In a new and surprising interpretation of a decades-old rule protecting retail investors from fraud in OTC equity markets, the U.S. Securities and Exchange Commission has applied Rule 15c2-11 to the fixed income markets.

The Rule, also known as the SEC’s penny stock quote rule, was implemented in 1971, amended in 1975, 1991, and again in 2020, is and always has been targeted at protecting retail investors from OTC equity market fraud and has never been enforced in fixed income markets.

SIFMA members, including our investor members whom the Rule is nominally purported to protect, strongly believe this rule is not needed in or appropriate for fixed income markets. If the SEC proceeds with this application, the SEC must provide the opportunity for the public to receive notice and provide comment on the proposed application, given the material policy change its application would represent. Failure to take these steps would threaten the continued expansion of liquidity and transparency in these markets and may increase transaction costs, harming issuers, investors, and the broader economy that is served by fixed income markets.

Rulemaking by Letter

In December 2021, the SEC staff published a letter that affirmed its new interpretation and also established, a new and complex regulatory regime for Rule 15c2-11 as applied to fixed income securities. This was effectively an informal rulemaking by unilateral staff pronouncement, rather than through the typical agency processes for developing new regulations through public and deliberative proceedings via Commission (not staff) action.

“We continue to believe that for the Rule to be applied to fixed income securities it should be amended to reflect the differences between fixed income markets and OTC equity markets, and we believe that process will take additional time.” – SIFMA

This interpretation not only surprised the investment industry, but appears to have surprised at least some SEC Commissioners, as the Commission just months earlier voted unanimously to approve an unrelated 15c2-11 rulemaking release – which explicitly contemplated the rule as applying only to equity securities.

The Impact on the Rule 144A Market and Consequences for Capital Formation

In addition to rolling back technological advancements in the fixed income markets that have benefited issuers and retail and institutional investors alike (without a corresponding policy rationale), this new interpretation of Rule 15c2-11 was in direct tension with a different SEC rule, Rule 144A. This is because the SEC’s action would have required Rule 144A issuers to publish their financials for dealers to be able to quote their securities, without regard for the fact that Rule 144A already provides for this disclosure to all investors eligible to invest in their securities. This intersection in Rules would have created significant consequences for issuers and investors, threatening capital formation and the healthy functioning of markets.

On October 30, 2023 the SEC issued an exemptive order that provides relief to broker-dealers from the application of Rule 15c2-11 to quotations of Rule 144A fixed income securities. This relief is permanent (but could be amended by the SEC in the future). The relief does not apply to 144A equity securities. This is the right outcome for this market but does not solve the problem of applying the rule to other fixed income securities.