FLASHBACK FRIDAY: OTC Trading Now and Then


Stock fraud. Stock manipulation.

It’s always on the minds of regulators – especially the Securities and Exchange Commission – whether it occurs or can occur today, last year or tomorrow. While regulators like the SEC  have stepped up their surveillance of the markets and investor education efforts to prevent fraud, it can still happen. But with the help of the exchanges or in this case OTC Markets, who has continued to beef up its standards to keep stocks that trade on its three marketplaces safe for investors and minimize fraud.

In this Flashback Friday story, Cromwell Coulson, chairman of the National Quotation Bureau, owner and operator of the manually-traded pink sheets, which has now morphed into OTC Markets, looks back to 1998 and what he has done to make trading in small cap OTC Markets’ stocks safe.

Cromwell Coulson, OTC Markets

Coulson, in a recent conversation with Traders Magazine, said that the 1998 and 1999 Rule 15c2-11 proposal should acknowledge the SEC’s road back then was paved by good intentions, while also taking note of the overwhelming public backlash against the proposals. In 1991, and subsequently in 1998 and 1999, the SEC proposed comprehensive amendments to Rule 15c2-11 – including eliminating the piggyback exemption – to address concerns about fraud and manipulation in the OTC market. The 1991 proposals to do away with the piggyback exemption, and the 1998 proposed amendments and 1999 re-proposal, relied on microcap fraud prevention as a justification for eliminating the piggyback exemption.

“It is a well-known principle of market structure that increasing the number of market makers is a positive force,” said Coulson. “The piggyback exemption makes it easier for regulated brokers to quote and make a market in a publicly tradable security. An efficient public trading market provides the best estimate of a security’s value based upon publicly available information. Removing the piggyback exemption would diminish price competition and severely harm capital formation by increasing the costs and risks of market making. This would reduce the number of market makers and lower the quality of firms providing market making services.”

The SEC stated in the original proposal 30 years ago, “Without information, it is difficult for investors, securities professionals, and others to evaluate the risks presented by microcap securities.” OTC Markets Group agrees with that view and has successfully harnessed market forces to encourage issuers to provide current disclosure.

“We recognize the damage created by fraud and manipulative promotion and have used transparency to improve investor information and mitigate promotion risk to create better informed and more efficient markets,” Coulson said.  “Our efforts have been highly successful in solving the problem of actively traded issuers for which public information is limited.  Today, almost all trading volume takes place in securities with current information publicly available, and most of that dollar volume is in companies that are fully SEC reporting or listed on a qualified foreign exchange.”

But what about other stocks where there is limited or no information? Coulson said that the small minority of Pink securities that have been identified as “Pink Limited Information” or “Pink No Information” represent a very small portion of the OTC marketplace, comprising just 1% of the total dollar volume traded on OTC Markets Group’s various markets over the past 2 years. Any actively traded “dark” securities (a small number) can be easily targeted and reviewed by regulators for thoughtful trading suspensions. These changes correlate to the goal expressed in the proposal to provide greater investor access to information about OTC securities.

“Today, investors benefit from an increased amount of market data and financial information on the internet, including the information made publicly available on the OTC Markets Group website. To facilitate public markets in small-cap companies, the ultimate responsibility for the accuracy of information provided should always lie with the issuer, rather than the broker-dealer,” Coulson said. “OTC Markets Group now organizes and operates 10,000 securities into three differentiated markets:  OTCQX Best Market, OTCQB Venture Market and Pink, based upon eligibility standards related to disclosure, governance, and financial standards. Our tiered market structure incentivizes public companies to provide higher quality disclosure, while highlighting those less transparent and riskier securities for which brokers can restrict access.”

He added that public availability of adequate current disclosure is a core principal of the OTCQX and OTCQB Rules for companies trading on his markets.

“Our stock promotion policy and best practices for public companies offer a framework of disclosure-based standards and guidance to our issuers for limiting risk of fraudulent promotion and ensuring adequate disclosures in company-sponsored investor relations materials,” Coulson continued. “Our OTCQX and OTCQB markets have been recognized by the SEC as established public markets for pricing securities offerings, and by twenty-eight (and counting!) state regulators based on the disclosure provided by companies with securities trading on those more transparent markets.”

And what if fraud is suspected? Coulson said that in the context of small company trading, OTC Markets Group is often the first to be contacted by investors or brokers that see signs of manipulative trading activity or fraudulent promotional campaigns and works with regulators.

“We often gather the information available, refer cases with the dots connected and help identify bad actors to the SEC and FINRA,” Coulson said. “However, only the SEC and FINRA have the authority to halt or suspend trading in an OTC security.”

