Proposed new SEC rules for OTC securities, relevant for us?

[writser]

I came across this today: https://www.sec.gov/news/press-release/2019-189 . The SEC is proposing changes to rule 15c2-11 which would make it more difficult for brokers to offer quotes on OTC stocks without current financials or shell companies. At this point it's not completely clear how exactly the rules will change (and if they will change), so this is all a bit speculative but any thoughts on how this would affect CAOX, PDER, PDRX and other OTC forum favorites? I guess that for some companies it will act as a pressure to start filing but for other companies (like CAOX?) it might imply that liquidity will dry up even more (if that is possible ..).

 

Still some open questions. What exactly is "publicly available"?

 

Also, I'm not an expert on piggy-backing. Can somebody explain to me: if I enter an order for CAOX in my brokerage account, does that also fall under rule 15c2-11? I.e. can't IB / TDAM / Schwab publish my price if they are not allowed to piggyback anymore? Or does that rule only hold for prop orders and can they still publish customer flow? I'm afraid it's probably the former.

 

 

 

[Foreign Tuffett]

Bumping this, as it has the potential to be problematic for many of us COB&Fers.

 

 

 

[Foreign Tuffett]

 

 

http://www.nonamestocks.com/2019/10/sec-wants-to-stop-trading-in-dark-stocks.html

[benhacker]

 

Make your voice heard.

[Spekulatius]

 

Make your voice heard.

 

Done. On the other side, forced sales sounds interesting too. There could be real bargains to be had, if funds owning these buggers can’t hold them any more, because the value is unknown. A private investor would need to be willing to hold them for a decade.

 

< Corrected for grammar >

[mjohn707]

Done, and copy attached:

 

Dear SEC Staff,

 

I have read with the greatest excitement the SEC’s proposed changes to 17 CFR 240,15c2-11, and I urge the SEC to please approve these amendments as quickly as possible, as they will no doubt have a salutary effect for investors and their hard-won capital.  I additionally have great faith that the SEC, acting with their usual wisdom and foresight, has carefully weighed the potential positives and negatives of this proposal, and I imagine it will be almost a chore to retrod arguments and points that that were already more eloquently stated, subtly argued, and augustly disposed of within the agency.  And yet still as they say, out of the abundance of the heart the mouth speaketh, and I hope these quick thoughts might be of no great trouble, even if not of any great value.  Take them as you might as a recitation of simple facts by a child, with a pat on the head and the patience we owe to all those in our charge.

 

The SEC was established with a goal no doubt originally, and who can really recall exactly what it was, but it was likely something to the effect of protecting the capital markets against bad-faith actors, and allowing smaller investors, those without institutional access to trust and participate in the growth of the economy.  We are of course all born with burdens to overcome, and it is clear that the SEC recognizes that their own burden was a mission improperly or inadequately stated, or perhaps just due for a sort of evolution to fit our modern circumstances.  Either way, it is undoubtedly a fundamental truth that the most dangerous actor in the modern capital markets is no longer the penny-stock promoter or the speculative operator raising money from the unsophisticated, but is actually instead the investor themself, who has over a great deal of time repeatedly demonstrated that they are incapable of making prudent decisions with their own money.  A brief list of examples follows.

 

Funding Whitney Tilson’s hedge fund

Participating in Tesla capital raises

Investing in Enron shares

Investing with Sanda Biglari

Cheerfully paying 2 & 20 for investment advice

 

I could list page after page of additional examples.  Fundamentally the agency must understand that the goal of any new regulations must ultimately be to protect the investor from the greatest danger to capital formation in these benign markets, which is the investor's own poor decision making.  And since the SEC’s mission, the very reason for the agency’s existence, is to protect investor capital, it must follow logically that the agency must seek to restrict, to the greatest extent possible under law, the ability of investors to make their own decisions.  And fundamentally it must also follow that any rule that restricts an investor from making their own decisions must be deserved, reasonable, and inarguably correct.

 

The proposed changes to 17 CFR 240,15c2-11 would eliminate trading in a huge number of non-reporting OTC securities, making these securities almost impossible to trade.  Such a change would be tremendously helpful for investors, as it would eliminate at least one potential venue to continue to make poor investment decisions.  Some would even argue that it would be wise if the rule could potentially be expanded at a later date to include a greater range of securities, perhaps to some or even most of the securities that trade in the more liquid markets as well.  Any proposal or change to this effect, of potentially eliminating trading in a greater number or even all listed securities would no doubt be a tremendous outcome for greater investment protection, as it would come closer to achieving the agency’s true goal of protecting the investor from themself more completely.  And certainly the agency could at least study the potential effects and benefits a wider ban would have for the investing public, but we must understand that the work of good governance is not completed in a day, and patience and small steps must be the order of everything.

