SEC Provides Much-Anticipated Guidance for the Publication of Quotations for Securities in the OTC Market

On November 22, 2024, the Securities and Exchange Commission's ("SEC") Division of Trading and Markets issued a much-anticipated "no-action letter" ("2024 NAL") clarifying the application of amended Rule 15c2-11 under the Securities Exchange Act of 1934 (the "Rule") to fixed-income securities.

The Rule applies when a broker or dealer (collectively, "broker-dealer") intends to publish a quotation[1] for a security in a quotation medium.[2] Unless an exception applies, the broker-dealer must gather and review certain information about the issuer of the security[3] and, after such review, have a reasonable basis to believe that the information is accurate in all material respects and that the sources of the information are reliable.[4] Because Rule 15c2-11(f)(1) provides an exception for securities admitted to trading on a national securities exchange, the Rule effectively governs the publication of quotations for securities in the "over-the-counter" market.

Background

From its inception in 1971, the focus of the Rule has been on quotations for thinly traded and small capitalization stocks for which there was little publicly available information and, therefore, a heightened risk of fraudulent and manipulative activity, particularly with regard to retail investors.[5] Over the 50 years that the Rule had been in effect, its potential application to fixed-income securities was largely ignored. In 1998, the SEC had declared that "Rule 15c2-11 covers debt securities," while acknowledging that: broker-dealers may not have focused on that; debt securities were frequently held by institutional (rather than retail) investors; and the debt market did not appear to be subject to the abuses that the Rule was intended to address.[6] In 1999, the SEC proposed to exclude, inter alia, debt securities from the Rule, but it took no further action.

In the 2019 Proposing Release, the SEC proposed major changes to the Rule. Although the proposing release included a question as to whether "other securities (e.g., debt securities, non participatory preferred stock, or investment grade asset-backed securities) … should also be excepted from the Rule's provisions,"[7] the 2020 Adopting Release did not address the fixed-income market.[8]

Potential Disruptions to the Rule 144A Market (Resolved)

Among other things, the 2020 Amendments limited the ability of broker-dealers to publish quotations where the required information was not "publicly available" as that term was newly defined.[9] The failure of the 2020 Amendments to address the fixed-income market raised significant problems for broker-dealers seeking to publish quotations for such securities because information about the issuers of many fixed-income securities did not fit into any of the information categories in Rule 15c2-11(b) and was generally not "publicly available." In particular, the issuers of fixed-income securities offered and sold pursuant to Rule 144A under the Securities Act of 1933 (the "Securities Act") invariably did not have information that was publicly available.[10] The 2020 Amendments to Rule 15c2-11 had a compliance date of September 28, 2021.

To address the concerns of the fixed-income securities industry, in September 2021 the SEC Staff issued a "no-action letter" ("NAL") that effectively deferred the application of the amended Rule to fixed-income securities until January 3, 2022.[11] In response to continued industry concerns, the SEC Staff issued another no-action letter on December 16, 2021, that established a complex and phased approach to implementing the 2020 Amendments to fixed-income securities.[12] The Second 2021 NAL permitted broker-dealers to rely on specific categories of issuers and issuer information to publish their quotations for debt securities, including quotations for Rule 144A securities, in quotation mediums. That position, however, was set to expire on January 5, 2024. In response to widespread expressions of concern for disruption of the Rule 144A market, in particular, when the NAL expired, the SEC Staff modified its position and issued an extension in November 2022 that would expire on January 5, 2025.

One of the principal industry concerns with the application of the Rule to fixed-income securities and the terms of the NALs was the predicted disruption of the large market for securities issued under Rule 144A when the latest NAL expired. In effect, the argument was that requiring publicly available issuer information for such securities was inconsistent, if not incompatible, with the nature of Rule 144A itself for the reasons discussed above. The Commission itself responded to these concerns: in October 2023, the SEC issued an exemption from the Rule for quotations "with respect to a fixed income security to be sold in compliance with the safe harbor in Rule 144A."[13]

The Exemption Order cleared the way for broker-dealers to publish quotations for Rule 144A fixed-income securities. And, although industry participants largely viewed the terms of the 2022 NAL as workable (other than for Rule 144A securities), the 2022 NAL would expire on January 4, 2025. The SEC Staff issued yet another NAL on November 22, 2024, "[i]n response to discussions with industry representatives regarding the operational and systems changes necessary to comply with the Amended Rule for certain fixed income securities."[14]

The SEC Staff's Latest No-Action Position

The Staff's position in the 2024 NAL is virtually identical to the 2022 NAL (which has now been withdrawn), with two significant differences:[15]

1. there is no expiration date to the position, i.e., it has an indefinite duration; and
2. in footnote 4, the relief applies to fixed-income securities of "a wholly owned subsidiary of a company (1) for which the applicable Rule 15c2-11(b) information is current and publicly available and (2) whose guarantee of such securities of the wholly owned subsidiary is full and unconditional." This means that the parent company information must comply with Rule 15c2-11(b) (the information requirements of Rule 144A(d)(4) would satisfy paragraph (b)), and is limited to a wholly owned subsidiary whose securities are fully and unconditionally guaranteed by the parent.

Importantly, the 2024 NAL also retains footnote 3 verbatim from the 2022 NAL that effectively permits continuous quotations for qualifying fixed-income securities in quotation systems that are not interdealer quotation systems.[16] The 2024 NAL is essentially an acknowledgment that applying the Rule to most fixed-income securities is not feasible and does not make sense when there is adequate information about the issuer.

The 2024 NAL will come as welcome relief to broker-dealers quoting fixed-income securities. Many have adopted policies and procedures to reflect the conditions in the 2024 NAL. However, other questions about the application of the Rule to fixed-income quotations may persist. For example: when is a quotation "published";[17] what expressions of market interest qualify as "quotations"; and what venues for expressing market interest qualify as "quotation mediums"? Or the Commission could obviate the need to resolve these potential issues by following through on its prior proposals and issue an exemption or adopt an exception to exclude fixed-income securities from the Rule altogether. There may be more to come in this area.

DWT's financial services group regularly provides regulatory counseling advice to clients on complex trading rule requirements like Rule 15c2-11 in the context of regulatory inquires, exams, and enforcement matters. DWT's attorneys are continuing to monitor for developments in this space through related enforcement actions and regulatory developments.