The 211 Rules And Shell Companies

The panic among OTC Markets shell companies is likely related to the upcoming expiration of the 18-month period granted by the 15c2-11 rules for shell companies to retain eligibility. These rules, which came into effect on September 28, 2021, provide a piggyback exception allowing broker-dealers to publish quotations for shell companies for a limited period of 18 months. This exception enables shell companies to complete a reverse merger with an operating business or begin operations themselves within the specified timeframe.

For companies that were shell companies on September 28, 2021, and still fall into the shell status, the 18-month period will expire on March 28, 2023. The panic is likely driven by the urgency for these companies to take appropriate actions within the given timeframe to maintain their eligibility under the 15c2-11 rules.

It's important for OTC Markets shell companies to carefully assess their situation, evaluate strategic options, and consider taking necessary steps to meet the regulatory requirements within the specified timeframe. This may involve pursuing a reverse merger, implementing a business plan to commence operations, or exploring other avenues that align with regulatory expectations. Companies facing this deadline should consult legal and financial professionals for guidance tailored to their specific circumstances.

What is a Shell Company?

The definition of a shell company, as per Rule 15c2-11, aligns with Securities Act Rules 405 and 144 and Exchange Act Rule 12b-2. It includes an issuer, excluding business combination-related shell companies and asset-backed issuers, that has no or nominal operations and either no or nominal assets, or assets consisting solely of cash or cash equivalents, or assets consisting of any amount of cash and cash equivalents and nominal other assets. Notably, startups or companies with limited operating history are not automatically deemed shells; a "reasonable basis" must be established for this determination based on factors such as public filings, financial statements, and business descriptions.

As the 18-month deadline approaches for companies that were shell companies on September 28, 2021, OTC Markets has provided FAQs for shell companies on its 15c2-11 resource center page. OTC Markets has also assigned a surveillance team to review shell status, and a company may be identified as a shell if it self-identifies as such in SEC periodic reports or reports filed with OTC Markets through the alternative disclosure system.

It's important to distinguish this process from the ongoing "shell risk" designation that OTC Markets may periodically apply to companies. The shell risk flag is determined at OTC Markets' discretion based on an evaluation of various metrics such as asset composition, operational expenditures, and income-related factors. If a company receives a shell risk flag, it has the opportunity to provide evidence, including changes in financial condition reflected in publicly reported financial statements, to request the removal of the flag.

What will Happen to a Shell Company That Has Remained a Shell for 18 Months?

If a company qualifies as a shell company and remains in that status for 18 months, it will lose piggyback eligibility under Rule 15c2-11. However, it won't lose the unsolicited quotation exception. If the company also fails to maintain current information as mandated by Rule 15c2-11, it will be shifted to the Expert Market on OTC Markets.

The move to the Expert Market means the company's securities will be quoted based on unsolicited customer orders and broker-dealer requests, but the absence of piggyback eligibility indicates a loss of efficiency in the quoting process. It's important for companies in this situation to diligently work towards regaining or maintaining compliance with Rule 15c2-11 to ensure optimal market access.

Piggyback Exception

Rule 15c2-11 is a crucial regulation governing when a broker-dealer can initiate or continue to quote a security. The rule mandates that there must be current public information about a company to facilitate a broker-dealer's information review, ensuring accuracy and reliability.

The piggyback exception is an important aspect of Rule 15c2-11, allowing a broker-dealer to rely on an information review completed by entities like OTC Markets or another broker-dealer. To qualify for this exception, certain conditions must be met, including the requirement for current and publicly available information, the presence of at least a one-way priced quotation from another broker-dealer, and a limitation on the number of consecutive days without a quotation.

Moreover, the rule sets specific criteria, such as the absence of an SEC trading suspension within the prior 60 calendar days and a restriction on shell companies that have been in that status for 18 months. If a company has been a shell for 18 months, it loses eligibility for the piggyback exception, impacting its ability to have its security quoted by a broker-dealer. The rule also includes a conditional 15-day grace period to continue quotations when current information becomes temporarily unavailable.

Unsolicited Quotation Exception

The unsolicited quotation exception provides an alternative for broker-dealers to quote a security, allowing for certain scenarios where a customer requests a quote for a security, and the broker-dealer provides the quote in response to that specific request. This exception is distinct from the piggyback exception, and its application is not affected by a company's status as a shell.

When a company loses piggyback eligibility due to being a shell for 18 months, it can still rely on the unsolicited quotation exception. This exception allows the company's security to be quoted by broker-dealers upon customer request, even if the piggyback exception is no longer available.

