Full text of Federal Reserve Bank of New York Circulars : 9193. Margin Regulations

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FEDERAL RESERVE BANK
OF NEW YORK

[

Circular No. 9193 ~|
November 24, 1981 J

MARGIN REGULATIONS
Proposed Changes in Criteria for List o f OTC Margin Stocks

To All Banks, Brokers and Dealers, and Persons Extending
Securities Credit in the Second Federal Reserve District:

Following is the text o f a statement issued November 19 by the Board of Governors of the
Federal Reserve System:
The Federal Reserve Board today proposed for comment amendments to some of the criteria
that over-the-counter (OTC) stocks must meet and continue to meet to be included on its list of OTC
Margin Stocks.
The Board requested comment by January 29, 1982.
More than 1400 stocks are now on the list and subject to the Board’ s regulations.
The Board’ s proposal would eliminate the current requirement that an issuer be organized under
the laws of the United States or a State, thereby making stocks of foreign issuers that are traded on the
OTC market eligible for margin credit if they meet the other criteria for listing. It would also
eliminate certain criteria now in use and reduce some financial criteria to more closely resemble
requirements of major exchanges.

Enclosed — for institutions subject to Regulations G, T, and U in this District — is the text
of the Board’ s proposal. It will be published in the Federal Register, and will also be furnished
upon request directed to our Circulars Division (Tel. No. 212-791-5216).
Comments on the proposal should be submitted by January 29, 1982 and may be sent to our
Regulations Division.

nthony

Solom on,

President.

<v;—

Title 12 - Banks and Banking
Chapter II - FEDERAL RESERVE SYSTEM
SUBCHAPTER A - BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Part 207 - Securities Credit by Persons Other than Banks, Brokers, or Dealers
Part 220 - Credit by Brokers and Dealers
Part 221 - Credit by Banks for the Purpose of Purchasing or Carrying Margin Stocks
[Docket No. R-0372]
Proposal to Revise Criteria for Initial and Continued
Inclusion on the List of OTC Margin Stocks
AGENCY:

Board of Governors of the Federal Reserve System.

ACTION:

Proposed amendments.

SUMMARY: The Board proposes to amend the requirements set forth in Regula
tions G, T and U for inclusion and continued inclusion on the List of OTC
Margin Stocks ("OTC List"). Brokers and dealers may not extend credit on
stocks which are traded over-the-counter unless such stocks appear on the
OTC List. Loans by banks and other lenders that are used to purchase
stocks that appear on the OTC List are subject to the Board's margin require
ments.
The proposed amendments would modify three areas in the existing
rules for initial and continued OTC List eligibility. First, they would
permit equity securities of foreign issuers and American Depository Receipts
("ADRs") to be considered for OTC List inclusion. Second, the proposals
would replace certain criteria which must currently be met in the alterna
tive and replace them with mandatory requirements. Finally, existing
financial criteria would be relaxed to more closely resemble requirements
established by major exchanges.
DATE:

Comments should be received by January 29, 1982.

ADDRESS: Comments, which should refer to Docket No. R-0372, may be mailed
to the Secretary, Board of Governors of the Federal Reserve System,
20th Street and Constitution Avenue, N.W., Washington, D.C. 20551,
or delivered to Room B-2223 between 8:45 a.m. and 5:15 p.m. Comments
received may be inspected at Room B-1122 between 8:45 a.m. and 5:1«5 p.m.,
except as provided in section 261.6(a) of the Board's Rules Regarding
Availability of Information [12 CFR § 261.6(a)].
FOR FURTHER INFORMATION CONTACT: Robert S. Plotkin, Assistant Director,
Laura Homer, Securities Credit Officer, or Jamie Lenoci, Financial Analyst,
Division of Banking Supervision and Regulation (202-452-2781).

[Enc. Cir. No. 9193]