 

If for some reason these changes cannot be made, I would ask the SEC to implement some sort of rule, the nature of which is not particularly important, that will limit the options that investors have.  Anything that restricts the ability of investors to make their own poor decisions about their capital will only be to their eventual benefit.

 

Regards,

 

mjohn707

Twitter participant

 

[Foreign Tuffett]

writser

 

The below is from page 118 of the full proposed rule document.

 

The Commission proposes to define the term “publicly available” to mean available on EDGAR or on the website of a qualified IDQS, a registered national securities association, the issuer, or a registered broker-dealer. Further, publicly available shall not mean where access to proposed paragraph (b) information is restricted by user name, password, fees, or other constraints

 

My interpretation (not legal advice) is that companies like PDRX that post annual reports on their websites or otcmarkets.com would pass this test. However, the dark companies that only mail/email out their financials would not.

 

I think that in practice, many brokers will stop allowing retail customers to buy any and all dark companies if this rule goes through. Merrill already did this last year.

 

Spekulatius

 

Yeah, I think that since this rule will (I think?) turn many dark companies into Level 2 assets, even small funds/SMAs able to own illiquid stocks will have a tough time owning them.

 

mjohn707

 

Ha ha ha. Well put.

[benhacker]

Spek, I'd be curious which of us long term investors, with our own money, would be ok to lock up $$$ in private companies where we are minorities?

 

In principal, not different than how we *should* think about investing.  In practice, quite different IMO.

 

private businesses (even vs. truly illquid ones) should trade with a liquidity discount....

 

I have 1% of my assets in a liquidating co (non-traded completely) and 3% in firm(s) that could (maybe) become unquoted per the above rule.  I'm a very long term investor, but for my clients, it's hard to say "yeah, you can move your money, but XYZ Co, that shit is now private..." :)

 

Certainly, individuals can do what they please, but I think most of us would rightly hesitate giving up tradeability...

[Spekulatius]

Spek, I'd be curious which of us long term investors, with our own money, would be ok to lock up $$$ in private companies where we are minorities?

 

In principal, not different than how we *should* think about investing.  In practice, quite different IMO.

 

private businesses (even vs. truly illquid ones) should trade with a liquidity discount....

 

I have 1% of my assets in a liquidating co (non-traded completely) and 3% in firm(s) that could (maybe) become unquoted per the above rule.  I'm a very long term investor, but for my clients, it's hard to say "yeah, you can move your money, but XYZ Co, that shit is now private..." :)

 

Certainly, individuals can do what they please, but I think most of us would rightly hesitate giving up tradeability...

 

Yes, if you manage money for others and hold shares in noinfo stocks, you are between a rock and a hard place. As you stated, an individual investor can do as he pleases.

 

I don’t like this rule either,  that’s why I wrote a comment email to the SEC as well, but then again, if it causes forced sales, I am willing to take the other side and buy some shares at deep discounts to prevailing prices ( let’s say 30% below prevailing prices) and see what happens.

[LongHaul]

Feel free to call a WSJ reporter.  They are generally looking for stories and this might get their interest for a story.

Not sure which reporter would be a good fit but perhaps one that has covered similar regulation.

 

WSJ Newsroom: 212-416-2000 

[Foreign Tuffett]

I continue to be concerned about this. The good news is that at least one of the five current SEC Commissioners (Hester Pierce) seems aware of the issues this new rule might cause:

 

"Initial commentary in response to our proposal is admittedly not very supportive. Encapsulating early sentiment, one commentator wrote, “This is a terrible proposal, one that will destroy wealth and value for savvy investors who spend extensive time researching and gleaning information from OTC-traded companies, even if those companies do not report to the SEC.”[9] Admittedly, getting the balance right is difficult. As we finalize the rule, we need to make sure that it hinders fraudsters without killing the market for micro-cap stocks. I look forward to further commentary to assist us in properly designing the rule to achieve our objective of ensuring that retail investors can get the information they need to make decisions without imposing undue costs on broker-dealers, issuers, or investors."

 

https://www.sec.gov/news/speech/peirce-broken-windows-51st-annual-institute-securities-regulation

 

 

Interesting that the OTC Markets Group met with Pierce only 10 days after she gave the above speech.

