(The news featured below is a selection from the news covered in Federal Securities Law Reporter, which is distributed to subscribers of Federal Securities Law Reporter.)

SEC Adopts Amendments to Penny Stock Rules

The SEC adopted amendments to the penny stock rules. The amendments affect the definition of a penny stock and add new requirements for the delivery of information to penny stock customers. The SEC advised that it specifically considered the impact of the amendments on small business capital formation.

The SEC received 11 comment letters in response to its proposed amendments. The amended definition of penny stock preserves the status quo with respect to existing markets. Nasdaq raised concerns that the proposed amendments would undermine the ability of small companies to access capital markets or list their securities on viable secondary markets because they would encourage regulatory arbitrage. Nasdaq suggested that the SEC instead should adopt truly uniform standards across all affected markets and exchanges.

The SEC said that the grandfathering of reported securities on existing national securities exchanges would not encourage regulatory arbitrage. The exchanges and Nasdaq may continue to establish and change their listing standards, the SEC noted. Any changes that would tighten the listing standards for compliance would not have any effect on the penny stock status of securities listed on that market.

The SEC also pointed out that it could use its exemptive authority in the event of sudden economic or geopolitical events resulting in significant market disruptions. The agency also stated that it did not wish to adopt uniform requirements because markets should establish their own listing standards.

The SEC excluded from the definition of penny stock those security futures products that are listed on a national securities exchange or an automated quotation system sponsored by a registered national securities association. The SEC concluded that this approach is consistent with the treatment of options under the penny stock rules and noted that security futures products are already subject to a special disclosure regime.

The amendments imposed a uniform waiting period of two business days before a penny stock transaction can be effected. The two-day period starts when the disclosure document is sent, whether electronically or by mail. The broker-dealer must also have a signed and dated acknowledgement of the receipt of the disclosure document. The SEC explained that it wanted to preserve parity between electronic and paper communications with respect to the disclosure requirements of the penny stock rules and believes that two business days is sufficient for an investor to consider a proposed transaction. The SEC added that investors must acknowledge the receipt of three separate documents under the penny stock rules, which should be sufficient to alert them to the significance of their investment decision.

The penny stock disclosure document was also amended to make it more readable. The SEC recognizes the increasingly electronic nature of commerce, particularly in the securities industry, and has replaced the explanatory document with a hyperlink to the SEC's Web site where it provides investors with information about penny stocks. The paper disclosure documents will include the Internet address for the SEC's Web site. The SEC believes the amendments reflect changes in technology over the past 10 years while still providing penny stock investors with important information before a sale occurs.

One of the commenters criticized the SEC's proposal as too complex. The SEC agreed that the penny stock rules are complex, but pointed out that broker-dealers are exempt from the requirements unless they solicit penny stock transactions. The rules are narrowly focused to protect retail investors against abusive and fraudulent sales practices, according to the SEC. Broker-dealers that choose to engage in this business must be prepared to adhere to the requirements of the penny stock rules, in the SEC's view. The rules are effective September 12, 2005.