SEC Approval of an Amendment to Schedule H to the NASD By-Laws Requiring Members to Demonstrate Compliance With Rule 15c2-11 Before Initiating Quotations in a Quotation Medium

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EXECUTIVE SUMMARY

On May 1, 1990, the SEC approved an amendment to Schedule H of the NASD By-Laws to require member firms to file specified information with the NASD before initiating (or resuming) a quotation of a non-NASDAQ over-the-counter security ("non-NASDAQ security") in any quotation medium. Quotation mediums include the OTC Bulletin Board, the National Quotation Bureau's Pink Sheets™ publication, regional/local mediums comparable to the Pink Sheets™, and any other service that falls within the broad definition of "quotation medium," as defined in Rule 15c2-11 (e)(1) under the Securities Exchange Act of 1934 (the "Act").

The new NASD filing requirements encompass information that broker-dealers must maintain pursuant to paragraphs (a)(1) - (5) of Rule 15c2-11. For example, paragraph (a)(1) specifies maintenance of a copy of an issuer's prospectus relating to certain offerings registered with the SEC under the Securities Act of 1933.

In addition, member firms will have to specify the factors considered in establishing their initial priced entries for a non-NASDAQ security before such entries may be published in any quotation medium. In those instances where a member firm can rely on one of the stated exemptions from Rule 15c2-11, including the so-called "piggyback" exemption, no filing would be necessary. These new requirements will take effect on July 2, 1990. The text of the amendment follows this notice.

BACKGROUND

On May 1, 1990, the SEC approved an NASD rule change that amends Schedule H to the NASD By-Laws to require member firms, before initiating or resuming the quotation of a non-NASDAQ security in any quotation medium, to file with the NASD copies of the information needed to comply with Rule 15c2-11 under the Act and certain additional information.¹ The NASD's review of this material is intended to ensure strict compliance by member firms with Rule 15c2-11.

Furthermore, this rulemaking initiative complements other regulatory efforts undertaken by the NASD as well as the SEC to curtail abusive practices involving so-called "penny stocks."

SUMMARY OF NEW REQUIREMENTS

A principal purpose of the new filing requirement in Schedule H is to ensure that members have complied with the information maintenance requirements of Rule 15c2-11. This rule requires that broker-dealers gather and maintain certain information before initiating or resuming the quotation of a non-NASDAQ security² in a quotation medium such as the OTC Bulletin Board or the NQB's Pink Sheets™ publication. The rule specifies maintenance of categories of information depending, for example, on whether the issuer is an Exchange Act reporting company or whether the issue to be quoted was the subject of a recent offering registered with the Commission under the Securities Act of 1933. Similarly, if the issue represents the outstanding stock of a nonreporting company, paragraph (a)(5) of Rule 15c2-11 specifies 16 elements of information that the broker-dealer must have before starting to quote the security in any quotation medium.

As amended, Schedule H requires members to file with the NASD, before initiating or resuming the quotation of a non-NASDAQ security in any quotation medium, a Form 211 accompanied by two copies of the information needed to comply with Rule 15c2-11. Although the amendment establishes a new filing requirement, the amount of information to be furnished approximates what member firms currently are required to file and maintain to satisfy Rule 15c2-11³. Amended Schedule H, however, requires submission of additional information relating to the initial or resumed publication of a priced entry in certain instances.

Amended Schedule H further provides that all required information be received by the NASD at least three business days before a member initiates (or resumes) the publication of quotations for a non-NASDAQ security in any quotation medium.⁴ During this three-day period, the NASD staff will conduct a substantive review of the member's submission and notify the member about the adequacy of its submission by the end of this period. If any deficiency is found, the NASD staff will advise the firm either to amend or supplement its submission. If additional information is submitted, the NASD staff will act on it within seven business days of receipt. Significantly, until the member has demonstrated full compliance with Rule 15c2-11 and Schedule H, a member will not be able to access the OTC Bulletin Board for the affected security. The member will be promptly notified in writing of such a determination.⁵ Nonetheless, if a member proceeded to publish its quotation in another quotation medium without fully complying with Schedule H and Rule 15c2-11, such action would be reviewed by a District or Market Surveillance Committee to determine if disciplinary action is warranted.

