statistical rating 
organization, as that term is used in Rule 15c3-1 under the Exchange 
Act,\39\ in one of its generic rating categories that signifies 
investment grade.\40\ Commenters on this

[[Page 11130]]

issue generally supported excluding fixed-income securities from the 
Rule.
---------------------------------------------------------------------------

    \38\ Non-participatory preferred stock means non-convertible 
capital stock, the holders of which are entitled to a preference in 
payment of dividends and in distribution of assets on liquidation, 
dissolution, or winding up of the issuer, but are not entitled to 
participate in residual earnings or assets of the issuer. See 
paragraph (j)(8) of the Rule proposal, which is based upon a 
definition contained in Rule 902(a)(1) of Regulations S (17 CFR 
230.902(a)(1)).
    \39\ 17 CFR 240.15c3-1 (net capital requirements for broker-
dealers).
    \40\ The Commission's staff is engaged in a project to consider 
the development of disclosure and registration requirements 
specifically related to asset-backed securities. As part of that 
project, the staff intends to examine further the role of ratings 
with respect to asset-backed securities. Therefore, we consider it 
appropriate to limit the proposed exclusion to investment grade 
asset-backed securities at this time.
---------------------------------------------------------------------------

    The fraud and manipulation that we have observed in the microcap 
securities have not been evident in the fixed-income market. In 
addition, non-convertible debt securities, non-participatory preferred 
stock, and investment grade asset-backed securities generally trade at 
prices and in denominations that make them less likely targets for 
manipulation. Further, the type of issuer information required by the 
Rule is much less relevant to the pricing and trading of these types of 
securities.
    Q16. Should this exclusion apply to all asset-backed securities or 
should the exclusion apply only to asset-backed securities that are 
rated investment grade on the basis that those securities are even less 
likely to be subject to fraudulent activities?
    Q17. Should the Rule exclude all non-convertible debt and non-
participatory preferred stock or should the exclusion apply only to 
non-convertible debt and non-participatory preferred stock that are 
rated investment grade?
5. Other Exceptions
    The exceptions relating to quotations for exchange-listed and 
Nasdaq securities, quotations representing a customer's unsolicited 
order, and quotations for exempted securities remain substantively the 
same as currently in the Rule. As we indicated in the Proposing 
Release, the unsolicited status of the customer orders would be called 
into question if a broker-dealer repeatedly publishes quotations on the 
basis of the unsolicited customer order exception.\41\
---------------------------------------------------------------------------

    \41\ Proposing Release, 63 FR at 9669. Also, we are combining 
into a single provision the current exceptions for exchange-listed 
and Nasdaq securities.
---------------------------------------------------------------------------

    Q18. Should unsolicited customer orders be required to be 
identified as such in the quotation medium? Is it feasible for 
quotation mediums to show that the quote represents an unsolicited 
customer order?

B. Quotations Subject to the Rule

1. The Initial Quotation for a Covered OTC Security
    As indicated above, the Rule's requirements will apply at the time 
of discrete quotation events. Subject to the Rule's exceptions, the 
amendments will prohibit the first broker-dealer from publishing a 
priced or unpriced quotation for a covered OTC security in a quotation 
medium unless it has obtained and reviewed specified information about 
the issuer and the security. Further, this information will need to be 
submitted to the NASD, in accordance with the NASD's rules, at least 
three business days before the quotation is published.\42\ There is one 
situation that ``restarts'' the Rule's requirements: following the 
termination of a Commission trading suspension ordered pursuant to 
Exchange Act Section 12(k),\43\ the broker-dealer publishing the first 
quote, whether it is priced or unpriced, must comply with Rule 15c2-11. 
In essence, this is the way the Rule currently works.
---------------------------------------------------------------------------

    \42\ For a discussion of the requirements under the reproposed 
amendments concerning the submission of information to the NASD, see 
Part III.I. below.
    \43\ 15 U.S.C. 781(k).
---------------------------------------------------------------------------

    We believe that the Rule should cover the first quotation as a 
means to assure that there is basic information about the issuer 
available to the marketplace before trading in the security begins and 
to alert regulators that trading in the security will be starting. The 
NASD uses Rule 15c2-11 submissions for surveillance and enforcement 
purposes and routinely provides copies of this information to the 
Commission.
2. Priced Quotations
    While the first broker-dealer must obtain the required information 
for the initial quotation (priced or unpriced) for a covered OTC 
security as discussed above, thereafter the Rule will only apply to 
broker-dealers submitting their first priced quotations. The Rule's 
review requirements are also triggered when a broker-dealer first 
publishes a priced quotation following the lapse of five or more 
business days of its priced quotations for the security. In addition, 
as discussed below, a broker-dealer must satisfy the Rule's 
requirements if it publishes a priced quotation as of a specific date 
following the end of the issuer's fiscal year.
    We propose to focus the Rule's requirements after publication of 
the first quote on priced quotations, because recent microcap 
manipulation schemes have primarily involved priced quotations. In 
addition, priced quotes are used as indicia of value for a variety of 
purposes (e.g., bank loans or pledges of securities). This revision 
also responds to the concerns of several commenters that the earlier 
proposal could have resulted in some broker-dealers being precluded 
from publishing any quotations if they could not obtain the Rule's 
required information. We solicit commenters' views, however, on whether 
unpriced indications of interest will be used more often in unlawful 
microcap activities, and, if so, whether the Rule should cover all 
initial quotations.
3. Annual Review
    The amendments require a broker-dealer to review the specified 
information annually if the broker-dealer publishes priced quotations 
for the security. The date by which the annual review must be performed 
depends on whether the issuer is a domestic or a foreign company:
     Domestic Issuers: The annual review must occur prior to 
the first priced quotation that is more than four months after the end 
of the issuer's fiscal year.
     Foreign Private Issuers: The annual review must occur 
prior to the first priced quotation that is more than seven months 
following the end of the issuer's fiscal year.
    The purpose of this requirement is to make sure that the broker-
dealer periodically reviews fundamental information about the issuer if 
the broker-dealer continues to publish priced quotations. The broker-
dealer should know if no current information about the issuer exists or 
if current information reflects a significant change in the issuer's 
ownership, operations, or financial condition.
    While we originally proposed two alternative dates for conducting 
the annual review, to simplify the Rule we are reproposing only one 
date for each type of security.\44\ Four months after the end of the 
issuer's fiscal year, a broker-dealer publishing priced quotes for a 
covered OTC security of a domestic issuer must have conducted the 
annual review. In the case of a foreign private issuer's security, the 
annual review must occur before the broker-dealer publishes a priced 
quote following the date that is seven months after the issuer's fiscal 
year end. We believe that these time periods give a broker-dealer 
sufficient time to obtain and review updated issuer information for 
both reporting and non-reporting issuers.
---------------------------------------------------------------------------

    \44\ The initial proposal would have permitted a broker-dealer 
to conduct the annual review as of the anniversary date of the 
initial quotation.
---------------------------------------------------------------------------

    Some commenters opposed the annual review requirement because of 
potential recordkeeping burdens, the perceived difficulty of obtaining 
the required information, and the loss of liquidity that could 
potentially occur if broker-dealers could not publish priced quotes 
because current issuer information was unavailable.\45\

[[Page 11131]]

Commenters stated that the Rule's review requirements represented a 
shift from the Commission and the SROs to broker-dealers of the burdens 
of overseeing issuer compliance with regulatory requirements.\46\ Some 
commenters wrote that the annual review is only appropriate for certain 
non-reporting companies or issuers for which only limited information 
is available. Other commenters stated that the annual review should not 
apply to issuers that are current in their reporting requirements 
because this information is available on EDGAR.\47\ A number of 
commenters, however, generally supported some sort of required annual 
review for broker-dealers publishing priced quotations, although they 
differed as to the securities that should be subject to this 
provision.\48\
---------------------------------------------------------------------------

    \45\ See Letter from A.G. Edwards & Sons, Inc., (April 27, 1998) 
(A.G. Edwards Comment Letter); and Letter from National Quotation 
Bureau, LLC, (April 27, 1998) (NQB Comment Letter).
    \46\ See, e.g., A.G. Edwards Comment Letter.
    \47\ See, e.g., NQB Comment Letter.
    \48\ See Letter from NASD Regulation, Inc., (July 17, 1998) 
(NASD Comment Letter); Letter from North American Securities 
Administrators Association, Inc., (April 27, 1998) (NASAA Comment 
Letter); and SIA Comment Letter.
---------------------------------------------------------------------------

    The amendments will apply the annual review requirement to priced 
quotations for both reporting and non-reporting issuers' securities. We 
believe that an annual review requirement for both reporting and non-
reporting issuers' securities fulfills the objectives of the Rule 
without imposing significant burdens on broker-dealers. This is 
especially so because we are revising the Rule to cover only those 
securities that, in our view, are most likely to be the subject of 
microcap fraud schemes and are also limiting the scope of the annual 
review to priced quotations. We also note that because information 
about reporting issuers is available on the Commission's website, the 
review of information about these issuers can be accomplished quite 
easily.
    Commenters are requested to provide us with their views on the 
reproposal's focus on priced quotations.
    Q19. Should the Rule cover all broker-dealers' initial quotations, 
whether priced or unpriced, as the earlier proposal would have? Will 
the reproposal cause broker-dealers to publish unpriced quotes to avoid 
complying with the Rule?
    Q20. Should the Rule apply exclusively to priced quotes, i.e., the 
Rule would not cover any unpriced quotes?
    Q21. Are there other approaches that would be more appropriate, 
e.g., to cover any initial quote for a covered OTC security by a 
broker-dealer, whether priced or unpriced, but not to apply the Rule or 
at least the annual review requirement to reporting issuers' 
securities? How would such a proposal help reduce instances of microcap 
fraud?
    Q22. Is the Rule text sufficiently clear in identifying the 
quotation events that are subject to the Rule's provisions? Are there 
other quotation events that should be covered by the Rule?
    Q23. Should the provision pertaining to a lapse in quotations of 
five consecutive business days or more provide for a longer time 
period, e.g., ten consecutive business days without a priced quotation, 
or a shorter time period, e.g., three consecutive business days without 
a priced quotation?
    Q24. Should the Rule give broker-dealers the option to conduct the 
annual review as of the anniversary date of the initial quotation by 
the broker-dealer?

C. Information Required Under the Rule

    The amendments are substantially identical to the earlier proposal 
with respect to the issuer information that a broker-dealer must review 
before publishing a quotation for a covered OTC security. Under the 
reproposal, a broker-dealer subject to the Rule must gather, review, 
and maintain in its records the following issuer information:
     For an issuer that has conducted a recent public offering 
either registered under the Securities Act of 1933 (Securities Act) or 
effected pursuant to Regulation A under the Securities Act, a copy of 
the prospectus or offering circular;
     For an issuer that files reports with the Commission 
pursuant to Sections 13 or 15(d) of the Exchange Act\49\ (reporting 
issuer), the issuer's most recent annual or semi-annual report and any 
subsequent quarterly and current reports;
---------------------------------------------------------------------------

    \49\ 15 U.S.C. 78m and 78o(d).
---------------------------------------------------------------------------

     For an issuer that is an insurance company of the kind 
specified in Section 12(g)(2)(G) of the Exchange Act,\50\ the issuer's 
most recent annual statement referred to in Section 12(g)(2)(G)(i);
---------------------------------------------------------------------------

    \50\ 15 U.S.C. 78l(g)(2)(G).
---------------------------------------------------------------------------

     For an issuer that is not required to file reports 
pursuant to Sections 13 or 15(d) of the Exchange Act and that is a bank 
or savings association, the issuer's most recent annual report and any 
subsequent reports filed with its appropriate federal or state banking 
authority; and
     For any other issuer, the information, including certain 
financial information, specified in proposed paragraph (c)(6) of the 
Rule, which must be reasonably current in relation to the day a 
quotation is submitted.
    The broker-dealer also must obtain and review the supplemental 
information contained in paragraph (d) of the reproposed Rule. A 
broker-dealer must review a copy of any trading suspension order issued 
under Section 12(k) for any of the issuer's securities during the 12 
months preceding the publication of the quotation, as well as any other 
material information, including adverse information, that comes to the 
broker-dealer's knowledge or possession before publication of the 
quotation. A broker-dealer must consider this supplemental information, 
along with the issuer information, when it determines whether it has a 
reasonable basis for believing that the issuer information is accurate 
and from reliable sources. While we are not including a requirement 
that the broker-dealer obtain and review any trading suspension for a 
foreign security that was issued by a foreign financial regulatory 
authority, this information must be taken into account by the broker-
dealer if it comes to the broker-dealer's knowledge or possession at 
the time that a review is required.
    In addition, the broker-dealer must make a record of the 
significant relationship information contained in paragraph (e) of the 
reproposed Rule, which is unchanged from the Proposing Release. Under 
this provision, a broker-dealer would have to document specified 
information such as whether the broker-dealer has any affiliation with 
the issuer or arrangements to receive any consideration to publish the 
quote, and whether the quote is being published on behalf of another 
broker-dealer or the issuer, any of its insiders, or any large 
shareholder.
    Commenters generally did not object to the issuer, significant 
relationship, and supplemental information requirements; in fact, some 
commenters favored the enhanced information requirements for non-
reporting issuers.\51\ Therefore, we are reproposing these requirements 
without any substantive changes, other than revisions relating to 
financial statements for non-reporting issuers, as discussed

[[Page 11132]]

below in Part III.C.4. We are addressing below specific points that a 
few commenters raised about the information requirements and other 
provisions. Commenters are welcome to provide their views on the 
information requirements for the various categories of issuers and 
should consult the Proposing Release for a more detailed description of 
these provisions.\52\
---------------------------------------------------------------------------

    \51\ In response to the 78 comment letters that we received from 
issuers of securities quoted on the OTC Bulletin Board who were 
concerned about continued liquidity for their securities, we note 
that 33 of these issuers are reporting companies. Also, under 
recently approved amendments to NASD Rules 6530 and 6540, all of 
these issuers ultimately will need to be reporting companies current 
in their reporting obligations in order for their securities to 
remain on the OTC Bulletin Board. See note 6 above and accompanying 
text. There should be no burdens on reporting issuers to provide 
information to broker-dealers wishing to publish quotations because 
the issuer information should be available on EDGAR, as long as the 
issuers are current in their reporting obligations.
    \52\ See Part II.A.4. of the Proposing Release at 63 FR 9661, 
9664-9669.
---------------------------------------------------------------------------

1. Reporting Issuers Delinquent in Their Filings
    In the case of an issuer delinquent in its reporting obligations, a 
broker-dealer will not be able to publish an initial priced quotation, 
or continue to publish priced quotations after the annual review date, 
because it will not be able to obtain the specified reports. A few 
commenters indicated concern about the possible adverse implications 
for the market for delinquent issuers' securities if broker-dealers 
could not publish quotes when current issuer information was 
unavailable.\53\ As noted above, we are revising the Rule to permit 
broker-dealers to publish unpriced quotations, even in the absence of 
current issuer information (except in the case of the first quotation 
for the security).
---------------------------------------------------------------------------

    \53\ See, e.g., NASAA Comment Letter.
---------------------------------------------------------------------------

2. Issuers in Bankruptcy
a. Reporting Issuers
    A few commenters urged us to permit broker-dealers to continue to 
quote the securities of reporting issuers that had filed for 
reorganization under federal bankruptcy law because it would provide 
liquidity for these securities.\54\ They noted that it was often 
burdensome for small companies that had filed for reorganization under 
Chapter 11 of the Bankruptcy Code \55\ to produce audited financial 
statements to comply with Exchange Act reporting requirements.
---------------------------------------------------------------------------

    \54\ See, e.g., Letter from Daniel J. Demers (March 27, 1998) 
(Demers Comment Letter); Letter from Robotti & Company, Inc., (April 
27, 1998) (Robotti Comment Letter); and NQB Comment Letter. In 1989, 
we sought comment on whether there were situations, such as 
bankruptcy, that should be addressed if the piggyback provision were 
revised. See Securities Exchange Act Release No. 27247 (September 
14, 1989), 54 FR 39194 (1989 Release). Commenters on the 1989 
Release argued that it was appropriate to permit broker-dealers to 
continue quoting the securities of issuers that had filed for 
bankruptcy because it provided liquidity for these securities and 
suggested that issuers in bankruptcy be identified in the quotation 
system by using a special indicator.
    \55\ 11 U.S.C. 1101 et seq.
---------------------------------------------------------------------------

    Commenters suggested that broker-dealers could satisfy the Rule's 
requirements by reviewing bankruptcy court filings made by an issuer in 
Chapter 11 reorganization when current Exchange Act reports were 
unavailable. One commenter also suggested that the Commission permit 
delinquent reporting companies that experience a 51% ownership change 
as a result of a confirmed plan of reorganization to begin reporting 
from the effective date of the reorganization plan with a filing with 
the Commission, attaching the court-approved disclosure statement 
together with a certified audited balance sheet as of the effective 
date.\56\
---------------------------------------------------------------------------

    \56\ Demers Comment Letter; see also 11 U.S.C. 1125. The 
disclosure statement includes, among other things, a description of 
the issuer's business plan, a description of any securities to be 
issued, and financial information.
---------------------------------------------------------------------------

    The reproposal will require a broker-dealer publishing quotations 
for a reporting issuer's securities to obtain the issuer's Exchange Act 
reports, even if the reporting issuer has filed for Chapter 11 
reorganization. Thus, if a reporting issuer that has filed for Chapter 
11 reorganization becomes delinquent in its reporting obligations, a 
broker-dealer will not be able to publish priced quotations covered by 
the Rule. For example, a broker-dealer could not continue to publish 
priced quotations as of the annual review date for a covered security 
of a reporting debtor that has become delinquent in its reporting 
obligations.\57\
---------------------------------------------------------------------------

    \57\ Broker-dealers would be able to continue to publish 
unpriced quotations.
---------------------------------------------------------------------------

    The bankruptcy court filings for an issuer undergoing 
reorganization under Chapter 11 are not adequate to satisfy the Rule's 
requirements. These Rule 2015 bankruptcy reports ordinarily contain 
only data about issuer receipts and disbursements and not the type of 
issuer financial information contemplated by Rule 15c2-11.\58\ In some 
cases, our Division of Corporation Finance may grant issuers in 
bankruptcy no-action relief with respect to Exchange Act filing 
requirements.\59\ These no-action positions, however, are predicated on 
little or no trading occurring in the debtor's securities. The Rule 
2015 bankruptcy reports that the Division of Corporation Finance 
accepts under its no-action position do not satisfy Rule 15c2-11 
because this financial report usually contains only information about 
issuer receipts and disbursements. Where a reporting issuer receives 
this type of no-action position, a broker-dealer would not be able to 
obtain the issuer information required by the Rule until the debtor's 
reorganization plan becomes effective, and the debtor files a Form 8-K, 
which instead of attaching the Rule 2015 bankruptcy reports, now 
includes the issuer's audited balance sheet. Under Rule 15c2-11, 
broker-dealers could review this 8-K, which contains an issuer's 
audited balance sheet, and then publish priced quotations. From then 
on, the issuer must file its Exchange Act periodic reports for all 
periods that begin after the plan becomes effective.\60\ The 
publication of quotations by a broker-dealer indicates that a market 
exists for the issuer's securities. It would be inconsistent with the 
premise of the no-action position (i.e., that there is no trading in 
the issuer's securities) if a broker-dealer were able to stimulate 
trading by publishing quotations without having the issuer's Exchange 
Act reports.
---------------------------------------------------------------------------

    \58\ See Federal Rule of Bankruptcy Procedure 2015 (Rule 2015 
bankruptcy reports).
    \59\ See Staff Legal Bulletin No. 2 (April 15, 1997) (CF) (Staff 
Legal Bulletin No. 2), which is available through our Internet 
website at <http://www.sec.gov/rules/othern/slbcf2.txt>. Under Staff 
Legal Bulletin No. 2, our Division of Corporation Finance has 
granted no-action relief permitting an issuer in Chapter 11 
reorganization to satisfy its Exchange Act reporting obligations by 
filing the Rule 2015 bankruptcy reports on Exchange Act Form 8-K. 
See 17 CFR 249.308. Under Staff Legal Bulletin No. 2, the staff has 
allowed a company to substitute its Rule 2015 bankruptcy reports for 
its Exchange Act periodic reports when there is little or no trading 
in the debtor's securities.
    \60\ See Staff Legal Bulletin No. 2.
---------------------------------------------------------------------------

    Q25. Are there circumstances in which a broker-dealer should be 
permitted to publish priced quotations for the securities of delinquent 
reporting issuers in bankruptcy? Please describe these circumstances. 
Should the Rule prohibit broker-dealers from publishing unpriced quotes 
for the securities of these issuers?
b. Non-Reporting Issuers Emerging From Bankruptcy
    The Proposing Release contained amendments to permit broker-dealers 
that quote the securities of non-reporting companies emerging from 
bankruptcy to review the bankruptcy court-approved disclosure statement 
and issuer financial information required by the Rule from the date 
that the bankruptcy court confirms the reorganization plan.\61\ The 
commenters who addressed this issue supported the proposal to limit a 
broker-dealer's review to the post-reorganization information.\62\ The 
amendments are unchanged from the original proposal.
---------------------------------------------------------------------------

    \61\ See 11 U.S.C. 1125. The disclosure statement includes, 
among other things, a description of the issuer's business plan, a 
description of any securities to be issued, and financial 
information.
    \62\ See Letter from Florida Division of Securities (April 27, 
1998) (Florida Comment Letter); NQB Comment Letter; Demers Comment 
Letter; and Robotti Comment Letter. Mr. Demers suggested that the 
required financial information for non-reporting issuers emerging 
from bankruptcy be from the ``effective date'' of the plan, instead 
of the ``confirmation date'' of the plan. We are retaining this 
amendment from the confirmation date because adequate information is 
available about the non-reporting issuer at this point for Rule 
15c2-11 purposes.

