The Financial Sector Regulatory Authority (FINRA) has published a regulatory notice (RN 21-32) on September 14, 2021 soliciting comments on its policy relating to the allocation of OTC symbols to unlisted equity securities. FINRA is considering whether it should start assigning OTC symbols to unlisted equity securities that do not have a valid CUSIP ID, in the limited case where a broker makes its best efforts to obtain a CUSIP ID and provides documentation to identify the title.
Although FINRA is not yet proposing any changes to the rules of this policy, if it goes ahead with the concepts of RN 21-32, it could lead to improved trading relationships and price transparency for securities. digital assets, among other types of unlisted equity securities. The comment period for RN 21-32 expires November 15, 2021.
OTC SYMBOL ASSIGNMENT PROBLEM
According to FINRA, its rules require brokers to report OTC equity transactions and restricted equity transactions made in accordance with Rule 144A of the Securities Act of 1933 to the OTC Reporting Facility (ORF). OTC equity transactions reported to the ORF are publicly disclosed, included in FINRA’s audit trail and, at the reporting company’s option, submitted to the National Securities Clearing Corporation (NSCC) for clearing and regulation. Restricted equity transactions conducted in accordance with Rule 144A are reported to ORF for regulatory purposes only and are not publicly disclosed or sent to NSCC.
As part of this process, FINRA assigns OTC symbols to OTC equity securities and Rule 144A restricted equity securities in order to assist broker-dealers in their reporting obligations and in the during the initiation of the listing of an unlisted equity security. In terms of policy, FINRA requires that a security have a valid CUSIP identifier before an OTC symbol is assigned to it. Currently, FINRA does not assign an OTC symbol to securities that do not have a CUSIP, and in some cases issuers are unwilling to work with a broker to obtain a CUSIP. In these circumstances, brokers cannot report transactions in unlisted equity securities to the ORF and must use Form T to report these transactions. As noted in RN 21-32, the use of Form T is cumbersome and transactions reported on Form T are neither publicly disclosed nor incorporated into FINRA’s audit trail on an automated basis. FINRA noted that these issues arise for transactions in the following types of unlisted equity securities:
- Equity securities previously restricted after the expiration of the legal holding period (once freely tradable, the security is an OTC equity security and transactions must be reported accordingly)
- Rule 144A Restricted Equity Securities
- Unlisted Direct Participation Programs (DPP) and Real Estate Investment Trust (REIT)
- Equity securities issued under article 1145 of the Bankruptcy Code by companies emerging from bankruptcy
- More recently, digital asset securities
PROPOSED POLICY CHANGE
FINRA is considering changing its policy to allow the allocation of OTC symbols to OTC equity securities and Rule 144A restricted equity securities that do not have a valid CUSIP identifier in limited circumstances. Companies requesting OTC symbols for these titles would be required to:
- demonstrate their best efforts to obtain a CUSIP identifier for a title; and
- provide sufficient documentation to identify and categorize the security, including, for example, that it is an unrestricted equity security (unless it is traded in accordance with Rule 144A).
To demonstrate the best efforts to obtain a CUSIP, FINRA notes that brokers could submit copies of correspondence with the issuer or a written summary of its attempts to work with the issuer. Documentation to identify and categorize the security could include the prospectus or other relevant offering documents, or a numeric or other publicly available identifier for the security, for example, ISIN, if applicable. Notably, if the documentation provided by a broker is not sufficient to identify and categorize the security, FINRA states that its staff may also require a broker to provide legal advice. That said, FINRA also states that broker-dealers should generally provide legal advice that an instrument, such as a digital asset security, is an unrestricted equity security or a restricted equity security. of rule 144A (and must therefore be declared to the ORF). FINRA noted that the attribution of an OTC symbol would not necessarily mean that FINRA agrees with the requesting company that the instrument is an equity security and that it could deny a request for an OTC symbol. over-the-counter if the documentation provided does not adequately demonstrate that the security is an unrestricted equity security.
While FINRA defends the economics of policy change by noting an increase in market transparency and a reduced burden by not having to use the T-form, FINRA recognizes that the proposed policy may introduce a new risk to them. businesses and investors. FINRA points out that a valid CUSIP may provide additional guarantees to FINRA regarding the existence and uniqueness of a security; the absence of a valid CUSIP would force FINRA to rely more on the documentation and information provided by the broker.
FINRA appears to ignore the potential significant challenges and upfront financial costs for brokers who might seek legal advice regarding the status of assets as equity securities. This issue is of particular concern in the realm of digital assets, where SEC guidance increasingly comes in the form of enforcement actions rather than actionable policy statements. Indeed, in the absence of clear guidance from the SEC on the status of digital asset securities, law firms may be reluctant to issue opinions out of concern for accountability to themselves and their clients. Further, FINRA appears to ignore the potential disincentive for communications with issuers when it suggests that brokers could simply share communications with issuers with FINRA, and potentially expose issuers and brokers to liability if communications are misinterpreted or taken out of context.
Ultimately, although the policy change proposed by FINRA is aimed at increasing market transparency, if implemented as proposed, it may have the opposite effect. To this end, brokers and issuers should consider submitting comments on RN 21-32 outlining their concerns so that FINRA can adequately address any potential concerns associated with this policy change.