By John Filar Atwood
Three industry associations have sent a letter to members of the Senate Banking and House Financial Services Committees asking them to reverse a 2021 staff interpretation that in January would begin to apply 1934 Act Rule 15c2-11, the penny stock quote rule, to fixed income securities. In the letter, the National Association of Manufacturers, Securities Industry and Financial Markets Association (SIFMA), and U.S. Chamber of Commerce said the interpretation reverses 50 years of SEC policy and will force private companies to publicly disclose competitively sensitive information.
Rule 15c2-11 applies to the publication or submission of quotations by broker-dealers in a quotation medium other than a national securities exchange. It states that before a broker-dealer may initiate or resume quotations for a security in a quotation medium, the broker-dealer must review basic information about the issuer of the security.
The SEC adopted amendments to Rule 15c2-11 in 2020 to provide new protections for retail investors in OTC equity securities. Then in a September 2021 no-action letter to the Financial Industry Regulatory Authority (FINRA), the staff expressed the view that Rule 15c2-11, including the 2020 amendments, applies to other types of OTC securities, including fixed income securities. The staff followed up with a December 2021 no-action letter to FINRA that laid out its planned phased approach to the application of Rule 15c2-11 to the fixed income markets.
Associations’ objections. In their letter to members of Congress, the associations noted that in the 50 years of the existence of Rule 15c2-11, the SEC has never attempted to enforce compliance with the rule for fixed income securities. They stated that many private companies issue fixed income securities in the form of corporate bonds offered under Rule 144A, and that applying the 2020 amendments to fixed income securities will require these private issuers to make detailed financial data publicly available before broker-dealers can freely quote their securities.
The associations further noted that Rule 144A requires that securityholders and prospective purchasers be given the right to obtain, upon request, specified operational and financial information about an issuer. They said that when it promulgated Rule 144A, the SEC determined after considering public comments that the “available upon request” approach appropriately balanced investor protection and capital formation. Now the staff has overturned that balance without public notice-and-comment or any analysis of the potential impacts of the policy change, they argued.
The associations said that under the new interpretation, private companies will be forced to go beyond what is required by Rule 144A and instead make public their confidential and competitive information for their debt to be freely quoted on the secondary market. In their view the requirement will impose significant costs on those businesses by exposing sensitive information to competitors and undermining their right as non-public companies to avoid public scrutiny of their financial data. Further, private companies that choose to protect the confidential information will experience decreased liquidity given that broker-dealers will not be able to freely quote their securities, they added.
Retroactive impact. The associations are concerned that the SEC intends for the new staff interpretation to be retroactive, which will impair investments in private company bonds made by institutional investors even if those investments were made years ago. They noted that investors in Rule 144A bonds will face the challenge of trying to determine which issuers will comply with the new interpretation, which will not, and whether they need to sell their investments, which they believe will further depress prices.
The associations also took issue with the SEC’s adoption of the new interpretation without providing opportunities for public review and feedback. The agency also bypassed its obligation to conduct a full analysis of the potential impacts of its rule proposals, they said.
SIFMA’s concerns. In a more detailed posting in its website, SIFMA stated that while the SEC staff argued that technically the rule has always applied to fixed income securities, the truth is that no one viewed the rule to include the fixed income markets. The rule has never been applied to or enforced in fixed income securities markets and does not contemplate the differences in how liquidity is provided in fixed income markets compared to equity markets. In SIFMA’s view, the interpretation represents rulemaking by unilateral staff pronouncement, rather than through the typical processes for developing new regulations through public and deliberative proceedings via Commission rulemaking.
SIFMA said that a potential impact of the interpretation is a reduction of the availability of quotes for some fixed-income products, such as securities not clearly exempt from rule. This would return those markets to more bilateral interaction for certain securities, in SIFMA’s opinion. For some products, there is no clear short- or long-term solution, SIFMA continued, and it believes there could be a dramatic decrease in dealer activity that could be construed as a quotation, which would make price transparency needed by investors in fixed income securities less available.
The three associations encouraged Congress to step in before the new interpretation takes effect in January to prevent the SEC from imposing public disclosure obligations on privately held Rule 144A issuers.