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[[Page 11133]]

3. Non-Reporting Foreign Private Issuers
    In the case of a foreign private issuer that relies on an exemption 
from registration under Section 12(g) \63\ of the Exchange Act by 
complying with Exchange Act Rule 12g3-2(b), Rule 15c2-11 specifies that 
a broker-dealer must review the information submitted to the Commission 
under Rule 12g3-2(b).\64\ To qualify for the registration exemption, 
the issuer must furnish to the Commission information that the issuer 
has made or is required to make public under the law of the country in 
which the foreign private issuer is domiciled or incorporated; has 
filed or is required to file with a stock exchange on which the 
securities are traded and which the exchange has made public; or has 
distributed or is required to distribute to its securityholders. For 
foreign private issuers that do not furnish the Commission with 
information under Rule 12g3-2(b), the Rule currently requires broker-
dealers to obtain and review the same kind of information, including 
financial information, as required for non-reporting domestic issuers.
---------------------------------------------------------------------------

    \63\ 15 U.S.C. 78l(g).
    \64\ 17 CFR Sec. 240.12g3-2(b).
---------------------------------------------------------------------------

    We note that Rule 12g3-2(b) contains no specific requirements 
governing the categories of information the issuer must furnish to the 
Commission under the exemption. As a result, there is no assurance that 
broker-dealers publishing quotes will obtain the same type of 
information for each foreign private issuer that claims the Rule 12g3-
2(b) exemption as they must for other non-reporting foreign private 
issuers. This can be problematic since a number of issuers claiming the 
Rule 12g3-2(b) exemption are foreign microcap companies that can 
potentially be subject to the same kinds of abusive practices as their 
U.S. counterparts.
    Therefore, we are proposing to change Rule 15c2-11 requirements 
with respect to quotations for the securities of foreign issuers 
complying with Rule 12g3-2(b). Broker-dealers publishing quotations for 
the securities of Rule 12g3-2(b) issuers will have to obtain and review 
the information specified in paragraph (c)(6) of the reproposed 
Rule.\65\ However, as described in more detail below, we propose to 
revise the financial statements that must be reviewed for non-reporting 
foreign private issuers to recognize the foreign status of these 
issuers.\66\ By eliminating the provision for Rule 12g3-2(b) issuers, 
all non-reporting foreign private issuers will be treated similarly 
under Rule 15c2-11.
---------------------------------------------------------------------------

    \65\ Some of the paragraph (c)(6) information that broker-
dealers will have to obtain and review may be present in the foreign 
issuer's Rule 12g3-2(b) materials.
    \66\ See Part III.C.4. below.
---------------------------------------------------------------------------

    Commenters were divided on whether we should amend the provisions 
of the Rule governing the review of information for non-reporting 
foreign private issuers.\67\ Because the reproposal excludes the 
securities of many larger foreign issuers from Rule 15c2-11 and also 
distinguishes between U.S. and foreign accounting standards for those 
foreign issuers that continue to be covered, many of the reasons for 
permitting broker-dealers to rely on Rule 12g3-2(b) information have 
been addressed.
---------------------------------------------------------------------------

    \67\ For example, some commenters stated that we should delete 
the reference to Rule 12g3-2(b) and require broker-dealers to review 
the same information as required for all other foreign non-reporting 
issuers whose securities are subject to Rule 15c2-11. See, e.g., 
Florida Comment Letter. Other commenters, however, indicated that we 
should continue to require broker-dealers to review only the home 
country information that certain foreign issuers submit to the 
Commission under Rule 12g3-2(b). See, e.g., SIA Comment Letter.
---------------------------------------------------------------------------

    Q26. Should broker-dealers be required to obtain and review the 
same type of issuer information with respect to non-reporting foreign 
private issuers providing information under Rule 12g3-2(b) as they must 
for other non-reporting foreign issuers? Are there reasons to retain a 
special provision in Rule 15c2-11 for foreign issuers furnishing 
information under Rule 12g3-2(b)?
    Q27. What is the experience of broker-dealers under the Rule when 
the foreign issuer has not furnished information to the Commission 
under Rule 12g3-2(b)? How difficult or easy will it be for broker-
dealers to obtain the paragraph (c)(6) information for a non-reporting 
foreign private issuer?
4. Other Non-Reporting Issuers
    The amendments parallel the Proposing Release in their treatment of 
non-reporting issuers (i.e., those non-reporting issuers that are not 
financial institutions covered by paragraph (c)(4)), except for the new 
exclusions discussed in Part III.A. above and the revisions to the 
required financial information for non-reporting issuers. As in the 
Proposing Release, the Rule will require broker-dealers to review more 
information than currently required about the issuer's outstanding 
securities; the issuer's insiders, including their disciplinary 
history; and certain significant events involving the issuer, among 
other items. This information will provide a broker-dealer that is 
considering whether to publish quotations for such an issuer greater 
understanding of the issuer's operations and a better indication of 
whether potential or actual fraud or manipulation may be present.
    Several commenters supported the requirement for a broker-dealer to 
review the disciplinary information about the insiders of non-reporting 
issuers. One commenter believed that if broker-dealers are allowed to 
publish quotations without obtaining this disciplinary information, it 
would create a loophole for issuers to avoid disclosing information 
that would be of utmost importance and would thereby defeat the goal of 
the Commission.\68\ While no commenters directly opposed the 
requirement to obtain disciplinary information, several commenters 
objected to the enhanced information requirements in general as too 
difficult and burdensome, especially when issuers are unwilling to 
volunteer information.\69\
---------------------------------------------------------------------------

    \68\ See NASAA Comment Letter.
    \69\ See, e.g., Letter from David B. Schneider (April 21, 1998).
---------------------------------------------------------------------------

    Q28. Should the Rule require the disciplinary history information 
for the insiders of all issuers of covered OTC securities, and not just 
insiders of non-reporting issuers, on the basis that microcap fraud can 
involve issuers whose insiders have histories of prior misconduct?
    We are proposing to amend the financial information that a broker-
dealer must review when publishing quotations of both domestic and 
foreign non-reporting issuers. The reproposal lists the financial 
statements required for a domestic issuer, which must be prepared in 
accordance with U.S. GAAP, and sets forth when these financial 
statements will be presumed ``current'' under the Rule. Absent contrary 
information, a domestic issuer's balance sheet will be considered 
current if it is as of a date that is less than 15 months before the 
quotation is published, rather than less than16 months as now specified 
in the Rule.\70\ This revision comports with existing Exchange Act 
requirements regarding when a domestic reporting issuer's financial 
statements are considered

[[Page 11134]]

current. The reproposal also will require broker-dealers to review the 
specified financial information for such part of the two preceding 
fiscal years (in the case of the balance sheet, the preceding fiscal 
year) that the issuer (or any predecessor) has been in existence.
---------------------------------------------------------------------------

    \70\ This provision is a presumption that financial information 
that is less than 15 months old is current. However, if the broker-
dealer has other information that indicates that the issuer's 
financial condition has materially changed from that shown in the 
financial statements, this presumption may not apply, and the 
broker-dealer should determine whether more recent financial 
information is available. Financial information older than 15 months 
is not current and does not satisfy the Rule's requirements. The 
presumption for non-financial information is that this information 
is considered current if it is as of a date within 12 months of 
publication of the quotation.
---------------------------------------------------------------------------

    The reproposal also will revise the requirements with respect to 
the financial statements that broker-dealers must review when 
publishing a quotation for a non-reporting foreign private issuer's 
security. The reproposal lists the financial statements that the 
broker-dealer must review, which must be prepared in accordance with a 
comprehensive body of accounting principles, and sets forth when these 
financial statements will be considered current under the Rule. For a 
non-reporting foreign private issuer, its balance sheet will be 
presumed current if it is as of a date less than 18 months before the 
quotation is published.\71\ Also, if the balance sheet is as of a date 
more than 9 months before the quotation is published, the broker-dealer 
must obtain more current financial information only to the extent that 
the issuer has prepared it. The broker-dealer must obtain the specified 
financial information for the two preceding fiscal years (one year with 
respect to the balance sheet) that the issuer has been in existence.
---------------------------------------------------------------------------

    \71\ This presumption will operate in the same manner as for 
domestic issuers. See footnote 70 above.
---------------------------------------------------------------------------

    Q29. Are the financial statement requirements, including the 
presumption regarding when the information is considered current, clear 
and capable of being complied with by broker-dealers publishing 
quotations? Should there be longer time periods for the presumption 
regarding when the financial statements for a non-reporting foreign 
private issuer are considered current? If so, what time periods would 
be appropriate?
    Q30. Are there any information requirements for non-reporting 
issuers that should be added or removed from reproposed paragraph 
(c)(6)?

D. Information Available Upon Request

    We believe that some microcap frauds could be prevented if there 
were greater investor access to information about those securities and 
their issuers. Accordingly, we are reproposing, with some revisions, 
the requirement that a broker-dealer publishing quotations for any 
covered OTC security make the information promptly available upon 
request. In response to the Proposing Release, several commenters 
suggested that we restrict the types of persons and entities to which a 
broker-dealer must provide the information.\72\ The amendments require 
a broker-dealer to provide information upon request to any current 
customer, prospective customer, information repository, or other 
broker-dealer.
---------------------------------------------------------------------------

    \72\ See, e.g., Letter from Security Traders Association (April 
28, 1998) (STA Comment Letter). We originally proposed that the 
information be made available to anyone upon request.
---------------------------------------------------------------------------

    A few commenters asserted that broker-dealers should not be 
required to provide information that already is generally available to 
the public from other sources (e.g., information for reporting 
companies that is available on EDGAR).\73\ We are addressing these 
concerns in the amendments by requiring broker-dealers to provide the 
required information that is not accessible through EDGAR, any other 
federal or state electronic information system, or an information 
repository. Further, most commenters responding to this issue were 
concerned about the cost of providing information to others upon 
request.\74\ We believe that the cost of requiring broker-dealers to 
make the information available (including to other broker-dealers) upon 
request is minimal.\75\
---------------------------------------------------------------------------

    \73\ See e.g., Letter from Richard P. Ryder, Esq. (May 12, 
1998).
    \74\ See e.g., Letter from The Bond Market Association Comment 
Letter (April 27, 1998); NQB Comment Letter; and Florida Comment 
Letter.
    \75\ A broker-dealer may charge for the reasonable expenses it 
incurs in producing and forwarding copies of the Rule 15c2-11 
information.
---------------------------------------------------------------------------

    The amendments retain in substantial form the clause that providing 
information to others does not constitute a representation by the 
broker-dealer that the information is accurate. Rather, providing the 
information to others constitutes a representation that the information 
is current in relation to the date the information was reviewed, and 
that the broker-dealer has a reasonable basis for believing that the 
information was accurate as of the date recorded and was obtained from 
reliable sources.
    Q31. Should we require broker-dealers to make the information 
available to anyone who requests it, particularly if broker-dealers are 
permitted to charge reasonable fees? Should broker-dealers be required 
to provide information to fewer classes of persons?

E. Information Repository

    The amendments, as in the Proposing Release, eliminate the 
piggyback provision of the Rule. The elimination of the piggyback 
provision and the potential for increased costs of compliance suggest 
the desirability of having a data base of information about the non-
reporting issuers of covered OTC securities.\76\ Such a data base also 
would enhance the availability of information about little-known 
issuers to investors, other professionals, and regulators. The 
consensus among the commenters who specifically addressed this issue 
was that the creation of a repository would foster access to 
information about issuers that do not participate in the public 
disclosure system.\77\ For these reasons, we encourage the development 
of one or more repositories of Rule 15c2-11 information, but we note 
that the existence of a repository will not be necessary for broker-
dealers to comply with the Rule.
---------------------------------------------------------------------------

    \76\ We note that, for reporting issuers, information 
repositories already exist. Broker-dealers are able to access and 
review the required information on our EDGAR system, available 
through our Internet website at <http://www.sec.gov>. In addition, 
broker-dealers may consult federal or state electronic information 
systems for information about issuers of covered OTC securities.
    \77\ See e.g., Letter from Singer Frumento Sichenzia, LLP, 
(April 13, 1998).
---------------------------------------------------------------------------

    The amendments establish that the Commission may, upon written 
application, designate an entity as an information repository.\78\ In 
determining whether to grant or deny such a designation, the Commission 
will consider whether an entity:
---------------------------------------------------------------------------

    \78\ This authority will be delegated to the Director of the 
Commission's Division of Market Regulation. We propose to amend Rule 
200.30-3, which provides for delegation of authority to the 
Director, to include the designation of information repositories. 
See 17 CFR 200.30-3.
---------------------------------------------------------------------------

     Collects information about a substantial segment of 
issuers of securities subject to the Rule;
     Maintains current and accurate information about such 
issuers;
     Has effective acquisition, retrieval, and dissemination 
systems;
     Places no inappropriate limits on the issuers from or 
about which it will accept or request information;
     Provides access to the documents deposited with it to 
anyone willing and able to pay the applicable fees; and
     Charges reasonable fees.
    In general, the Commission will consider whether an entity wishing 
to act as an information repository is so organized and has the 
capacity to be able reasonably to obtain and provide to others current 
information required by the Rule. An information repository will be 
required to notify the Commission of any material changes in the facts 
and circumstances of their application for designation as an 
information repository. In the event that an information repository no 
longer satisfies these attributes, we may withdraw such designation.

[[Page 11135]]

    Some commenters suggested that the Commission assume the task of 
serving as the Rule 15c2-11 information repository.\79\ Because the 
issuers that would be the focus of any information repository generally 
would not be required to file periodic reports with the Commission, 
this is not a function that we can assume at this time. The NASD has 
also advised us preliminarily that it is unable to undertake the 
responsibility of serving as an information repository at the present 
time. Therefore, we encourage private sector initiatives for the 
creation of one or more Rule 15c2-11 information repositories.
---------------------------------------------------------------------------

    \79\ See, e.g., STA Comment Letter.
---------------------------------------------------------------------------

    Q32. Are there other criteria that should be used to determine the 
information repository designation?

F. Definitions

    Reproposed paragraph (j) of the Rule sets forth the definitions 
applicable to all provisions of the Rule. Most of the definitions are 
unchanged from the Proposing Release, but a few definitions are revised 
to respond to commenters' suggestions or to add clarity to the 
amendments.
    Quotation Medium. The current definition of ``interdealer quotation 
system'' will be incorporated into the definition of ``quotation 
medium'' in paragraph (j)(12).\80\ This definition of quotation medium 
is quite inclusive: it covers any publication, alternative trading 
system (ATS), or other device that is used by brokers or dealers to 
make known to others their interest in transactions in any security, 
including offers to buy or sell at a stated price or otherwise, or 
invitations of offers to buy or sell.\81\ A few ATSs expressed concern 
about whether they would have to comply with the Rule's information 
review requirements with regard to any covered OTC security that is 
traded on their systems by broker-dealer subscribers to such ATSs.\82\ 
ATSs are included in the definition of ``quotation medium'' if they 
display subscriber orders to any person other than ATS employees. The 
Rule's information review requirements, however, apply only to the 
broker-dealers that submit quotations for publication by the ATS, and 
not to the ATS functioning as the quotation medium for them. The Rule 
will apply to an ATS only if, as a registered broker-dealer, it 
displays its own orders in the ATS.
---------------------------------------------------------------------------

    \80\ Under the current Rule, interdealer quotation system is 
defined as any system of general circulation to brokers or dealers 
which regularly disseminates quotations of identified brokers or 
dealers. A separate definition of ``interdealer quotation system'' 
is no longer necessary because of the proposed elimination of the 
piggyback provision and the revision that the information be 
furnished to the NASD in accordance with NASD rules, rather than to 
interdealer quotation systems.
    \81\ We are using the term ``alternative trading system,'' which 
encompasses the term ``electronic communications network.'' See 
Securities Exchange Act Release No. 40760 (December 8, 1998), 63 FR 
70844.
    \82\ See e.g., Letter from Instinet (April 22, 1998).
---------------------------------------------------------------------------

    An issue has also been raised about whether Rule 15c2-11 applies to 
broker-dealers submitting orders through an ATS. We understand that 
some broker-dealers have taken the position that compliance with Rule 
15c2-11 is not necessary when they submit an order through an ATS.\83\ 
They have viewed such an order for the security as not constituting a 
quotation within the meaning of Rule 15c2-11. These orders may 
represent transactions for the broker-dealer's own account. The Rule's 
definition of quotation makes clear that the Rule covers any indication 
of interest by a broker or dealer in receiving bids or offers from 
others for a security, or any indication by a broker or dealer that it 
wishes to advertise its general interest in buying or selling a 
particular security. Thus, broker-dealers are subject to the Rule when 
they place any indication of interest in any quotation medium, 
including an ATS, that they wish to receive bids or offers in a covered 
OTC security, unless they can rely on one of the Rule's exceptions.\84\
---------------------------------------------------------------------------

    \83\ For example, some broker-dealers have claimed to submit 
customer ``orders'' in quotations mediums following the termination 
of a Commission trading suspension issued under Exchange Act Section 
12(k).
    \84\ To rely on the exception for an unsolicited customer order, 
the order must represent an unsolicited indication of interest of a 
customer (other than a person acting as or for a dealer) of the 
broker-dealer submitting the order to the ATS.
---------------------------------------------------------------------------

    Also, we are clarifying the Rule's application to broker-dealers 
that publish quotations in multiple quotation mediums or move their 
quotations from one quotation medium to another. If the broker-dealer 
complies with the Rule's provisions, based upon a review of 
information, it may publish quotations in one or more quotation 
mediums.\85\
---------------------------------------------------------------------------

    \85\ We have previously interpreted the Rule to require a 
broker-dealer that was publishing quotations in a particular 
interdealer quotation system to review issuer information before 
publishing quotations in another interdealer quotation system unless 
it relied upon an exemption. See Letter re: OTC Bulletin Board 
Display Service (December 20, 1993) (conditional exemption 
permitting broker-dealers that are currently publishing quotations 
in an interdealer quotation system to publish quotations in the OTC 
Bulletin Board without reviewing issuer information under the Rule); 
and Letter re: OTC Bulletin Board; Modification of Exemption 
(December 1, 1998) (modifying the exemption granted in 1993). Upon 
adoption of the reproposed amendments, we will rescind this 
interpretation and related exemptions.
---------------------------------------------------------------------------

    Net tangible assets. We are proposing to add a definition to the 
Rule to assist broker-dealers in assessing whether or not a security 
can meet the proposed exception to the Rule for securities of issuers 
with net tangible assets exceeding $10 million. Net tangible assets 
means total assets less intangible assets and liabilities and this 
determination must be based on the issuer's current financial 
statements, which must be audited.

