U.S.A.: Low Priced Securities – Enhancement of risk mitigation and settlement measures
Further to rules promulgated by the Securities and Exchange Commission (SEC), Clearstream Banking1 informs customers of new settlement measures required for Low Priced Securities (LPS), effective
1 August 2022
Background
In the U.S.A., LPS continues to be a topic of discussion. The SEC approaches the topic largely from an investor protection standpoint and defines LPS as securities priced less than USD 5.00 and which are traded over the counter. Risks associated with some of the LPS make them particularly susceptible to market manipulation or fraud. The SEC has promulgated rules under section 15(h) of the Securities Exchange Act of 1934 requiring broker dealers to make certain disclosures to investors in LPS.
SEC Bulletin: Risks Associated with Omnibus Accounts Transacting in Low-Priced Securities
Broker-dealers AML obligations and regulations governing LPS
The SEC bulletin reminds broker-dealers of their existing AML due diligence and reporting obligations under the Banking Secrecy Act (BSA) and Financial Industry Regulatory Authority (FINRA), for LPS transactions maintained by foreign financial institutions in omnibus accounts. The BSA requires broker-dealers to establish a risk-based AML program, including policies and procedures to detect, monitor and report suspicious activities.
Foreign Financial Institutions (FFI) pose greater AML risks in regard to LPS as there is a lack of transparency into FFI’s underlying client identity.
Measures implemented by Citibank N.A. (Citi) as Clearstream Banking's depository in the U.S.A.
Citi has informed Clearstream of new risk mitigating measures required for LPS to be implemented as of 1 August 2022. Citi will proactively mitigate risk by preventing new or additional LPS holdings into Citi accounts. Citi will perform a real-time validation of all securities received from customers based on risk criteria established by the OTC Markets Group as data vendor.
Based on this validation, Citi will automatically reject any receipt transactions for securities identified as LPS according to certain criteria, by transmitting a real-time SWIFT MT548 to its customers, thus preventing the settlement of the LPS transaction in the market
Citi will however enable free and against payment delivery transactions of these assets identified as LPS and strongly recommend their customers to reduce or eliminate their LPS holdings.
Citi will apply the above settlement procedure to all securities which meet the following criteria established by the OTC Markets Group:
a. LPS equity (including convertible instruments and preferred stocks) securities with market value of USD 50 million or less, which are traded on OTC and not on the National Market System (NMS) such as NYSE and NASDAQ.
b. “Caveat Emptor” securities: A Caveat Emptor security is a designation the OTC Markets Group places on a security after a determination was made surrounding the company that there may be potential risk to investors which include a questionable stock promotion, known investigation of fraudulent activity committed by the company or insiders. In general, these securities do not qualify to trade on a national market.
c. “Grey Market”: In general, securities that are not listed on any stock exchange nor formally quoted on OTC (Over-the-Counter) Markets or OTCBB (Over-the-Counter Bulletin Board), and that do not qualify to trade on a national market.
d. “OTC Pink” which consists of companies that depending of the amount of available information, are potentially riskier and more susceptible to fraud, i.e. with
i. Shell Condition or Shell Risk Condition;
ii. No Information with Shell Condition or Shell Risk Condition;
iii. Limited with Shell Condition or Shell Risk Condition.
Impact on customers
Settlement impact
For Clearstream Banking customers instructing to receive holdings in these LPS via SWIFT MT540/541 from the local market, Clearstream Banking will comply with Citi risk criteria as defined here above by the OTC Group Markets. Clearstream Banking will consequently transmit rejection of these receipt settlement instructions via SWIFT MT548 whenever received from Citi, effective 1 August 2022.
- If the transaction is received prior to settlement day, Clearstream Banking will transmit a SWIFT MT548 status, received from Citi, to inform customers of the impending risk for settlement as follows:
:25D::SETT//PENF
:16R:REAS
:24B::PENF//NARR
:70D::REAS//LPS DOES NOT MEET CITIS REQ
:16S:REAS
- If any of the risk measures which Citi is restricting continues to be reported on settlement day by the OTC, Clearstream Banking will transmit Citi updated status via SWIFT MT548 to inform its customer of a rejection. The rejection status will also be transmitted for transactions received on settlement day, which Citi is restricting. Please note that no further processing will be performed by Citi and Clearstream Banking once the receipt transaction is rejected.
:25D::IPRC//CAND
:16R:REAS
:24B::CAND//CSUB
:70D::REAS// LPS DOES NOT MEET CITIS REQ
:16S:REAS
For both statuses noted above, Clearstream Banking will provide Citi risk measure determined by the OTC in the field :70D::REAS. This will include one of the following:
- OTC CAVEAT EMPTOR
- OTC COND FOR GREY MARKET FOR DOM COMP
- SHELL COMPANY OR SHELL RISK
- DELINQUENT REPORTING
If multiple risks measures apply to the security, field :70D:: will not provide all the risk measures but will instead indicate “LPS DOES NOT MEET CITI’S REQUIREMENTS”.
Absent any other specific restrictions, free and against payment deliveries or transfers of these LPS will be further processed by Citi and thus supported for processing by Clearstream Banking.
Due diligence requirements
While market counterparts including Citi as Clearstream Banking‘s depository play an active role in the monitoring of these LPS, customers are also required to adopt proactive measures to mitigate the associated risks to these instruments.
Clearstream Banking customers and underlying clients are responsible to ensure their brokers understand market conditions, the AML obligations and the regulations governing these LPS.
There will be no published list with all LPS subject to the OTC risk measures as the content of the LPS list can constantly fluctuate according to market/company financial conditions, for example, the delinquent LPS status can be removed if the company updates its filing. A list of securities considered as LPS will however be available at customer's request as support and on a non-exhaustive basis by sending an email to CADatabase.cs@clearstream.com with the subject: CBL LPS US Market
It remains the customer‘s entire responsibility to check all these criteria with their respective brokers and counterparties.
Further information
For further information, customers may contact Clearstream Banking Client Services or their Relationship Officer.
------------------------------------------
1. Clearstream Banking refers collectively to Clearstream Banking S.A., registered office at 42, avenue John F. Kennedy, L-1855 Luxembourg, and registered with the Luxembourg Trade and Companies Register under number B-9248, and Clearstream Banking AG (for Clearstream Banking AG customers using Creation Accounts), registered office at 61, Mergenthalerallee, 65760 Eschborn, Germany, and registered in Register B of the Amtsgericht Frankfurt am Main, Germany, under number HRB 7500.