- 2 -

SUPPLEMENTARY INFORMATION: In July 1969, the Board adopted criteria for
including stocks on the OTC List. In discussions leading to the selection
of such criteria, the Board indicated-generally that (a) stocks to be
included on the List should have market characteristics similar to.exchangelisted securities, (b) manipulation by issuers to be included or excluded
from the OTC List should be made as difficult as possible, and (c) fluctua
tions in the number of stocks on the List should be minimized.
The changes now proposed in the OTC List criteria are the result
of a review of the OTC margin stock listing and .continued listing require
ments in light of recent developments in the securities markets in general,
the OTC Market in particular, and staff experience with administering
the requirements. It is believed that revising the criteria is especially
appropriate at this time because of a recent decision to revise the List
three times a year commencing in 1982, rather than twice a year as is the
current practice. This has been a frequent recommendation of the securities
industry. The following is a discussion of the specific proposals to amend
OTC List criteria.
A. Deleting Requirement that Issuer Be Organized Under the Laws of the
United States or a State.
As early as 1964, when the SEC first recommended a broadening
of the Federal Reserve's margin authority to encompass over-the-counter
stocks, the Board indicated that securities, to be eligible for credit at a
broker, should meet the prerequisites of (1) market depth, (2) a reliable
system of quotations, and (3) sufficient issuer disclosures. The National
Association of Securities Dealers Automated Quotation System ("NASDAQ"),
now in operation for ten years, has greatly improved the efficiency of the
OTC market and has addressed the first two concerns of the Board. Ther
SEC, over the past few years, has improved and strengthened its disclosure
rules, so that financial information on foreign as well as domestic issues
is available to the public in a comprehensive and timely fashion. In
addition, the National Association of Securities Dealers ("NASD") requires
that its domestic and foreign issuers file financial data with it as a
prerequisite for trading on NASDAQ.
None of the approximately one-hundred eighty (180) foreign stocks
currently in the NASDAQ system can be placed on the OTC List, as they do
not meet the existing criterion, which requires all OTC List candidates to
be "organized under the laws of the United States or a State." A growing
number of requests have been received from both investor groups and the
general public to include foreign OTC stocks on the OTC List. When the
Board first adopted its criteria for inclusion on the List, there was
insufficient financial disclosure for foreign issues. This problem has
now been remedied. Furthermore, foreign issues can and do list on national
exchanges and are therefore automatically eligible for margin credit.
In this connection, the Board also proposes to allow American
Depository Receipts ("ADRs") to be eligible for inclusion on the OTC List.
ADRs are receipts issued against securities of foreign issuers deposited in

3 -

an American depository, and are exempt from registration under Section 12
of the '34 Act. There are approximately sixty (60) ADRs currently in NASDAQ.
The Board would allow ADRs to be considered for inclusion on the OTC List,
provided the foreign securities against which the ADRs are issued are.
registered pursuant to Section 12 of the '34 Act, which imposes certain
reporting requirements upon the foreign issuer. This approach is consistent
with the policy currently employed by stock exchanges with respect to
exchange listings V and with the Securities and Exchange Commission's
current proposal to allow ADRs to be designated as national market system
securities. **/
B.
Deleting Alternative Criterion Requiring a $5 Million Market
Value and Making Remaining Criteria Mandatory
The second proposal to change OTC List criteria involves the
alternative requirements with respect to the size and character of the
issue and issuer. At present, a stock can fail one of the three criteria
of a $5.00 minimum price, $5 million capital and surplus (hereinafter
capital), or $5 million in market value and still be placed on the OTC List.
A'Study of price movements over the past six years indicates that the
price criterion, as an alternative to capital, is too sensitive as an objec
tive measurement for marginability. Each revision of the OTC List is
influenced by the price trends of the survey period used and many stocks
that meet the price criterion during a high price cycle fail during the
subsequent low cycle. A staff study showed that 26% of the stock added to
the recently revised OTC List were failing the criterion by the time the
OTC List was published.
Although the capital criterion has never been amended, the growing
number of stocks placed on the List without meeting the $5 million minimum
capital requirement since the 1976 changes has been of concern. Currently,
the List includes approximately one hundred companies reporting less than
$5 million in capital (35% of the stocks added to the April 6, 1981 List
reported less than $5 million). These companies are often highly specula
tive promotional companies with no actual production that are designated as
"developmental companies" under SEC rules. Although the OTC List is not
designed to be one of -principally "quality-oriented" stocks, it would seem
that the inclusion of such companies does not adequately enable the Board
to meet its inherent responsibi1ity of investor protection. Companies
reporting low capital themselves have sometimes voiced concern that inclu
sion on the OTC List might result in an increase in speculative trading
activity in their stock. The NASD has also recently adopted higher quali
fication standards for initial inclusion on NASDAQ. The standards, which
were adjusted to reflect "ongoing economic realities," included raising
the capital requirement from $500,000 to $1 million. At present, the New
York Stock Exchange requires capital of $16 million and the American Stock
Exchange requires capital of $4 million before a stock may be listed.
*/ An exchange will list ADRs only if the underlying foreign security
"also is listed and, therefore, registered under Section 12.
**/

SEC Release No. 34-18131.