A member must demonstrate compliance with Rule 15c2-ll regardless of whether its initial or resumed quotation is a priced entry.⁶ Rule 15c2-11(e)(3) defines "quotation" to mean actual bids/offers, indications consisting only of the firm's name and the telephone number of its OTC trading desk, and bid wanted/offer wanted indications reflecting proprietary trading interest. The definition of "quotation" in Section l(d) of amended Schedule H tracks the language of paragraph (e)(3) of the rule. In situations where a firm's initial or resumed quotation is a priced entry, amended Schedule H obligates the member firm, when filing with the NASD, to specify the basis for determining the proposed bid and/or offer as well as the factors considered in making that determination.

A broker-dealer cannot avoid having to justify its first priced entry simply by initiating or resuming quotation of a non-NASDAQ security on a "name only" basis and later inserting a priced entry for that security in the same quotation medium. In this circumstance, amended Schedule H would require a supplemental filing explaining the basis for the initial priced entry. The obligation to make this supplemental filing arises only if the broker-dealer previously made a filing under Section 4 of amended Schedule H to initiate or resume quotation of that particular non-NASDAQ security and that initial or resumed quotation did not constitute a priced entry.

A member firm has no obligation to file information under amended Schedule H when it properly qualifies for one of the exemptions contained in paragraphs (f)(l), (2), (3), and (5) of Rule 15c2-11⁷. The most significant of these is the so-called "piggyback" exemption provided by paragraph (f)(3) of the rule. To rely on the piggyback exemption, a firm must first determine whether the subject non-NASDAQ security has met the frequency-of-quotation test found in paragraphs (f)(3)(i) or (ii) of Rule 15c2-11. (With respect to the OTC Bulletin Board, this capability will be available on-line to market-maker participants after the 60-day startup period.) If so, a firm can begin to enter quotations for the security in that quote medium. Thus, in instances where a member can validly claim the piggyback exemption, no filing whatsoever would be required under Section 4 of amended Schedule H. Nevertheless, in the event that a member firm decides to publish a quotation in the NQB "Pink Sheets,"™ claiming the piggyback exemption, the Form 211 should be sent to the NASD.

Rule 15c2-11 currently permits the practice of "self-piggybacking." This refers to situations where a broker-dealer initiates or resumes quotation of a non-NASDAQ security in a quote medium by complying with the applicable information maintenance requirement under paragraph (a) of Rule 15c2-11. If, after 30 calendar days have elapsed, the broker-dealer's quotes satisfy the frequency requirement for piggybacking, Rule 15c2-11 does not obligate the member to obtain updated issuer information to continue quoting the company's non-NASDAQ security in that quote medium. The ability of a broker-dealer to self-piggyback does not alter a firm's filing obligation under amended Schedule H to justify its first priced entry. Specifically, if a firm makes an acceptable filing under Section 4 of Schedule H but publishes no priced entry in the medium during the ensuing 30 days, it must make a supplemental filing to justify its first priced entry at any time thereafter. Similarly, if the same firm initially published an unpriced entry (i.e., indication of interest) and wished to change to a priced entry during the first 30 days, it must make a supplemental filing to justify that first priced entry. In sum, the obligation to make a supplemental filing arises only where the firm's initial (or resumed) quotation required a filing under amended Schedule H and that filing did not contain disclosure of the basis for and factors considered in the firm's first priced entry.

The NASD also wishes to address how amended Schedule H would apply following a Commission trading suspension pursuant to Section 12(k) of the Act. Upon expiration of the suspension, any firm wishing to initiate or resume the quotation of the suspended security in a quote medium must first compile the requisite issuer information under paragraph (a) of Rule 15c2-11. Next, the firm would make the filing with the NASD required by amended Schedule H. If the firm proposed to publish a priced entry in a quote medium, the Schedule H filing must include statements setting forth the basis and factors considered in determining the priced entry. Assuming that the NASD's review disclosed no deficiency with the filing, the firm could proceed to publish its proposed quotation in the medium(s) identified in the filing. Other firms wishing to quote the same security during the next 30 days would have to follow the same procedure. Thereafter, additional firms could initiate or resume quotation of the subject security under the piggyback exemption, provided that the conditions in paragraph (f)(3) of Rule 15c2-11 can be met. If so, those firms would have no obligation to make any filing with the NASD under amended Schedule H.

