15g-3 justification (2012)

SUPPORTING STATEMENT
for the Paperwork Reduction Act Information Collection Submission
“Rule 15g-3”

A.

Justification
(1)

Necessity for Information Collection

The term "penny stock" generally refers to low-priced, speculative securities that are
traded in the over-the-counter market. The great majority of securities that are eligible for
trading in the United States are not traded on an established national securities exchange or the
National Association of Securities Dealers Automated Quotation System ("NASDAQ"). Most of
these non-NASDAQ, over-the-counter securities are not actively traded in any forum, and
frequently there is little public information available with respect to their issuers.
Beginning in the mid-1980s, penny stock transactions and associated abuses grew
geographically and in volume. Technological advances related to interstate telecommunications
contributed substantially to this growth. This period also witnessed a dramatic growth in the
number of broker-dealers that concentrated their activities primarily or entirely in penny stock
transactions. In 1989, the Commission identified a corresponding increase in the number of
investor complaints concerning these broker-dealers. Government officials and commentators
have stressed the threat posed by penny stock fraud to economic progress and the legitimate
securities industry. Penny stock fraud remains a serious national concern.
In its report concerning the Securities Enforcement Remedies and Penny Stock
Enforcement Act of 1990 (the "Penny Stock Act"), the House Committee on Energy and
Commerce (the "Committee") identified two primary factors spurring the growth of penny stock
fraud: (i) a lack of public information concerning penny stocks, which facilitates price
manipulation and deprives investors of a basis on which to make investment decisions, and (ii)
the presence of a large number of individuals acting as promoters or associated with penny stock
issuers or broker-dealers "who are repeat offenders of state or federal securities laws, other
convicted felons, and persons having strong ties to organized crime."1 With respect to recidivist
offenders, the Committee noted the limited classes of persons that the Commission had authority
to bar from association with broker-dealers.
Many of the abusive practices identified in the penny stock market can be attributed to the
communication by broker-dealers to their customers of false or misleading information as to the
value or market price of securities in order to induce transactions in those securities. These
practices are more likely to flourish where there is a paucity of price, quotation, and other market
information concerning a security. Where such information is available to investors, they have a
1

House Committee on Energy and Commerce, Penny Stock Reform Act of 1990, H.R.
Rep. No. 617, 101st Cong., 2d Sess. (July 23, 1990) (reporting H.R. 4497) ("House
Report"), at 21.

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greater ability to judge the veracity of sales agent claims. Most penny stocks are not actively
traded in any secondary market, and dealer quotations, if they exist at all, traditionally have been
confined to the "pink sheets." Moreover, pink sheet quotations generally do not serve as a
reliable indication of the price at which a public customer could effect a purchase or sale
transaction.
The large-scale and persistent pattern of abuse described above represents a continuing
threat to individual investors in particular and to investor confidence generally. Moreover,
issuers themselves may in some cases be deceived by promoters who make unfounded promises
of easy and efficient access to new capital.
To help address these concerns, Rule 15g-3 was adopted by the Commission pursuant to
the provisions of Section 15(g) of the Securities Exchange Act of 1934 (the "Exchange Act").
This section, which was added to the Exchange Act by Section 505 of the Penny Stock Act,
mandates specific measures to increase the level of disclosure to investors concerning penny
stocks generally and specific penny stock transactions.
Section 503 of the Penny Stock Act added Section 3(a)(51) to the Exchange Act, which
generally defines the term "penny stock" to include equity securities other than securities that are
traded on exchanges or automated quotation systems meeting criteria established by the
Commission, issued by registered investment companies, or otherwise excluded or exempted by
the Commission based on price, net tangible assets, or other relevant criteria. Section 3(a)(51)
also grants to the Commission certain additional authority to classify or exempt securities as
penny stocks. Rule 3a51-1 further excludes from the term "penny stock" securities traded on an
exchange or automated quotation system that meets certain requirements, transactions in which
are reported pursuant to a consolidated transaction reporting plan, or that are priced at five
dollars per share or more.
Under Section 15(g)(1), it is unlawful for a broker or dealer to use the mails or other
means of interstate commerce to effect, induce, or attempt to induce customer transactions in
penny stocks except in accordance with the requirements of Section 15(g) and the rules
promulgated thereunder. In general, Section 15(g): (i) requires broker-dealers, prior to effecting
a penny stock transaction, to provide to the customer a risk disclosure document that contains
certain information describing the nature and level of risk in the penny stock market, the brokerdealer's duties to the customer, and the customer's rights and remedies for violations, as well as a
narrative description of certain aspects of a dealer market generally, all in such form and
containing such additional information as the Commission may require by rule; (ii) mandates that
the Commission adopt rules relating to the disclosure, prior to each penny stock transaction and
in the customer confirmation, of information concerning (A) price data, including bid and ask
quotations, and the depth and liquidity of the market for particular securities and (B) the amount
and a description of the compensation received by broker-dealers and their associated persons;
(iii) calls for Commission rulemaking to require broker-dealers to provide for customers monthly
account statements indicating the market value of the penny stocks in their accounts or indicating
that the market value can not be determined because of the unavailability of firm quotes; and (iv)