G. Preservation of Documents and Information

    To facilitate compliance with the Rule's recordkeeping 
requirements, we believe that it is appropriate to codify the Rule's 
record preservation requirements in Rule 17a-4,\86\ rather than in Rule 
15c2-11. Rule 17a-4 obligates broker-dealers to preserve documents and 
information that they must compile pursuant to Commission rules for the 
time period and in the manner specified in the various provisions of 
Rule 17a-4. As in the Proposing Release, Rule 17a-4 would be amended to 
add the information specified in reproposed paragraphs (c), (d), and 
(e) of Rule 15c2-11 to the other information that broker-dealers are 
already required to preserve under Rule 17a-4.\87\
---------------------------------------------------------------------------

    \86\ 17 CFR 240.17a-4. We will add new paragraph (b)(11).
    \87\ This proposed recordkeeping requirement was discussed by 
few commenters and generally was viewed favorably. See e.g., NASAA 
Comment Letter.
---------------------------------------------------------------------------

    With regard to issuer information that is accessible to broker-
dealers through our EDGAR system, any other federal or state electronic 
information system,\88\ or an information repository, the amendments 
provide different requirements. If broker-dealers obtain and review the 
information contained on such systems, they will not need to preserve 
such information separately, as long as they document the review and 
the information is accessible on such system for the same period of 
time that

[[Page 11136]]

the broker-dealers are obligated to preserve such information pursuant 
to Rule 17a-4.
---------------------------------------------------------------------------

    \88\ Broker-dealers publishing quotes for securities of exempt 
financial institutions may obtain the regulatory reports from the 
financial institution by contacting their primary bank regulatory 
agency. Broker-dealers can access the Federal Reserve System's 
National Information Center of Banking Information Internet website 
at <http://www.ffiec.gov/NIC>, the Office of the Comptroller of the 
Currency's Internet website at <http://www.occ.treas.gov>, which has 
information about individual nationally chartered banks, or the 
Federal Deposit Insurance Corporation's (FDIC) Internet website at 
<http://www.fdic.gov>, which provides the most recent Call Reports 
for all FDIC insured banks. Broker-dealers that access exempt 
financial institution information through these websites would be 
able to satisfy the Rule's requirements by recording their review 
and preserving the information in the same manner as for EDGAR 
information discussed above.
---------------------------------------------------------------------------

H. Transition and Exemptive Authority Provisions

    We are reproposing the transition provision covering quotations by 
broker-dealers that were initiated prior to the effective date of the 
proposed amendments and, with a slight modification, the provision 
giving the Commission the authority to grant exemptions from the 
Rule.\89\ These proposed provisions were viewed as adequate by the few 
commenters who discussed them.\90\
---------------------------------------------------------------------------

    \89\ The reproposal would provide the Commission with the 
authority to grant an exemption from the Rule for any quotation for 
a security or any class of security.
    \90\ See, e.g., Florida Comment Letter.
---------------------------------------------------------------------------

I. Information submitted to the NASD

    Rule 15c2-11 currently requires any broker-dealer covered by the 
Rule to submit the information required under paragraph (a)(5) (i.e., 
for non-reporting issuers) to the interdealer quotation system, in the 
form prescribed by the system, at least three business days before 
submitting a quotation for publication. We intend to amend this 
obligation by requiring broker-dealers to submit the information that 
they must review only to the NASD, in accordance with the NASD's rules.
    The amendments are substantially the same as originally proposed, 
except for one change. Under the Proposing Release, a broker-dealer 
would be in compliance with the requirement to obtain current reports 
filed by a reporting issuer, if the broker-dealer obtained all current 
reports filed with the Commission by an issuer as of a date up to three 
business days before the earlier of the date the broker-dealer 
submitted the quotations to the quotation medium and the date the 
broker-dealer submitted information to the NASD. To reduce the chance 
that a broker-dealer would overlook a recently filed report containing 
material issuer information, we are proposing to eliminate the 
reference to the date the information was submitted to the NASD. This 
means that a broker-dealer would be required to obtain current reports 
filed by a reporting issuer after the broker-dealer had submitted 
information to the NASD, if such reports were filed more than three 
business days in advance of the publication of the quotation.

IV. General Request for Comments

    We solicit comment on all aspects of the amendments to Rule 15c2-
11, as well as on any other matter that might have an impact on the 
reproposal discussed above. In particular, we seek comment on the 
whether the reproposal will help focus the Rule on those securities and 
quotations most likely to be involved in microcap fraud. Commenters are 
requested to address whether there are other ways to amend the Rule 
that would help reduce fraud and manipulation in the OTC market. 
Commenters also are invited to address whether the Rule's text is 
sufficiently clear and understandable, or whether it can be simplified 
without sacrificing its purposes. We also request commenters to provide 
us with their views regarding whether the original proposal, or aspects 
of it, are preferable to the reproposal.
    We encourage commenters to focus on the various provisions of the 
reproposal and bring to our attention any compliance or other specific 
issues that they may encounter if the reproposal is adopted. Commenters 
are urged to provide us with their views as expeditiously as possible 
so that we can complete our review of Rule 15c2-11.

V. Effects on Efficiency, Competition, and Capital Formation

    Section 23(a)(2) of the Exchange Act requires the Commission, in 
adopting rules under the Exchange Act, to consider the anti-competitive 
effects of any rules it adopts thereunder, and to not adopt any rule 
that would impose a burden on competition not necessary or appropriate 
in the public interest.\91\ Furthermore, Section 3(f) of the Exchange 
Act \92\ requires the Commission, when engaged in rulemaking, to 
consider or determine whether an action is necessary or appropriate in 
the public interest, and whether the action will promote efficiency, 
competition, and capital formation.
---------------------------------------------------------------------------

    \91\ 15 U.S.C. 78w(a)(2).
    \92\ 15 U.S.C. 78c.
---------------------------------------------------------------------------

    We preliminarily believe that the reproposal would not have any 
anti-competitive effects that are not necessary or appropriate in the 
public interest. By applying the Rule to the first broker-dealer 
publishing any quotations for a security in a quotation medium and to 
other broker-dealers publishing priced quotations thereafter, the 
availability of information about issuers of covered OTC securities 
should be increased. This should help improve the level of competition 
among broker-dealers publishing priced quotations and enhance the 
extent of information about OTC issuers that is available to the 
investing public. Moreover, by excluding unpriced quotations from the 
Rule, anti-competitive burdens will be reduced because broker-dealers 
that cannot, or do not want to, obtain the specified information can 
still advertise their interest in buying or selling a particular OTC 
security in a quotation medium. Finally, the reproposal should have a 
beneficial impact on capital formation because microcap fraud 
ultimately increases the costs of raising capital for legitimate 
smaller issuers. Investors may be less willing to commit their 
resources if they are concerned about fraudulent activities in OTC 
securities.
    We request comments on the benefits, as well as the adverse 
consequences, that may result with respect to efficiency, competition 
and capital formation, if the reproposal is adopted.

VI. Costs and Benefits of the Amendments

    We request commenters to evaluate the costs and benefits associated 
with the amendments to Rule 15c2-11. We have identified certain costs 
and benefits relating to the reproposal, which are discussed below, and 
encourage commenters to discuss any additional costs or benefits. In 
particular, we request comments on the potential costs for any 
necessary modifications to information gathering, management, and 
reporting systems or procedures that would be necessary to implement 
the amendments, as well as any potential benefits resulting from the 
reproposal for issuers, investors, broker-dealers, securities industry 
professionals, regulators or others. Commenters should provide analysis 
and data to support their views on the costs and benefits associated 
with the amendments.

A. Benefits

    Incidents of microcap fraud frequently involve issuers for which 
public information is limited.\93\ Without information, it is difficult 
for investors, securities professionals, and others to evaluate the 
risks presented by these securities. Consequently, many investors fall 
prey to persons who make false representations and unrealistic 
predictions about these securities. The publication of quotations by 
broker-dealers can facilitate the fraudulent promotion of microcap 
securities.
---------------------------------------------------------------------------

    \93\ See, e.g., SEC v. Global Financial Traders, Ltd., 
Litigation Release Nos. 15291 (March 14, 1997), and 15338 (April 17, 
1997).
---------------------------------------------------------------------------

    In our view, the reproposal generally would improve the quality of 
the markets for securities subject to Rule 15c2-11 and would help 
protect

[[Page 11137]]

investors from fraudulent schemes involving these securities. The 
reproposal is focused on the OTC-quoted securities of smaller issuers. 
Absent the amendments, we believe that some broker-dealers would submit 
quotations without regard to basic information about relatively unknown 
issuers. In our view, when broker-dealers must review specified issuer 
information before publishing priced quotations, they are less likely 
to become unwitting participants in unlawful schemes of unscrupulous 
broker-dealers or promoters. Market makers in the securities of 
legitimate microcap issuers, as well as the issuers themselves, also 
would benefit from improving the integrity of this market sector. One 
benefit of the reproposal is that the scope of the Rule will be revised 
so that broker-dealers will not have to obtain information about those 
securities that satisfy any one the proposed alternative tests.
    We also believe that the amendments will serve an important 
surveillance function. Currently, only the first broker-dealer quoting 
a security in a quotation medium must gather, review, and preserve the 
information. The amendments will require the first broker-dealer 
initiating any quotation and all broker-dealers initiating priced 
quotations thereafter to satisfy the Rule's information review 
requirements. Moreover, under NASD Rule 6740,\94\ broker-dealers 
demonstrate their compliance with that rule by filing the Rule 15c2-11 
information with the NASD. Recently, the review of Forms 211 filed with 
the NASD has resulted in a number of Commission trading suspensions and 
other enforcement actions.
---------------------------------------------------------------------------

    \94\ NASD Manual, Marketplace Rules, Rule 6740.
---------------------------------------------------------------------------

    The amendments require broker-dealers publishing quotes in 
compliance with the Rule to provide the information upon request to any 
customer, prospective customer, other broker-dealers, or information 
repository unless the information is available through a government 
sponsored database. This amendment will help make information about 
non-reporting issuers more widely available to the public.
    We also believe that the amendments will ease significantly the 
Rule's recordkeeping requirement because broker-dealers will not have 
to retain information that is available on the Commission's EDGAR 
system or on the information systems of other federal or state 
authorities. Access to EDGAR and similar government-sponsored 
information systems is free on the Internet. Given that approximately 
60% of securities on the OTC Bulletin Board and Pink Sheets are issued 
by reporting companies, whose reports are included on EDGAR, a 
significant recordkeeping cost savings to broker-dealers should result.
    We do not have the data to quantify the value of the benefits 
described above. We seek comments on the value of these benefits and on 
any benefits, not already identified, that may result from the adoption 
of the amendments.

B. Costs

    We anticipate that the elimination of the piggyback provision will 
create the most significant costs that the industry will incur. 
Currently, only those broker-dealers that publish quotations during the 
first 30 days of the security's trading are required to obtain and 
review the specified information before they initiate quotations. As 
reproposed, the Rule will continue to require the first broker-dealer, 
before initiating a priced or unpriced quotation for a covered OTC 
security in a quotation medium, to review the specified information. 
Thereafter, the reproposed Rule will impose the review requirement only 
on broker-dealers publishing priced quotations, including in connection 
with the annual review requirement. Of course, if the Commission 
suspends trading under Exchange Act Section 12(k) for any of the 
issuer's securities, the Rule's requirements are triggered.
    The first broker-dealer, before initiating any quotation for a 
covered OTC security, is currently required to incur the cost of having 
to gather and review the issuer information. As a result of the 
amendments, that broker-dealer will incur the cost to update that 
information annually if it continues to publish priced quotations. 
Thereafter, any broker-dealer publishing priced quotations for a 
covered OTC security will incur costs when it first publishes a priced 
quotation and when it conducts the required annual review. To the 
extent a broker-dealer does not already have the required information, 
it will incur costs for the collection and review of this information. 
Moreover, a broker-dealer also will incur costs associated with 
creating the records required by the Rule and retaining the Rule's 
required information for the specified period of time under the 
amendment to Rule 17a-4.
    We estimate that approximately 60% of the issuers of OTC stocks are 
reporting issuers, while the remaining 40% are non-reporting issuers. 
Based on this assumption, broker-dealers publishing priced quotations 
for the OTC securities of reporting issuers should be able to obtain 
the prescribed information required by the reproposed Rule from the 
Commission's EDGAR system and therefore should incur minimal costs to 
comply with the Rule. We believe that it will take a broker-dealer a 
maximum of 4 hours to collect, review, record, retain, and supply to 
the NASD the information pertaining to a reporting issuer, and a 
maximum of 8 hours to collect, review, record, retain, and supply to 
the NASD the information pertaining to a non-reporting issuer.\95\ We 
estimate that it will cost a broker-dealer an average cost of $40 per 
hour (based on a blended compensation rate for clerical and supervisory 
compliance staff) to obtain and review the necessary information 
required by the Rule.\96\
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    \95\ We computed these cost estimates after reviewing, among 
other sources, responses to a survey of broker-dealers conducted by 
the NQB about issues raised in the Proposing Release. The results of 
the NQB's survey are available in File No. S7-3-98 at the 
Commission's Public Reference Room, 450 Fifth Street N.W., 
Washington, D.C. 20549.
    \96\ The cost estimate assumes that clerical staff are paid at 
an average rate of $15 per hour and supervisory compliance staff are 
paid at an average rate of $100 per hour. The blended compensation 
rate assumes that 70% of the time is clerical and 30% is supervisory 
compliance [(0.7  x  $15) + (0.3  x  $100) = $40].
---------------------------------------------------------------------------

    We recently approved changes to NASD Rules 6539 and 6540 to limit 
the quotations on the OTC Bulletin Board to securities of issuers that 
are current in their reports filed with us or other regulatory 
authority, and to prohibit NASD members from quoting a security on the 
OTC Bulletin Board unless the issuer has made current filings with 
us.\97\ While these NASD Rule changes may result in more issuers 
choosing to become reporting issuers in order to continue to qualify 
for quotation on the OTC Bulletin Board, we are at this time unable to 
adequately quantify the cost impact or burden that the reproposal 
imposes in relation to these rule changes. However, we believe that, 
generally, any increase in the number of reporting issuers subject to 
the Rule will cause a reduction in the number of the burden hours and 
associated costs. We are of the view that because reporting issuer 
information is readily available from the Commission's EDGAR system 
and, because we estimate that broker-dealers only have to spend 4 hours 
reviewing reporting issuer information, instead of the estimated 8 
hours to review non-reporting issuer information, the reduced time 
spent reviewing issuer information will result in lower costs to 
broker-dealers.
---------------------------------------------------------------------------

    \97\ See OTC Bulletin Board Release.
---------------------------------------------------------------------------

    However, broker-dealers publishing priced quotations for the OTC 
securities of non-reporting issuers are likely to incur greater costs 
in complying with

[[Page 11138]]

the Rule. For purposes of the Paperwork Reduction Act, we estimate the 
total burden hours for all broker-dealers to be 143,278 hours and the 
total cost to be $5,731,120. Some broker-dealers may not want to expend 
the time or the cost to obtain the non-reporting issuer information and 
may therefore choose not to publish priced quotes. On the other hand, 
the costs broker-dealers incur in obtaining and reviewing information 
about non-reporting issuers may be reduced if one or more on-line 
information repositories of this information are established. We seek 
comments on the reasonableness of these estimates for annual hourly and 
dollar costs to broker-dealers. We also seek comments on the extent to 
which these cost estimates will be affected by the new NASD rule to 
limit the OTC Bulletin Board to the securities of issuers current in 
their periodic filings.
    Although Rule 15c2-11 does not regulate issuers, there may be some 
indirect costs imposed on issuers, particularly non-reporting issuers, 
because they may be contacted by broker-dealers to provide the 
information specified in the Rule. Non-reporting issuers would incur 
the cost of having to collect and provide the requested information to 
each requesting broker-dealer. However, we are assuming that non-
reporting issuers maintain their financial information in compliance 
with prevailing accounting standards and, in most instances, would have 
available updated financial information prepared in accordance with 
generally accepted accounting principles (GAAP). The NASD has informed 
us that financial statements submitted with the Form 211 generally are 
prepared in accordance with GAAP, and many are audited.
    Regarding start-up, operating, and maintenance costs, we believe 
that broker-dealers that collect, review, and retain the information 
currently required by the Rule, would incur only marginal start-up, 
operating, and maintenance costs (i.e., to expand systems already in 
place) to comply with the Rule as reproposed. Further, some broker-
dealers already may be collecting the required information for other 
purposes. However, we believe that some broker-dealers may not have 
adequate systems in place to retain issuer information and would, 
therefore, incur start-up, operating, and maintenance costs in order to 
comply with the requirements of the amendments.
    We estimate that about 100 broker-dealers in the aggregate will 
incur start-up, operating, and maintenance costs of $100,000 
($1,000 x 100) associated with reporting issuer information, and 
$400,000 ($4,000 x 100) associated with non-reporting issuer 
information. Total start-up, operating and maintenance cost burden for 
broker-dealers is estimated to be $500,000 ($100,000+$400,000) or an 
average of $5,000 for each broker-dealer.
    We assume that non-reporting issuers, because they generally 
maintain their financial information in compliance with prevailing 
accounting standards, will not incur any start-up costs to prepare the 
required information in response to broker-dealers' requests. We also 
believe that reporting issuers of covered OTC securities will not incur 
start-up costs as a result of the amendments since such issuers already 
provide the required information to the Commission under the federal 
securities laws. Therefore, we believe issuers will not incur start-up 
costs as a consequence of the adoption of the Rule amendments, as 
reproposed.
    Finally, the Rule, as modified by the amendments, could affect the 
liquidity of some securities. If broker-dealers are unable to obtain 
the required issuer information, they would have to refrain from 
publishing priced quotations in that security. This could make it 
somewhat more difficult for investors to determine what prices other 
market participants are willing to bid or offer for the security, 
although they could call a broker-dealer publishing a name-only 
quotation to obtain a priced quotation. Thus, while investors are still 
able to obtain price information, the cost of obtaining this 
information may increase. However, under the reproposal, after the 
first quotation for a security is published, broker-dealers could 
publish unpriced quotes without complying with the Rule's provisions. 
In addition, broker-dealers could rely on the exception that permits 
them to publish quotes representing unsolicited customer orders.
    Any effect on liquidity must be weighed against the benefit of 
reducing instances of fraud or manipulation. Greater investor access to 
information should result in more informed investor decisions and 
potentially could result in additional trading, and thus liquidity, for 
covered OTC securities. We have modified the proposals to permit 
broker-dealers to publish unpriced quotations for OTC securities 
without reviewing the specified information (other than the first 
broker-dealer to quote the security). This revision responds to the 
views of those commenters that expressed concerns about the Rule's 
impact on liquidity.

