OTC 101 - Regulation

The Basics
The OTC market and broker-dealers’ activities in the market are regulated by The Financial Industry Regulatory Authority (FINRA), the U.S. Securities and Exchange Commission (SEC) and various state securities regulators. As well, companies with SEC-registered securities are regulated by the SEC. Pink OTC Markets is neither a stock exchange nor a self-regulatory organization (SRO) and is not regulated by either FINRA or the SEC.

Complaints regarding companies should be directed to the SEC, while complaints regarding broker-dealers or other investment professionals should be directed to FINRA.

The Rules
Key OTC market regulations include:

• Best Execution (FINRA Rule 2320)
• Limit Order Protection (FINRA Manning Interpretation – IM 2110-2)
• Firm Quotes (FINRA Rule 5220 & IM-5220)
• Initial Quote Disclosure Requirements (FINRA Rule 6440)
• Short Position Disclosure (FINRA Rule 34560)
• Minimum Quotation Size Requirements (FINRA Rule 6450)

Best Execution (FINRA Rule 2320) – FINRA requires member firms to find the market with the best price to execute their customer order. Pink Quote and the OTCBB Quotation System are the two recognized inter-dealer quotation systems for facilitating electronic best execution by broker-dealers. The two quotation systems may only be used to satisfy best execution if there are two or more priced quotes in a security. If less than two priced quotes exist for a security, broker-dealers must contact three other dealers for priced quotations. See complete text of Rule 2320.

Plain speak: Broker-dealers may not give their customers prices inferior to those currently being quoted on inter-dealer quotation systems.

Limit Order Protection (FINRA Manning Interpretation – IM 2110-2) – FINRA members may not trade for their own account at prices that would satisfy Limit Orders currently within their order book. See complete text of IM 2110-2.

Plain speak: Broker-dealers cannot use their knowledge of customer orders to provide customers with inferior prices. For example, buying a security for less than a known Limit Order price and then selling the security to the customer at the Limit Order price.

Firm Quotes (FINRA Rule 5220 & IM-5220) – FINRA requires every member to trade a security at its publicly quoted (Pink Quote or OTC Bulletin Board) price and size. See complete text of Rule 5220.

Plain speak: Broker-dealers must honor quotes posted on an inter-dealer quotation system.

Initial Quote Disclosure Requirements (FINRA Rule 6440) – To initiate quotations on an inter-dealer quotation system for an OTC security not currently being quoted or to resume quotations after a four day absence or SEC suspension, a market maker must submit a Form 211 to FINRA. Once FINRA approves the 211, the market maker may submit a quotation to the applicable inter-dealer quotation system(s) they selected on the Form 211. See complete text of Rule 6440.

Plain speak: In most cases, FINRA approval of Form 211 is required for new quotation on Pink Quote or the OTCBB.

Short Position Disclosure (Rule FINRA 4560) – FINRA members must report their short interest positions in OTC equity securities at mid-month and end of the month. See complete text of Rule 4560.

Plain speak: FINRA publishes the short interest list seven days after the 15th and last day of each month. This information is available for every OTC security on OTCMarkets.com.

Minimum Quotation Size Requirements (Rule FINRA 6450) – FINRA members acting as market makers by submitting quotations into an inter-dealer quotation system must adhere to the minimum size requirements set by FINRA. For example, all quotations with a price less than or equal to $.50 must have a minimum size of 5,000 shares. See complete text of Rule 6450 and view complete price-size table.

Plain speak: Broker-dealers must post quotes in an inter-dealer quotation system of certain minimum sizes.

More information may be found in Pink OTC’s ‘OTC Market Regulation’ or on the FINRA and SEC websites.

Feeling smart? Let’s delve into some more complex concepts and OTC Market scenarios in Part 4 – Advanced Concepts.

http://www.otcmarkets.com/learn/regulation