- 4 -

As indicated before, the third alternative criterion -- an
aggregate market value of $5 million -- is also partially a price deter
minant criterion. This criterion is of limited value, since it only affects
stocks worth between $5 and $10 per sTiare. In other words, the criteria of
$5 minimum price and one million publicly held shares would automatically
provide a $5 million aggregate market value. During the past two years,
only seven per cent of the stocks added to the List failed the aggregate
market value test. Accordingly, it appears that retention of this test is
not justi fied.
Deletion of the $5 million market value test would leave only two
remaining alternative criteria: a $5 minimum price per share and capital
of $5 million, both of which would be mandatory. This would lessen the
effect of systemic fluctuations which have indirectly been affecting the
size and composition of the List.
C. Reducing the publicly held share requirement from 500,000 to
400,000 shares and the capital reguirement from $5 million to $4 million.
The Board has received complaints that in some respects the pre
sent 0TC criteria are more stringent than some exchange listing requirements
In response to these complaints and in order to lessen the impact of the
switch from alternative to mandatory requirements, the Board believes that
some of the financial criteria can be reduced. These changes would bring
the Board's 0TC margin criteria more in line with those of the American
Stock Exchange.
The Board, therefore, proposes that the publicly held shares
requirement be reduced from 500,000 to 400,000 shares and that the capital
requirement be reduced from $5 million to $4 million.
D.

Continued Inclusion on the PTC List.

The Board proposes that correspond!'ng changes to the criteria for
continued inclusion on the 0TC List be made. The continued listing criteria
which are less stringent than the initial criteria, would contain mandatory
requirements of.an average minimum of $1 price and $1 million in capital,
rather than $3 per share and $2.5 million as at present. These changes
would promote stability of the List and would also lessen the impact of
the switch from alternative to mandatory requirements.
If the proposals are adopted, the Board at this time would expect
to apply the new criteria only to newly added stocks. Current 0TC margin
stocks would be "grandfathered" under the existing continued criteria for
two years.
If their capital position does not increase or they otherwise
fail to meet the continued listing criteria at that time, they woulc*be
subject to deletion from the 0TC List.
Accordingly, pursuant to §§ 7 and 23 of the Securities Exchange
Act of 1934, as amended (15 U.S.C. §§ 78g, 78w), the Board proposes to
amend Regulations G, T and U (12 CFR Parts 207, 220 and 221 respectively)
as follows:

5
PART 207 —

SECURITIES CREDIT BY PERSONS OTHER THAN BANKS, BROKERS, OR DEALERS

Section 207.5 —
*

(d)

SUPPLEMENT

★

Requirements. for inclusion on list of PTC margin stocks
(1) The stock is registered under section 12 of the
Securities Exchange Act of 1934 ("the Act"), or is an
American Depository Receipt ("ADR") of a foreign issuer
whose securities are registered under section 12 of the
Act, or is a stock of a foreign issuer required to file
reports under section 15(d) of the- Act,
*

(4) the issuer has been in existence for at least
three years,
*

(7) There are 400,000 or more shares of such stock out
standing in addition to shares held beneficially by
officers, directors or beneficial owners of more than
10 percent of the stock,
(8) The minimum average bid price of such stock, as
determined by the Board, is at least $5 per share, and
(9) The issuer has at least $4 million of capital,
surplus, and undivided profits.
(e) Requirements for continued inclusion on list of PTC
margin stocks.
(1) The stock is registered under section 12 of the
Securities Exchange Act of 1934 ("the Act"), or is an
American Depository Receipt ("ADR") of a foreign issuer
whose securities are registered under section 12 of
the Act, or is a stock of a foreign issuer required
to file reports under section 15(d) of the Act,
★

★

(6) The minimum average bid price of such stocks, as
determined by the Board, is at least $1 per share, and
(7) The issuer has at least $1 million of capital,
surplus, and undivided profits.
Part 220 -- CREDIT BY BROKERS AND DEALERS
A.

