The Financial Industry Regulatory Authority (FINRA) published a regulatory notice (RN 21-32) on September 14, 2021 requesting comment on its policy relating to the assignment of OTC symbols to unlisted equity securities. FINRA is considering whether it should begin assigning OTC symbols to unlisted equity securities that do not have a valid CUSIP identifier, in the limited circumstance where a broker-dealer demonstrates its best efforts to obtain a CUSIP identifier and provides documentation to identify the security.
Although FINRA is not yet proposing rule changes on this policy, if it moves forward with the concepts in RN 21-32, it could result in enhanced trade reporting and price transparency for digital asset securities, among other types of unlisted equity securities. The comment period for RN 21-32 expires on November 15, 2021.
ISSUE WITH ASSIGNING OTC SYMBOLS
According to FINRA, its rules require that broker-dealers report trades in OTC equity securities and trades in restricted equity securities effected pursuant to Rule 144A of the Securities Act of 1933 to the OTC Reporting Facility (ORF). Trades in OTC equity securities reported to the ORF are publicly disseminated, integrated into FINRA’s audit trail and, at the option of the reporting firm, submitted to the National Securities Clearing Corporation (NSCC) for clearance and settlement. Trades in restricted equity securities effected pursuant to Rule 144A are reported to the ORF for regulatory purposes only and are not publicly disseminated or sent to NSCC.
In connection with this process, FINRA assigns OTC symbols to OTC equity securities and Rule 144A restricted equity securities to assist broker-dealers in their reporting obligations and in connection with the initiation of quoting in an unlisted equity security. As a policy matter, FINRA requires that a security have a valid CUSIP identifier before an OTC symbol will be assigned to it. Currently, FINRA does not assign an OTC symbol to securities that do not have a CUSIP, and in some instances, issuers are unwilling to work with a broker-dealer in getting a CUSIP assigned. In these circumstances, broker-dealers cannot report trades in the unlisted equity securities to the ORF and must use Form T to report these transactions. As discussed in RN 21-32, the use of Form T is burdensome, and trades reported on Form T are neither publicly disseminated nor integrated into FINRA’s audit trail on an automated basis. FINRA noted that these issues arise for trades in the following types of unlisted equity securities:
- Previously restricted equity securities after the statutory holding period has expired (once freely tradable, the security is an OTC equity security and trades must be reported accordingly)
- Rule 144A restricted equity securities
- Non-listed direct participation programs (DPPs) and real estate investment trusts (REITs)
- Equity securities issued under Section 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 permit the assignment of OTC symbols to OTC equity securities and Rule 144A restricted equity securities that do not have a valid CUSIP identifier in limited circumstances. Firms requesting OTC symbols for such securities would be required to:
- demonstrate their best efforts to obtain a CUSIP identifier for a security; and
- provide documentation sufficient to identify and categorize the security, including, e.g., that it is an unrestricted equity security (unless traded pursuant to Rule 144A).
To demonstrate best efforts at obtaining a CUSIP, FINRA notes that broker-dealers 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 pertinent offering documents, or a numeric or other publicly available identifier for the security—e.g., ISIN, if applicable. Notably, if documentation provided by a broker-dealer is not sufficient to identify and categorize the security, FINRA states that its staff also may require that a broker-dealer provide an opinion of counsel. That said, FINRA also states that broker-dealers generally would be expected to provide an opinion of counsel that an instrument, such as a digital asset security, is an unrestricted equity security or a Rule 144A restricted equity security (and thus reportable to the ORF). FINRA noted that the assignment of an OTC symbol would not necessarily mean that FINRA agrees with the requesting firm that the instrument is an equity security and that it could deny a request for an OTC symbol if the documentation provided does not adequately demonstrate that the security is an unrestricted equity security.
Although FINRA defends the economics of the policy change by noting an increase in market transparency and a reduced burden in not having to use Form T, FINRA recognizes that the proposed policy may introduce a new risk to firms and investors. FINRA points out that a valid CUSIP may provide additional assurances to FINRA regarding the existence and uniqueness of a security; the lack of a valid CUSIP would require FINRA to more heavily rely on the documentation and information provided by the broker-dealer.
FINRA appears to ignore the potential significant challenges and upfront financial costs to broker-dealers that might seek to obtain opinions of counsel regarding the status of assets as equity securities. This issue is of particular concern in the digital asset space where SEC guidance increasingly comes in the form of enforcement actions rather than actionable policy statements. Indeed, absent clear guidance from the SEC on the status of digital asset securities, law firms may be reluctant to issue opinions out of concern for liability for themselves and their clients. In addition, FINRA seems to ignore the potential chilling effect regarding communications with issuers when it suggests that broker-dealers would be able to simply share with FINRA communications with issuers, and potentially expose issuers and broker-dealers to liability if the communications are misconstrued or taken out of context.
Ultimately, while FINRA’s proposed policy change is intended to increase market transparency, if implemented as proposed, it may result in the opposite effect. To this end, broker-dealers and issuers alike should consider submitting comments on RN 21-32 highlighting their concerns so that FINRA can adequately consider all potential concerns associated with this policy change.