Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Granting Approval of Proposed Rule Change and Amendment No. 1 To Be 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. 34-40878; File No. SR-NASD-98-51]

Self-Regulatory Organizations; National Association of Securities

Dealers, Inc.; Order Granting Approval of Proposed Rule Change and

Amendment No. 1 To Be Proposed Rule Change by the National Association

of Securities Dealers, Inc. Relating to Microcap Initiatives-Amendments

to NASD Rules 6530 and 6540

January 4, 1999.

I. Introduction

On October 7, 1998, the National Association of Securities Dealers,

Inc. (``NASD''), through its wholly-owned subsidiary, the Nasdaq Stock

Market, Inc. (``Nasdaq'') submitted to the Securities and Exchange

Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of

the Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\

and Rule 19b-4 thereunder,\2\ proposed amendments to NASD Rules

[[Page 1256]]

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.

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

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

\2\ 17 CFR 240.19b-4.

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

The proposed rule change, including Amendment No. 1, appeared in

the Federal Register on November 4, 1998.\3\ The Commission received

three comments concerning the proposed rule change.\4\ This order

approves the proposed rule change, as amended.

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

\3\ Securities Exchange Act Rel. No. 40606 (October 27, 1998),

63 FR 59610.

\4\ Electronic comment letters from Edward Zorek, Tai Jim, and

R. Jeffrey Bacon were received by the Commission at rule-

[email protected] on November 11, 1998, November 28, 1998, and

November 29, 1998, respectively. The substance of the comments

received is discussed in Section III. Summary of Comments.

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

II. Description of Proposal

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 examation 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

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

primary national securities exchange. Eligible securites 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

strick 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\ DPP's 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 unjustied 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 believes that this loss is outweighted 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 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 the 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. 78l(g)(2)(G).

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

To remain eligible for quotation on the OTCBB, an 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 at 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

[[Page 1257]]

deadline for the issuer to submit a report to the appropriate

regulator.

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

\12\ EDGAR is the SEC's 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 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).

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

III. Summary of Comments

The Commission received three comments on the proposed

amendments.\14\ All three commenters supported the proposal; noting

that the proposed amendments should help to reduce fraud in OTCBB

traded securities.

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

\14\ See supra note 4.

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

IV. Discussion

The Commission believes that the proposal is consistent with

Section 15A of the Act \15\ as it will protect investors and the public

interest by requiring issuers listed on the OTCBB to file reports

containing current financial information with the Commission or

appropriate regulatory agency. Specifically, the Commission believes

the proposal is consistent with the requirements of Section 15A(b)(6)

and (11) of the Act.\16\ Section 15A(b)(6) 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, to remove impediments to and perfect the mechanism

of a free and open market and a national market system, and, in

general, to protect investors and the public interest.\17\ Section

15A(b)(11) requires that the rules of the association be designed to

produce fair and informative quotations, to prevent fictitious or

misleading quotations, and to promote orderly procedures for

collecting, distributing, and publishing quotations.\18\

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

\15\ 15 U.S.C. 78o-3.

\16\ 15 U.S.C. 78o-3(b)(6) and (11).

\17\ 15 U.S.C. 78o-3(b)(6).

\18\ 15 U.S.C. 78o-3(b)(11).

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

Under proposed Rule 6530, market makers will not be permitted to

quote OTCBB traded securities unless the issuer has made current

filings with the appropriate regulatory agency. The filing requirement

ensures that companies trading on the OTCBB market will have current,

public information that investors can access, from the appropriate

regulatory agency, when considering whether to invest in an OTCBB

traded security. Proposed Rule 6530 should provide investors in OTCBB

securities with more information on which to base investment decisions.

The Commission also believes that limiting quotations on the OTCBB to

the securities of issuers that report to the SEC or applicable

regulatory authority may help to reduce fraud and manipulation. As a

result of the reporting requirement, financial data on issuers will be

available and issuers that provide false or misleading information in

their required filings may be subject to liability for making those

statements.\19\ The Commission finds that proposed Rule 6530 is

consistent with the Act because it will protect investors and the

public interest.\20\

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

\19\ See, e.g., SEC v. Savoy Industries, Inc., 587 F.2d 1149

(D.C. Cir. 1978), cert denied, 440 U.S. 913 (1979); Exchange Act

Rule 10b-5, 17 CFR 240.10b-5.

\20\ 15 U.S.C. 78o-3(b)(6).

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

Proposed Rule 6530 provides that domestic securities that were

previously trading on the OTCBB will not be subject to the proposal

until six months after the approval date. Neither foreign issuers nor

issuers of securities not currently trading on the OTCBB will be able

to take advantage of the phase-in provision; these issuers will be

obligated to immediately comply with Rule 6530, as amended. The

Commission believes that the phase-in period is reasonable and

consistent with the Act. The Commission believes that the phase-in

period for issuers of domestic securities that were previously trading

on the OTCBB will provide these issuers with ample notice of the rule

change and adequate time to comply with the new rules' requirements.

Regarding issuers of domestic securities not currently quoted on the

OTCBB and foreign securities, the Commission believes it is consistent

with the Act and in the public interest that they be required to comply

with the amendments to Rule 6530 effective immediately. The Commission

finds that the phase-in period for issuers previously quoted on the

OTCBB and immediate effectiveness of the amendments to Rule 6530 with

respect to other issuers is reasonable, and consistent with Section

15A(b)(6) of the Act.\21\

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

\21\ 15 U.S.C. 78o-3(b)(6).

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

Proposed amendments to Rule 6540 will permit NASD members to quote

only the securities of issuers that satisfy the requirements of

proposed Rule 6530. As proposed, Rule 6540 will also necessitate that

NASD members provide the NASD copies of reports filed with the

Commission or other applicable regulatory authority. These reports can

be provided by any market maker in the security to the NASD. Once a

market maker has properly filed all necessary reports with the NASD,

all market makers in the security may quote the security, as long as

the reports remain current. The Commission believes that the rule

should ensure that market makers have current financial information

available to them regarding issuers quoted on the OTCBB and enable NASD

market makers to reflect this information in their quote. The

Commission finds that proposed Rule 6540 is consistent with Section

[[Page 1258]]

15A(b)(11) of the Act \22\ in that it is designed to produce fair and

informative quotations, to prevent fictitious or misleading quotations

and to promote orderly procedures for collecting, distributing, and

publishing quotations.

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

\22\ 15 U.S.C. 78o-3(b)(11).

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

V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the

Act,\23\ that the proposed rule change (SR-NASD-98-51) is approved, as

amended.

\23\ 15 U.S.C. 78s(b)(2).

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

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\24\

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

\24\ 17 CFR 200.30-3(a)(12).

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

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-414 Filed 1-7-99; 8:45 am]

BILLING CODE 8010-01-M