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provides the Commission with authority to adopt additional rules regarding disclosure by brokerdealers to their customers of information related to penny stock transactions.
Rule 15g-3 makes it unlawful for a broker-dealer to effect a transaction in any penny
stock without first disclosing, and subsequently confirming, to the customer current quotation
prices or similar market information. In each case, the broker-dealer also must disclose the
number of shares to which the bid and offer prices apply.
The scope of the rule is limited by operation of Rule 3a51-1 and Rule 15g-1, which
exempts certain transactions from certain rules adopted under Section 15(g). Specifically, the
rule does not apply to transactions: (i) by a broker-dealer that does less than five percent of its
securities business in penny stocks and that has not been a market maker, during the past year, in
the penny stock that is the subject of the transaction; (ii) in securities the issuer of which has net
tangible assets in excess of $2 million, if that issuer has been in continuous operation for at least
three years, or $5 million, if the issuer has been in continuous operation for less than three years;
(iii) where the purchaser is an institutional accredited investor; (iv) that are not recommended by
the broker-dealer; or (v) in securities registered or approved for registration, and executed on, a
national securities exchange that makes transaction reports available pursuant to an effective
transaction reporting plan, or authorized, or approved for authorization, for quotation in the
NASDAQ system. Other exclusions and exemptions are available.
(2)

Purpose and Use of the Information Collection

The information is required to be provided to customers of broker-dealers that effect
penny stock transactions in order to provide those customers with information that is not
otherwise publicly available. Without this information, investors would be less able to protect
themselves from fraud and to make informed investment decisions.
(3)

Consideration given to Information Technology

The Commission's electronic filing project, called EDGAR for Electronic Data Gathering,
Analysis & Retrieval, is designed to automate the filing, processing, and dissemination of full
disclosure filings. Such automation will increase the speed, accuracy, and availability of
information, generating benefits to investors and financial markets. This improved information
technology is not applicable to this rule, because the information is sent to individual investors
and is meant to be contained in written form.
Broker-dealers that already provide account statements generally generate these
statements through automated means through information systems that contain updated
information concerning securities held in each customer's account. It is anticipated that brokerdealers furnishing account statements under the rule would also be able to generate account
statements through automated means and that automated processing would limit the burden
imposed by the requirement.