VII. Initial Regulatory Flexibility Act

    We have prepared an Initial Regulatory Flexibility Analysis (IRFA) 
\98\ regarding the amendments to Rule 15c2-11 and the reproposed 
companion amendment to Rule 17a-4 under the Exchange Act. The following 
summarizes the IRFA.
---------------------------------------------------------------------------

    \98\ See 5 U.S.C. 603.
---------------------------------------------------------------------------

    As discussed in the IRFA, the amendments specify the information 
that a broker-dealer must gather and review before publishing 
quotations for covered OTC securities. The reproposed Rule is intended 
to prevent broker-dealers from publishing quotations for covered OTC 
securities in a quotation medium without obtaining, reviewing, and 
retaining current information about the issuer. The reproposed Rule 
applies primarily to priced quotations.
    The amendments to the Rule would affect all broker-dealers, 
including a number of small broker-dealers, seeking to publish 
quotations for covered OTC securities.\99\ The number of small broker-
dealers that publish quotations for covered OTC securities in quotation 
mediums is not known at this time. However, we recently estimated that 
about 13% of all registered broker-dealers would be characterized as 
small.\100\ We estimate that, at any given time, there are 
approximately 400 broker-dealers, including small broker-dealers, that 
submit quotations for covered OTC securities. Therefore, based on this 
estimate, we believe that approximately 52 small broker-dealers 
(400 x 13%) would be affected by the amendments. In fact, it is 
possible that few, if any, broker-dealers publishing quotations for 
covered OTC securities would be classified as a small business, because 
as market makers they typically require more than $500,000 in capital 
to support their market making activities. In the Proposing Release, we 
solicited but did not receive any comments on the number of small 
broker-dealers that would be affected by the amendments. We are again 
soliciting comments on the number of small broker-dealers that would be 
affected by the amendments.
---------------------------------------------------------------------------

    \99\ For purposes of the regulatory flexibility analysis, a 
broker-dealer is considered ``small'' if its total capital is less 
than $500,000, and is not affiliated with a broker-dealer that has 
$500,000 or more in total capital.
    \100\ See Securities Exchange Act Release No. 40122 (June 24, 
1998), 63 FR 35508 (adopting amendments to the definitions of 
``small business'' or ``small organization'' under the Investment 
Company Act of 1940, the Investment Advisers Act of 1940, the 
Securities Exchange Act of 1934, and the Securities Act of 1933).
---------------------------------------------------------------------------

    The amendments would indirectly have an impact on those small 
issuers that may be requested to provide the information required by 
the Rule to

[[Page 11139]]

broker-dealers publishing quotations in those issuers' securities. 
Based on Exchange Act Rule 0-10(a), a small issuer is one that on the 
last day of its most recent fiscal year had total assets of $5,000,000 
or less. In the Proposing Release, we solicited but did not receive any 
comments on the total number of issuers of covered OTC securities; the 
number (or percentages) of these issuers that are small issuers; and 
the total number (or percentage) of small issuers of covered OTC 
securities that are reporting and non-reporting issuers, respectively. 
We are again seeking comments on these issues.
    The IRFA notes that the availability of the Commission's EDGAR 
system and similar systems sponsored by federal or state authorities 
should assist broker-dealers in collecting and reviewing the reports 
required by the Rule. In addition, the prevalent use of computers and 
the Internet, on which access to EDGAR is free, should also reduce the 
recordkeeping and compliance costs for all broker-dealers by automating 
the information collection and retention process.
    The IRFA recognizes that the amendments indirectly affect certain 
issuers, particularly non-reporting issuers. The amendments would 
require the first broker-dealer to publish any quotation for a covered 
security to review the Rule's information. Thereafter, other broker-
dealers must review information about the issuer when they first 
publish or resume publishing a priced quotation for a covered security, 
and all broker-dealers publishing priced quotations must conduct an 
annual review. We are not aware of any information repository, 
electronically accessible or otherwise, now in existence that covers 
all of the information about non-reporting issuers that broker-dealers 
must gather to comply with the Rule. Consequently, non-reporting 
issuers must collect and provide the required information to each 
requesting broker-dealer. We assume that non-reporting issuers maintain 
their financial information in compliance with generally accepted 
accounting standards and that the costs incurred by non-reporting 
issuers to prepare the necessary information in response to broker-
dealers' requests would be minimal.
    The IRFA discusses the kinds of possible alternative proposals that 
we have considered. These include, among others, creating differing 
compliance or reporting requirements or timetables that take into 
account the resources available to small entities, and whether such 
entities could be exempted from the reproposed rule, or any part 
thereof. Therefore, having considered the foregoing alternatives in the 
context of the amendments, we do not believe they would accomplish the 
stated objectives of the proposal.
    We encourage the submission of written comments regarding any 
aspect of the IRFA. In particular, we seek comments on: (i) the number 
of small entities that would be affected by the amendments, including 
the number of small broker-dealers and issuers; (ii) the number of 
small entities that are issuers of covered OTC securities; and (iii) 
the number of small entities that are reporting and non-reporting 
issuers of covered securities, respectively. Comments should also 
specify the costs of compliance with the amendments, and suggest 
alternatives that would meet the objectives of the amendments in a more 
effective manner, while imposing costs equal to or less than the 
amendments. In describing the nature of any impact that the amendments 
would have, empirical data supporting these views should be provided.
    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, we are also requesting information regarding the potential 
impact of the proposed amendments on the economy on an annual basis. In 
particular, comments should address whether the proposed changes, if 
adopted, would have a $100,000,000 annual effect on the economy, cause 
a major increase in costs or prices, or have a significant adverse 
effect on competition, investment, or innovations. Commenters should 
provide empirical data to support their views.
    Comments should be submitted in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, 
Washington, DC 20549. Comments may also be submitted electronically at 
the following E-mail address: [email protected]. All comment 
letters should refer to File No. S7-5-99; this file number should be 
included on the subject line if E-mail is used. Comment letters will be 
available for public inspection and copying in the Commission's Public 
Reference Room, 450 Fifth Street, NW, Washington, DC 20549. 
Electronically submitted comment letters will also be posted on the 
Commission's Internet website (http://www.sec.gov).
    A copy of the Initial Regulatory Flexibility Analysis may be 
obtained by contacting Chester A. McPherson, Office of Risk Management 
and Control, Division of Market Regulation, Securities and Exchange 
Commission, 450 Fifth Street, NW, Washington, DC 20549, at (202) 942-
0772.

VIII. Paperwork Reduction Act

    Certain provisions of the amendments contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (PRA).\101\ The title for the collection of 
information is: ``Publication or submission of quotations without 
specified information.'' Accordingly, the collection of information 
requirements contained in the Rule and the initial proposal were 
submitted to the Office of Management and Budget (OMB) for review, in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11, and were approved 
by OMB. The Rule has been assigned OMB Control No. 3235-0202.\102\
---------------------------------------------------------------------------

    \101\ 44 U.S.C. 3501 et seq.
    \102\ The Commission notes that a separate PRA filing was not 
prepared to reflect the proposed companion changes to Rule 17a-4. 
The burden hours and costs described for the Rule include and 
account for the anticipated burdens that may arise as a result of 
the proposed change to Rule 17a-4.
---------------------------------------------------------------------------

A. Collection of Information Under the Amendments

    As reproposed, the Rule would require the first broker-dealer, 
before initiating a priced or unpriced quotation for a covered OTC 
security in a quotation medium, to gather and review the issuer 
information, and to review updated information annually if it continues 
to publish priced quotations. This review requirement would also be 
imposed on any other broker-dealer publishing a priced quotation for a 
covered OTC security. Broker-dealers submitting priced quotations for 
the security would be required to collect, review, and retain the 
Rule's specified information annually. Broker-dealers would also have 
to record the sources of their information, the date their review 
occurred, and the person responsible for the review. Also, the 
proposals would require broker-dealers publishing quotations for a 
covered OTC security to collect, review, and retain more information 
than is required currently.
    Under Rule 15c2-11, the information that is collected pursuant to 
the Rule must be submitted to the NASD at least three business days 
before any quotation is published.\103\ Finally, the amendments would 
require broker-dealers to provide the information specified to any 
customer, prospective customer, other broker-dealer or information 
repository that requests it.
---------------------------------------------------------------------------

    \103\ The NASD has a rule requiring broker-dealers that initiate 
or resume quotations for covered equity securities to submit 
verification that they have collected the information necessary to 
comply with NASD requirements, as well as Rule 15c2-11. See NASD 
Manual, Marketplace Rules, Rule 6740.

---------------------------------------------------------------------------

[[Page 11140]]

B. Proposed Use of Information

    Broker-dealers must collect and review the information required 
under the amendments if they publish the first quotation for a covered 
OTC security or if they publish priced quotations. Moreover, the Rule 
requires that broker-dealers have a reasonable basis for believing that 
the information about the issuer and related persons is accurate and 
from reliable sources. This information collection protects investors 
by deterring fraudulent or manipulative quotations for thinly-traded 
securities whose issuers are relatively unknown. Because information 
about these issuers is not widely disseminated and often is not 
current, fraudulent and manipulative schemes are easier to perpetrate. 
Moreover, this collection of information helps broker-dealers guard 
against becoming unwitting participants in fraudulent or manipulative 
schemes. The Rule 15c2-11 information gathering requirements also serve 
an important surveillance function for both the Commission and the 
NASD. Recently, the Commission has used the Rule 15c2-11 information to 
suspend trading in the issuers' securities pursuant to Section 12(k) of 
the Exchange Act where publicly available information about the issuer 
raised questions about the accuracy and adequacy of the issuers' 
disclosures.

C. Respondents

    The amendments would apply to those broker-dealers that publish 
quotations for a covered OTC security in a quotation medium as of 
specified quotation events. The amendments also indirectly affect 
issuers that are asked by broker-dealers to provide this information. 
Most of the Rule 15c2-11 information that would be required for issuers 
that publicly file periodic reports with the Commission (reporting 
issuers) is available electronically on EDGAR or through the Internet. 
Thus, the reproposal is likely to have a greater paperwork burden when 
broker-dealers publish quotations for the securities of issuers that do 
not participate in the Commission's public reporting program, (i.e., 
non-reporting issuers) or do not file reports with other federal or 
state regulatory authorities.

D. Total Annual Reporting and Recordkeeping Burden

    The amendments would require broker-dealers to collect, review, 
retain, and record certain issuer and supplemental information when 
they are the first broker-dealer to quote the security; when they first 
publish priced quotations for a covered OTC security; and if they are 
publishing priced quotations as of the annual review requirement. The 
discussion below estimates the collection of information burden one 
year after the anticipated date of effectiveness of the amendments when 
broker-dealers that publish quotes for covered OTC securities 
qualifying for the reproposed transition provision must fully comply 
with the Rule's information requirements. The discussion below also 
provides estimates for the same period for issuers that may be 
contacted to provide the information. In particular, the following 
analysis measures the cost to broker-dealers of: (1) collecting, 
reviewing, recording, and retaining the required issuer information and 
supplying it to the NASD; (2) responding to requests for issuer 
information from customers, prospective customers, other broker-dealers 
and information repositories; and (3) starting up or maintaining 
systems for the collection and retention of issuer information. The 
analysis below also addresses the indirect cost to issuers who must 
furnish information to requesting broker-dealers.
1. Burden-Hours for Broker-Dealers
    Based on information provided by the NASD and NQB, we estimate that 
as of December 31, 1998, there were approximately 6,625 covered OTC 
securities quoted in the OTC Bulletin Board and 3,225 quoted in the 
Pink Sheets for a total of 9,850 covered OTC securities.\104\ We also 
believe that approximately 10% (985) of these securities would not be 
subject to the Rule, based on the exceptions that are included in this 
reproposing Release and that approximately 8,865 securities would be 
subject to the Rule. According to NASD estimates, we also believe that 
approximately 1,400 new applications from broker-dealers to initiate or 
resume publication of covered equity securities in the OTC Bulletin 
Board and/or the Pink Sheets or other quotation mediums were approved 
by the NASD for the 1998 calendar year. We have estimated that 60% of 
the covered OTC securities were issued by reporting issuers, while the 
other 40% were issued by non-reporting issuers. We also estimate that 
broker-dealers publish priced quotations for approximately 90% of the 
covered OTC securities quoted in the OTC Bulletin Board and publish 
priced quotes for about 10% of the covered OTC securities quoted in the 
Pink Sheets. According to NASD and NQB estimates, we believe that, on 
average, there are approximately 4.3 broker-dealers publishing priced 
quotations for each covered OTC security, and that at any given time 
there are no more than 400 broker-dealers that submit priced quotations 
for covered OTC securities. Finally, the reproposed Rule's transition 
provision would not subject the broker-dealers quoting the securities 
of the estimated 8,865 potentially covered securities currently quoted 
in the OTC Bulletin Board and/or the Pink Sheets until the annual 
review requirement is triggered. Therefore, only those new applications 
that are submitted after the reproposal becomes effective would be 
subject to the initial review requirement.
---------------------------------------------------------------------------

    \104\ We recognize that there may be covered OTC securities 
quoted in other quotation mediums, but at this time we do not have 
the empirical data to include them in our estimations.
---------------------------------------------------------------------------

    Because the amendments would require the first broker-dealer 
publishing a quotation, priced or unpriced, for a particular security 
to collect issuer information, we believe that during the first year 
after the amendments are effective, broker-dealers that are publishing 
the first quotations (whether priced or unpriced) for covered OTC 
securities in the aggregate would have to conduct approximately 1,260 
initial reviews of issuer information.\105\ We believe that it will 
take a broker-dealer about 4 hours to collect, review, record, retain, 
and supply to the NASD the information pertaining to a reporting 
issuer, and about 8 hours to collect, review, record, retain, and 
supply to the NASD the information pertaining to a non-reporting 
issuer.
---------------------------------------------------------------------------

    \105\ This estimate is based on the assumption that the NASD 
will, in the first year after the reproposal becomes effective, 
approve 10% fewer Form 211 filings than the 1,400 applications 
approved in 1998.
---------------------------------------------------------------------------

    We therefore estimate that after the reproposal has become 
effective, the broker-dealers who are the first to publish the first 
quote for a covered OTC security of a reporting issuer (priced or 
unpriced) will require 3,024 hours (1,260 x 60% x 4) to collect, 
review, record, retain, and supply to the NASD the information required 
by the Rule as reproposed. We estimate that after the reproposal has 
become effective the broker-dealers who are the first to publish the 
first quote for a covered OTC security of a non-reporting issuer 
(priced or unpriced) will require 4,032 hours (1,260 x 40% x 8) to 
collect, review, record, retain, and supply to the NASD the information 
required by the Rule as reproposed. We therefore estimate the total 
annual burden hours for the first broker-dealers to be 7,056 hours 
(3,024+4,032).
    The Rule also would require an annual review for broker-dealers

[[Page 11141]]

publishing priced quotations for covered OTC securities. We have 
estimated that each issuer is quoted by about 4.3 broker-dealers. We 
are assuming that of the universe of approximately 8,865 potentially 
affected covered OTC securities, broker-dealers would publish priced 
quotations for approximately 90% of the OTC Bulletin Board securities 
or 5,366 securities ((6,625 x 90%) x 90%) and for 10% of the Pink Sheet 
securities or 290 securities (3,225 x 90%) x 10%).\106\ Therefore, we 
estimate that priced quotations will be published for approximately 
5,656 (5,366+290) covered OTC securities. Given that about 60% of OTC 
stocks are issued by reporting issuers and the other 40% by non-
reporting issuers, and that it would take a broker-dealer 4 and 8 
hours, respectively, to meet the requirements of the reproposed Rule 
for these issuers, we estimate the burden hours as follows: for 
reporting issuers we estimate approximately 58,375 hours 
(3,394 x 4.3 x 4), and for non-reporting issuers we estimate 
approximately 77,847 hours (2,263 x 4.3 x 8). Therefore, we estimate 
the total annual paperwork burden hours for all broker-dealers to be 
143,278 hours (7,056+58,375+77,847).
---------------------------------------------------------------------------

    \106\ Some securities have priced quotations published in both 
of these quotation systems. To avoid double counting, such 
securities are counted as OTC Bulletin Board securities.
---------------------------------------------------------------------------

2. Burden-Hours for Issuers
    Regarding the burden on issuers to provide broker-dealers with the 
required information, we believe that the 5,319 issuers of covered OTC 
securities (based on our estimate that 60% of the 8,865 potentially 
covered OTC securities are reporting issuers) will not bear any 
additional hourly burdens under the amendments because these issuers 
already report the required information to the Commission through 
mandated periodic filings. Further, reporting issuer information is 
widely available to broker-dealers through a variety of media. However, 
non-reporting issuer information is not widely available. Consequently, 
these issuers must provide the information required by the amendments 
to requesting broker-dealers before quotations in their securities can 
be published. We believe that the 3,546 issuers of non-reporting 
covered OTC securities (based on an estimate that 40% of the 8,865 
potentially covered OTC securities are non-reporting ) will spend an 
average of 9 hours each to collect, prepare, and supply the information 
required by the proposals to the first broker-dealer that requests this 
information. Thereafter, we estimate that it will take an average of 1 
hour for an issuer to provide the same information to the remaining 3.3 
broker-dealers that request the information. Accordingly, we estimate 
the 3,546 non-reporting issuers annually will incur 31,914 hours 
(3,546 x 9 x 1) to comply with the first broker-dealer's request for 
information, and 11,702 hours (3,546 x 1 x 3.3) to comply with the 
subsequent 3.3 broker-dealer requests for an annual total of 43,616 
burden hours (31,914+11,702). On average, therefore, each non-reporting 
issuer would spend approximately 12.3 burden hours (43,616/3,546) per 
year to comply with these requests.
3. Total Burden-Hour Costs to Broker-Dealers and Issuers
    We estimate the collection of information will require 
approximately 186,894 burden hours annually (143,278 + 43,616) from 
approximately 3,946 respondents (400 broker-dealers and 3,546 issuers).
4. Capital Cost to Broker-Dealers and Issuers
    We believe that broker-dealers that now collect, review, and retain 
the information required by the current Rule will not incur any 
significant start-up costs to expand systems already in place. Further, 
broker-dealers that are collecting the information required by the 
proposals for other purposes also will not incur significant start-up 
costs. However, we believe some broker-dealers may not have adequate 
systems in place to retain issuer information and will incur start-up 
costs in order to comply with the requirements of the amendments. We 
assume that of the 400 broker-dealers that provide quotations for 
covered OTC securities, about 100 broker-dealers will incur additional 
start-up costs, while the remaining 300 broker-dealers will only incur 
incremental costs. Because the information for reporting issuers will 
be generally available on EDGAR and such availability satisfies the 
recordkeeping requirements of the proposals, we are assuming that the 
start-up costs associated with retaining information on reporting 
issuers will average $1,000 per broker-dealer, whereas the same costs 
will be $4,000 per broker-dealer for non-reporting issuer information. 
We estimate that broker-dealers in the aggregate will incur start-up, 
operating, and maintenance costs of $100,000 ($1,000  x  100) 
associated with reporting issuer information, and $400,000 ($4,000  x  
100) associated with non-reporting issuer information. Total start-up, 
operating and maintenance cost burden for broker-dealers is estimated 
to be $500,000 ($100,000 + $400,000) or an average of $5,000 for each 
broker-dealer.
    We assume that non-reporting issuers, because they maintain their 
financial information in compliance with prevailing accounting 
standards, will not incur any start-up costs to prepare the required 
information in response to broker-dealers' requests. We also believe 
that reporting issuers of covered OTC securities will not incur start-
up costs as a result of the amendments since such issuers already 
provide the required information to the Commission under the federal 
securities laws. Therefore, we believe issuers will not incur start-up 
costs as a consequence of the adoption of the Rule amendments, as 
reproposed.

E. General Information About the Collection of Information

    The collection of information under the amendments is mandatory and 
would be required at periodic intervals: by the first broker-dealer to 
publish any quote for a covered OTC security, by broker-dealers 
publishing priced quotes thereafter, and by broker-dealers publishing 
priced quotes at the time of the annual review requirement. Broker-
dealers would be required to retain the information they collect for a 
period of not less than three years. Information collected under the 
Rule would not be kept confidential. Any agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid control number.

F. Request for comments

    Pursuant to 44 U.S.C. 3506(c)(2)(B), we are soliciting comments to:
    (i) evaluate whether the reproposed collection of information is 
necessary for the proposed performance of the functions of the agency, 
including whether the information will have practical utility;
    (ii) evaluate the accuracy of our estimates of the burden of the 
reproposed collection of information;
    (iii) enhance the quality, utility, and clarity of the information 
to be collected; and
    (iv) minimize the burden of collection of information on those who 
are to respond, including through the use of automated collection 
techniques or other forms of information technology. We seek data about 
quotations for covered OTC securities in OTC quotation mediums other 
than the OTC Bulletin Board and the Pink Sheets. We seek comments on 
our estimate of the number of issuers affected by the reproposed Rule 
and on the time estimates made for broker-dealers and

[[Page 11142]]

issuers to comply with the information collection requirements.
    Persons desiring to submit comments on the collection of 
information requirements should direct them to the Office of Management 
and Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Room 10102, 
New Executive Office Building, Washington, DC 20503, and should also 
send a copy of their comments to Jonathan G. Katz, Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549, and refer to File No. S7-5-99. OMB is required to make a 
decision concerning the collections of information between 30 and 60 
days after publication of this release in the Federal Register, so a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days of this publication.

IX. Statutory Basis and Text of Proposed Amendments and Rule

    The rule amendments are being proposed pursuant to Sections 3, 
10(b), 15(c), 15(g), 17(a), and 23(a) of the Securities Exchange Act of 
1934, 15 U.S.C. Secs. 78c, 78j(b), 78o(c), 78o(g), 78q(a), and 78w(a).

List of Subjects in 17 CFR Part 240

    Broker-dealers, Fraud, Reporting and recordkeeping requirements, 
Securities.

Text of Reproposed Rule

    In accordance with the foregoing, Title 17, chapter II, part 240 of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for part 240 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. Secs. 77c, 77d, 77g, 77j, 77s, 77z-2, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 
78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 
78ll(d), 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-
4 and 80b-11, unless otherwise noted.
* * * * *
    2. Section 240.15c2-11 and the section heading are revised to read 
as follows:


Sec. 240.15c2-11  Publication or submission of quotations without 
current information.

    Preliminary Note: As a means reasonably designed to prevent 
fraudulent, deceptive, or manipulative acts or practices, this 
section prevents a broker or dealer from publishing a quotation for 
a security or, directly or indirectly, submitting a quotation for a 
security for publication in a quotation medium, unless the broker or 
dealer complies with the provisions of this section or relies on an 
exception contained in paragraph (h) of this section. As used in 
this section, the term ``you'' refers to a broker or dealer.

