Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 to the Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Microcap Initiatives-Amendments to NASD Rules 6530 and 6540

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40606; File No. SR-NASD-98-51]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change and Amendment No. 1 to the Proposed Rule Change by the National

Association of Securities Dealers, Inc. Relating to Microcap

Initiatives-Amendments to NASD Rules 6530 and 6540

October 27, 1998.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act'' or ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice

is hereby given that on July 20, 1998, the National Association of

Securities Dealers, Inc. (``NASD'' or ``Association''), through its

wholly-owned subsidiary, the Nasdaq Stock Market, Inc. (``Nasdaq'')

filed with the Securities and Exchange Commission (``SEC'' or

``Commission'') the proposed rule change as described in Items I, II,

and III below, which Items have been prepared by the NASD. On October

7, 1998, the NASD filed with the Commission Amendment No. 1 to the

proposal.\3\ The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons.

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

\1\ 15 U.S.C. 78s(b)(1).

\2\ 17 CFR 240.19b-4.

\3\ Letter from Robert E. Aber, General Counsel, Nasdaq, to

Katherine A. England, Assistant Director, Division of Market

Regulation (``Division''), Commission, dated October 7, 1998

(``Amendment No. 1''). The substance of Amendment No. 1 is

incorporated into this notice.

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

I. Self-Regulatory Organization's Statement of the Terms of

Substance of the Proposed Rule Change

The Association is proposing amendments to NASD Rules 6530 and 6540

to limit quotations on the OTC Bulletin Board (``OTCBB'')

to the securities of issuers that are current in their reports filed

with the SEC or other regulatory authority, and to prohibit a member

from quoting a security on the OTCBB unless the issuer has made current

filings, respectively. Proposed new language is in italics; proposed

deletions are in [brackets].

* * * * *

6530. OTCBB Eligible Securities

A Member shall be permitted to quote the [The] following categories

of securities [shall be eligible for quotation] in the Service:

(a) any domestic equity security that satisfies the requirements of

paragraph (1) and either paragraph (2) or (3) or (4) below;

(1) the security is not listed on The Nasdaq Stock Market

(``Nasdaq'') or a registered national securities exchange in the U.S.,

except that an equity security [securities that are] shall be

considered eligible if it:

(A[1]) is listed on one or more regional stock exchanges, and

(B[2]) [do] does not qualify for disseminating of transactions

reports via the facilities of the Consolidated Tape [shall be

considered eligible.]; and

(2) the issuer of the security is required to file reports pursuant

to Section 13 or 15(d) of the Act or the security is described in

Section 12(g)(2)(B) of the Act, and, subject to a thirty calendar day

grace period, the issuer of the security is current in its reporting

obligations, or

(3) the security is described in Section 12(g)(2)(G) of the Act

and, subject to a sixty calendar day grace period, the issuer or the

security is current in its reporting obligations, or

(4) the issuer of the security is a bank or savings association

that is not required to file reports with the Commission pursuant to

Section 13 or 15(d) of the Act and, subject to a sixty calendar day

grace period, the issuer of the security is current with all required

filings with its appropriate Federal banking agency or State bank

supervisor (as defined in 12 U.S.C. 1813).

(b) any foreign equity security or American Depositary Receipt

(ADR) that meets all of the following criteria:

(1) [prior to April 1, 1998, is not listed on Nasdaq or a

registered national securities exchange in the U.S., except that a

foreign equity security or ADR shall be considered eligible if it is:

(A) listed on one or more regional stock exchanges, and

(B) does not qualify for dessimination of transaction reports via

the facilities of the Consolidated Tape.

(2) after March 31, 1998,] the security is registered with the

Securities and Exchange Commission pursuant to Section 12 of the

[Securities Exchange Act] Act [of 1934] and the issuer of the security

is current in its reporting obligating; or the security satisfies the

requirements of paragraph (a)(2) or (3) or (4) above; and

(2) the security is not listed on Nasdaq or a registered national

securities exchange in the U.S., except that a foreign equity security

or ADR shall [be considered eligible] meet this subparagraph (2) \4\ if

it is:

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

\4\ The proposed rule text was changed from ``subparagraph (3)''

to ``subparagraph (2)'' to correct the internal cross-reference.

Telephone conversation between Sara Nelson Bloom, Associate General

Counsel, Nasdaq, and Robert B. Long, Attorney, Division Commission,

on October 28, 1998.

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

(A) listed on one or more regional stock exchanges, and

(B) does not qualify for dissemination of transaction reports via

the facilities the Consolidated Tape.