Despite losing piggyback eligibility, the company's quotation will still be visible on its OTC Markets quotation page. This ensures continued transparency and access to information for the public, even if the company no longer qualifies for the piggyback exception.

Warning! This security is eligible for Unsolicited Quotes Only

The cautionary messages and restrictions imposed on a security's quotation status highlight the challenges and risks associated with trading in stocks of shell companies, especially those subject to the restrictions of Rule 15c2-11. The distinction between proprietary broker-dealer quotations and unsolicited customer orders is crucial in understanding the limitations on market making and trading activities for these securities. The prevalence of trading on an unsolicited basis in the OTC Markets underscores the unique dynamics of these markets, where retail investors often drive activity based on their individual decisions rather than broker recommendations.

The regulatory framework, including the Penny Stock Act and Regulation Best Interest, contributes to the cautious approach taken by broker-dealers when dealing with penny stocks and low-priced, high-risk securities. The focus on risk disclosure and compliance obligations reflects the regulatory intent to protect investors from the inherent risks associated with these types of securities.

Overall, the evolving landscape of OTC Markets, combined with regulatory scrutiny and investor caution, underscores the need for transparency, due diligence, and risk awareness in the trading of such securities. Investors and market participants should carefully consider the specific characteristics and regulatory implications of these securities, recognizing the potential challenges and opportunities they present.

When Will Shell Company Status Be Determined?

The upcoming review of shell company status on March 28, 2023, marks a significant milestone for OTC Markets-listed companies that may be subject to the 18-month rule under Rule 15c2-11. Companies in this category should proactively engage with OTC Markets, providing comprehensive information that supports their argument against being classified as a shell company. This outreach process is essential for maintaining eligibility and avoiding potential disruptions in market access.

The emphasis on early and thorough communication with OTC Markets underscores the importance of companies taking a proactive approach to compliance and demonstrating their operational status. Providing OTC Markets with a detailed discussion about the company's development stage, revenue status, and other pertinent factors will contribute to a more informed decision on shell company classification.

Waiting until the last minute is not advisable, given the time constraints involved in the review process. Companies should act promptly to present their case and address any concerns raised by OTC Markets. This proactive engagement aligns with broader compliance best practices and helps companies navigate regulatory requirements effectively.

What Can a Shell Company do Today – and What it Should Not Do

Companies facing potential shell status under Rule 15c2-11 have several options to consider:

Maintain Current Strategy: Companies can continue with their current strategy, looking for an appropriate business combination target. When such a transaction is closed, the company can then follow the process to retain piggyback eligibility. It's important to note that merely announcing or signing definitive documents for a transaction does not impact shell status; the transaction must be completed.
Expedite Pending Transactions: If a shell company has a pending transaction, expediting the closing process before the March 28 deadline could be an option. This approach also allows for timely filing and review by OTC Markets.
Begin Organic Operations: A shell company contemplating organic operations can initiate these activities immediately. However, the operations must be genuine, and information about the new activities must be provided to OTC Markets with sufficient lead time before the March 28 deadline.
Caution on Placeholder Operations: If a shell company intends to establish temporary placeholder operations to avoid shell status, full disclosure of this intention is crucial. Failure to disclose such intentions could constitute securities fraud. Companies must be transparent about their plans, avoiding misleading statements or omissions that could be deemed fraudulent.

The cautionary note about fully disclosing intentions is particularly important, drawing parallels to historical instances of shell creation without adequate disclosure, leading to enforcement actions and legal consequences. Companies must adhere to securities laws, including Exchange Act Rule 10b-5, which prohibits fraudulent acts, untrue statements, or omissions of material facts in connection with the purchase or sale of securities.

The emphasis on transparent and accurate disclosure aligns with regulatory standards and helps companies navigate these complexities while maintaining compliance with securities laws.

What Can a Company Do to Re-Obtain Piggyback Eligibility?

If a shell company loses piggyback eligibility, it must undergo a new 15c2-11 review by either a broker-dealer or OTC Markets under the initial quotation standards when it ceases to be a shell company. Details on this process can be found in the blog links provided in the opening paragraph. OTC Markets conducts a 211 current information review only for companies applying to the OTCQB or OTCQX tiers of trading. With the increasing disclosure requirements in today's regulatory environment, a target company should ideally meet the criteria for trading on the OTCQB or OTCQX tiers, including obtaining audited financial statements, when considering going public via reverse merger with a public shell company that trades on the Pink Open Market.