    (a) When a broker or dealer must comply with this section. You must 
comply with paragraph (b) of this section when you publish:
    (1) The first quotation for a security;
    (2) The first quotation following the termination of a Commission 
trading suspension ordered pursuant to section 12(k) of the Act (15 
U.S.C. 78l(k)) in any security of the issuer of the suspended security;
    (3) Your first quotation at a specified price for the same security 
after another broker or dealer publishes the first quotation for a 
security as described in paragraph (a)(1) or (a)(2) of this section;
    (4) A quotation at a specified price for a security after a period 
of five or more consecutive business days when you did not publish any 
quotations at a specified price for that security;
    (5) Your first quotation at a specified price for a security after 
the date that is four months after the end of the issuer's fiscal year, 
unless the issuer is a foreign private issuer; or
    (6) Your first quotation at a specified price for a security of a 
foreign private issuer after the date that is seven months after the 
end of the issuer's fiscal year.
    (b) The steps a broker or dealer must take to comply with this 
section. For each security in which you publish any of the quotations 
listed in paragraph (a) of this section, you must:
    (1) Review the issuer information described in paragraph (c) of 
this section and the supplemental information described in paragraph 
(d) of this section;
    (2) Determine that you have a reasonable basis under the 
circumstances for believing that the issuer information described in 
paragraph (c) of this section, when considered in conjunction with the 
supplemental information described in paragraph (d) of this section, is 
accurate in all material respects and was obtained from reliable 
sources;
    (3) Make a record of:
    (i) The issuer information described in paragraph (c) of this 
section, the supplemental information described in paragraph (d) of 
this section, and the sources from which you obtained the information. 
You will be considered to have obtained the issuer information 
described in paragraphs (c) or (d)(1) of this section if you obtained 
it through the EDGAR system, any other federal or state electronic 
information system, or an electronic information system operated by an 
information repository, and you have the means to access the 
information for the period required under Sec. 240.17a-4(b)(11);
    (ii) Any significant relationship information described in 
paragraph (e) of this section;
    (iii) The date that you reviewed the information described in 
paragraphs (c), (d), and (e) of this section; and
    (iv) The person responsible for your compliance with the 
requirements of this section; and
    (4) Preserve the records required to be made under paragraph (b)(3) 
of this section in accordance with Sec. 240.17a-4(b)(11).
    (c) The issuer information that a broker or dealer must review. The 
type of information that is considered ``issuer information'' and that 
must be reviewed under paragraph (b) of this section depends on the 
status of the issuer.
    (1) Issuers with a recent public offering. If the issuer filed a 
registration statement under the Securities Act (other than a 
registration statement on Form F-6 (17 CFR 239.36)) that became 
effective less than 90 calendar days before you publish the quotation, 
and that is not the subject of a stop order, the issuer information is 
the prospectus specified by section 10(a) of the Securities Act (15 
U.S.C. 77j(a)).
    (2) Issuers with a recent Regulation A offering. If the issuer 
filed a notification under Regulation A under the Securities Act (17 
CFR 230.251 through 230.263) and was authorized to commence the 
offering less than 40 calendar days before you publish a quotation, and 
the offering circular provided for under Regulation A is not the 
subject of a suspension order, the issuer information is the offering 
circular.
    (3) Certain reporting issuers. If the issuer is current in filing 
annual or semi-annual reports required under section 13 or 15(d) of the 
Act (15 U.S.C. 78m or 78o(d)) or section 30(a) of the Investment 
Company Act of 1940 (15 U.S.C. 80a-29(a)), the issuer information is 
the issuer's most recent annual or semi-annual report and any quarterly 
and current reports filed by the issuer after such annual or semi-
annual report. You will be considered in compliance with the 
requirement to obtain current reports filed by the issuer if you obtain 
all current reports filed by that issuer as of the date that is three 
business days before you publish the quotation. However, until the 
issuer has filed its first annual or semi-annual report, the issuer 
information is:
    (i) The prospectus specified by section 10(a) of the Securities Act 
(15

[[Page 11143]]

U.S.C. 77j(a)) that was included in a registration statement filed by 
the issuer under the Securities Act and that became effective within 
the prior 15 months; or
    (ii) The registration statement filed by the issuer under section 
12 of the Act (15 U.S.C. 78l) that became effective within the prior 15 
months (other than a registration statement on Form F-6 (17 CFR 
239.36)), and any quarterly and current reports filed by the issuer 
after the registration statement became effective.
    (4) Certain financial institutions. If the issuer is not required 
to file reports under sections 13 or 15(d) of the Act and is a bank or 
savings association, as those terms are defined in 12 U.S.C. 1813, the 
issuer information is the issuer's most recent annual report and any 
subsequent reports filed with the issuer's appropriate Federal banking 
agency or State bank supervisor, as those terms are defined in 12 
U.S.C. 1813.
    (5) Certain exempted insurance companies. If the issuer is exempt 
from section 12(g) of the Act (15 U.S.C. 78l(g)) by complying with 
section 12(g)(2)(G) of the Act (15 U.S.C. 78l(g)(2)(G)), the issuer 
information is the issuer's most recent annual statement referred to in 
section 12(g)(2)(G)(i) of the Act (15 U.S.C. 78l(g)(2)(G)(i)).
    (6) Other issuers. If the issuer is not covered by paragraphs 
(c)(1) through (c)(5) of this section, the issuer information is the 
information listed below in paragraphs (c)(6)(i) through (c)(6)(xiii) 
of this section. Except as specified in paragraph (c)(6)(xiii) of this 
section, this information is presumed to be current if it is as of a 
date within 12 months before you publish the quotation and must be the 
most current information that you know or have reason to know is 
available:
    (i) The exact name of the issuer and any predecessor;
    (ii) The address and telephone number of the issuer's principal 
executive offices;
    (iii) The state of incorporation of the issuer, if it is a 
corporation;
    (iv) The date on which the issuer's fiscal year ends;
    (v) For each class of the issuer's securities outstanding:
    (A) The exact title of the security;
    (B) The par or stated value of the security;
    (C) The number of securities or total principal amount outstanding 
of the security;
    (D) The class and number of securities issuable upon the security's 
exercise, exchange or conversion, if applicable; and
    (E) The total number of securityholders of record for the security 
as of the end of the issuer's most recent fiscal year or a more recent 
date;
    (vi) The exact title and class of the security to be quoted;
    (vii) The name, address and telephone number of the transfer agent;
    (viii) A description of the issuer's business and facilities;
    (ix) A description of the issuer's products or services;
    (x) The full names and business addresses of the executive 
officers, directors, general partners, promoters, and control persons 
of the issuer, and the number of securities of each class of the 
issuer's securities that are beneficially owned by each such person as 
of the end of the issuer's last fiscal year or a more recent date;
    (xi) The following information:
    (A) A description of any of the following actions to which any 
executive officer, director, general partner, promoter, or control 
person of the issuer has been the subject during the prior five years:
    (1) A conviction in a criminal proceeding or named as a defendant 
in a pending criminal proceeding (excluding traffic violations and 
other minor offenses);
    (2) The entry of an order, judgment, or decree, not subsequently 
reversed, suspended or vacated, by a court of competent jurisdiction 
that permanently or temporarily enjoins, bars, suspends or otherwise 
limits involvement in any type of business, securities, commodities, or 
banking activities;
    (3) A finding or judgment by a court of competent jurisdiction (in 
a civil action), the Commission, the Commodity Futures Trading 
Commission, or a state securities regulator of a violation of federal 
or state securities or commodities law, which has not been reversed, 
suspended, or vacated; and
    (4) The entry of an order by a self-regulatory organization that 
permanently or temporarily bars, suspends or otherwise limits 
involvement in any type of business or securities activities; or
    (B) A statement from the issuer that no executive officer, 
director, general partner, promoter, or control person of the issuer is 
the subject of any of the actions listed in paragraphs (c)(6)(xi)(A)(1) 
through (4) of this section; or
    (C) A description of the steps you have taken to obtain from the 
issuer the information needed to comply with paragraphs (c)(6)(xi)(A) 
or (c)(6)(xi)(B) of this section and a statement that the issuer failed 
or refused to provide this information;
    (xii) The following information:
    (A) A description of any of the following events involving the 
issuer, its predecessor, or any of its majority-owned subsidiaries that 
occurred in the prior two years:
    (1) A change in control;
    (2) An increase of 10% or more of the same class of outstanding 
equity securities;
    (3) A merger, acquisition, or business combination;
    (4) An acquisition or disposition of significant assets;
    (5) A bankruptcy proceeding; and
    (6) The delisting of securities by any securities exchange or 
Nasdaq; or
    (B) A statement from the issuer that the issuer, its predecessor, 
and its majority-owned subsidiaries have not been the subject of any of 
the actions or events listed in paragraphs (c)(6)(xii)(A)(1) through 
(6) of this section; or
    (C) A description of the steps you have taken to obtain from the 
issuer the information needed to comply with paragraphs (c)(6)(xii)(A) 
or (c)(6)(xii)(B) of this section and that the issuer failed or refused 
to provide this information; and
    (xiii) The financial information listed below in paragraphs 
(c)(6)(xiii)(A) or (c)(6)(xiii)(B) and (c)(6)(xiii)(C) of this section:
    (A) If the issuer is not a foreign private issuer, the issuer's 
most recent balance sheet, statement of cash flows, statement of 
comprehensive income, and statement of operations (income), prepared in 
accordance with U.S. generally accepted accounting principles. Unless 
you know or have reason to know that more current information is 
available, this information will be presumed to be current if:
    (1) The balance sheet is as of a date that is less than 15 months 
before you publish the quotation;
    (2) The statement of cash flows, statement of comprehensive income, 
and statement of operations (income) are for the 12 months preceding 
the date of such balance sheet; and
    (3) If the balance sheet is as of a date that is more than 6 months 
before you publish the quotation, it must be accompanied by an 
additional statement of cash flows, statement of comprehensive income, 
and statement of operations (income) for the period from the date of 
such balance sheet to a date that is less than 6 months before you 
publish the quotation.
    (B) If the issuer is a foreign private issuer, the issuer's most 
recent balance

[[Page 11144]]

sheet and statement of operations (income), and to the extent prepared 
by the issuer, statement of cash flows, statement of comprehensive 
income, and statement of changes in shareholders' equity, prepared in 
accordance with a comprehensive body of accounting principles. Unless 
you know or have reason to know that more current information is 
available, this information will be considered current if:
    (1) The balance sheet is as of a date that is less than 18 months 
before you publish the quotation;
    (2) The statement of cash flows, statement of comprehensive income, 
statement of operations (income), and statement of changes in 
shareholders' equity are for the 12 months preceding the date of such 
balance sheet; and
    (3) If the balance sheet is as of a date that is more than 9 months 
before you publish the quotation, it must be accompanied by an 
additional statement of cash flows, statement of comprehensive income, 
statement of operations (income), and statement of changes in 
shareholders' equity for the period from the date of such balance sheet 
until a date that is less than 9 months before you publish the 
quotation, if any such statements have been prepared by the issuer.
    (C) The same financial information required by paragraph 
(c)(6)(xiii)(A) and (B) of this section for such part of the two 
preceding fiscal years as the issuer or any predecessor has been in 
existence (one year with respect to the balance sheet), prepared in 
accordance with U.S. generally accepted accounting principles (or 
prepared in accordance with a comprehensive body of accounting 
principles in the case of a foreign private issuer). However, if the 
issuer has emerged from reorganization pursuant to Chapter 11 of the 
Bankruptcy Code (11 U.S.C. 1101 et seq.) and the reorganization plan 
has been in effect less than two years, the financial information 
required under this paragraph (c)(6)(xiii) is the court-approved 
disclosure statement filed under 11 U.S.C. 1125 and the financial 
information described in this paragraph (c)(6)(xiii) from the date of 
the entry of the bankruptcy court order confirming the issuer's 
reorganization plan pursuant to 11 U.S.C. 1129.
    (d) The supplemental information that a broker or dealer must 
review. The type of information that is considered ``supplemental 
information'' and that you must review under paragraph (b) of this 
section is the following:
    (1) A copy of any trading suspension order issued by the Commission 
under section 12(k) of the Act (15 U.S.C. 78l(k)) for any securities of 
the issuer or its predecessor (if any) during the 12 months before you 
publish the quotation, or a copy of the public release issued by the 
Commission announcing such trading suspension order; and
    (2) A copy or a written record of any other material information 
(including adverse information) about the issuer that comes to your 
knowledge or possession before you publish a quotation.
    (e) The significant relationship information that the broker or 
dealer must make and keep a record of. The type of information that is 
considered ``significant relationship'' information and that you must 
make and keep a record of under paragraph (b) of this section is the 
following:
    (1) Any direct or indirect affiliation between the issuer and you 
or between the issuer and any of your associated persons;
    (2) Whether you are publishing the quotation on behalf of any other 
broker or dealer, or any of its associated persons, and, if so, the 
name of such broker or dealer, or the associated person, and the terms 
of the arrangement;
    (3) Whether you have received, or have any arrangement to receive, 
any monetary or other consideration from any person for publishing the 
quotation and, if so, a description of the consideration and the name 
of the person providing the consideration; and
    (4) Whether you are publishing the quotation directly or indirectly 
on behalf of the issuer, or any executive officer, director, general 
partner, promoter, control person, or any person, who is directly or 
indirectly the beneficial owner of more than 10 percent of the 
outstanding units or shares of any equity security of the issuer, and, 
if so, the name of such person, and the basis for any exemption under 
the federal securities laws for any sales of such securities on behalf 
of such person.
    (f) The information a broker or dealer must submit to the NASD. At 
least three business days before you publish a quotation covered by 
paragraph (a) of this section, you must submit to the NASD, in 
accordance with NASD rules, the information required in paragraphs (c), 
(d), and (e) of this section.
    (g) The broker or dealer must make certain information required by 
this section available upon request.
    (1) If you publish a quotation for a security in compliance with 
this section, you must make the issuer, supplemental, and significant 
relationship information specified in paragraphs (c)(5), (c)(6), (d), 
and (e) of this section promptly available upon request to any 
customer, prospective customer, other broker or dealer, or information 
repository. By providing this information to others under this 
paragraph (g), you do not represent that the information is accurate; 
rather, you represent that, as of the date recorded under paragraph 
(b)(3)(iii) of this section, you had a reasonable basis under the 
circumstances for believing that the information was accurate and 
current in all material respects and was obtained from reliable 
sources; but
    (2) You do not need to comply with paragraph (g)(1) of this section 
to the extent that the information is reasonably available through 
EDGAR, any other federal or state electronic information system, or an 
information repository.
    (h) When a broker or dealer is not required to comply with this 
section. You are not required to comply with this section when you 
publish a quotation for:
    (1) A security that is listed on a national securities exchange or 
Nasdaq; is traded on such exchange or Nasdaq on the same day as, or on 
the business day immediately before, the day you publish the quotation; 
and is not suspended, terminated, or prohibited from trading on such 
exchange or Nasdaq;
    (2) An exempted security, as defined in section 3(a)(12) of the Act 
(15 U.S.C. 78c(a)(12));
    (3) A security where the quotation represents the unsolicited order 
of a customer (other than a person acting as or for a dealer);
    (4) A non-convertible debt security or a non-participatory 
preferred stock;
    (5) An asset-backed security that is rated by at least one 
nationally recognized statistical rating organization, as that term is 
used in Sec. 240.15c3-1, in one of its generic rating categories that 
signifies investment grade;
    (6) A security with a worldwide average daily trading volume value 
of at least $100,000 during each month of the six full calendar months 
immediately before the date you publish the quotation;
    (7) A convertible security, if the underlying security meets the 
requirements of paragraph (h)(6) of this section;
    (8) A security that has bid price, as published on a national 
securities exchange, Nasdaq, or quotation medium, of at least $50 per 
share. If the security is a unit composed of one or more securities, 
the bid price of the unit divided by the number of shares of the unit 
that are not warrants, options,

[[Page 11145]]

rights, or similar securities must be at least $50; or
    (9) A security of an issuer that has net tangible assets in excess 
of $10,000,000.
    (i) The steps to take to become an information repository.
    (1) An entity seeking information repository designation must file 
an application with the Director of the Commission's Division of Market 
Regulation in Washington, DC. The application should provide detailed 
information explaining how the entity satisfies the attributes set 
forth in paragraph (i)(2) of this section. The entity must also file 
any additional information relating to the attributes set forth in 
paragraph (i)(2) of this section that the Director of the Commission's 
Division of Market Regulation subsequently requests;
    (2) In determining whether to designate an entity as an information 
repository, the Commission will consider whether the entity:
    (i) Collects information about a substantial segment of issuers of 
securities subject to this section;
    (ii) Maintains current and accurate information about such issuers;
    (iii) Has effective acquisition, retrieval, and dissemination 
systems;
    (iv) Places no inappropriate limits on the issuers from or about 
which it will accept information;
    (v) Provides access to the documents deposited with it to anyone 
willing and able to pay the applicable fees;
    (vi) Charges reasonable fees; and
    (vii) In general, is so organized and has the capacity to be able 
to reasonably carry out the purposes of this section.
    (3) An information repository must notify the Director of the 
Commission's Division of Market Regulation of any material changes that 
occur in the facts and circumstances of its application for such 
designation; and
    (4) In the event it is determined that an information repository no 
longer satisfies all of the attributes set forth in paragraph (i)(2) of 
this section, the Director of the Commission's Division of Market 
Regulation may revoke such designation.
    (j) The definitions applicable to this section. For purposes of 
this section, the following definitions apply:
    (1) Alternative trading system has the same meaning contained in 
Sec. 242.300(a) of this chapter.
    (2) Asset backed security has the meaning contained in General 
Instruction I.B.5. to Form S-3 (17 CFR 239.13).
    (3) Information repository means an entity that:
    (i) Gathers and provides to brokers or dealers and others current 
issuer information described in paragraph (c) of this section when this 
information is not routinely or widely made available, electronically 
or otherwise; and
    (ii) Is designated by the Commission as an information repository 
as described in paragraph (i) of this section.
    (4) Issuer, in the case of quotations for American Depositary 
Receipts, means the issuer of the deposited shares represented by such 
American Depositary Receipts.
    (5) NASD means the National Association of Securities Dealers, 
Inc., and its wholly owned subsidiaries (including, but not limited to, 
NASD Regulation, Inc. and The Nasdaq Stock Market, Inc.).
    (6) Nasdaq means The Nasdaq National Market and The Nasdaq SmallCap 
Market, both operated by The Nasdaq Stock Market, Inc.
    (7) Net tangible assets means total assets less intangible assets 
and liabilities. For purposes of this section, net tangible assets must 
be demonstrated by current financial statements, as described in 
paragraph (c)(6)(xiii) of this section, and:
    (i) If the issuer is not a foreign private issuer, the financial 
statements must be audited and reported on by an independent public 
accountant in accordance with Sec. 210.2-02 of this chapter; or
    (ii) If the issuer is a foreign private issuer, the financial 
statements must be prepared in accordance with a comprehensive body of 
accounting principles, audited in compliance with requirements of the 
country of incorporation, and reported on by an accountant duly 
registered and in good standing in accordance with the regulations of 
that jurisdiction.
    (8) Non-participatory preferred stock means non-convertible capital 
stock, the holders of which are entitled to a preference in payment of 
dividends and in distribution of assets on liquidation, dissolution, or 
winding up of the issuer, but are not entitled to participate in 
residual earnings or assets of the issuer.
    (9) Promoter has the same meaning contained in Sec. 230.405 of this 
chapter.
    (10) Publish means to publish a quotation for a security in a 
quotation medium or, directly or indirectly, to submit a quotation for 
a security for publication in a quotation medium.
    (11) Quotation means any bid or offer at a specified price with 
respect to a security, or any indication of interest by a broker or 
dealer in receiving bids or offers from others for a security, or any 
indication by a broker or dealer that advertises its general interest 
in buying or selling a particular security.
    (12) Quotation medium means any:
    (i) System of general circulation to brokers or dealers that 
regularly disseminates quotations of identified brokers or dealers; or
    (ii) Publication, alternative trading system, or other device that 
is used by brokers or dealers to disseminate quotations to others.
    (13) Securities Act means the Securities Act of 1933 (15 U.S.C. 77a 
et seq.).
    (k) How this section applies to securities for which a broker or 
dealer is publishing quotations immediately before the effective date 
of the amendments. If you were publishing a quotation for a security on 
the business day immediately before April 7, 1999, you may continue to 
publish quotations for the security without complying with paragraph 
(b) of this section until you publish a quotation described in 
paragraphs (a)(2), (a)(3), (a)(4), (a)(5), or (a)(6) of this section.
    (l) The Commission can grant exemptions from this section. This 
section does not prohibit the publication of any quotation for a 
security or a class of securities, if the Commission, on written 
request or its own motion, exempts such quotation, either 
unconditionally or on specified terms and conditions.
    3. Section 240.17a-4 is amended by adding paragraph (b)(11) to read 
as follows:


Sec. 240.17a-4  Records to be preserved by certain exchange members, 
brokers and dealers.

* * * * *
    (b) * * *
    (11) The records required to be obtained pursuant to Sec. 240.15c2-
11.
* * * * *
    Dated: February 25, 1999.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
    Note: This Appendix to the Preamble will not appear in the Code 
of Federal Regulations.