(c) any equity security that [is] meets the following criteria:

(1) the security is undergoing delisting from either the New York

Stock Exchange, Inc. (NYSE) or the American Stock Exchange, Inc. (AMEX)

for non-compliance with maintenance-of-listing standards; and

(2) the security is subject to a trading suspension imposed by the

NYSE or

[[Page 59611]]

AMEX preceding the actual delisting; and

(3) the security satisfies the requirements of paragraph (a)(2) or

(3) or (4) above.

(d) any Direct [District] Participation Program as defined in Rule

6910 that is not listed on Nasdaq or a registered national securities

exchange in the U.S. and that satisfies the requirements of paragraph

(a)(2) or (3) or (4) above.

(e) Paragraphs (a)(2) and (3) and (4) above will not apply with

respect to any domestic equity security quoted in the Service on the

effective date of this rule change until six months after that date.

* * * * *

Rule 6540. Requirements Applicable to Market Makers

(a) No change.

(b) No change.

(1) Permissible Quotation Entries: no change.

(2) Impermissible Quotation Entries.

(A) No member or person associated with a member shall enter into

the Service a priced bid and/or offer, an unpriced indication of

interest (including ``bid wanted'' or ``offer wanted'' indications), or

a bid or offer accompanied by a modifier to reflect unsolicited

customer interest in any security that does not satisfy the

requirements of Rule 6530.

(B) No member or person associated with a member shall enter into

the Service a priced bid and/or offer, an unpriced indication of

interest (including ``bid wanted'' or ``offer wanted'' indications), or

a bid or offer accompanied by a modifier to reflect unsolicited

customer interest in any security of an issuer that does not make

filing with the Securities and Exchange Commission through the

Electronic Data Gathering, Analysis, and Retrieval (``EDGAR'') system

(or in paper format, if specifically permitted by Commission Rules)

unless the member:

(i) notifies the Association of the issuer of the security's

schedule for the filing of all periodic reports or financial reports

required pursuant to the Act or regulatory authority, respectively, and

the identity of the regulatory authority with which such reports are

filed, or ensures that such notice is provided; and

(ii) provides to the Association the issuer's periodic reports

required pursuant to the Act, or the issuer's financial reports

required by regulatory authority, prior to the expiration of the grace

period described in Rule 6530(a)(3), or ensures that the required

periodic reports are provided to the Association within that time

period.

(3) [(2)] Voluntary Termination of Registration

No change.

(4) [(3)] More Than One Trading Location

No change.

(5) [(4)] Clearance and Settlement

No change.

(c) Compliance With Market Maker Requirements

Failure of a member or a person associated with a member to comply

with this Rule may be considered conduct inconsistent with high

standards of commercial honor and just and equitable principles of

trade, in violation of Rule 2110.

* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the NASD included statements

concerning the purpose of and basis for the proposed rule change and

discussed any comments it received on the proposed rule change. The

text of these statements may be examined at the places specified in

Item IV below. The NASD has prepared summaries, set forth in Sections

A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

1. Purpose

The NASD has actively studied the OTC market in an effort to

address abuses in the trading and sales of thinly traded, thinly

capitalized (microcap) securities. These securities are not listed on

Nasdaq or any exchange and trade on the OTCBB, in the ``pink sheets''

published by the National Quotation Bureau, Inc. (``Pink Sheets''), and

in other quotation media where there are no listing requirements. With

respect to its examination of the OTCBB in particular, the NASD noted

the lack of reliable and current financial information about the

issuers, and the perception by the public that the OTCBB is similar to

a highly regulated market, such as the registered exchanges or

Nasdaq.\5\

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

\5\ In addition, the NASD has filed a proposed rule change

through its subsidiary, NASD Regulation, to require a member to

review current financial statements and other business information

about the issuer of a security that is not listed on Nasdaq or a

national securities exchange before that member could recommend a

transaction to a customer in the security and to provide certain

disclosure information on the trade confirmation for all customer

transactions (solicited and unsolicited) in such securities. See SR-

NASD-98-50.