Section 220.8 —

SUPPLEMENT

★
(h)

★

Requirements for inclusion on list of PTC margin stocks
(1) The stock is registered under section 12 of the
Securities Exchange Act of 1934 ("the Act"), or is an
American Depository Receipt ("ADR") of a foreign issuer
whose securities are registered under section 12 of the
Act, or is a stock of a foreign issuer required to file
reports under section 15(d) of the Act,
*

★

(4) the issuer has been in existence for at least
three years,
*

(1) The stock is registered under section 12 of the
Securities Exchange Act of 1934 ("the Act"), or is an
American Depository Receipt ("ADR") of a foreign issuer
whose securities are registered under section 12 of
the Act, or is a stock of a foreign issuer required
to file reports under section 15(d) of the Act,
★

★

7
(4) Daily quotations for both bid and asked prices for
the stock are continuously available to the general public
(5) There are 300,000 or more shares of such stock
outstanding in addition to shares held beneficially by •
officers, directors, or beneficial owners of more than 10
percent of the stock,
(6) The minimum average bid price of such stocks, as
determined by the Board, is at least $1 per share, and
(7) The issuer has at least $1 million of capital,
surplus, and undivided profits.
PART 221 -- CREDIT BY BANKS FOR THE PURPOSE OF PURCHASING OR CARRYING MARGIN
STOCKS
III.

Section 221.4 -- SUPPLEMENT
'<

*
(d)

★

Requirements for inclusion on list of PTC margin stocks.
(1) The stock is registered under section 12 of the
Securities Exchange Act of 1934 ("the Act"), or is an
American Depository Receipt ("ADR") of a foreign issuer
whose securities are registered under section 12 of
the Act, or is a stock of a foreign issuer required
to file reports under section 15(d) of the Act,
★

★

(4) the issuer has been in existence for at least
three years,
*

(e)

Requirements for continued inclusion on list of PTC
margin stocks.
(1) The stock is registered under section 12 of the
Securities Exchange Act of 1934 ("the Act"), or is
an American Depository Receipt ("ADR") of a foreign
issuer whose, securities are registered under section 12
of the Act, or is a stock of a foreign issuer required
to file reports under section 15(d) of the Act,
*

(4) Daily quotations for both bid and asked prices for
the stock are continuously available to the general public,
(5) There are 300,000 or more shares of such stock
outstanding in addition to shares held beneficially by
officers, directors, or beneficial owners of more than 10
percent of the stock,
(6) The minimum average bid price of such stocks, as
determined by the Board, is at least $1 per share, and
(7) The issuer has at least $1 million of capital,
surplus, and undivided profits.
INITIAL REGULATORY FLEXIBILITY ANALYSIS:
The Board requests comment on proposed amendments to the
requirements for inclusion and continued listing on the List of 0TC
Margin Stocks. These requirements are designed to identify those stocks
traded in the over-the-counter market which have the degree of national
investor interest, depth and breadth of market, the availability of
information respecting the stock and its issuer and the character and
permanence of the issuer to meet the Board's statutory responsibilities.
Many of the proposed changes relax the listing criteria that
0TC stocks must satisfy, both to qualify for inclusion on the 0TC List
and to remain on it. For example, foreign stocks would become eligible
for inclusion, and many of the financial requirements of the 0TC List
would be altered to resemble more closely those of the American Stock
Exchange. However, one significant proposed change working in the
direction of tightening standards would eliminate the practice of us*ng
alternative criteria and thereby make the capital criterion mandatory.
Because the proposals involve a mixture of relaxing and
tightening changes, it is not easy to judge the overall impact on small
domestic entities--primarily those small-sized corporations whose stocks
are traded in the over-the-counter market. While the proposed relaxations

• V.

9 -

in specific criteria would make it easier for some firms to qualify for
the List and remain on the List, the-proposed elimination of alternative
criteria will deny OTC margin eligibility to other stocks.
In particular,
the proposal to make all criteria mandatory, including the proposed
minimum net worth listing requirement, would deny initial access to the
List to those firms with less than $4 million in capital, surplus, and
undivided profits whose stocks are traded OTC. Had this criterion been
in effect in recent years, a substantial number of stocks that were
added to the List would be excluded.
Of course, exclusion from the OTC List does not necessarily
preclude a stock from becoming marginable; the issuing firm can
alternatively take steps to list that stock on a national exchange.
Such listing automatically confers eligibility for margin credit to
stock; however, such listing does involve additional cost to the company.
It should be noted that the NASD has recently announced
changes to its NASDAQ National List listing requirements, some of which
became effective November 17, 1981. The changes will require some
time for adjustment--by investors, traders, and issuers alike--and
could change the characteristics of over-the-counter trading.
Accordingly, the Board believes the use of the National List--which has
been suggested as an alternative to its own criteria--is premature at
this time. As soon as experience is gained with the National List the
Board will weigh its use in view of its statutory responsibilities.
By order of the Board of Governors of the Federal Reserve System,
November 18, 1981.

(signed) William W. Wiles
Wi11iam W. Wi1es
Secretary of the Board
L
[SEAL]

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Full text of Federal Reserve Bank of New York Circulars : 9193. Margin Regulations

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