Notice To Members 94-8

SEC Approves NASD Rules Governing Access To And Use Of The OTC Bulletin Board Service

Published Date:

SUGGESTED ROUTING

Legal & Compliance
Operations
Trading

Executive Summary

On January 5, 1994, the Securities and Exchange Commission (SEC) approved an NASD rule change codifying existing requirements for access to and use of the OTC Bulletin Board® service (OTCBB).1 This codification will provide a ready reference to OTCBB rules and operational requirements in a discrete section of the NASD Manual. Among the items covered in the codification are: definitions of OTCBB eligible securities, procedures for initiating quotation entries, and limited exemptions from Securities Exchange Act Rule 15c2-11. The rules are effective immediately because they simply restate various NASD rule changes approved earlier by the SEC. The text of the codified rules follows the discussion.

Background And Description Of Rule Change

The SEC recently approved an NASD rule change (File No. SR-NASD-93-56) codifying all existing requirements governing access to and use of the OTCBB. Since the OTCBB was launched as a pilot program on June 1, 1990, the NASD has adopted several operational and regulatory requirements affecting OTCBB users. Until now, these requirements had never been compiled and published in a discrete segment of the NASD Manual. However, these requirements were contained in the following NASD rule filings that the SEC had approved: (1) File No. SR-NASD-88-19 approved in Release No. 34-27975 (May 30, 1990) and containing the basic operational requirements for the OTCBB pilot; (2) File No. SR-NASD-90-37, approved in Release No. 34-28404 (August 31, 1990) and expanding by 30 minutes the quotation-update period applicable to market makers in foreign/ADR issues; (3) File No. SR-NASD-91-12, approved in Release No. 34-29261 (May 31, 1991) and establishing a firmness requirement for all priced bids/offers in domestic over-the-counter (OTC) equity securities; (4) File No. SR-NASD-91-38, approved in Release No. 34-29616 (August 27, 1991) and establishing the parameters for an inside bid/ask calculation2; (5) File No. SR-NASD-92-48, approved in Release No. 34-32647 (July 16, 1993) and establishing real-time trade-reporting requirements for OTC equity securities; and (6) File No. SR-NASD-93-17 approved in Release No. 34-32570 (July 1, 1993) and revising minimum quotation size requirements applicable to OTCBB market makers.

This codification restates the requirements contained in the foregoing rule filings and will be published in the NASD Manual beginning at paragraph 2571. Because they are substantially the same as the earlier SEC-approved NASD rule changes, the codified OTCBB rules are deemed to be immediately effective. Generally, this codification should facilitate NASD administration of, and member firm compliance with, the operational requirements that are unique to the OTCBB.

Following the text of the codified OTCBB rules is a supplemental item reflecting the SEC's recent grant of limited exemption from Rule 15c2-11 under the Securities Exchange Act of 1934. Although the SEC granted this exemption on December 20, 1993, the procedures for its implementation could not be finalized until February 1994. (A separate mailing has been sent to NASD member firms on those procedures.) This exemption is intended to facilitate expanded usage of the OTCBB by market makers desiring to reflect market making positions in a real-time quotation medium. In part, the SEC's grant of the exemption was premised on the initiation of real-time trade reporting for OTC equities last December 20th. The SEC has attached certain conditions that must be satisfied to rely on the new exemption. These conditions are highlighted in the supplement to the codified OTCBB rules reprinted below.

Questions regarding this Notice may be directed to Michael J. Kulczak, Associate General Counsel, at (202) 728-8811 or Market Operations at (203) 375-9609.

(Note: New language is underlined.)

OTC Bulletin Board® Service Rules Applicability

Section 1. These rules shall be known as the "OTC Bulletin Board Rules" and govern the operation and use of the OTC Bulletin Board® service ("OTCBB" or "Service") by broker-dealers admitted to membership in the National Association of Securities Dealers. Inc. ("NASD") and their associated persons. Unless otherwise indicated, the requirements of the OTC Bulletin Board Rules are in addition to the requirements contained in the NASD's Rules of Fair Practice. By-Laws. Schedules to the By-Laws. and Rules of Practice and Procedure for the Automated Confirmation Transaction Service

Operation of the Service

Section 2. The OTCBB provides an electronic quotation medium for subscribing members to reflect market making interest in OTCBB-eligible securities. Subscribing market makers can utilize the Service to enter, update, and display their proprietary quotations in individual securities on a real-time basis. Such quotation entries may consist of a priced bid and/or offer: an unpriced indication of interest (including "bid wanted" or "offer wanted" indications); or a bid/offer accompanied by a modifier to reflect unsolicited customer interest. A subscribing market maker can also access the proprietary quotations that other firms have entered into the Service along with highest bid and lowest offer (i.e., an inside bid-ask calculation) in any QTCBB-eligible security with at least two market makers displaying two-sided markets.

OTCBB-Eligible Securities

Section 3. The following categories of securities shall be eligible for quotation in the Service:

(a) any domestic equity security that is not listed on The Nasdaq Stock Market™ or a registered national securities exchange in the U.S.: and
(b) any foreign equity security or American Depositary Receipt ("ADR") that is not listed on The Nasdaq Stock Market or a registered national securities exchange in the U.S.

Requirements Applicable to Market Makers

Section 4. Market-maker participation in the OTCBB is voluntary and open to any NASD member firm that: satisfies the financial/operational requirements applicable to member firms engaged in over-the-counter market making; subscribes to Level 3 Nasdaq Workstation service; and demonstrates compliance with (or qualifies for an exception from) Rule 15c2-11 [17 CFR 240.15c2-11] under the Securities Exchange Act of 1934 at the time of initiating (or resuming) the quotation of any OTCBB-eligible security in the Service. Section 4 of Schedule H to the NASD By-Laws sets forth the procedure for demonstrating compliance with Rule 15c2-11.