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

The OTCBB provides a real-time quotation medium that NASD member

firms can use to enter, update, and retrieve quotation information

(including unpriced indications of interest) for equity securities

trade over-the-counter that are neither listed on Nasdaq nor on a

primary national securities exchange. Eligible securities include

national, regional, and foreign equity issues, warrants, units. Direct

Participation Programs (``DPPs''),\6\ and American Depositary Receipts

(``ADRs'')\7\ not listed on any other U.S. national securities market

or exchange. Unlike Nasdaq or registered exchanges where individual

companies apply for listing on the market--and must meet and maintain

strict listing standards--there are no listing standards for the OTCBB,

and there currently is no requirement that issuers of securities on the

OTCBB make current, publicly-available reports with the SEC or other

regulator. In fact, over half of the companies that are currently

quoted on the OTCBB are not subject to any public reporting

requirements.

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

\6\ DPPs are securities offerings that permit investors to

directly participate in the cash flow and tax consequences of the

underlying investments. DPPs provide for the ``flow through'' of tax

results. Thus, gains and losses are taxed to the investor not the

issuer of the security.

\7\ ADRs are receipts for shares of foreign corporations that

are held by U.S. banks and bought and sold in the U.S. by investors,

without utilizing overseas markets.

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

The proposed rule change was developed in an effort to balance the

benefits that the transparency of the OTCBB provides with the public

need for information about the issuers being quoted. The NASD is

concerned that where there is no public information available regarding

a security, the broad-based automated display of quotations in that

security creates an unjustified perception of reliability. While the

NASD realizes that the new rule may result in the lack of real-time

quotations for those securities that become ineligible for the OTCBB,

it believe that this loss is outweighed by the benefit to investors who

would, under the proposed rule, have access to information about the

companies in which they may invest. In addition, transactions in

securities ineligible for the OTCBB would still be subject to real-time

last sale trade reporting. These reports are publicly disseminated

through market data vendors on a real-time basis.

Amendment to Rule 6530

This proposed amendment to rule 6530 would limit quotations on the

OTCBB to the securities of issuers that make current filings pursuant

to

[[Page 59612]]

Sections 13 \8\ and 15(d) of the Act,\9\ securities of depository

institutions that are not required to make filings under the Act, but

file publicly-available reports with their appropriate regulatory

agencies, registered closed-end investment companies, and insurance

companies that are exempt from registration under Section 12(g)(2)(G)

of the Act.\10\

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

\8\ 15 U.S.C. 78m.

\9\ 15 U.S.C. 78o-(d).

\10\ 15 U.S.C. 78(g)(2)(G).

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

To remain eligible for quotation on the OTCBB, as issuer must

remain current in its filings with the SEC or applicable regulatory

authority. A member would be required to inform the NASD of the

issuer's reporting schedule. Based upon that schedule, the NASD will

affix a modifier on the security's symbol if the NASD has not received

information that the report was timely filed.\11\ The addition of the

modifier to the symbol, as well as any changes to the symbol necessary

to accommodate the modifier, will be publicly reported on the OTCBB

Daily List, which is available to market makers and investors through

the OTCBB web site as http://www.otcbb.com. Once an issuer is

delinquent in filing a required report (e.g., Form 10-K, Form 10-Q,

Form 20-F, Insurance Company Annual Statement, or call report), a

security of the issuer may continue to be quoted on the OTCBB for a 30

or 60 calendar day grace period from the due date of the report,

depending on the type of issuer. After the grace period, quotations in

the security of the delinquent issuer would not be permitted on the

OTCBB.

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

\11\ It is contemplated that the modifier will be affixed one to

two days after the report is due.

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

Filings for most OTCBB issuers are available through the SEC's

Electronic Data Gathering, Analysis, and Retrieval (``EDGAR'')

system.\12\ Foreign issuers are generally permitted to file in paper

format and copies of these filings are available from the Commission.

Exchange Act filings of banks and thrifts are available upon filing

from the financial institution's primary bank regulatory agency. The

grace period for these issuers is 30 days. In the case of banks and

thrifts that are not required to make Exchange Act filings, members can

obtain call report information from the National Information Center of

Banking Information website (http://www.ffiec.gov/nic) or the Federal

Deposit Insurance Corporation's website (http://www.fdic.gov). Call

reports are filed 30 days after the end of each calendar quarter and

are available to the public within 15 days of filing. Insurance

companies file annual statements with the National Association of

Insurance Commissioners (``NAIC'') by March 1 of each year. This

information is released to the public by NAIC by April 1. Because of

the delay in the availability of call reports and insurance company

annual statements, the proposed rule permits a 60 calendar day grace

period for the quotation of securities of these companies after the

deadline for the issuer to submit a report to the appropriate

regulator.

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

\12\ EDGAR is the SEC system for the receipt, acceptance, and

review of documents submitted in electronic format.