Appendix

Guidance on the Scope of a Broker-Dealer's Review Under Current Rule 
15c2-11 and the Amendments

I. Introduction

    To assist broker-dealers in complying with Rule 15c2-11 (Rule) \1\ 
under the Securities Exchange Act of 1934 (Exchange Act),\2\ we are 
setting forth the factors that they should consider in carrying out 
their review obligations

[[Page 11146]]

under the Rule as it currently exists and under the amendments proposed 
in Securities Exchange Act Release No. 34-41110.\3\ We are providing 
this guidance because commenters on the initial proposal \4\ expressed 
concerns about their review obligations under its provisions, 
particularly in light of elimination of the piggyback provision, the 
addition of an annual review requirement, and the obligation to obtain 
enhanced issuer information. This guidance applies, unless otherwise 
noted, to a broker-dealer's obligations under the current Rule as well 
as under the reproposal.
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    \1\ 17 CFR 240.15c2-11.
    \2\ 15 U.S.C. 78a et seq.
    \3\ This appendix sets forth guidance on a broker-dealer's 
review obligations under the Rule as it currently exists and under 
the proposed amendments. If the Commission takes final action on the 
proposed amendments, the Appendix will be revised to delete 
references to the proposal and to reflect the final rule. We expect 
that the Appendix will provide useful guidance to broker-dealers in 
conducting the document review required by the Rule.
    \4\ Securities Exchange Act Release No. 39670 (February 17, 
1998), 63 FR 9661 (Proposing Release).
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    Rule 15c2-11 regulates the publication of quotations for OTC 
securities in a quotation medium.\5\ The Rule generally prohibits 
broker-dealers from publishing a quotation unless they have reviewed 
specified information about the issuer. The kind of information 
depends on the nature of the issuer, e.g., whether the issuer is 
subject to the Exchange Act's periodic reporting requirements 
(reporting issuer) or is an issuer that is not subject to the 
Exchange Act's reporting requirements (non-reporting issuer). 
Broker-dealers must also have a reasonable basis for believing that 
the issuer information, when considered in conjunction with any 
supplemental information,\6\ is accurate in all material respects 
and that it was obtained from a reliable source.
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    \5\ A quotation is broadly defined as any indication that a 
broker-dealer is willing to buy or sell a particular security. The 
reproposed Rule, however, applies most directly to priced 
quotations. Rule 15c2-11 applies to broker-dealers that publish 
quotations for securities traded in the OTC markets. In this 
appendix, ``OTC stocks'' or ``OTC securities'' refers to securities 
that are not listed on a national securities exchange or Nasdaq. 
``Covered OTC securities'' refers to those OTC securities that are 
subject to Rule 15c2-11. Rule 15c2-11 applies to securities quoted 
on the OTC Bulletin Board, operated by the National Association of 
Securities Dealers, Inc. (NASD); the Pink Sheets operated by the 
National Quotation Bureau, Inc. (NQB); and similar quotation 
systems.
    \6\ See footnote 14 below for a description of ``supplemental 
information.''
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    The Rule is precise about the kind of issuer and other 
information that the broker-dealer must obtain and review before 
publishing quotations and about how current that information must 
be. However, some commenters on the Proposing Release stated that 
they were unclear about the nature of the broker-dealer's obligation 
to determine that the broker-dealer reasonably believes that the 
source of the Rule 15c2-11 information is reliable and that the 
information is accurate in all material respects. We are giving our 
views on the steps a broker-dealer should take to assess the 
reliability of the source of the required information and the 
accuracy of that information.\7\
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    \7\ This discussion confirms and supplements earlier guidance on 
Rule 15c2-11 issues. See Securities Exchange Act Release No. 29094 
(April 17, 1991), 56 FR 19148 (1991 Adopting Release); Securities 
Exchange Act Release No. 27247 (September 14, 1989), 54 FR 39194 
(1989 Proposing Release).
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II. Quotation Events Triggering the Review Requirement

    Under the current Rule, the first broker-dealer to publish a 
priced quotation must obtain and review the Rule's required 
information. Under the current Rule's piggyback exception, a broker-
dealer does not have to satisfy these information requirements when 
it publishes a quotation for a security if it, or any other broker-
dealer, is already publishing regular quotations for the 
security.\8\ This means that the first market maker publishing a 
quotation is the only one that has to obtain the required 
information, and thereafter, any other market maker can publish 
quotations in the security indefinitely, unless there is a 
significant lapse in quotation activity.\9\
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    \8\ 17 CFR 240.15c2-11(f)(3). The security must have been the 
subject of quotations on at least 12 business days during the 
previous 30 calendar days, with no more than 4 consecutive business 
days elapsing without a quotation. Effectively, the Rule applies 
only to those market makers publishing quotations during the first 
30 days of a security's trading. The ability to piggyback on one's 
own quotations is referred to as ``self-piggybacking.''
    \9\ The piggyback exception would be eliminated under the 
proposed amendments.
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    The amendments will restructure Rule 15c2-11 by setting forth 
more clearly the quotation events that trigger the Rule, the 
requirements that the broker-dealer must satisfy, and the nature of 
the information that the broker-dealer must review. The amendments 
state that no broker-dealer, directly or indirectly, may publish the 
described kinds of quotations for a security in any quotation 
medium, without first complying with the Rule's provisions.\10\ 
Under the amendments, the Rule will apply at specified points in 
time, namely, when a broker-dealer publishes:
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    \10\ The current Rule applies to an interdealer quotation 
system, which is a quotation medium of general circulation to 
brokers or dealers which regularly disseminates quotations of 
identified brokers or dealers. 17 CFR 240.15c2-11(e)(2). Under the 
proposed amendments, the definition of ``interdealer quotation 
system'' would be incorporated into the definition of ``quotation 
medium.'' Under the amendments, a ``quotation medium'' will be a 
system of general circulation to brokers or dealers that regularly 
disseminates quotations of identified brokers or dealers; or 
publication, alternative trading system, or other device that is 
used by brokers or dealers to disseminate quotations to others.]
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     the first quotation for a security;
     its first quotation at a specified price for a security 
after another broker or dealer published the first quotation for the 
same security.
     the first quotation following the termination of a 
Commission trading suspension ordered pursuant to section 12(k) of 
the Exchange Act \11\ in any security of the issuer of the suspended 
security;
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    \11\ 15 U.S.C. 78l(k).
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     a quotation at a specified price for a security after a 
period of five or more consecutive business days when it did not 
publish any quotations at a specified price for that security;
     its first quotation at a specified price for a security 
after the date that is four months after the end of the issuer's 
fiscal year, unless the issuer is a foreign private issuer; or
     its first quotation at a specified price for a security of 
a foreign private issuer after the date that is seven months after the 
end of the issuer's fiscal year.
    If the Rule applies, under both the current Rule and the 
amendments, the broker-dealer must:
     review the Rule's specified information;
     determine that it has a reasonable basis for believing 
that the information is accurate in all material respects and was 
obtained from reliable sources;
     Record the date it reviewed the specified information, 
the sources of the information, and the person at the firm 
responsible for the broker-dealer's compliance with the Rule; and
     Preserve the specified information in accordance with 
Rule 17a-4.\12\
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    \12\ 17 CFR 240.17a-4.
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    We set out below in more detail the review obligation required 
of a broker-dealer before it publishes a quotation for covered OTC 
securities. In general, the broker-dealer must first form a 
reasonable belief about the source's reliability. Then the broker-
dealer should examine the materials to make sure it has obtained all 
of the information required by the Rule, including any supplemental 
information known by the broker-dealer. In reviewing this 
information, the Rule requires that the broker-dealer must have a 
reasonable basis under the circumstances for believing that the 
issuer information described in paragraph (a) [reproposed paragraph 
(c)] of the Rule,\13\ when considered in conjunction with the 
supplemental information described in paragraph (b) [reproposed 
paragraph (d)] of the Rule,\14\ is accurate in all material

[[Page 11147]]

respects and was obtained from reliable sources.
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    \13\ Currently, a broker-dealer must review and maintain in its 
records certain issuer information, which, depending on the issuer, 
may include prospectuses or offering circulars; certain Exchange Act 
reports; other regulatory filings; information furnished to the 
Commission pursuant to Section 12(g)(2)(G)(i) of the Exchange Act; 
or certain financial information for non-reporting issuers. The 
amendments expand the information required for issuers that do not 
file periodic reports with the Commission (e.g., non-reporting 
issuers). In addition, broker-dealers would be required to make the 
issuer information available to anyone who requested it.
    \14\ In addition to a copy of any trading suspension order 
issued by the Commission pursuant to Exchange Act Section 12(k), the 
broker-dealer must record and consider any other material 
information (including adverse information) regarding the issuer 
that comes to its knowledge or possession before publishing a 
quotation under the Rule. Paragraph (b) [reproposed paragraph (d)] 
does not require a broker-dealer to maintain trivial information or 
information from an uncertain source. Also, the broker-dealer is not 
required to affirmatively seek out information about the issuer 
beyond that specifically required by the Rule. However, if material 
information about the issuer comes to its knowledge or possession 
(orally or in writing), the broker-dealer must take that information 
into account in assessing whether the issuer information is accurate 
and is from a reliable source. See footnote 35 below regarding how 
to obtain information about Commission trading suspensions.
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    In addition, we are providing numerous examples of ``red flags'' 
often associated with Rule 15c2-11 documents. A red flag is 
information that under the circumstances signals that one or more of 
the required items of information may be materially inaccurate. We 
consider these red flags to be indications that should lead a 
broker-dealer to inquire whether it had a reasonable basis to 
believe that the issuer information is accurate in all material 
respects and that it was obtained from a reliable source.
    The red flags that we discuss have been present in Commission 
enforcement actions, examinations conducted by our staff, and 
reviews of Rule 15c2-11 conducted by the National Association of 
Securities Dealers, Inc. (NASD) submissions, but our discussion is 
not meant to be exhaustive. Other information may come into the 
broker-dealer's knowledge or possession that would lead it to 
question whether the source is reliable or whether the required 
information is accurate in all material respects. The adequacy of a 
broker-dealer's review must be considered on a case-by-case basis.
    The reproposed Rule would require a broker-dealer to obtain and 
review some issuer information not required by the current Rule, 
such as criminal or securities law violations and additional issuer 
information. Until the proposal is adopted, the Rule does not 
require the broker-dealer to obtain and review this information. 
This information, however, would be a red flag and, under the 
current Rule, could be ``material information'' that the broker-
dealer must take into account when conducting its review 
obligations.

III. The Review Process

A. Introduction

    While the broker-dealer must obtain and review the required 
information, the standard of review is based on a broker-dealer's 
arriving at a reasonable belief, not a certainty, that the 
information is accurate and was obtained from a reliable source. 
Although broker-dealers often refer to their Rule 15c2-11 files as 
``due diligence'' files, the Rule's standard of review does not 
approach the depth of inquiry generally associated with an 
underwriter's obligations in a registered public offering or with a 
retail broker's obligations in recommending a security to a 
customer. As discussed below, the scope of review is relatively 
simple in the case of an issuer that has just completed a public 
offering or an offering under Regulation A \15\ or that files 
periodic reports with the Commission.\16\ In these cases, the 
broker-dealer must obtain and review information that is on file 
with the Commission, in addition to any supplemental information. In 
the case of a non-reporting issuer, where there may be no 
information filed with a regulatory authority, the broker-dealer 
must obtain the required information from sources its deems reliable 
and must review this information together with any supplemental 
information.
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    \15\ 17 CFR 230.251-230.263.
    \16\ Under the reproposal, the broker-dealer can look to filings 
made with other federal or state regulatory authorities for certain 
types of issuers, e.g., financial institutions.
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    The Rule does not currently specify the status of the person who 
must conduct the review on the broker-dealer's behalf. Under the 
reproposed Rule, the broker-dealer must make a record of the person 
at the firm who is responsible for the broker-dealer's compliance 
with the Rule's provisions.\17\ Generally, the person performing the 
review should have sufficient experience or authority at the firm to 
make sure that the Rule's requirements are fully satisfied.
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    \17\ See text of reproposed Rule 15c2-11(b)(3)(iv).
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    Rule 15c2-11 is intended to prevent broker-dealers from becoming 
involved in the fraudulent manipulation of OTC securities. However, 
even if a broker-dealer technically complies with the Rule's 
requirements, it would be subject to liability under other antifraud 
provisions of the securities laws, such as Rule 10b-5, if a broker-
dealer publishes quotations as part of a fraudulent or manipulative 
scheme.\18\
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    \18\ 17 CFR 240.10b-5.
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B. Source Reliability

1. Determining Whether a Source is Reliable

    The broker-dealer must first have a reasonable basis for 
believing that Rule 15c2-11 information comes from a reliable 
source. In general, this means that the information was derived from 
the issuer. If the information is from the issuer or its officers 
and directors, attorney, or accountant, the broker-dealer generally 
can assume that the source is reliable, absent red flags to the 
contrary.\19\ If the information is from EDGAR or another 
governmental website or an independent retrieval service \20\ or 
standard research sources \21\ or an information repository 
contemplated under the reproposed Rule, the broker-dealer can 
satisfy the Rule's requirement to have a reasonable basis for 
believing that the source of the information is reliable. If the 
broker-dealer receives the information from an independent and 
objective source, such as a bank that is not a market maker in the 
security, which represents that it has prepared the information or 
received the information directly from the issuer, the broker-dealer 
typically may rely on that representation as to the source. Because 
broker-dealers frequently obtain the Rule 15c2-11 information from 
these sources, the reliability of the information's source is not 
often called into question.
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    \19\ Because of recent microcap fraud cases involving promoters, 
a broker-dealer should not presume a promoter is a reliable source 
of issuer information. See SEC Charges 44 Stock Promoters in First 
Internet Securities Fraud Sweep, Press Release 98-117 (October 28, 
1998) available at <http://www.sec.gov/news/press/98-117.txt>.
    \20\ Examples of an ``independent retrieval service'' would be 
the SEC's Public Reference Room or a document retrieval service.
    \21\ Examples of ``standard research sources'' include 
publications such as Standard & Poor's Standard Corporation Manual 
and Moody's Investors Service Manuals.
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    Occasionally, the broker-dealer may obtain the Rule 15c2-11 
information from sources not associated with the issuer, such as 
another market maker.\22\ In this case, the requesting broker-dealer 
should inquire about the original source of the information. The 
broker-dealer providing the information must make a record of the 
source of the issuer information and can supply this information to 
the requesting broker-dealer.
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    \22\ The proposed Rule will require a broker-dealer to provide 
the information to another broker-dealer upon request.
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    When a red flag regarding the source's reliability exists, the 
broker-dealer must inquire further to reasonably determine whether 
the information's source is reliable. To satisfy the Rule's 
requirements, the broker-dealer must ascertain the original source 
of the information, especially when a broker-dealer is provided 
information from another broker-dealer that encourages the 
publication of quotations rather than responds to a request for 
information.\23\ If the broker-dealer providing the information 
refuses to substantiate that the information is from the issuer, 
this refusal is a red flag that may indicate that the source is 
unreliable. If the broker-dealer is told that the issuer has 
prepared or approved the information, the broker-dealer may need to 
verify that representation by directly contacting the issuer.
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    \23\ See Bunker Securities, Inc., 48 S.E.C. 859 (1987), aff'd 
without opinion, 833 F.2d 303 (3d Cir. 1987).
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2. Examples of Unreliable Sources

    The Report of Investigation Regarding Transactions in the 
Securities of Laser Arms Corporation (Laser Arms Report) illustrates 
when a broker-dealer did not have a reasonable basis to believe that 
the information about a non-reporting issuer was from a reliable 
source.\24\ The Laser Arms Report noted that ``inherent in the 
requirement of paragraph (a)(5) [reproposed paragraph (c)(6)] is 'the 
premise that the broker-dealer must at least verify that it has 
received the required information and know that source of the 
information.'' \25\
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    \24\ 50 S.E.C. 489 (1991). The Laser Arms Report was issued 
pursuant to the investigative authority granted to the Commission 
under Section 21(a) of the Exchange Act (15 U.S.C. 78u(a)).
    \25\ Laser Arms Report at 501, citing Securities Exchange Act 
Release No. 34-29095 (April 17, 1991), 56 FR 19158 (1991 Proposing 
Release).
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    The broker-dealer that submitted the initial application to quote 
Laser Arms stock did not make any attempt to verify the source of the 
issuer information contained in the Laser Arms Memorandum. In fact, it 
was a fictitious document prepared by a recidivist securities law 
violator who was the

[[Page 11148]]

undisclosed principal of Laser Arms.\26\ The broker-dealer's immediate 
source of the Laser Arms Memorandum was a trader at another broker-
dealer whom he had known for less than one year, had seen on only a few 
occasions, and had dealt with primarily by telephone. The broker-dealer 
did not review or attempt to determine the source of any part of the 
information in the Laser Arms Memorandum. Any attempt to contact the 
issuer directly probably would have led to the discovery that Laser 
Arms was a shell corporation with no assets, operations, or 
products.\27\ Under these circumstances, the Commission did not believe 
that this broker-dealer, or any of the broker-dealers to subsequently 
publish quotations, had a reasonable basis for believing that the 
source of the Rule 15c2-11 information was reliable.\28\
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    \26\ The Laser Arms Memorandum misrepresented Laser Arms as a 
high technology weapons manufacturer and the developer of a self-
chilling beverage can. The memorandum also included forged 
certificates of incorporation, fictitious balance sheets, and 
auditor's report which the signature of the accountant had been 
forged.
    \27\ Another broker-dealer who attempted to call Laser Arms 
learned there was no telephone listing for the company. This broker-
dealer nevertheless initiated a market in Laser Arms' securities.
    \28\ See also Bunker Securities, Inc., 48 S.E.C. 859 (1987, 
aff'd without opinion, 833 F.2d 303 (3d Cir. 1987).
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C. Document Review Obligations

