- A new SEC rule meant to protect retail investors from pump-and-dump schemes has also blocked access to thousands of over-the-counter stocks.
- The new rule prevents brokers from providing price quotations on OTC stocks that don’t release up-to-date financials.
- But the rule has also restricted individual investors’ ability to buy stocks of sound companies, giving professional investors an edge.
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A new SEC rule created to protect investors from pump-and-dump schemes has had the unintended consequence of giving professional investors an edge over individual investors since it went into effect at the end of September.
As most pump-and-dump operations take advantage of illiquid, over-the-counter securities that don’t provide current financial information, the rule sought to prevent brokers from providing price quotations on securities that don’t have up-to-date financials.
Technological advancements related to the rule change “enable us to require that information in the OTC market be more timely, enabling investors to make better informed investment decisions, and reducing fraud in these markets where retail presence is significant and, unfortunately, pump-and-dump and other frauds are too common,” former SEC Chairman Jay Clayton said last year.
Of the more than 12,000 securities that trade on the OTC Markets, more than 2,000 of them are currently subject to the price-quotation limitation.
But while the rule change might make it harder for schemers to inflate stock prices with false or misleading information and then dump shares on unwitting investors, it also makes it nearly impossible for retail investors to buy OTC securities of profitable, dividend-paying businesses that don’t post updated financials.
That has led to a drop in demand for many OTC securities, resulting in sharp declines in stock prices. Retail investors that hold an OTC stock that now falls under the new SEC rule are only left with the option of selling their security, not buying more.
One OTC security that saw a big drop after the rule went into effect was Canandaigua National, an upstate New York community bank that is profitable and offers a 4% dividend yield. The stock, which barely traded hands even before the rule change, saw its price fall 27% virtually over night.
“We find ourselves in a situation where there are real opportunities sitting in front of us, but we can’t take advantage of them!” retired investor Dave Wetzel told The Wall Street Journal.
But professional investors can still buy OTC stocks that fall under the SEC rule, which is meant to protect individual investors who may have access to less information.
And David Waters of Alluvial Capital Management is doing just that. “It’s created an opportunity for professionals at the expense of retail investors. It’s an unfair transfer of value,” Waters told The Wall Street Journal.