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

Amendment to Rule 6540

This proposed amendment to Rule 6540 would prohibit member firms

from quoting an issuer's security if the issuer has not made current

reports with the SEC or the appropriate regulatory authority. Members

must also provide such reports to the NASD, although the reports may be

provided by any market maker in the security. The NASD is exploring

ways to reduce the burden of this requirement for members, particularly

with respect to issuers who are EDGAR filers. As discussed above, the

NASD will affix a modifier to the security's symbol if the NASD has not

received information that the report was timely filed. This indication

will provide members with notice that the NASD has not received

information that the issuer's report was timely filed. Once the NASD

provides this notice, the member will have the opportunity to acquire

the necessary report and provide it to the NASD before the end of the

grace period.

Phase-In

The new requirements will be immediately effective upon approval of

the rule for securities not previously quoted on the OTCBB. Securities

quoted on the OTCBB on the date the rule becomes effective will be

afforded at least six months to comply with the new requirements.

Specifically, and in order to accommodate the resource demands that may

be placed upon the SEC when certain issuers elect to file current

public reports, the new requirements will be applied in a month-by-

month staggered manner for a period from six to eighteen months from

the date the rule is approved. The NASD will apply the new rule to

approximately the same number of issuers for each month during that

period in order to evenly distribute the SEC's anticipated work load.

The delayed effectiveness of the rule should also enable market makers,

investors, and issuers to take appropriate action. It should be noted

that for issuers who file a Form 10 or Form 10SB with the SEC to

register under Section 12(g) of the Exchange Act,\13\ all SEC comments,

if any, must be cleared with the SEC before securities can be quoted on

the OTCBB.

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

\13\ 15 U.S.C. 78l(G).

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

2. Statutory Basis

The NASD believes that the proposed rule change is consistent with

the provisions of Section 15A(b)(6) \14\ of the Act, which requires,

among other things, that the Association's rules be designed to prevent

fraudulent and manipulative acts and practices, to promote just and

equitable principles of trade, and, in general, to protect investors

and the public interest. In addition, Section 15A(b)(11) \15\ of the

Act requires that the rules of a registered national securities

association be designed to produce fair and informative quotations,

prevent fictitious or misleading quotations and to promote orderly

procedures for collecting, distributing, and publishing quotations. The

NASD believes the proposed rule change, which will address actual and

potential fraud in the quotation and trading of non-listed securities

and the investor perception that the OTCBB is equivalent to Nasdaq or

exchange markets in terms of standards, regulatory structure and

oversight, will accordingly protect investors and the public interest.

Further, the NASD believes limiting the OTCBB to companies that provide

public information will prevent fictitious and misleading quotations.

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

\14\ 15 U.S.C. 78o-3(b)(6).

\15\ 15 U.S.C. 78o-3(b)(11).

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

B. Self-Regulatory Organization's Statement on Burden on Competition

The NASD does not believe that the proposed rule change will impose

any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants, or Others

The proposed rule change was published for comment in NASD Notice

to Members 98-14 (``Notice'' or ``NTM'') in January, 1998. A total of

44 comments were received in response to the Notice.

Of the 44 responses received, 18 responses (or 41%) were from

broker/dealer firms or registered persons and the balance of 26

comments (or 59%) were from individual investors, issuers, various

state agencies, trade associations, and other interested parties. In

providing comments, a majority of commenters expressed a

[[Page 59613]]

position (i.e., approval or disapproval) regarding each specific

proposal. Other commenters did not provide a stated position on each

proposal, but identified particular issues with certain proposals and

provided written comment.

Twenty-two commenters opposed the proposal, 19 commenters supported

it, and three did not take a definitive position. Those commenters who

disapproved of the proposed changes generally believed that the changes

would decrease transparency and liquidity and would increase the

regulatory burden that small issuers face. One commenter opined that

the annual cost to an issuer to comply with the Exchange Act reporting

requirements would be $150,000.

Those commenters supporting the proposed changes generally felt the

changes will help eliminate fraud by providing investors with reliable

information. These commenters thought the deterrence of fraud and

increased availability of information outweighed the increase burden on

companies.

Commenters indicated that the rule as proposed in the Notice should

be modified to recognize issuers filing under Section 15(d) of the

Exchange Act.\16\ A commenter encouraged the NASD to accept reports

filed with regulatory agencies outside of the Exchange Act, such as

call reports filed by financial institutions. The rule as published in

the Notice would have permitted members to maintain quotes in a

security in which an issuer is delinquent in its reports with the SEC

or regulatory authorities for a period of ten days. Other commenters

supported an expansion of the grace period for filing a report with the

SEC to 30 days after its due date.