    Once the broker-dealer has formed a reasonable belief about the 
source's reliability, it should examine the materials to make sure it 
has obtained all of the information required by the Rule. This means 
that a broker-dealer must not only review the information about the 
issuer of the security to be quoted but also consider any supplemental 
information.\29\ The Rule requires that the broker-dealer must have a 
reasonable basis under the circumstances for believing that the issuer 
information described in paragraph (a) [reproposed paragraph (c)] of 
the Rule, when considered in conjunction with the supplemental 
information described in paragraph (b) [reproposed paragraph (d)] of 
the Rule, is accurate in all material respects.
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    \29\ See footnote 14 above for a definition of supplemental 
information.
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    Unlike the duties of an underwriter in a securities offering, Rule 
15c2-11 ordinarily does not require a broker-dealer to conduct an 
independent inquiry about the issuer of the security to be quoted. A 
broker-dealer publishing quotes for a covered OTC security may have no 
relationship with the issuer, and the Rule does not demand that the 
broker-dealer develop one to obtain information. However, the broker-
dealer must review the required information, together with any 
supplemental information that comes to its attention, and should be 
alert to red flags.
    Because documents filed with the Commission are subject to 
liability provisions, a broker-dealer generally can reach a 
reasonable belief as to the accuracy of information contained in 
these documents.\30\ This also would be true for documents filed 
with financial institutions' regulatory authorities, which broker-
dealers may obtain and review when publishing quotes for the 
securities of certain banks, provided for in paragraph (c)(4) of the 
reproposed Rule.
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    \30\ See Sections 11 and 27 of the Securities Act, 15 U.S.C. 77k 
and 77x, and Sections 18 and 32 of the Exchange Act, 15 U.S.C. 78r 
and 78ff. See 1991 Adopting Release, 56 FR 19148, 19150 (1991).
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    If a registration statement incorporates other documents by 
reference, the broker-dealer may be required to obtain some of the 
incorporated documents to satisfy the Rule's information gathering 
and review requirements. It should not be necessary for the broker-
dealer to be familiar with all aspects of the filed documents. The 
broker-dealer should focus on those sections that describe the items 
of information set forth in Rule 15c2-11(a)(5) [reproposed Rule 
15c2-11(c)(6)], the issuer's identified ``risk factors,'' \31\ any 
recent material business combinations, such as the merger of a 
reporting shell into a non-reporting company, and current financial 
information.
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    \31\ If the issuer's registration statement, pursuant to Item 
401 of Regulation S-K, describes criminal or other disciplinary 
proceedings involving a reporting issuer's officer, director, 
general partner, promoter, or control person, this would be a red 
flag. Reproposed Rule 15c2-11(c)(6)(xi) will require broker-dealers 
to inquire about these types of criminal or other disciplinary 
proceedings involving a non-reporting issuer's office, director, 
general partner, promoter, or control person. Under the current 
Rule, however, a broker-dealer's knowledge of criminal or other 
disciplinary proceedings involving a reporting or non-reporting 
issuer's officer, director, general partner, promoter, or control 
person would be a red flag.
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    In contrast to information from other kinds of issuers, non-
reporting issuer information generally has not been filed with any 
regulatory authority. Thus, the broker-dealer cannot make any 
assumptions about the accuracy of such information. Similarly, a 
broker-dealer cannot make any assumptions about the accuracy of 
information to documents and other materials that are submitted to 
the Commission by foreign private issuers under Rule 12g3-2(b). 
Although they are submitted to the Commission, these documents are 
not ``filed'' and so are not subject to the liabilities that attach 
to reporting issuer information. These documents are prepared in 
accordance with the standards of the issuer's home jurisdiction, not 
the standards set forth under the U.S. federal securities laws, and 
broker-dealers should independently assess the accuracy of such 
information. Broker-dealers will also need to independently assess 
the accuracy of information filed with foreign securities regulatory 
authorities, based on considerations such as the disclosure and 
liability standards under foreign law. In reviewing the Rule's 
required information for non-reporting issuers, the kinds of 
significant events that require a domestic reporting issuer to file 
a Form 8-K under the Exchange Act \32\ also should be considered red 
flag events.
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    \32\ 17 CFR 249.308.
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    Where no red flags appear during the review of current and 
complete information, the broker-dealer would have a reasonable 
basis for believing that the Rule's information is accurate. At this 
point, the broker-dealer's review ordinarily would end, i.e., the 
broker-dealer would not be required to question the financial 
statements or any other information required to be obtained and 
reviewed. The Rule does not require the broker-dealer to question 
any information unless the information contains apparent material 
discrepancies, or other information in the broker-dealer's knowledge 
or possession (i.e., paragraph (b) [reproposed paragraph (d)] 
information) reasonably indicates that the paragraph (a) [reproposed 
paragraph (c)] information is materially inaccurate.
    When red flags are present, the broker-dealer's efforts to 
satisfy itself with respect to the accuracy of the information will 
vary with the circumstances and may require the broker-dealer to 
obtain additional information or seek to verify existing 
information. If the broker-dealer is aware that the required issuer 
information is materially inaccurate, it may nevertheless publish 
quotations without violating the Rule, as long as the broker-dealer 
can supplement that information with additional information that the 
broker-dealer reasonably believes is accurate. If the immediate 
source of the issuer information is unreliable, however, the broker-
dealer should view that source with skepticism and attempt to obtain 
the Rule's information from another source. For example, a broker-
dealer that is aware that the required issuer information is 
inaccurate could produce a written record reflecting the additional, 
corrected information or could obtain other materials, such as a 
more recent Form 8-K,\33\ that would permit the broker-dealer to 
comply with the Rule. If the broker-dealer sees that the auditor's 
report in an issuer's financial statements is qualified, the broker-
dealer may need to contact the accountants about the basis for such 
qualification. If the broker-dealer learns that an issuer's control 
person has been convicted of securities fraud, it should contact the 
appropriate regulatory authority to ascertain the facts.\34\
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    \33\ 27 CFR 249.308.
    \34\ Even thought he criminal and securities law violations 
specified in reproposed paragraph (c)(6)(xi) are not specified in 
paragraph (a)(5) of the current Rule, a broker-dealer's knowledge of 
such information would be material adverse information under the 
current rule, and such violations would be a red flag.
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    The Rule's provisions are triggered by discrete quotation 
events. Once the broker-dealer has complied with the Rule's 
requirements with respect to a particular quotation event, there is 
no continuing duty to obtain and review the information. Of course, 
when a quotation event occurs, e.g., the broker-dealer is publishing 
priced quotations as of the annual review date

[[Page 11149]]

required by the reproposed Rule, it must conduct a review of current 
issuer information. In this case, the review process would be the 
same as described above. However, the review process should be 
somewhat simpler because the broker-dealer would already have gained 
some familiarity with the issuer as a result of its prior review.

D. Scope of Review Following a Trading Suspension

    A Commission trading suspension is a material event affecting 
the market for an issuer's securities.\35\ After the termination of 
a trading suspension, a broker-dealer may not enter a quotation 
unless and until it has strictly complied with all the provisions of 
the Rule. Before initiating or resuming a quotation for securities 
subject to Rule 15c2-11, the broker-dealer must conduct a careful 
review in a professional manner of the basis for the trading 
suspension to determine whether there is a reasonable basis for the 
broker-dealer to believe that the information about the issuer is 
accurate and current. The broker-dealer may be unable to reach a 
reasonable basis for relying on the questioned financial statements 
in the Commission's order even if the information otherwise 
satisfies the Rule's presumption of ``current'' information.\36\ 
This presumption is obviated if the broker-dealer has information to 
the contrary.\37\
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    \35\ See Section 12(k) of the Exchange Act. Information 
regarding recent trading suspension orders can be obtained by 
calling 800-SEC-0330. The broker-dealer must obtain a copy of the 
trading suspension order or a copy of the Commission release 
announcing the trading suspension. Copies of Commission releases may 
be obtained through our Internet website at <http://www.sec.gov/
enforce/tsuspend.htm> or from the Commission's Public Reference Room 
in Washington, D.C. and in regional Commission offices. Also, 
Commission releases are available form information databases (e.g., 
LEXIS), and also are published in the SEC Docket, which is available 
from publication services (e.g., Commerce Clearing House, Inc.).
    \36\ The reproposal contains a presumption that the financial 
information of both reporting issuers and domestic and foreign non-
reporting issuers is current if it is less than 15 months old. 
However, if the broker-dealer has other information that indicates 
that the issuer's financial condition has materially changed from 
that shown in the financial statements, this presumption may not 
apply, and the broker-dealer should determine whether more recent 
financial information is available. Financial information older than 
15 months is not current and does not satisfy the Rule's 
requirements.
    \37\ General Bond & Share Co., 51 S.E.C. 411 (1993) (Commission 
opinion), rev'd on other grounds, General Bond & Share Co. v. SEC, 
39 F.3d 1451 (10th Cir. 1994); See also Robin Rushing and Harold 
Gallison, Jr., Securities Exchange Act Release No. 36910 (February 
29, 1996).
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    The broker-dealer must also check the reliability of the source 
of the information, particularly when the same source is providing 
updated information. If the broker-dealer seeks assurances or 
additional information from the source (in most cases, the issuer) 
about the matters cited in the Commission trading suspension order, 
great caution should be used before relying on the statements or 
assurances from the issuer. The broker-dealer may have to test the 
accuracy of the information or the source's reliability by 
conducting an independent review or obtaining verification of 
information provided by the issuer. The broker-dealer may need to 
seek an opinion of an independent accountant or attorney to form a 
reasonable basis to believe that the Rule's information is accurate 
and from a reliable source. In one enforcement action, a broker-
dealer unreasonably relied on pre-suspension financial statements 
when the Commission's trading suspension was based upon a lack of 
accurate financial information and the issuer's auditors indicated 
to the broker-dealer that they were having problems verifying the 
issuer's financial information.\38\
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    \38\ Robin Rushing and Harold Gallison, Jr., Securities Exchange 
Act Release No. 36910 (February 29, 1996); see also Bagle 
Securities, Inc., Securities Exchange Act Release No. 27673 
(February 5, 1990); William V. Frankel & Company, Securities 
Exchange Act Release No. 27649 (January 26, 1990); Richfield 
Securities, Inc., Securities Exchange Act Release No. 26129 
(September 29, 1988).
---------------------------------------------------------------------------

    A broker-dealer may have difficulty obtaining the necessary 
information about an issuer after the expiration of a trading 
suspension. This difficulty, however, does not relieve the broker-
dealer of its responsibilities under the Rule. If any broker-dealer 
is uncertain as to what is required by the Rule, it should refrain 
from entering quotations relating to the securities in question 
until the Rule's provisions have been met.

IV. Examples of Red Flags

    If the broker-dealer discovers at any stage of the review 
process any red flags in the issuer information (whether the issuer 
is a reporting or non-reporting company), it cannot publish a quote 
unless and until those red flags are reasonably addressed. Material 
inconsistencies in the paragraph (a) [reproposed paragraph (c)] 
information, or material inconsistencies between that information 
and the paragraph (b) [reproposed paragraph (d)] information, are 
red flags. We have set out below examples of red flags that we have 
noticed in microcap fraud cases or in Rule 15c2-11 submissions made 
to the NASD. These examples, however, are not comprehensive, as red 
flags depend on the facts and circumstances of each case.
    We are providing examples of red flags that require additional 
scrutiny by the broker-dealer to comply with Rule 15c2-11. These 
examples, however, are not exhaustive. Conversely, the presence of 
these or other red flags is not necessarily an indication of 
microcap fraud or even inaccurate issuer information. The red flag 
simply means that the broker-dealer should question whether the 
issuer information is accurate, and in certain cases, from a 
reliable source. The more red flags that are present, the more a 
broker-dealer should scrutinize the issuer information.
    1. Commission Trading Suspensions. As indicated above, 
Commission trading suspension orders generally raise significant red 
flags as to whether the Rule 15c2-11 information is accurate and 
whether its source is reliable. Broker-dealers publishing quotes 
once a trading suspension terminates must satisfy the Rule's 
requirements, which may include seeking verification from the issuer 
or soliciting the views of an independent professional.
    2. Foreign Trading Suspensions. A trading suspension by a 
foreign regulator may indicate that the issuer information is 
unreliable or inaccurate. However, a trading suspension in a foreign 
market may be imposed simply because the issuer failed to meet 
exchange listing standards. If the broker-dealer learns of a foreign 
trading suspension, it should attempt to determine the basis for the 
suspension order and assess whether the issuer information is still 
accurate and whether its source is still reliable.
    3. Concentration of ownership of the majority of outstanding, 
freely tradeable stock. Concentration of ownership of freely 
tradeable securities is a prominent feature of microcap fraud cases. 
When one person or group controls the flow of freely tradeable 
securities, this person or persons can have a much greater ability 
to manipulate the stock's price than when the securities are widely 
held. In a ``pump and dump'' scheme, retail interest is stimulated, 
and the price of the securities is manipulated upward, at the behest 
or under the control of the manipulators who control much of the 
stock. Often, other broker-dealers that are not intentionally 
participating in improper activities publish quotations in response 
to escalating demand for the security resulting from increasing 
retail sales. The promoters of these companies, company insiders, 
and unscrupulous brokers make substantial profits when they sell 
their shares at inflated prices. When the scheme is over, the 
security's price plummets, and innocent investors who paid a premium 
price are left holding worthless shares.\39\
---------------------------------------------------------------------------

    \39\ See New Allied Development Corporation, Securities Exchange 
Act Release No. 37990 (November 26, 1996)(New Allied's control 
persons had substantial stock interest in nominee accounts); 
Douglass and Co., Inc., 46 S.E.C. 1189 (1978); Gotham Securities 
Corporation, 46 S.E.C. 723 (1976). Paragraph (c)(6)(x) of the 
reproposed Rule will require disclosure of the beneficial ownership 
of the issuer's stock by its executive officers, directors, general 
partners, promoters, or control persons.
---------------------------------------------------------------------------

    4. Large reverse stock splits. Microcap fraud schemes can 
involve the substantial concentration of the publicly-traded float 
through a reverse stock split. The subsequent issuance of large 
amounts of stock to insiders increases their control over both the 
issuer and trading of the stock.\40\
---------------------------------------------------------------------------

    \40\ Emshwiller, ``Reverse Stock Splits At Many Firms Spark 
Outcry.'' The Wall Street Journal, November 20, 1998, at Cl; SEC v. 
Magna Technologies, Inc., Litigation Release No. 12227 (August 21, 
1989) (insiders of Magna effected a 4-for-1 reverse stock split, 
concentrated ownership in themselves, and then manipulated the price 
of Magna's stock by disseminating false and misleading information).
---------------------------------------------------------------------------

    5. Companies in which assets are large and revenue is minimal 
without any explanation. A red flag exists when the issuer assigns a 
high value on its financial statements to

[[Page 11150]]

certain assets that are often unrelated to the company's business 
and were recently acquired in a non-cash transaction. In this 
situation, the company's revenues often are minimal and there 
appears to be no valid explanation for such large assets and minimal 
revenues.\41\
---------------------------------------------------------------------------

    \41\ New Allied Development Corporation, Securities Exchange Act 
Release No. 37990 (November 26, 1996).
---------------------------------------------------------------------------

    Also, a red flag is present when the financial statements of a 
development stage issuer list as the principal component of the 
issuer's net worth an asset wholly unrelated to the issuer's line of 
business. For example, from a review of Rule 15c2-11 submissions, 
art collections or other collectibles that are unrelated to the 
issuer's business apparently have been overvalued on the financial 
statements of some issuers.\42\ While assets that are unrelated to 
the business of the issuer are not always an indication of potential 
microcap fraud, some unscrupulous issuers have overvalued these 
types of assets in an effort to inflate their balance sheets.
---------------------------------------------------------------------------

    \42\ See In the Matter of Rom N. De Guzman, Securities Exchange 
Act Release No. 37747 (September 30, 1996).
---------------------------------------------------------------------------

    6. Shell corporation's acquisition of private company. A shell 
corporation is characterized by no business operations and little or 
no assets. In a fraud scheme, a reporting company with a large 
number of shares controlled by one person or a small number of 
persons often merges with a non-reporting company having some 
business operations. The new public company is then used as the 
vehicle for ``pump and dump'' and other fraudulent schemes. Broker-
dealers placing quotes for these issuers' securities should be 
mindful of the potential for abuse.\43\
---------------------------------------------------------------------------

    \43\ See New Allied Development Corporation, Securities Exchange 
Act Release No. 37990 (November 26, 1996); Stylex Homes, Inc., 
Securities Exchange Act Release No. 36299 (September 29, 1995); 
Bunker Securities, Inc., 48 S.E.C. 859 (1987), aff'd without 
opinion, 833 F. 2d 303 (3d Cir. 1987); Butcher & Singer, Inc., 48 
S.E.C,. 640, aff'd without opinion, 833 F. 2d 303 (ed Cir. 1987); 
Douglass and Co., Inc., 46 S.E.C. 1189 (1978); A.J. Carno Co., 1976 
SEC LEXIS 2764 (February 23, 1976) (initial decision), order 
dismissing proceeding and withdrawing broker-dealer registration, 
Securities Exchange Act Release No. 14647 (April 10, 1978); Gotham 
Securities Corporation, 46 S.E.C. 723 (1976).
---------------------------------------------------------------------------

    7. Offerings under Rule 504 of Regulation D where one or more of 
the following factors are present:
     Little capital is raised in the Rule 504 offering and 
there appears to be no business purpose except to provide some 
shareholders with free-trading shares;
     The Rule 504 offering is preceded by an unregistered 
offering to insiders or others for services rendered at prices well 
below the price in the subsequent offering;
     Sales immediately following the Rule 504 offering are 
at substantially higher prices than those paid in the Rule 504 
offering; or
     A shell company and an operating company merge, which 
results in the operating entity becoming the surviving entity. The 
surviving entity goes ``public'' by issuing shares pursuant to Rule 
504.\44\
---------------------------------------------------------------------------

    \44\ See example 6, above.
---------------------------------------------------------------------------

    Rule 504 of Regulation D allows non-reporting companies to raise 
up to $1 million per year in ``seed capital'' without complying with 
Securities Act registration requirements. The freely tradable nature 
of securities issued in Rule 504 offerings has facilitated a number 
of fraudulent schemes through the OTC Bulletin Board Display Service 
(OTC Bulletin Board) or the Pink Sheets published by the National 
Quotation Bureau, Inc. (NQB).\45\ Broker-dealers should be alert to 
information in the Rule 15c2-11 materials where an active trading 
market is being promoted for securities issued solely in a Rule 504 
transaction.
---------------------------------------------------------------------------

    \45\ See Securities Act Release No. 33-7644 (February 19, 1999) 
in which we adopted amendments to Rule 504 of Regulation D that 
limit the circumstances where general solicitation is permitted and 
``freely tradeable'' securities may be issued in reliance on Rule 
504 to transactions (1) registered under state law requiring public 
filing and delivery of a disclosure document to investors before 
sale, or (2) exempted under state law permitting general 
solicitation and general advertising so long as sales are made only 
to ``accredited investors.''
---------------------------------------------------------------------------

    8. A registered or unregistered offering raises proceeds that 
are used to repay a bridge loan made or arranged by the underwriter 
where:
     The bridge loan was made at a high interest rate for a 
short period;
     The underwriter received securities at below-market 
rates prior to the offering; and
     The issuer has no apparent business purpose for the 
bridge loan.
    Broker-dealers have given small issuers bridge loans at a high 
interest rate for a short time period.\46\ In exchange for this 
bridge loan, the broker-dealer receives a significant number of 
shares of the issuer's common stock at a price that is substantially 
below market rates. The broker-dealer then engages in a scheme to 
manipulate the stock's price and ultimately benefits when it dumps 
the stock at an artificially high price.\47\
---------------------------------------------------------------------------

    \46\ Emshwiller, ``NASD Quietly Takes Aim at IPO Bridge-Loan 
Trend,'' The Wall Street Journal, January 20, 1998, at Cl.
    \47\ See Memory Metals, Inc., Securities Act Release No. 6820 
(February 22, 1989).
---------------------------------------------------------------------------

    9. Significant write-up of assets upon a company obtaining a 
patent or trademark for a product. The significant write-up of 
assets upon the issuer's obtaining a patent or trademark for a 
product is a technique used by issuers engaged in microcap fraud to 
inflate their balance sheets.\48\
---------------------------------------------------------------------------

    \48\ New Allied Development corporation, Securities Exchange Act 
Release No. 37990 (November 26, 1996); see also Frederick R. Grant, 
Securities Exchange Release No. 38239 (February 5, 1997); Atlantis 
Group, Inc., securities Exchange Act Release No. 37932 (November 8, 
1996); Eli Buchalter, Securities Exchange Act Release No. 37702 
(September 19, 1996); Milton Mermelstein, Securities Exchange Act 
Release No. 37222 (May 16, 1996).
---------------------------------------------------------------------------

    10. Significant asset consists of OTC Bulletin Board or Pink 
Sheet companies. We have noticed that some microcap fraud schemes 
involve issuers whose major assets are substantial amounts of shares 
in other OTC Bulletin Board or Pink Sheet companies.
    11. Assets acquired for shares of stock when the stock has no 
market value. In microcap fraud cases, the issuer's financial 
statements often indicate that the issuer acquired assets to which 
it assigned substantial value in exchange for its essentially 
worthless stock.\49\
---------------------------------------------------------------------------

    \49\ See New Allied Development Corporation, Securities Exchange 
Act Release No. 37990 (November 26, 1996) (the respondents obtained 
new Allied, a public shell, which was a dormant uranium mining 
company with no assets, in a transaction which resulted in insiders 
controlling 52.4% of New Allied's stock; New Allied then acquired an 
interest in real estate associated with worthless gambling concerns 
in exchange for New Allied stock); Douglass and Co., Inc., 46 S.E.C. 
1189 (1978).
---------------------------------------------------------------------------

    12. Significant write-up of assets in a business combination of 
entities under common control. 
    Those persons engaged in microcap fraud often use a business 
combination such as a merger as an opportunity to falsify financial 
statements.\50\ We have seen microcap fraud schemes in which 
unscrupulous issuers use purchase method accounting \51\ to write up 
the historical value of an asset to an artificially high value in 
situations when the entities involved in the business combination 
are under common control or otherwise have a high degree of common 
ownership. For example, Generally Accepted Accounting Principles 
(GAAP) requires that the acquisition of one entity by another entity 
be accounted for at historical cost in a manner similar to that in 
``pooling of interests'' accounting when these entities are under 
common control.\52\
---------------------------------------------------------------------------

    \50\ See New Allied Development corporation, Securities Exchange 
Act Release No. 37990 (November 26, 1996) (the respondents 
disseminated materially false documents to market makers, including 
unaudit financial statements, that valued new Allied's medical and 
consumer products at $2,150,000 although their historical costs were 
approximately $17,000); A.J. Carno Co., 1976 SEC LEXIS 2764 
(February 23, 1976) (Initial Decision), order dismissing proceeding 
and withdrawing broker-dealer registration, Securities Exchange Act 
Release No. 14647 (April 10, 1978) (Management Dynamics, Inc.'s (MD) 
founding officer and director wrote MD shareholders to recommend the 
acquisition of the assets of a real estate developer. Press releases 
and shareholder letters reinforced the misleading impression that 
the transaction was certain to generate substantial income for MD).
    \51\ When two companies merge, compliance with Generally 
Accepted Accounting Principles requires that the combination be 
accounted for as either the ``pooling method'' or ``purchase 
method.'' With the pooing method, the historical costs of the two 
companies are added together. With purchase method accounting, the 
company being acquired writes up its assets to fair market value, 
which generally are greater than the historical costs.
    \52\  Ronald Effren, Securities Act Release No. 7256, Securities 
Exchange Act Release No. 36713 (January 16, 1996); see also Martin 
Halpern, Securities Exchange Act Release No. 34727 (September 27, 
1994).
---------------------------------------------------------------------------

    13. Unusual auditing issues.
     Auditors refuse to certify financial statements or they 
issue a qualified opinion; or
     There has been a change of accountants.\53\
---------------------------------------------------------------------------

    \53\  See Securities Exchange Act Form 8-K, Item 4; Merle S. 
Finkel, Securities Act Release No. 7401 (March 12, 1997) (original 
auditors notified systems of Excellence that purported registration 
statement on Form S-8 had not been filed and that other 
irregularities exist in connection with issuance of this stock; 
thereafter, Systems of Excellence retained new auditor who issued 
materially false or inaccurate audit reports.

