By Anne Sherry, J.D.
Two manufacturing groups are asking the SEC to amend Rule 15c2-11 to expressly exempt fixed-income securities that satisfy the requirements of Rule 144A. According to the petition for rulemaking, Rule 15c2-11, the penny stock quote rule, was understood not to apply to fixed-income securities until a 2021 staff interpretation created an unprecedented reversal of policy. If the reversal stands, private companies will be required to disclose competitively sensitive information even though they only offer securities to sophisticated investors.
Background. Rule 15c2-11 applies to the publication or submission of quotations by broker-dealers other than on a national securities exchange. 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. The SEC amended Rule 15c2-11 in 2020 to provide new protections for retail investors in OTC equity securities, including a new mandate that issuer information be made publicly available. Then in a September 2021 no-action letter to 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.
The petitioners are the National Association of Manufacturers and the Kentucky Association of Manufacturers. They also seek emergency interim relief and a stay. NAM previously asked SEC officials to abandon the new interpretation of the penny stock quote rule. A few months later it, along with SIFMA and the U.S. Chamber of Commerce, wrote to the Senate Banking and House Financial Services Committees asking them to reverse the 2021 staff interpretation.
Petition. The members of NAM and KAM include privately held manufacturers that issue Rule 144A securities. According to the petition for rulemaking, the staff determination will harm companies’ ability to raise funds, disrupt the market for Rule 144A securities, and harm investors. The 2021 staff interpretation disrupts 50 years of practice during which Rule 15c2-11 has not applied to fixed-income securities. It also conflicts with the SEC’s approval of a FINRA rule implementing the 2020 amendments that expressly excludes Rule 144A.
The petitioners argue that the SEC has never assessed the effect of Rule 15c2-11 on the Rule 144A market and that, if it had done so, it would have realized that all the relevant policy considerations argue against applying the rule to fixed-income securities. The SEC has justified Rule 15c2-11 as protecting retail investors, but retail investors cannot participate in the Rule 144A market, which is limited to qualified institutional buyers. In promulgating Rule 144A, the SEC specifically determined that making issuer information available by request sufficed to protect the sophisticated investors in that market. By contrast, Rule 15c2-11 requires public disclosure.
Extending the rule to fixed-income securities will harm issuers and in turn investors, by reducing the value of their Rule 144A securities and the liquidity and transparency of the market as a whole. The petition cites a study from Ernst & Young that found that applying the penny stock quote rule to Rule 144A securities would reduce job creation and decrease U.S. GDP by $100 billion over the next ten years. The new interpretation also harms broker-dealers by significantly increasing their costs and risks.
The petition offers several avenues for addressing the concerns it raises. The Commission could amend Rule 15c2- 11 to expressly exempt Rule 144A securities or, in the alternative, accomplish the exemption using its Rule 15c2-11(g) exemptive authority. The Commission also could address the most serious adverse consequences of applying Rule 15c2-11 to Rule 144A securities by either exempting Rule 144A securities from the public disclosure requirements of Rule 15c2-11 or by specifying that these issuer-information and broker-dealer verification requirements are satisfied as long as the issuer complies with the current information requirement under Rule 144A.