Exploring the Fundamentals: How the OTC Markets Work

Every day, regulated broker-dealers, public companies, and their investors, depend on OTC Markets to trade and value billions of dollars of securities. Our mission is to create better-informed and more efficient financial markets, and we provide our users with the tools, transparency, and technology to succeed in the public markets.   

In this piece, we take a closer look at what differentiates OTC Markets Group, including our market structure, our disclosure services, and our regulatory environment.  In September 2021, the SEC’s amendments to Rule 15c2-11 (“Rule 211”) will alter the regulatory landscape and allow us to bring greater organization to the OTC market.

A Closer Look at OTC Trading

We operate the regulated electronic market where SEC-registered, FINRA-member broker-dealers efficiently trade OTC securities.  Competing broker-dealers (“market makers”) display the price at which they are willing to buy (the “bid”) a security, and the price at which they are willing to sell (the “ask”).  Our real-time data allows broker-dealers to execute client trades at the best prices with a choice of counterparties.    

Industry-leading market makers, such as Citadel Securities, GTS, Jane Street, StoneX, Susquehanna/G1X and Virtu, make up the diverse community of 90+ regulated broker-dealers providing continuous liquidity and execution services for investors.  Market makers attract business by competing on price, execution quality, and their ability to fill large or specialized orders.

Market makers serve thousands of online, retail, and institutional broker-dealers that send investor orders to be executed electronically, at the best price.  With a broad range of industry expertise, our diverse community of regulated market makers can trade everything from smaller, innovative, and entrepreneurial companies, to investor-focused community banks and international companies.

Our SEC and FINRA Regulated Alternative Trading Systems (“ATS”)

Our registered trading platforms, OTC Link® ATS and OTC Link ECN, enable investors to easily trade through the broker of their choice and empower companies to improve the quality of information available for investors.  Both of our platforms are highly regulated by the SEC, and OTC Link ATS is an SCI regulated entity.

OTC Link ATS is what’s known as a qualified interdealer quotation system (“Qualified IDQS”) that electronically connects a network of regulated broker-dealers.  With the upcoming changes to Rule 211, OTC Link ATS will play a greater role in bringing a company onboard to begin to be quoted on our markets, as well as monitoring ongoing issuer disclosure. This new regulatory status will also streamline a company’s pathway to the public markets.

Built for Diverse Companies, from Early Stage to Investment Grade

Public companies have a duty to disclose financial and other material information, so investors have timely, accurate, and complete information to make thoughtful decisions about when or where to invest.  OTC Markets provides companies with the platform to be public and the tools they need to provide ongoing disclosure, certify their compliance with U.S. securities laws, and demonstrate their corporate governance best practices.

Our data-driven market standards and rules incentivize company disclosure and the public availability of data, so that investors can find the right price in a diverse range of companies.  We organize companies into tiers, largely based on the quality of their public disclosure, and recognize multiple financial reporting standards to efficiently support companies of all sizes, industries, and geographies.  Our tiered market structure scales to work for small and mid-size companies as they seek to mature and grow, while also providing a global gateway for international companies to efficiently access U.S. public markets.  As companies establish their operations, improve their corporate governance, and increase their public disclosure, they can qualify to move up through our markets.

Transparency Driven by an “Information-First” Focus

Over the course of the last 20 years, our markets have increased the level of transparency and improved availability of information for investors. These enhancements have helped to improve the capital formation process and underscore the concept that we designed our markets for companies that want to do the right thing.

Our tiered markets, OTCQX, OTCQB and Pink, continue to evolve to support the needs of public companies.  Advancements in technology allow markets to become more diverse and trading to become more decentralized.  Access to digital information makes markets efficient and connects all participants equitably.  We recognize a variety of disclosure standards which allow companies to provide the best disclosure in the most effective manner possible.  This framework also permits investors to decide on the merits of an investment.  In most instances, the market feedback process works, and companies end up with a fair valuation as a result.

By offering an efficient platform to be public, more companies are choosing to share information with investors than ever before. Today, OTCQX, OTCQB and Pink companies that provide current information to investors comprise approximately 99% of total OTC dollar volume.

Regulatory Oversight of the OTC Markets

As our mission critical market infrastructure has become a backbone of the public markets, the recognition of our role and associated regulatory responsibilities has advanced in a manner similar to that of the exchanges.

Today, the majority of U.S. states recognize OTCQX and OTCQB market disclosure standards for compliance with Blue Sky laws, and the upcoming changes to Rule 211 codify our critical role in monitoring ongoing issuer disclosure.

