FINRA Regulatory Notice 21-03 – Fraud Prevention – Low Priced Securities

On February 10th, FINRA published Regulatory Notice 21-03 which focuses on fraud prevention for low-priced exchange-listed and OTC securities. The communication urges firms to review their policies and procedures relating to red flags of potential securities fraud involving low-priced securities. At the detailed data level, the notice references many of the concepts and data points OTC Markets Group has been proactively implementing over the course of the last decade to increase transparency and efficiency in the market. Our latest blog delves into the detection and monitoring points raised, location and availability of the data and how best to incorporate the information into a low-priced security risk program.

The notice is very explicit in identifying and defining key indicators of fraud involving low-priced securities. Within the ‘Issuers’ section, every defined indicator is currently a data point which is monitored by OTC Markets, including:

Promotion – OTC Markets has been monitoring promotion for both OTC and small cap-listed securities since 2018. Current promotions are flagged on security quote pages and on the compliance statistics page on Complete historical data and respective dates are identified within our Compliance Analytics product and our web-based solution – Canari.

Shells &  Shell Risk OTC Markets flags ‘Shells’ and ‘Shell Risk,’ which identifies companies that display characteristics common to shell companies, on while our compliance products note former shells (look back of 5 years) and shell risk issuers.

Hot Sector – Our ‘Hot Sector’ concept monitors securities affiliated with volatile, retail-driven sectors. Currently, we have identified the following hot sectors: Cannabis, Crypto and Covid-19. Hot Sector data is only available through our Small Cap listed, Compliance Analytics and Canari products.

Prohibited Service Providers – For more than 10 years, OTC Markets has catalogued and made publicly available a Prohibited Attorney’s list. In 2015, we supplemented this list to include other types of Service Providers.

Disclosure Information/Market Tiers – One of our original designations, our market tiers are available for every OTC security on and included in all of our real-time, reference and compliance data products. Details on our market tiers and their respective disclosure rules may be found here.

Within our compliance product suite, we also track the following data points mentioned in the FINRA notice: Company Name Changes, Reverse Splits, Microcap status, Shares Outstanding and Price Volume Change Data.

The monitoring section focuses on the definition of low-priced security policy and the implementation of repeatable processes for the monitoring of those policies. Both directives require a holistic understanding of the data and the tools necessary to automate/standardize the workflows. A few key takeaways:

Issuer + Customer Information – the notice outlines a number of monitoring best practices whereby the combination of Issuer information (e.g. promotion, shell status, activity) with customer specific information (e.g. position, customer activity, % of shares outstanding) is crucial to understanding overall risk. Programs which do not successfully integrate the two data sets will overlook risky scenarios, create false positives, and increase manual due diligence requirements.

Low-Priced Securities | Listed & OTC – the notice clearly recommends that low-priced securities policies and procedures must be put in place regardless of the market on which these securities are traded. They explicitly call out listed securities in a number of their best practices, for example within the ‘Other Controls’ section, “identifying and, if necessary, prohibiting customers from opening new accounts with, or depositing in existing accounts, restricted shares of low-priced listed or low-priced OTC securities;”

There are currently 633 listed securities trading below $5.00 and 1452 securities with a market cap of less than 300 million – ‘microcap securities’ by SEC definition*. These securities should be included in any comprehensive low-priced security (LPS) program.

Automation – FINRA lists over 19 best practices within the monitoring section and over 22 items within the detection section. This scale and type of oversight requires that automation be leveraged across the organization. As noted above, customer and issuer risk information must be integrated in order to establish the foundation for policy and surveillance programs.

Automation can highlight risk areas, but often more importantly, it can assist in triaging risk issues. Our Compliance Analytics and Small Cap Analytics products quantify issuer risk across 19 and 14 factors respectively. This data, when combined with customer information, can prioritize issues and automate processes that dictate when additional review/approval is required. This way personnel can quickly address high-risk, high-impact situations.

Notice 21-03 provides a very comprehensive view into FINRA’s expectations for compliance groups as it pertains to low-priced securities, both listed and OTC. The notice does not create any new requirements, but it does compile existing compliance guidance and best practices into a checklist which firms must assume will be reviewed.

OTC Markets Group’s compliance-focused data points and risk scoring solutions can assist firms in building a data-driven program which evaluates red flags, leverages automation, and most importantly, helps reduce fraud in the U.S. small cap markets.

*data as of February 22, 2021


Matthew Fuchs, EVP of Market Data, leads the product development, distribution and sales of market data at OTC Markets Group. Prior to joining OTC Markets Group, he served in a number of financial technology roles at the National Research Exchange, Bearing Point and Arthur Andersen. Matt received a BA from Columbia University

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