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September 10, 2007

Pink Sheets Presses SEC on ADRs

By Peter Chapman

Pink Sheets, for the second time in two years, is calling on the Securities and Exchange Commission to require the Financial Industry Regulatory Authority (FINRA) to disseminate last-sale data on American Depository Receipts (ADRs) traded over the counter in real time.

"It is shocking that U.S. investors are unable to monitor the quality of executions they receive from their broker-dealers in such an important part of the market for OTC equity securities," Cromwell Coulson, Pink Sheets' chief executive, told the SEC in a letter.

ADRs traded in the pinks account for about $300 million a day in trades, according to Pink Sheets. That's double the traded value of the entire OTC Bulletin Board, the more respected half of the OTC marketplace.

Pink Sheets made its plea as part of the regulatory approval process underway to strengthen the front-running rules governing the OTC market.

FINRA (formerly the NASD) will begin applying the Manning Rule, which covers trading ahead of customer limit orders in Nasdaq securities, to the OTC market in November (see separate article).

That is expected to result in an increase in limit orders. Customers whose limit orders in ADR names are filled would benefit if ADR trades were publicly reported in real time, Pink Sheets argues. Today, FINRA just disseminates a summary of OTC ADR trading activity at the end of the day.

FINRA executives maintain they are willing to disseminate the information, but are prevented from doing so by the SEC. At a breakfast this summer in Jersey City, N.J., sponsored by the Security Traders Association of New York, traders asked a FINRA representative why FINRA would not transmit real-time trade reports in OTC ADRs. The executive told the group that FINRA was ready to do so, but the SEC was opposed to the move. The SEC had no comment.

(The SEC does permit the dissemination of last-sale data in real time for OTC trades of unregistered domestic securities.)

This is the second time Pink Sheets has asked the SEC to remove the ban on real-time trade reports in OTC ADRs. In 2005, it made a similar request, but got nowhere. This time as before, it has the support of the STA, which also sent a letter to the SEC. Pink Sheets also has the support of TD Ameritrade whose retail customers account for a big chunk of OTC trading.

Pink Sheets' quest is not completely altruistic. Any increase in transparency in these names is bound to improve the fortunes of the Pink Sheets and the dealers that trade the stocks, Coulson acknowledges. "More transparency makes investors happier," he says. "So if there is more transparency, investors will be more willing to trade."

Market makers have been required to report OTC trades to FINRA's Automated Confirmation Transaction (ACT) service since 1993. FINRA began disseminating real-time reports of trades of domestic OTC equities in 1994. But it has never disseminated real-time last-sale reports for OTC ADRs.

FINRA has always maintained it can't disseminate the data (from which it earns revenues) because of SEC concerns over trading unregistered foreign securities. Most OTC ADRs are unregistered, meaning the firms have not filed certain legal and financial documents with the U.S. government.

The SEC has stated in the past that it is worried that too much transparency could lead investors to trade these securities and get into trouble.

When FINRA's OTC Bulletin Board launched in 1990, the SEC did not allow market makers to update their ADR quotes in real time. It permitted only two updates a day, rendering the prices mere indications of interest.

And in 1997, the NASD, under SEC pressure, banned all quotations in OTC ADRs traded on the OTCBB market.

"The NASD is concerned that where there is no public information available regarding a security," the NASD said at the time, "the broad-based automated display of quotations in that security creates an unjustified perception of reliability."

Today, very few ADRs are listed on the OTCBB, having long ago fallen to the Pink Sheets. There, the quotes are firm and disseminated in real time. Most ADRs that are registered with the federal government trade on the New York and Nasdaq stock exchanges.