In sum, the proposed amendment would not subject member firms to any filing requirement whenever they can validly claim one of the exemptions provided under paragraph (f) of Rule 15c2-11, including the piggyback exemption. These exemptions are specifically referenced in the first sentence of Section 4 of amended Schedule H.

The new filing requirements prescribed by Schedule H will take effect on July 2, 1990. Questions regarding compliance with amended Schedule H and requests for Form 211 should be directed to Dan Sibears, Roger Sherman, or Ken Worm of the NASD's NNOTC Compliance Unit at (202) 728-8149. Members' filings pursuant to Section 4 of Schedule H should be sent to:

National Association of Securities Dealers, Inc.
NNOTC Compliance Unit, 5th Floor
1735 K Street, NW
Washington, DC 20006-1506

TEXT OF AMENDED SCHEDULE H TO THE NASD BY-LAWS

Section 1â€" Definitions

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Section 4 â€" Submission of Rule 15c2-11 Information on Non-NASDAQ Securities

Except as provided in subsections (f)(l), (2), (3) and (5) of Rule 15c2-11 under the Securities Exchange Act of 1934, no member shall initiate or resume the quotation of a non-NASDAQ security in any quotation medium unless the member has demonstrated compliance with this rule and the applicable requirements for information maintenance under Rule 15c2-11. A member shall demonstrate compliance by making a filing with, and in the form required by, the Association, which filing must be received at least three business days before the member's quotation is published or displayed in the quotation medium. The information to be filed shall contain one copy of all information required to be maintained under subsections (a)(l), (2), (3)(iii), (4)(ii), or (5) of Rule 15c2-11, including any information that may be required by future amendments thereto. In addition, this filing shall identify the issuer, the issuer's predecessor in the event of a merger or reorganization within the previous 12 months, the type of non-NASDAQ security to be quoted (e.g., ADR, warrant, unit, or common stock), the quotation medium to be used, the member's initial or resumed quotation, and the particular subsection of Rule 15c2-11 with which the member is demonstrating compliance. Additionally, if a member is initiating or resuming quotation of a non-NASDAQ security with a priced entry, the member's filing must specify the basis upon which that priced entry was determined and the factors considered in making that determination.

If a member's initial or resumed quotation does not include a priced entry, a member shall supplement its prior filing under this section, in the form required by the Association, before inserting a priced entry for the affected non-NASDAQ security in a quotation medium. The supplemental filing shall specify the basis upon which the proposed priced entry was determined and the factors considered in making that determination. This supplemental filing must be received by the Association at least three business days before the member's priced entry first appears in a quotation medium.

All filings made with the NASD under this Section must be reviewed and signed by a principal of the member firm.

¹See Release No. 34-27968 (May 1, 1990), 55 FR 19132 (May 8, 1990).

²Following the termination of a Commission trading suspension pursuant to Section 12(k) of the Act, a broker-dealer must reestablish compliance with Rule 15c2-11 before reentering a quotation for that security in a quotation medium.

³No filing would be rquired if the member can qualify for one of the enumerated exemptions from Rule 15c2-11, including the piggyback exemption.

⁴The three-day period corresponds to the Commission's proposed amendment to paragraph (d) of Rule 15c2-11. See Release No. 34-27247 (September 14, 1989), 54 FR 39194 (September 25,1989), at 39205.

⁵If the NASD's review disclosed only minor or technical deficiencies, the NASD would have the option to contact the member firm by telephone and request submission of supplemental or revised Rule 15c2-11 information.

⁶Section l(f) of amended Schedule H defines "priced entry" as a quotation consisting of a bid, offer, or both at a specified price.

⁷Paragraph (4) establishes an exemption for the publication of a quotation on a municipal security. Because municipals are not within the scope of amended Schedule H, the latter exemption is not referenced.