Refresher on Current Information Requirements

Rule 15c2-11 aims to ensure adequate current information is available when a security enters the marketplace. Exchange Act Rule 15c2-11 outlines specific information required for maintaining a quotation, including a prospectus under the Securities Act of 1933 (such as a Form S-1), a qualified Regulation A offering circular, the company’s most recent annual and quarterly reports, information published pursuant to Rule 12g3-2(b) for foreign issuers, or specified information similar to those listed.

The 211 rules require current publicly available information to be timely filed or filed within 180 calendar days from a specified date, depending on the company's category. For SEC reporting issuers, the 180-day period begins on the date the reporting period ends. An alternative reporting (catch-all) company must ensure that current information is dated within 12 months of the quotation's publication, with a balance sheet less than 16 months old.

The rule allows a 15-day conditional grace period when current public information is no longer available within the 180-day specified period. Three conditions must be met for the grace period: a public determination by OTC Markets or FINRA that current public information is no longer available, all other conditions for reliance on the piggyback exception must be effective, and the grace period ends on the earliest of the company making current information available or the 14th calendar day after the public determination.

The chart provided in the text summarizes the time frames for which 15c2-11 information must be current and publicly available, timely filed, or filed within 180 calendar days from the specified period.

    
Category of Company 
    15c2-11 Current Information
  
    Exchange Act reporting company
    Filed within 180 days following end of a reporting period.

    Regulation A reporting company
    Filed within 120 days of fiscal year-end and 90 days of semi-annual period end.

    Regulation Crowdfunding filer
    Filed within 120 days of fiscal year-end.

    Foreign Private Issuer
    Since first day of most recent completed fiscal year, has filed information required to be filed by the laws of home country or principal exchange traded on.

    Catch-all company
    Current and publicly available annually, except the most recent balance sheet must be dated less than 16 months before submission of a quote and profit and loss and retained earnings statements for the 12 months preceding the date of the balance sheet.
 
Note that compliance with the requirement to include financial information for the 2 preceding years does not take effect until 2 years after the effective date (i.e., approximately 2 years and 2 months).  A catch-all company would still need to provide all other current information set forth in the rule, to qualify for the piggyback exception, beginning on the compliance date.

If a company fails to meet the current information requirements, it will be moved to the Expert Market. In the Expert Market, quotations are restricted from public viewing, and only broker-dealers and professional or sophisticated investors are allowed to view quotations in Expert Market securities. Despite these viewing restrictions, the Expert Market does not impose limitations on who can trade the securities. Rule 15c2-11 governs a broker’s ability to submit, publish, or distribute quotations (bids and offers) in OTC securities, and it doesn't regulate the underlying transactions or the ability of an investor to buy or sell a security.

While a company in the Expert Market will still have a quote page on the OTC Markets website, the quotes will not be visible to the public. The quote page will display two black diamonds and carry a message indicating the Expert Market status.

Warning! This security is traded on the Expert Market

The Expert MarketSM is designed to meet the pricing needs of broker-dealers and ensure investor best execution. In Expert Market securities, quotations are restricted from public viewing. OTC Markets Group has the authority to designate securities for quoting on the Expert Market in situations where it cannot confirm that the company is making current information publicly available under SEC Rule 15c2-11, or when the security is subject to other restrictions preventing public quoting. Additional information about the Expert Market can be found here.

Gayatri GuptaDecember 13, 2023

Nasdaq Compliance

The Nasdaq Stock Market features three tiers of listed companies, namely: (1) The Nasdaq Global Select Market, (2) The Nasdaq Global Market, and (3) The Nasdaq Capital Market. These tiers are characterized by progressively stringent listing requirements, with the Nasdaq Global Select Market setting the highest standards for initial listings and the Nasdaq Capital Market serving as the entry-level tier, particularly suitable for most small-cap issuers.

To list securities on Nasdaq, a company must fulfill minimum listing requirements, encompassing defined criteria related to financial performance, liquidity, and corporate governance. Nasdaq retains extensive discretion in the listing process and reserves the right to reject an application, even if the technical prerequisites are satisfied, if it deems such denial essential to safeguard the interests of investors and the public.

After securing a listing on Nasdaq, a company is obligated to adhere to ongoing listing standards. To initiate the listing process, a company seeking inclusion on Nasdaq must diligently complete and submit a comprehensive listing application to Nasdaq. This application should include specific documents and information as outlined by Nasdaq's requirements.