---------------------------------------------------------------------------

[[Page 11151]]

    Rule 15c2-11 does not contemplate that the broker-dealer 
scrutinize the issuer's financial statements with the expertise of 
an accountant. The above red flags, however, do not require an 
expertise in accounting matters and have appeared in several 
microcap fraud schemes. In one case, the respondents stated in the 
Form 211 submissions to the NASD that they relied on audited 
financial statements. However, the auditors orally advised the 
associated persons of the broker-dealer before they submitted the 
Form 211 that the auditor's opinion attached to the pro forma 
financial statement was qualified because of the auditor's inability 
to verify the issuer's financial information.\54\
---------------------------------------------------------------------------

    \54\ See Robin Rushing and Harold Gallison, Jr., Securities 
Exchange Act Release No. 36910 (February 29, 1996). In this case, 
the SEC also had entered a trading suspension for lack of accurate 
financial information.
---------------------------------------------------------------------------

    An accountant's resignation or dismissal is a characteristic 
found in some microcap fraud cases. If a broker-dealer sees any of 
these red flags, it should confirm the auditor's credentials with 
the appropriate state licensing authority, question the 
circumstances of the change in accountants, and carefully scrutinize 
the Rule's required information.
    14. Extraordinary items in notes to the financial statements, 
e.g., unusual related party transactions. Unusual related party 
transactions are sometimes found in microcap fraud schemes. For 
example, an issuer's financial statements may show a related party 
transaction between two companies, which later merge and inflate the 
worth of their assets by using purchase method accounting.\55\
---------------------------------------------------------------------------

    \55\ See Ronald Effren, Securities Exchange Act Release No. 
36713 (January 16, 1996).
---------------------------------------------------------------------------

    15. Suspicious documents.
     Inconsistent financial statements;
     Altered financial statements; or
     Altered certificates of incorporation.
    Altered or facially inconsistent issuer documents have been 
present in various microcap fraud schemes. For example, Polaris 
Mining Co. was a shell corporation with no meaningful assets and no 
trading market for its stock.\56\ Douglass and Co., Inc., a broker-
dealer, published quotations for Polaris in the Pink Sheets in 
violation of Rule 15c2-11 because the Polaris financial information 
upon which Douglass and Co., Inc. relied was deficient and 
contradictory on its face: two balance sheets for the same years 
contained blatant disparities. Both balance sheets valued certain 
mined but unprocessed ores at the estimated eventual selling price 
even though significant processing work remained to be done. One 
statement did not list property location. One statement had an item 
for capitalized expenses and the other statement for the same year 
did not. The former statement showed no retained earnings or 
accumulated deficit, suggesting that the figure for capitalized 
expenses was an arbitrary one designed to make assets and 
liabilities balance out.\57\
---------------------------------------------------------------------------

    \56\ Douglass and Co., Inc., 46 S.E.C. 1189 (1978).
    \57\ See also Butcher & Singer, Inc., 48 S.E.C. 640, aff'd 
without opinion, 833 F.2d 303 (3d Cir. 1987) (a salesman and later 
an officer of Butcher & Singer apparently obtained some blank stock 
certificates and forged former officers' signatures as well as the 
certificates' amounts and purported dates of issuance to himself and 
his family members; the broker-dealer, Butcher & Singer, failed to 
review the Rule's required information; Butcher & Singer might have 
noticed red flags that would have led to the discovery of the 
underlying fraud if it had reviewed the Rule's required 
information).
---------------------------------------------------------------------------

    In addition, issuer information that is altered on its face 
raises red flags that, at a minimum, require the broker-dealer to 
contact the issuer.\58\
---------------------------------------------------------------------------

    \5\ See United States v. Marshall Zolp, Litigation Release Nos. 
11494 (July 23, 1987) and 11236 (October 2, 1986)(fictitious 
certificates of incorporation and fictitious financial statements on 
which the name of another company had been whited out and the name 
of Laser Arms filled in).
---------------------------------------------------------------------------

    16. Broker-dealer receives substantially similar offering 
documents from different issuers with the following characteristics:
     The same attorney is involved;
     The same officers and directors are listed; and/or
     The same shareholders are listed.
    It is not uncommon for the same individuals to be involved in 
multiple microcap frauds. If a broker-dealer realizes after 
reviewing the information for several issuers that the same 
individuals are involved with these entities, the broker-dealer 
should make further inquiries to determine whether it has a 
reasonable basis to believe that the issuer information is accurate.
    17. Extraordinary gains in year-to-year operations. In microcap 
fraud cases, the issuer may show extraordinary gains in its year-to-
year operations. This may be accomplished through assigning an 
artificially high value to certain assets or through other 
manipulative devices that are red flags, such as the significant 
write-up of assets upon merger or acquisition.\59\
---------------------------------------------------------------------------

    \59\ See, e.g., A. J. Carno Co., 1976 SEC LEXIS 2764 (February 
23, 1976)(Initial Decision), order dismissing proceedings and 
withdrawing broker-dealer registration, Securities Exchange Act 
Release No. 14647 (April 10, 1978).
---------------------------------------------------------------------------

    18. Reporting company fails to file an annual report. The fact 
that a reporting company has not filed an annual report suggests 
that there is a potential problem with the company.\60\
---------------------------------------------------------------------------

    \60\ See Combined Companies International Corp., Securities 
Exchange Act Release No. 38653 (May 19, 1997); Robin Rushing and 
Harold Gallison, Jr., Securities Exchange Act Release No. 36910 
(February 29, 1996).
---------------------------------------------------------------------------

    19. Disciplinary actions against an issuer's officers, 
directors, general partners, promoters, or control persons.
    The following types of disciplinary actions should trigger 
further investigation by a broker-dealer:
     Indictment or conviction in a criminal proceeding; \61\
---------------------------------------------------------------------------

    \61\ Stylex Homes, Inc., Securities Exchange Act Release No. 
36299 (September 29, 1995).
---------------------------------------------------------------------------

     Order permanently or temporarily enjoining, barring, 
suspending or otherwise limiting an officer, director, general 
partner, promoter, or control person's involvement in any type of 
business, securities, commodities, or banking activities;
     Adjudication by civil court of competent jurisdiction, 
the Commission, the Commodity Futures Trading Commission or a state 
securities regulator to have violated federal or state securities or 
commodities law; or
     Order by a self-regulatory organization permanently or 
temporarily barring, suspending or otherwise limiting involvement in 
any type of business or securities activities.\62\
---------------------------------------------------------------------------

    \62\ The reproposed text of Rule 15c2-11(c)(6)(xi)(A)(2) 
requires the broker-dealer to review these factors for non-reporting 
issuers. Otherwise, under the reproposed text of Rule 15c2-
11(c)(6)(xi)(B) or (C), the broker-dealer must obtain a statement 
from the issuer that none of these events has occurred or must 
record the steps taken to obtain this information and that the 
issuer refused or failed to provide it. Even though the current Rule 
does not require the broker-dealer to obtain and review this 
information, we consider such information to be red flags under the 
Rule if it comes to the broker-dealer's attention.
---------------------------------------------------------------------------

    Many microcap fraud cases involve recidivist securities law 
violators.\63\ If a broker-dealer has information or could 
reasonably discover information about the above types of violations, 
it should question whether it has a reasonable basis to believe that 
the issuer's information is accurate and complete in these 
circumstances.
---------------------------------------------------------------------------

    \63\ See SEC v. I-Net Providers, Litigation Release No. 15219 
(January 17, 1997); New Allied Development Corporation, Securities 
Exchange Act Release No. 37990 (November 26, 1996).
---------------------------------------------------------------------------

    20. Significant events involving an issuer or its predecessor, 
or any of its majority owned subsidiaries.
    The following types of significant events should prompt further 
investigation by a broker-dealer:
     Change in control of the issuer; \64\
---------------------------------------------------------------------------

    \64\ See Exchange Act Form 8-K, Item 1.
---------------------------------------------------------------------------

     Substantial increase in equity securities;
     Merger, acquisition, or business combination;
     Acquisition or disposition of significant assets; \65\
---------------------------------------------------------------------------

    \65\ See Exchange Act Form 8-K, Item 2.
---------------------------------------------------------------------------

    Bankruptcy proceedings; \66\ or
---------------------------------------------------------------------------

    \66\ See Exchange Act Form 8-K, Item 3.
---------------------------------------------------------------------------

    Delisting from any securities exchange or the Nasdaq Stock 
Market.\67\
---------------------------------------------------------------------------

    \67\ The proposed text of Rule 15c2-11(c)(6)(xii)(A) requires 
the broker-dealer to review these factors. Otherwise, under the 
proposed text of Rule 15c2-11(c)(6)(xii)(B) or (C), the broker-
dealer must obtain a statement from the issuer that none of these 
events has occurred or must record the steps taken to obtain this 
information and that the issuer refused or failed to provide it. 
Even though the current Rule does not require the broker-dealer to 
obtain and review this information, we consider such information to 
be red flags under the Rule if it comes to the broker-dealer's 
attention.
---------------------------------------------------------------------------

    While not necessarily problematic, these are material events 
involving the issuer. The change in control of the issuer, merger, 
acquisition, or business combination, acquisition or disposition of 
significant assets can provide unscrupulous issuers an opportunity 
to artificially overvalue the issuer's assets to support an upward 
manipulation of the issuer's worthless

[[Page 11152]]

stock.\68\ An increase in the issuer's equity securities provides 
the securities necessary for such manipulation. Bankruptcy 
proceedings or a delisting from an exchange or the Nasdaq Stock 
Market may also indicate problems with an issuer that could lead the 
broker-dealer to conclude that it does not have a reasonable basis 
to believe that the issuer's financial information is accurate.\69\
---------------------------------------------------------------------------

    \68\ See New Allied Development Corporation, Securities Exchange 
Act Release No. 37990 (November 26, 1996); A. J. Carno Co., 1976 SEC 
LEXIS 2764 (February 23, 1976)(Initial Decision), order dismissing 
proceedings and withdrawing broker-dealer registration, Securities 
Exchange Act Release No. 14647 (April 10, 1978); see also Bion 
Environmental Technologies, Inc., Securities Exchange Act Release 
No. 36111 (August 16, 1995).
    \69\ See B.J. Thomas, Securities Exchange Act Release No. 38727 
(June 10, 1997); SEC v. Magna Technologies, Inc., Litigation Release 
No. 12227 (August 21, 1989); see e.g., Milton Mermelstein, 
Securities Exchange Act Release No. 37222 (May 16, 1996).
---------------------------------------------------------------------------

    21. Request to publish both bid and ask quotes on behalf of a 
customer for the same stock. The highly unusual request from a 
customer for the broker-dealer to publish both bid and ask quotes is 
a red flag ``that calls for appropriate inquiry on [the broker-
dealer's] part.'' \70\
---------------------------------------------------------------------------

    \70\ Alessandrini & Co., Inc., 45 S.E.C. 399 (1971), citing D.H. 
Blair & Co., 44 S.E.C. 320 (1970).
---------------------------------------------------------------------------

    22. Issuer or promoter offers to pay a ``due diligence'' fee. If 
a market maker receives an offer from an issuer to pay a ``due 
diligence'' fee in connection with making a market in the issuer's 
security, this is not solely a red flag.\71\ It is a violation of 
NASD Rule 2460 for the broker-dealer to accept this offer.\72\ If 
the broker-dealer receives any consideration in connection with 
publishing a quotation, the reproposed Rule requires the broker-
dealer to disclose any such compensation, as well as any other 
significant relationship information between the issuer and the 
broker-dealer publishing the quotation or any of its associated 
persons.\73\ In Douglass and Co., Inc., a registered representative 
said he would try to get the broker-dealer to initiate a market in 
the stock of Polaris Mining Co., but that it would cost the issuer 
about $1,500 to cover ``expenses.'' The registered representative 
later agreed to accept Polaris stock (some of which he kept himself) 
instead of the $1,500.\74\
---------------------------------------------------------------------------

    \71\ Butcher & Singer, Inc., 48 SEC 640, aff'd without opinion, 
833 F.2d 303 (3d Cir. 1987)(a salesman received 400,000 shares of an 
obscure penny stock for helping to develop and maintain a market in 
the stock); see Brent Duane Green, Securities Exchange Act Release 
No. 39210 (October 7, 1997); Steven Ira Wertman, Securities Exchange 
Act Release No. 38751 (June 20, 1997); Christopher D. Jennings, 
Securities Exchange Act Release No. 38696 (May 30, 1997).
    \72\ NASD Rule 2460, Payments for Market Making, prohibits any 
payment by an issuer or the issuer's affiliates and promoters, 
directly or indirectly, to a member for publishing a quotation, 
acting as a market maker, or submitting an application.
    \73\ See reproposed Rule 15c2-11(e); see also current Rule 15c2-
11(a)(5)(xvi).
    \74\ Douglass and Co., Inc., 46 S.E.C. 1189 (1978); see also See 
Robin Rushing and Harold Gallison, Jr., Securities Exchange Act 
Release No. 36910 (February 29, 1996); General Bond & Share Co., 51 
S.E.C. 411 (1993)(Commission opinion), rev'd on other grounds, 
General Bond & Share Co. v. SEC, 39 F.3d 1451 (10th Cir. 1994).
---------------------------------------------------------------------------

    23. Regulation S transactions of domestic issuers. Regulation S 
\75\ provides a safe harbor from the registration requirements of 
the Securities Act of 1933 for offers and sales of securities by 
both foreign and domestic issuers that are made outside the United 
States. We recently adopted amendments to Regulation S that are 
designed to prevent the abuses that relate to offshore offerings of 
equity securities of domestic issuers.\76\ Prior to the recent 
amendments, Regulation S transactions involving large amounts of the 
securities of U.S. issuers were particularly vulnerable to fraud and 
manipulation.\77\ The perpetrators of the fraud sold the securities 
to U.S. investors after the 40-day holding period expired, and 
little information was available to investors about the issuers.
---------------------------------------------------------------------------

    \75\ 17 CFR 230.901-230.905 and Preliminary Notes.
    \76\ Securities Act Release No. 7505 (February 17, 1998), 63 FR 
9632. We also adopted amendments that would affect applicable 
reporting requirements along with other amendments intended to 
prevent abuses of Regulation S. Since January 1, 1999, Regulation S 
transactions are required to be reported quarterly on Forms 10-Q and 
10-K.
    \77\ See Frederick R. Grant, Securities Exchange Release No. 
38239 (February 5, 1997); S.E.C. v. Enviromint Holdings, Inc., 
Litigation Release No. 14683 (October 6, 1995).
---------------------------------------------------------------------------

    Under the amendments, equity securities of U.S. issuers that are 
sold offshore under Regulation S are classified as ``restricted 
securities'' within the meaning of Rule 144 under the Securities 
Act, and the period during which these securities cannot be 
distributed in the United States is lengthened from 40 days to one 
year. These amendments make Regulation S abuses less likely, but 
broker-dealers should be alert to any questionable activities once 
the one-year holding period expires.
    24. Form S-8 stock. Form S-8 is the short-form registration 
statement for offers and sales of a company's securities to its 
employees, including consultants and advisors.\78\ The form has been 
abused by unscrupulous issuers to register on Form S-8 securities 
nominally offered and sold to employees or, more commonly, to so-
called consultants and advisors. These persons then resell the 
securities in the public markets, at the direction of the issuer or 
a promoter.\79\ In a typical pattern, an issuer registers on Form S-
8 securities underlying options issued to so-called consultants 
where, by prearrangement, the issuer directs the consultants' 
exercise of the options and resale of the underlying securities in 
the public market. The consultants then either remit to the issuer 
the proceeds from the sale of the underlying shares, or apply the 
proceeds to pay debts of the issuer that are not related to any 
services provided by the consultants.\80\ In some cases, these 
consultants perform little or no other service for the issuer. In 
other microcap frauds, the issuer uses Form S-8 to sell securities 
to ``employees'' who act as conduits by selling the securities to 
the public and remitting the proceeds (or their economic benefit) to 
the issuer.\81\ This public sale of securities by the issuer has not 
been registered, although the Securities Act requires registration. 
The failure to register this sale of securities deprives public 
investors of the protections afforded by the Securities Act.
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    \78\ Form S-8 under the Securities Act of 1933 (15 U.S.C. 77a et 
seq.).
    \79\ See S.E.C. v. Enviromint Holdings, Inc., Litigation Release 
No. 14683 (October 6, 1995).
    \80\ See, e.g., Spectrum Information Technologies, Inc., 
Securities Act Release No. 7426 (June 25, 1997); SEC v. Hollywood 
Trenz, Inc., Litigation Release No. 15730.
    \81\ See S.E.C. v. Charles O. Huttoe, Litigation Release Nos. 
15153 (November 7, 1996); 15185 (December 12, 1996)(unregistered 
public offering purporting to use Form S-8).
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    To prevent these abuses, Form S-8 and related rules impose 
certain restrictions on the use of the form for the sale of 
securities to certain consultants and advisors.\82\ We are also 
proposing additional amendments to Form S-8.\83\ Although these 
amendments should deter microcap abuses, broker-dealers nevertheless 
should be aware of the prior abuses of Form S-8 in microcap fraud 
cases.
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    \82\ Securities Act Release No. 33-7646 (February 19, 1999).
    \83\ Securities Act Release No. 33-7647 (February 19, 1999).
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    25. ``Hot industry'' microcap stocks. Another characteristic of 
microcap fraud cases is that they often involve stocks that are in 
vogue.\84\ In the past, oil and gas ventures and mining operations, 
as well as stocks of issuers with purportedly innovative products, 
have been popular in frauds involving low-priced stocks.
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    \84\ See Douglass and Co., Inc., 46 S.E.C. 1189 (1978) (November 
26, 1996)(mining operation); see also S.E.C. v. Bradley J. Simmons 
and American Energy Group, Ltd, Litigation Release No. 15353 (April 
29, 1997)(oil and gas company).
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    26. Unusual activity in brokerage accounts of issuer affiliates, 
especially involving ``related'' shareholders. Many microcap frauds 
begin with the deposit and sale of large blocks of an obscure stock 
by a new and unfamiliar customer who often is affiliated with an 
issuer.\85\ At the same time, the broker-dealer is encouraged to 
make a market in the stock by the issuer.
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    \85\ Laser Arms Report, 50 S.E.C. 489, 503; see also Butcher & 
Singer, Inc., 48 S.E.C. 640, aff'd without opinion, 833 F.2d 303 (3d 
Cir. 1987); Gotham Securities Corporation, 46 S.E.C. 723 (1976) (the 
family of the broker-dealer's principal owned a significant amount 
of the stock of Marcon Electronics Corp., which was a shell 
corporation with no assets; the family benefited when the broker-
dealer manipulated upward the price of the Marcon stock).
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    27. Companies that frequently change names. Frequent name 
changes are another characteristic that we have seen in microcap 
fraud cases. For example, Twenty First Century Health (TFCH) was 
originally a company called Big Valley Energy, Inc. Big Valley then 
changed its name to Biotronic Energy Engineering, Inc., then to The 
Sonoron Group, then to Zorro International, Inc., then to Health & 
Wealth, Inc., and finally became TFCH in 1995. At the promoter's 
request, TFCH issued false audited financial statements that 
recorded material, nonexistent assets.\86\
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    \86\ Merle S. Finkel, Securities Act Release No. 7401 (March 12, 
1997).
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    28. Companies that frequently change their line of business. 
Besides companies that frequently change their names, we also see

[[Page 11153]]

companies that frequently change their line of business in microcap 
fraud cases. For example, New Allied Development started out as a 
uranium mining company that was a dormant public shell with no 
assets.\87\ New Allied then acquired the rights to medical products 
in exchange for its overvalued stock. Next, New Allied became a 
vehicle to enter the gaming business purportedly to build a casino.
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    \87\ New Allied Development Corporation, Securities Exchange Act 
Release No. 37990 (November 26, 1996).

[FR Doc. 99-5299 Filed 3-5-99; 8:45 am]
BILLING CODE 8010-01-P