 

https://www.sec.gov/comments/s7-14-19/s71419.htm

 

The bad news is that OTC Markets seems to think the below is a good idea:

 

"Securities in companies that do not provide current information under the Rule, or otherwise fail

to meet an exception, should be eligible for quoting on an “Expert Market”, where quote

distribution is limited to professional investors. By using commonly understood market data

licenses intended only for professional investors, retail investors would not have access to quote

information in these securities, giving effect to the Proposal’s call for increased retail investor

protection while not disadvantaging the more experienced, sophisticated investors that make up

the bulk of the Proposal’s comment file to date. Many broker-dealer compliance teams already

use our “No Information” designation and other data-driven methods to make suitability

decisions. This results in broker-dealers putting up “gates” that restrict retail investors’ access

to “No Information” and other high-risk securities. The Commission can build on these industry

best practices to modernize the Rule and provide for an “Expert” market where brokers to [sic]

execute orders for financially sophisticated and risk tolerant investors."

 

https://www.sec.gov/comments/s7-14-19/s71419-6471877-199389.pdf

[Spekulatius]

Yes, I believe it is correct to be concerned about this. Once the gears of bureaucracy start to move, it can be hard to stop them. I would also think that the OTC probably is biased as they would benefit even if just some compansies chose to disclose financials on their system, regardless of collateral damage to investors into those companies that don’t.

 

Then on the other hand, there might be unique bargains available to individual investors who are willing to play a long term game regardless of liquidity issues. Any fund that might own these stocks now may be forced to sell these stocks, if the rule indeed gets implemented.

[oddballstocks]

I hate to say it, but my gut is that the SEC just rolls with this proposed rule.

 

Reason being...

 

I had a long conversation with a former regulator a few years ago, he worked in the pink/otc area.  He said 90% was fraud and scammy companies (which we all know), and in the 10% there could be value.  His boss held the view that ALL pink sheet companies were junk, and if a company was respectable they should just uplist.  If they didn't uplist it just proved they were a scam.  He was on a mission to eliminate the pink sheet stocks, that was the source of most of their regulatory problems, in their view.

 

Fast forward, changes keep rolling forward.  It's hard to trade most of these as-is, and now the SEC wants to make it harder.  They will be successful.

 

The irony of this is while they make public companies with some information hard to trade they are encouraging people to invest in private companies in venture rounds.

 

In many ways it makes no sense to be public anymore.  What's the point?  You can raise capital easily as a private company, and being public brings no additional benefit.

[Jurgis]

The irony of this is while they make public companies with some information hard to trade they are encouraging people to invest in private companies in venture rounds.

 

In many ways it makes no sense to be public anymore.  What's the point?  You can raise capital easily as a private company, and being public brings no additional benefit.

 

This is partly true: yes, people can invest in private companies with way less info, way less liquidity, and way less business results (and quite often pre-business) compared to public companies or even pink sheet companies.

 

OTOH, even in this world of money sloshing around, it's not that "easy" to raise money as private company. Depends a lot on your business and your numbers. Although for companies that have the numbers to go public it's likely possible to raise and stay private.

[InspireByReason]

Has anyone heard any updates on this?

[capitalg]

I haven't fully digested, but the SEC adopted an amendment to Rule 15c2-11 yesterday:  https://www.sec.gov/news/press-release/2020-212

 

Full text of final rule:  https://www.sec.gov/rules/final/2020/33-10842.pdf

[writser]

Good Twitter thread:

. We shall see how this works out in practice.

[Haasje]

I hate to say it, but my gut is that the SEC just rolls with this proposed rule.

 

Reason being...

 

I had a long conversation with a former regulator a few years ago, he worked in the pink/otc area.  He said 90% was fraud and scammy companies (which we all know), and in the 10% there could be value.  His boss held the view that ALL pink sheet companies were junk, and if a company was respectable they should just uplist.  If they didn't uplist it just proved they were a scam.  He was on a mission to eliminate the pink sheet stocks, that was the source of most of their regulatory problems, in their view.

 

Fast forward, changes keep rolling forward.  It's hard to trade most of these as-is, and now the SEC wants to make it harder.  They will be successful.

 

The irony of this is while they make public companies with some information hard to trade they are encouraging people to invest in private companies in venture rounds.

 

In many ways it makes no sense to be public anymore.  What's the point?  You can raise capital easily as a private company, and being public brings no additional benefit.

 

I know its not your opinion but of that guy. But what about companies that were on the "real exchanges" but sort of failed. And become too small for that cost structure.