The SEC introduced Rule 15c2-11 to prevent certain manipulative and fraudulent trading schemes that had arisen in connection with the distribution and trading of unregistered securities issued by shell corporations or other companies with thin markets. The SEC has amended the rule several times over the years to address transparency issues, among other things.
Rule 15c2-11 generally requires a broker or dealer before initiating (or resuming) any quotation for a security in a quotation medium, to gather specified information regarding the security and its issuer.
Based upon a review of such information, along with certain supplemental information contemplated in subsection (c) of the rule, broker-dealers must have a reasonable basis for believing that such information is accurate and is from a reliable source. There are a few exceptions, including the unsolicited indication of interest (“unsolicited quotation exception”), the piggyback exception, and the average daily trading volume (“ADTV”) exception. Despite those nuances, broker-dealers’ general duty is to conduct information gathering due diligence to support the quotation of over-the-counter (“OTC”) securities. Moreover, the rule does not apply to certain exempt securities, such as certain government securities and fixed income securities sold in reliance upon Rule 144A.
Ambiguity concerning fixed income securities was introduced when the SEC determined that Rule 15c2-11 applied to these types of securities. The industry reacted that it never understood that the rule applied to non-equity securities.
The SEC is proposing amendments to Rule 15c2-11 to replace the terms “security” and “securities” with the terms “equity security” or “equity securities.” Under the proposal, “equity security” (or “equity securities”) would be as defined in 17 CFR 240.3a11-1 (“Rule 3a11-1”). Leveraging the definition in Rule 3a11-1 should provide more clarity with respect to which securities are subject to the rule.
Notably, to the extent a crypto asset is an equity security as defined in Rule 3a11-1, Rule 15c2-11 would apply to brokers and dealers initiating (or resuming) quotations for such crypto assets in a quotation medium. The proposal also addresses the logic for expressly excluding non-equity securities, such as fixed income securities, from the scope of Rule 15c2-11, including differences in trading, information, and market dynamics.
The substantive information-gathering and review requirements would otherwise remain unchanged.
Key Updates to the SEC’s OTC Quotations Rule
The SEC is proposing amendments to Rule 15c2-11 to replace the terms “security” and “securities” with the terms “equity security” or “equity securities,” which the proposal states may include crypto assets structured as an equity product.
Compliance Considerations for Broker-Dealers
Whether or not this proposal is approved, broker-dealers should evaluate their compliance, operational, and supervisory procedures around quotation practices. As part of that effort, in an increasingly complicated landscape of product development, broker-dealers should ensure they have processes that accurately identify equity products subject to the rule. Broker-dealers should also consider the workflows and associated controls they will need in place to clear a product for traders to commence quotations on equity securities.
ACA Is Here to Help
Connect with an expert for assistance with reviewing and enhancing your compliance and operational controls around OTC order quotations, as well as associated supervisory procedures and recordkeeping processes that ensure compliance with Rule 15c2-11.