Stock promotion schemes can quickly hijack the price of a security, and by the time a regulatory halt becomes effective weeks later, much of the damage has already been done though. Based on 2016 promotion data from the OTC.today website, only 9 (1.93%) out of the 466 promoted OTC securities were suspended by the SEC—often well after the promotional campaign was over and the price had corrected. The ability of a system like OTC Link ATS to quickly implement trading halts and suspensions would greatly reduce the profits reaped from fraudulent promotion and other manipulative trading activities, Coulson advocated.

So, more regulation may not be enough to stop fraud then?

Coulson said that public companies today suffer from compounded effects of regulatory barriers and burdens to stop fraudsters. Regulations, he continued, have created high costs and compliance complexities impacting startups and smaller companies using FINRA member broker-dealers to raise capital and facilitate secondary trading, contributing to a reduction in the number of public companies today. These costs and complexities could be mitigated by using modern technology to reduce the burdens and make being public less painful.

“We need to maximize public information availability to empower investors and market participants. In a dynamic world, regulators should look to existing market practices and the wealth of company information and market data already available online to create real-time risk mitigation tools,” Coulson said. “This will allow regulators to build faster, more relevant processes to approve securities for trading, ensure that investors have access to adequate current disclosure, and respond to fraud or manipulation. And perhaps, most importantly, this will provide immense benefits for smaller companies looking to access well-regulated secondary markets.”


The following article originally appeared in the January 1998 edition of Traders Magazine

The SEC Approves Overhaul For the OTC Marketplace: NASD Joins Clean-Up With Tighter Listing Standard

By Michael L. O’Reilly

The Securities and Exchange Commission has proposed a regulatory initiative to curb small-cap fraud and increase the responsibilities of broker dealers quoting small, thinly-traded over-the-counter stocks.

In a similar push, the National Association of Securities Dealers will publish, at the end of this month, a list of companies no longer meeting new standards to list on Nasdaq.

At press time, the SEC declined to comment on the outcome of the agency’s Feb. 10 meeting.

At issue was a proposed SEC requirement that all broker dealers research and make available information on companies they quote on the pink sheets and the OTC Bulletin Board. At the moment, only the broker dealer initially quoting the over-the-counter stock is required to review the issuer’s financial data. Updates are not required.

The SEC initiative is part of a larger agency drive to cut down on stock fraud. The pink sheets and the OTC Bulletin Board are generally perceived by regulators to harbor some questionably-listed companies.

Indeed, the OTC Bulletin Board, although owned by the NASD, is not held to the regulatory agency’s listing standards.

Still, the SEC rule change may encourage rather than discourage small-cap fraud, according to Cromwell Coulson, chairman of the National Quotation Bureau, owner and operator of the manually-traded pink sheets.

“This rule springs from good intentions, but it will have the wrong results,” Coulson said. “The new rules may put the information obligation on the broker dealer, who is not controlling the source of information. That information is the responsibility of the listing company.”

He added that if broker dealers back away from quoting small-cap stocks, the listings could move to a wholly unregulated marketplace, like the Internet. “That type of black-market trading could hurt investors terribly,” Coulson warned.

Separately, the National Quotation Bureau last month announced it would automate the trading of their more than 2,700 listings, pending regulatory approval. Coulson said the new system would provide a real-time bulletin board of market-maker quotations and an electronic-negotiation and order-routing platform for subscribers. He hopes to have the pink sheets fully automated by year’s end.

“We will be getting a lot more listings with these new Nasdaq requirements,” Coulson said.

On Feb. 23, the NASD is expected to make public a list of companies that do not meet the new Nasdaq listing requirements, with a view of pushing these listings to the pink sheets or the OTC Bulletin Board.

Approved by the SEC last August, the changes include a requirement that all Nasdaq and Nasdaq SmallCap common and preferred stock have a minimum bid price of $1. If a Nasdaq stock dips below $1 for 30 days, the stock has 90 days to return to the $1 mark, where it must close above $1 for ten consecutive days. Failing that, the stock will be delisted. The NASD said this measure is a safeguard against market activity associated with low-priced securities namely stock fraud.

Most Nasdaq stocks will also be required to have two market makers, 400 round-lot shareholders, 750,000 shares in the public float, a market value of at least $5 million and $4 million in net tangible assets.

Additionally, the new rules state that each Nasdaq SmallCap listing must have 300 round-lot shareholders, 500,00 shares in the public float, a market value of at least $1 million and either $2 million in net tangible assets, a $35 million market capitalization or at least $500,000 in net annual income.

Coulson expects more than 2,000 Nasdaq issues to delist to the pink sheets or OTC Bulletin Board this year under the new requirements.




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