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(4)

Duplication

Broker-dealers are not otherwise required to provide the information required by the rule.
Investors would have no assurance of receiving the information, or comparable information, in
the absence of the rule.
(5)

Effect on Small Entities

Some of the broker-dealers that are subject to the rule are small businesses. However, the
additional cost of complying with the rule is minimal, because the information will already be
known by or readily available to the broker-dealer. Broker-dealers are required to provide the
information in writing following a trade, but because trade confirmations are already required,
the additional burden relates to incorporating this information in the trade confirmations that are
now provided.
(6)

Consequences of Not Conducting Collection

The information generally is required to be disclosed, orally or in writing, prior to the
trade, and is required to be disclosed in writing following the trade. Because in some cases, the
information may not be readily obtainable prior to the transaction, the rule allows the information
to be given promptly following the trade, provided that the customer is given the right to cancel
the transaction after he or she receives the information. Because the central purposes of the rule
are to provide investors with information needed to make investment decisions and to deter fraud
in the penny stock market, it is essential that the information be provided prior to the time that
the investor is bound to the trade. It is also essential that the information be provided in writing
following the trade so that there is a written record for the benefit of the customer and to assure
that the broker-dealer has complied with the rule. There is no comparable information already
available to investors. The penny stocks covered by the rule are not traded in a market that
makes such information publicly available. The information is available to broker-dealer firms
but would not generally be provided to customers of those firms in the absence of the
requirement imposed by the rule.
(7)

Inconsistencies with Guidelines in 5 CFR 1320.5(d)(2).

There are no special circumstances. The collection is consistent with
5 CFR 1320.5(d)(2).
(8)

Consultations Outside the Agency

The required Federal Register notice with a 60-day comment period soliciting comments
on this collection of information was published. No public comments were received.

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(9)

Payment or Gift to Respondents
No payment or gifts are provided to respondents.

(10)

Confidentiality

Though the information is not now generally available to public investors, it is not
considered confidential and no assurances of confidentiality are provided.
(11)

Sensitive Questions

Questions of a sensitive nature are not asked.
(12)

Burden of Information Collection

The staff estimates that there presently are approximately 209 broker-dealers subject to
the rule with respect to at least some of their transactions. The number of penny stock
transactions conducted by each firm will vary widely, depending on the size of the firm and
whether the firm concentrates its activities in penny stock transactions or conducts only a small
portion of its business in this area. Broker-dealers that do less than five percent of their business
in penny stocks will be exempt from the rule. A variety of types of transactions will be exempt,
including transactions that are not recommended by the broker-dealer. The staff estimates that,
on average, each firm subject to the rule will effect approximately 5,225 total transactions that
would be subject to the rule annually and that the average third-party disclosure burden of adding
the information to trade confirmations would be one minute per transaction. Accordingly, the
estimated average annual burden per firm would be 87 hours, and the estimated average annual
total burden on all firms would be 18,200 hours.
(13)

Costs to Respondent

Not applicable; (a) it is not anticipated that respondents will have to incur any capital and
start up cost to comply with the rule; (b) it is not anticipated that the respondents will have to
incur any additional operational or maintenance cost (other than provided for in item no. 12) to
comply with the rule.

(14)

Costs to Federal Government

Cost to the federal government results from appropriate regulatory agency staff time and
related overhead cost devoted to assuring compliance by broker-dealers with the requirements of
the rule. The staff estimates that approximately 50 hours of staff time per year will be devoted to
assuring that broker-dealers comply with the rule at a cost of $1,500 per year.

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(15)

Explanation of Changes in Burden

The total annual hourly burden of compliance has decreased from approximately
24,000 to 18,200 hours due to a decrease in the number of broker dealers subject to the penny
stock rules. We previously estimated that 240 broker-dealers were subject to the penny stock
rules. We now estimate that there are approximately 209 penny stock dealers subject to the
penny stock rules. Since the identities of penny stock dealers are not readily available, the
staff of the Commission developed a methodology to identify them.

(16)

Information Collection Planned for Statistical Purposes

Not applicable because the information will not be used for statistical purposes.
(17)

Display of OMB Approval Date

The Commission is not seeking approval to not display the expiration date for OMB
approval.
(18)

Exceptions to Certification

This collection complies with the requirements in 5 CFR 1320.9
B.

Collection of Information Employing Statistical Methods
This collection does not include statistical methods.