Typically, the application process spans a duration of four to six weeks. Once the application is submitted, a Nasdaq analyst is designated as the primary liaison with the company. Within two to three weeks of submission, the company can expect to receive an initial comment letter. The comment and review process persists until a decision is reached on the approval or denial of the application. Similar to filing with the SEC, a meticulously prepared Nasdaq application tends to attract fewer comments and facilitates a more streamlined process. Generally, the company's securities counsel assumes a leading role, serving as the primary contact for preparing the application and engaging in communication with Nasdaq.

Similarly to the SEC review process, Nasdaq conducts a thorough examination of publicly accessible information pertaining to a company. This encompasses, but is not limited to, SEC filings, the company's website, management communications and speeches, as well as press releases. The iterative nature of the review process typically doesn't necessitate a formal protocol, and communication is commonly facilitated through email correspondence and phone calls.

Listing Criteria For Nasdaq
For a company to list its securities on Nasdaq, it must satisfy the following criteria:

Specific Initial Requirements:
- Quantitative Standards: Meeting defined thresholds for both quantitative and qualitative factors.
- Qualitative Standards: Fulfilling certain qualitative benchmarks.
Continuing Requirements:
- Quantitative Criteria: Adhering to ongoing quantitative benchmarks.
- Qualitative Criteria: Maintaining specified qualitative standards.

The initial quantitative thresholds are typically set at a higher level than those required for continued listing. This distinction aims to ensure that companies achieve a sufficient level of maturity before being listed. Additionally, Nasdaq imposes rigorous corporate governance standards that listed companies must adhere to throughout their tenure on the exchange.

Before formally submitting a comprehensive listing application, a company has the option to pursue a preliminary listing eligibility review. In this stage, the Listing Qualifications Staff conducts a thorough examination of the company's public filings to assess its compliance with numerical listing requirements. Additionally, the team evaluates the company's adherence to corporate governance requirements outlined in the Marketplace Rules ("Rules"). This preliminary review provides valuable insights into the company's eligibility for listing on Nasdaq before committing to the full application process.

Upon completion of the preliminary review, the Listing Qualifications Staff will make an assessment regarding whether the company meets the numerical listing criteria. Additionally, any corporate governance or regulatory concerns raised during this phase will be considered to determine their impact on the listing approval. It's important to note that while the preliminary review provides insights, final approval necessitates the submission of a formal listing application. This application undergoes a thorough examination by the NASDAQ Listing Qualifications Staff. Furthermore, the final approval process involves satisfactory compliance with specific qualitative reviews. This includes an examination of the regulatory history of the company's officers, directors, and significant shareholders. Meeting these criteria is integral to obtaining the final approval for listing on Nasdaq.

Financial And Liquidity Requirements

    Requirements

    Equity Standard
    Market Value of Listed Standard
    Net Income Standard

    Listing Rules

    5505(a)
and
5505(b)(1)
    5505(a)
and
5505(b)(2)
    5505(a)
and
5505(b)(3)
    
    Stockholders Equity

    	$5 million
    	$4 million
    	$4 million
    
    The market value of publicly held shares

    $15 million
    $15 million
    $
      5 million
    
    Operating History

    	Two years
    N/A
    N/A
    
    The market value of listed securities

    N/A
    $50 million
    N/A
    
    Net income from continuing operations (in the latest fiscal
a year or in two of the last three
fiscal years)

    N/A
    N/A
    $750,000
    
    Publicly held shares

    	1 million
    	1 million
    	1 million
    
    Bid Price

    	$4
    	$4
    	$4)
    
    Closing Price

    	$3
    	$2
    	$43
    
    Corporate Governance

    Yes
    Yes
    Yes
    
    Total Shareholders

    300
    300
    300

Corporate Governance Requirements

Across all three tiers of the Nasdaq Stock Market, corporate governance requirements remain largely consistent. The categories encompassing corporate governance standards include:

Distribution of Annual or Interim Reports
Independent Directors
Audit Committee
Compensation Committee
Nomination of Directors
Code of Conduct
Annual Meetings
Solicitation of Proxies
Quorum
Conflict of Interest
Shareholder Approval
Voting Rights

These governance elements play a crucial role in ensuring transparency, accountability, and ethical conduct within listed companies, irrespective of the specific tier within the Nasdaq Stock Market.