Unlike the exchanges, OTC Markets Group is not an “SRO” or Self- Regulatory Organization.  We rely on the SEC to enforce securities laws and FINRA to regulate broker-dealers.  Only the SEC can suspend a security from trading; however, we will remove securities from the OTCQX and OTCQB markets when they fail to meet the market standards or when they give rise to public interest concerns.  For all OTC securities, FINRA is the only designated SRO that can halt trading.

Exchanges, and market operators such as OTC Market Group, do not have the power to prosecute companies or take legal action against officers, directors or investors that violate securities laws.  The SEC’s Division of Enforcement —takes responsibility for investigating possible violations of securities laws, and, in conjunction with the U.S. Department of Justice, prosecuting criminal actions.

Issuer Compliance:  How We Monitor Companies

We frequently receive questions regarding how we determine which companies comply with our market standards.  Our Issuer Compliance team is responsible for evaluating company compliance with OTCQX and OTCQB qualifications, as well as monitoring for incidences of stock promotion and other potential public interest concerns.

We use data-driven disclosure processes to monitor securities based on criteria and rules in place as well as the timeliness of their disclosure.  We monitor market activity and real-time feedback to identify outliers or concerns.  In many cases, OTC Markets Group makes the request to company executives to provide additional public disclosures to the market.

It is the responsibility of a public company’s management and directors to comply with securities laws, be truthful and provide the investing public with timely and accurate disclosure.  With that comes a duty to immediately release material news to the market and correct any misinformation that can affect the market pricing process.

Compliance Flags Help Better-inform Investors

One of our roles as a market operator is to help protect investors by arming them with key information.  Our compliance team uses ‘flags’ or icons such as Stop, Yield or CE (Caveat Emptor) to inform investors where there are gaps in company disclosure.  We also identify other potential risks we see in the market, such as shell companies and stock promotion.  These risk flags signify that further diligence should be done before investing in a security.

In many cases, we put the CE designation in place before the SEC or FINRA has taken action.  We use the CE flag when an irregularity or public interest concern emerges.  The CE alert allows retail brokers to quickly restrict client trading in a security with problematic activity.   We also make referrals to the SEC and note instances that warrant further scrutiny.

Prohibited Service Providers

Our published ‘Prohibited Service Providers’ list includes attorneys, accountants, auditors, investor relations firms and other service providers that have been convicted of criminal activity, are subject to SEC sanctions, or that have raised questions regarding the reliability of their work such that OTC Markets Group has determined not to accept their professional affirmations.

Investor Protection – A Concerted Effort

We provide our real-time compliance data to the SEC and other regulators so they can oversee market activity and monitor compliance with securities laws and regulations.  The broker-dealer community also consumes our digitalized data feeds, allowing them to whitelist securities, flag risks and automate internal AML/KYC compliance processes.

Greater transparency makes it easier for diligent investors to make informed decisions and allows broker-dealers to meet their regulatory obligations.  Our recordkeeping and referrals assist the SEC in enforcing federal securities laws and holding wrongdoers accountable.

Paving the Path Forward

Modern markets must meet the needs of a broad spectrum of companies, connect an ecosystem of brokers-dealers, and empower diligent investors to efficiently analyze, value and trade securities.

The latest SEC’s amendments to Rule 15c2-11 recognize OTC Markets Group’s operating model as a blueprint for market organization, guided by its commitment to investor protection through disclosure and emphasis on transparency and regulatory oversight across the markets.

While we are focused on implementing changes related to the SECs amended Rule 15c2-11 in advance of the upcoming September 2021 compliance date, we will continue to push for key initiatives and regulatory changes that shape and build the integrity and competitiveness of public markets.

R. Cromwell Coulson is President, CEO and a Director of OTC Markets Group, responsible for the company’s overall growth and strategic direction. Since leading the acquisition of OTC Markets’ predecessor business in 1997, Cromwell has transformed the company from a privately-held publisher of broker-dealer quotations into a publicly-traded company operating three public markets for 12,000 securities that trade nearly $445 billion in dollar volume annually. Cromwell is a strong advocate of improving capital formation, supporting a diverse ecosystem of broker-dealers, and empowering investors with increased disclosure and transparency. He has testified before Congress and spoken on these and other issues at numerous industry conferences. Cromwell is currently the Co-chair of the STANY Market Structure Committee and a former Chair (2017-2018) of the FINRA Market Regulation Committee that advises FINRA on rulemaking and trading issues. Prior to OTC Markets, Cromwell was an institutional trader and portfolio manager at Carr Securities Corporation. He holds an OPM from Harvard Business School and received his BBA from Southern Methodist University.

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