OTCBB-eligible securities that meet the frequency-of-quotation requirement for the so-called "piggyback" exception in paragraph (f)(3)(i) of Rule 15c2-11 are identified in the Service as "active" securities. A member can commence market making in any active security by registering as a market maker through a Nasdaq Workstation at the firm. In all other instances, a member must follow the procedure contained in Section 4 of Schedule H to become qualified as a market maker in a particular OTCBB-eligible security.3

(a) Permissible Quotation Entries
1. A member firm that has qualified as a market maker in a particular OTCBB-eligible security may enter into the Service a priced bid and/or offer, an unpriced indication of interest (including "bid wanted" and "offer wanted" indications) or a bid or offer accompanied by a modifier to reflect unsolicited customer interest. Every quotation entry must include the appropriate telephone number for the firm's trading desk.
2. A priced bid and/or offer entered into the Service for a domestic equity security must be firm up to the minimum quotation size specified in Section 5 of Schedule H to the NASD By-Laws. This firmness requirement applies only during normal business hours, i.e., 9:30 a.m. to 4:00 p.m. E.T.
3. A priced bid and/or offer entered into the Service for a foreign equity security or an ADR shall be non-firm.4 Moreover, a market maker is only permitted to update quotation entries in such securities twice daily, i.e., once between 8:30 a.m. and 9:30 a.m. E.T., and once between noon and 12:30 p.m. E.T.5
(b) Voluntary Termination of Registration.

A market maker can voluntarily terminate its registration in an OTCBB-eligible security by withdrawing its quotations in that security from the Service. The firm may re-register to quote the security by satisfying the requirements specified above in this Section

Transaction Reporting

Section 5. Member firms that effect transactions in OTCBB-eligible securities shall report them pursuant to the requirements of Part XII of Schedule D to the NASD By-Laws.

Addendum

By letter dated December 20, 1993, the Securities and Exchange Commission granted the NASD's request for a limited exemption from Rule 15c2-11 under the Securities Exchange Act of 1934 ("Exchange Act") for broker-dealers that publish or submit quotations for publication in the OTC Bulletin Board ("OTCBB") Service for certain over-the-counter ("OTC") OTC equity securities. This exemption is not available for American Depositary Receipts or OTC equities issued by a foreign private issuer, within the meaning of Exchange Act Rule 3b-4. Regarding domestic OTC equities, the exemption is available to a broker-dealer, subject to the following conditions at the time such broker-dealer submits or initiates quotations in the OTCBB:

1) The security is eligible for piggybacking pursuant to paragraph (f)(3) of Rule 15c2-11 in another interdealer quotation system:
2) A broker-dealer relying upon this exemption must itself have published quotations in the security in that interdealer quotation system on at least 12 business days during the preceding 30 calendar days, with no more than four consecutive business days without quotations:
3) The issuer of the security is not the subject of bankruptcy proceedings:
4) The issuer of the security is not delinquent in any of its reporting obligations under the Exchange Act or rules thereunder, if subject to Section 13(a) or 15(d) of the Exchange Act: and
5) If at any time the Commission subsequently suspends trading in the domestic OTC equity security pursuant to Section 12(k) under the Exchange Act, no broker or dealer will initiate or resume quotations in that security in the OTCBB unless the broker/dealer complies with

1 SEC Release No. 34-33433 (January 5, 1994) 59 FR 1772 (January 12, 1994).

2 For any equity security quoted in the OTCBB, an inside bid/ask calculation (i.e., the highest bid and lowest offer being displayed by market makers registered in a particular security) is available only if the security has at least two registered market makers, each displaying a priced bid and offer. If additional market makers are displaying either one- or two-sided quotations, those entries are also factored into the inside calculation. On the other hand, if the basic requirement of two market makers is not satisfied, an indication is generated denoting that no inside calculation is available.

3 On February 28, 1992. the Securities and Exchange Commission granted the NASD's request to create a limited exemption from Rule 15c2-l 1 that permits a broker-dealer to publish in or submit to a quotation medium quotations for a security immediately after such security is no longer authorized for quotation in The Nasdaq Stock Market, without having information specified by the Rule. This exemption is only available if all the following conditions are satisfied:

(1) the security's removal was attributable solely to the issuer's failure to satisfy the revised maintenance standards approved in Release No. 34-29638 (August 30, 19911. 56 FR 44108 (September 6, 19911:

(2) the security must have been quoted continuously in The Nasdaq Stock Market during the thirty calendar days preceding its delisting. exclusive of any trading halt not exceeding one day to permit the dissemination of material news concerning the security's issuer:

(3) the issuer must not be the subject of bankruptcy proceedings:

(4) the issuer must be current in its reporting pursuant to Section 13(a1 or 15(d) of the Exchange Act: and

(5) a broker-dealer relying upon this exemption must have been a market maker registered with the NASD in the security during the thirty day period preceding its removal from The Nasdaq Stock Market.

4 The non-firm or indicative nature of a priced entry in a foreign or ADR issue is specifically identified on the montage of market maker quotations accessible through the Nasdaq Workstation service for this subset of OTCBB-eligible securities.

5 Examples of entries that would be considered an update include a market maker inserting a new, non-firm priced quotation, substituting an unpriced indication for a non-firm priced entry, or an initial registration without a price.