Companies seeking listing on Nasdaq must adhere to specific corporate governance standards, including the following:

Compensation Committee with Independent Directors:
- The company is required to establish a compensation committee comprised of independent directors.
- The committee must consist of at least two members.
- Rule 5605(d)(2)(A) introduces an additional independence test for compensation committee members.
Responsibility for Executive Compensation:
- The compensation committee is tasked with determining or recommending to the entire board the compensation of the chief executive officer (CEO) and all other executive officers.

These standards are designed to ensure a level of independence and scrutiny in the decision-making processes related to executive compensation within the company.

The Application And Documents

The Nasdaq application package encompasses several key components:

Symbol Reservation Form:
- Used to request the reservation of a specific trading symbol for the company.
Listing Application:
- Requires supplemental documents and details about the company's financials, operations, and other pertinent information.
Listing Agreement:
- A formal agreement outlining the terms and conditions of the listing on Nasdaq.
Corporate Governance Certification:
- A certification affirming the company's commitment to meeting Nasdaq's corporate governance standards.
Initial Application Fee:
- Payable via check or wire transfer, this fee is a prerequisite for initiating the listing process.
Logo Submission Form:
- Used for submitting the company's logo for use in Nasdaq's materials.

These application forms are completed through the Nasdaq website listing center, utilizing the online platform to facilitate the submission of supplemental and supporting documents. It is advisable to thoroughly review all required paperwork in advance, ensuring that the necessary information is readily available before initiating the application process.

Symbol Reservation Form

The symbol reservation form is a concise, one-page electronic form where applicants input information for Nasdaq's consideration. Nasdaq symbols, limited to 1-5 characters, adhere to guidelines established by the Intermarket Symbols Reservation Authority (ISRA). The ISRA system is designed to organize symbols efficiently, prevent duplication, and reduce programming and operational complexities. The ISRA operates within the framework of the NMS Symbology Plan, a plan utilized by Nasdaq.

Key details about the symbol reservation process:

Symbol Choices:
- The form allows applicants to propose three symbol choices in order of preference.
- While Nasdaq generally honors the first choice if available, it retains the authority to assign, rescind, or reassign a trading symbol at its discretion.
ISRA and Nasdaq Authority:
- The ISRA and Nasdaq have overarching authority in managing the assignment of symbols.
Additional Information:
- The form captures essential details about the issuer and the planned public offering.
- Information may include the name of the attorney, lead underwriter (if applicable), CEO and CFO names, yearly revenues, company website, and the sector in which the company operates.

Completion of this symbol reservation form initiates the process of securing a trading symbol on Nasdaq, and it's essential to provide accurate and comprehensive information to facilitate this stage of the listing application.

The Application

The Nasdaq listing application process is comprehensive and varies based on the circumstances surrounding the listing sought. There are twelve distinct listing applications catering to different situations, including changes of control, switches from other exchanges or markets, spin-offs, and initial public offerings (IPOs). Each application, spanning approximately seven pages, collects detailed information about the company, covering areas such as address, contact and billing details, securities attorney and auditor information, transfer agent particulars, and the company's officers and directors. Specific information on the company's securities, including type, par value, and cusip number, is also required.

Furthermore, the application mandates disclosure of legal proceedings involving the company, its officers or directors, or significant shareholders over the past ten years. This encompasses inquiries, investigations, lawsuits, litigation, arbitrations, and other legal and administrative proceedings. Documents supporting the backup and final disposition of these matters must be provided.

Regarding private offerings within the prior six months, including bridge financings, shelf registrations, and Regulation S offerings, the company is required to disclose such activities. Additionally, the application delves into the company's background, posing questions to ensure compliance with seasoning rules.

While Nasdaq retains the right to request relevant supporting documents, specific documents are mandatory based on the application type. For an uplisting from an existing U.S. market, the application must include letters from three market makers confirming their commitment to making a market in the subject securities. Other required documents include a listing agreement, a logo submission form, a corporate governance certification form, regulatory correspondence over the past 12 months, and shareholder confirmation documents. Nasdaq often seeks confirmation from the company's transfer agent regarding the eligibility of the security for the direct registration program (DRS).

During the review of an up listing application, Nasdaq may request additional information, such as a Broadridge share range analysis and NOBO list, a certified shareholder list, details about mitigating any going concerns or opinions, income statement and/or balance sheet projections for the next 12 months, and confirmation of Sarbanes Oxley Section 302 and 906 certifications by the company, among other inquiries related to compliance and financial matters.