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

\16\ 15 U.S.C. 78o-(d).

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

After the public comment process, the staff recommended and the

Boards of the NASD and Nasdaq approved the following modifications to

the proposed rules. As to NASD Rule 6530, the proposed delinquency

grace period was expanded from ten days to thirty days for issuers

filing Exchange Act forms and to sixty days for insurance companies and

financial institutions that do not file Exchange Act forms. This

extended grace period is consistent with the proposed review period in

the SEC's Rule 15c2-11 proposal.\17\ Further, in the original Notice,

the staff solicited comment on whether certain non-Exchange Act

depository institutions that provide publicly-available financial

reports to banking regulators should be eligible for quotation on the

OTCBB. Based on the comments received, the nature of the issuers, the

independent oversight of banking regulators, and the SEC's position

that reports filed with federal or state bank supervisory agencies

contain information analogous to Exchange Act reports,\18\ the proposed

rule allows securities of these issuers to be quoted on the OTCBB if

the issuer provides timely reports to the appropriate Federal banking

agency or State bank supervisor and the information is publicly

available. Finally, consistent with comments received, the proposed

rule includes securities of issuers who are currently filing reports

with the SEC pursuant to Section 15(d) of the Act as eligible

securities for the OTCBB. An issuer becomes subject to Section 15(d) as

a result of registering securities under the Securities Act of 1933

(``Securities Act'') and is thereby required to make timely filings

with the SEC such as Forms 10-K, 10-Q, and 8-K or 20-F for at least a

year following the Securities Act registration.\19\

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

\17\ Exchange Act Release No. 39670 (February 17, 1998), 63 FR

9661 (February 25, 1998).

\18\ Id. 9667-68.

\19\ In addition to its requirements under Section 15(d), an

issuer may voluntarily register under Section 12(g) or be required

to register under Section 12(g) if it has 500 or more shareholders

of record and total assets of more than $10 million. Under both

scenarios, the issuer's securities would continue to qualify as

eligible securities for purposes of the OTCBB Rules if the issuer

maintains current filings with the SEC.

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

The staff and the NASD and Nasdaq Boards considered commenters'

objection that the proposed rule would decrease transparency for

securities no longer eligible for the OTCBB. However, this objection

was outweighed by the benefit of ensuring that there was publicly-

available information regarding issuers that are afforded the

visibility and credibility of the OTCBB. In this regard, the NASD

considered that in granting permanent approval to the OTCBB, the SEC

noted: ``As a general matter, transparency benefits the markets.

However, in the context of the inclusion of unregistered foreign

securities on the OTCBB, the benefits may be outweighed by the

potential harm from including unregistered securities on a visible U.S.

market operated by a self-regulatory organization.'' \20\ The SEC also

noted that ``the OTCBB may be inconsistent with the full disclosure

goals of the securities laws in allowing a regulated public marketplace

for unregistered securities.'' \21\ While these comments were made in

the context of unregistered foreign securities, the NASD believes that

the same concerns exist with respect to domestic securities for which

no public information is available.

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

\20\ Exchange Act Release No. 38456 (March 31, 1997), 62 FR

16635 at 16638 (April 7, 1997).

\21\ Id.

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

III. Date of Effectiveness of the Proposed Rule Change and Timing

for Commission Action

Within 35 days of the publication of this notice in Federal

Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the self-regulatory organization consents, the Commission will:

(A) by order approve the proposed rule change, or

(B) institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning the foregoing, including whether the proposal is

consistent with the Act. Persons making written submissions should file

six copies thereof with the Secretary, Securities and Exchange

Commission, 450 Fifth Street, NW, Washington, DC 20549. Copies of the

submission, all subsequent amendments, all written statements with

respect to the proposed rule change that are filed with the Commission,

and all written communications relating to the proposed rule change

between the Commission and any person, other than those that may be

withheld from the public in accordance with the provisions of 5 U.S.C.

552, will be available for inspection and copying at the Commission's

Public Reference Room. Copies of such filing will also be available for

inspection and copying at the principal office of the NASD.

All submissions should refer to File SR-NASD-98-51 and should be

submitted by November 25, 1998.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\22\

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

\22\ 17 CFR 200.30-3(a)(12).

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

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-29467 Filed 11-3-98; 8:45 am]

BILLING CODE 8010-01-M