Proposed SEC Rule Change


By Daniel J. Demers. MBA, L. Paul Hudgins, JD
Sidney J. Diamond, JD
El Paso, Texas

Twenty years after the enactment of the Bankruptcy Code, the Securities & Exchange Commission has agreed to modify Rule 1 5c2-11 by dispensing with prior financial accounting requirements to bring the Rule into compliance with the Code.

The problem was first identified by Clyde Mitchell shortly after the enactment of the Code when he stated that “reorganized debtors should be allowed access to public markets when they comply in good faith with minimum accounting standards and the SEC should prescribe such standards. Mere riskiness of a security does not justify blockading the innocent debtor from the public securities market.” (Clyde Mitchell, III, Securities Regulation in Bankruptcy Reorganization, 54 Am. Bankr. L.J. 101 (1980). See also Demers and DeSerio, The Incongruities Between The Federal Securities Act and the US. Bankruptcy Code, 1994-1995 Norton Annual Survey of Bank­ruptcy Law 195-2 I 9 (1994).

Rule 15c2-11 is the mechanism whereby a com­pany gains access to the Over-The-Counter Bulletin Board (“OTC”) or “Pink Sheet” securities markets. Typically a market maker sponsors a company for inclusion by submitting Form 211 with the OTC Bu­reau or the National Quotations Bureau (Pink Sheets). The principal difference between the OTC market and the Pink Sheets is that the former is a real time elec­tronic quotation service and the latter is a non-real time electronic quotation service.

The proposed Rule modification is part of a series of proposed Rule amendments contained in a release from the SEC dated February 17, 1998, entitled Pub­lication or Submission of Quotations Without Speci­fied Information, SEC Release No. 34-39670, 63 Fed. Reg. 9661 (Feb. 25, 1998).

The SEC initiative is the result of a petition (letter from Daniel J. Deniers to Nancy Sanow, Asst. Direc­tor, Division of Market Regulation, SEC November 14, 1997. File No. 4-405 SEC, available in public reference room, Washington, DC) filed with the SEC in November of 1997 which reasoned that the Rule, as written, was inconsistent with the American Insti­tute of Certified Public Accountants (AICPA) stan­dard operating procedures dealing with accounting for entities emerging from Chapter 11 proceedings:

Fresh start financial statements prepared by enti­ties emerging from Chapter 11 will not be compa­rable with those prepared before their plans were confirmed because they are, in effect, those of a new entity. Thus comparative financial statements that straddle a confirmation date should not be presented. (emphasis added by authors)

AICPA, standard operating procedure 907.

Additionally, the petition reasoned that the Rule was in conflict with § 1 I 42(a) of the Code: “[no] ap­plicable non-bankruptcy law, rule regulation relating to financial condition…[can interfere with the imple­mentation of the Plan].” The Rule also violates, both in spirit and in fact, § 1109(a) of the Code because the Rule, as written, effectively manipulates the re­organization process. This was the primary reason § 1109(a) was adopted as part of the Code in 1997.

Under the proposed Rule modification, market makers wishing to publish quotations in the non-re­porting issuer’s stock, would be limited to reviewing only “the court-approved disclosure statement for the issuer’s plan of reorganization and the issuer’s finan­cial information from the date the bankruptcy court confirms the reorganization plan.” Publication or Submission of Quotations Without Specified Informa­tion, SEC Release No. 34-39670, 63 Fed. Reg. 9661, 9668 (Feb. 25, 1998).

Certain additional information will be required to be reviewed by a broker-dealer before making a mar­ket in the stock. The following additional informa­tion will be required and probably should be included in the disclosure statement (or as an exhibit thereto) to facilitate the market making process:

A description of the following events that occurred during the preceding five years involving an execu­tive officer, general partner, promoter, or control per­son of the issuer:

(A) Conviction in a criminal proceeding or be­ing named a defendant in a pending criminal pro­ceeding (excluding traffic violations and other minor offenses);

(B) entry of an order, judgment, or decree, not subsequently reversed, suspended or vacated, by a court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limited involvement in any type of business, securities, commodities, or ba,thing activities;

(C) being found by a court of competent juris­diction (in a civil action), the SEC, the Commod­ity Futures Trading Commission, or a state secu­rities regulator to have violated federal or state securities or commodities laws, and the judgment or finding has not been reversed, suspended, or vacated;

(D) entry of an order by a self-regulatory organi­zation permanently or temporarily barring, sus­pending, or otherwise limiting involvement in any type of business or securities activities; and (F) a description of any of the following events involving the issuer or its predecessor, or any of its majority owned subsidiaries, that have oc­curred in the two years preceding the publica- – tion or submission for publication of the quotation:

(i) A change in control of the issuer;

(ii) increase in equity securities involving 10% or more of the same class of securities outstand­ing at the time of the offering;

(iii) any merger, acquisition, or business com­bination;

(iv) acquisition or disposition of significant assets;

(v) bankruptcy proceedings; and

(vi) delisting by any securities exchange or the NASDAQ Stock Market.


The proposed action to modify Rule 15c2-11 and bring it into compliance with the Code could have far-reaching effects on the number of successful Chapter 11 reorganizations, currently languishing at about twenty-two percent. Prior to the new SEC ini­tiative, plans which swapped debt for equity were often unworkable because the reorganized debtor was unable to comply with the Rules accounting infor­mation requirements. Thus it was difficult to find a sponsoring market maker to make quotations in the reorganized debtor’s equity securities issued through the plan of reorganization without expending consider­able post confirmation funds on prepetition accounting.

Under the proposed modified Rule pre-petition accounting information will be dispensed with, and will greatly facilitate the ability of the reorganized debtor to initiate market making in plan issued eq­uity securities. This will be especially important for companies which enter Chapter 11 proceedings as private companies and wish to emerge as non-report­ing public companies. The ability to swap debt for stock will be enhanced because of the ability to give such stock liquidity in the public market.

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