The Listing Agreement

The Listing Agreement is a concise document, spanning two pages, serving as a formal affirmation of the company's commitment to adhere to all rules and regulations set forth by the Nasdaq Stock Market. It includes provisions for indemnifying and holding Nasdaq harmless from liability. Notable points in the agreement include:

Compliance Assurance:
- The company explicitly agrees to comply with all rules and regulations stipulated by the Nasdaq Stock Market.
Indemnification Clause:
- The company indemnifies Nasdaq, meaning it undertakes to compensate or reimburse Nasdaq for any losses or damages incurred. This includes harm resulting from third-party trademark infringement claims related to the company's symbol and logo, as well as Nasdaq's use of the same.
Disclaimer of Warranty and Liability:
- The agreement contains a disclaimer of warranty and liability against Nasdaq for trading issues, with the exception of those resulting from gross negligence or willful misconduct.

This agreement establishes a clear framework for the relationship between the listed company and Nasdaq, emphasizing the company's commitment to regulatory compliance while providing indemnification for certain specified matters and delineating the scope of Nasdaq's liability.

Corporate Governance Certification Form

The corporate governance certification form certifies compliance with the governance requirements related to an audit committee, director nomination process, compensation committee, board composition, executive sessions, quorum, and codes of conduct. Where an exemption applies, the form requires specification of the exemption terms. The document specifies the different rules and exceptions in a check-the-box format.

Logo Submission Form

The logo submission form contains the guidelines for the logo and affirms Nasdaq’s rights to use the same. Nasdaq uses company logos in its marketing materials, on the MarketSite Video Wall and Tower, and websites.

Fees

Entry fees are based upon the aggregate number of shares to be listed at the time of initial listing, regardless of class, with a maximum cap of $75,000. Fees are assessed on the entry date in The Nasdaq Capital Market, except for $5,000, representing a non-refundable application fee. This fee must be submitted with the company’s application.

Nasdaq does not charge application or entry fees for any securities transferred from a national securities exchange.

Benefits Of Trading On An Exchange

There are many benefits to trading on an exchange instead of the OTC Markets. The most significant benefits to a business are the ability to attract analyst coverage and institutional investors and the corresponding increase in liquidity that comes with both. Stocks that trade on Nasdaq tend to have a lower bid/offer spread — again encouraging trading volume and liquidity. Exchange-traded securities are exempt from the penny stock definition, allowing more market maker and broker-dealer participation. As further explained below, a broker-dealer cannot recommend a penny stock transaction to its retail clients. Therefore, no analysts, financial advisors, or institutional investors make recommendations for purchases of penny stocks.

As an aside, this is one of the reasons that OTC Markets created the OTCQX market tier, which does not list penny stocks. It is also why the small-cap industry is pushing for a supported valid venture exchange (for further reading.

In today’s world, depositing stock and/or trade-in non-exchange traded securities is increasingly difficult. Despite the congressional efforts and SEC rulemaking in support of small-cap capital formation (for example, the JOBS Act, including the emerging growth company regulations, new Regulation A+ and Title III Crowdfunding and the new FAST Act), through enforcement and investigative proceedings, both the SEC and FINRA continue to apply pressure on broker-dealers, clearing firms and transfer agents to reduce the secondary trading and free flow of penny stocks. For more information on difficulties in depositing stocks.

Further On Penny Stocks

NASDAQ and NYSE MKT traded securities are exempted from the definition of a “penny stock” due to the initial and ongoing listing standards. Penny stock rules focus on broker-dealers’ activity in effectuating trades in penny stocks. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the “Penny Stock Act”) prohibits broker-dealers from effecting transactions in penny stocks unless they comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The rules promulgated thereunder, particularly Exchange Act rules 15g-1 through 15g-100 (the “penny stock rules”).

Section 15(h) of the Exchange Act provides that no broker or dealer may effectuate a customer’s purchase or sale of any penny stock unless such broker or dealer.

Approves the customer for the specific penny stock transaction and receives a written agreement to the transaction from the customer.
Furnishes the customer a risk disclosure document describing the risks of investing in penny stocks.
Discloses to the customer the current market quotation, if any, for the penny stock, including the bid and ask prices and the number of shares that apply to such bid and ask prices.
Discloses to the customer the amount of compensation the firm and its broker will receive for the trade.

In addition, after executing the sale, a broker-dealer must send its customer monthly account statements showing the market value of each penny stock held in the customer’s account.

Moreover, brokers and dealers subject to the penny stock rules are subject to additional disclosure requirements outlined in Rules 15g-2 through 15g-9. For my information on penny stocks and the rules affecting broker-dealer activity.

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