Subject: RE: File No. S7-5-99 Author: Date: 6/2/99 11:30 AM Dear SEC Staff, I have recently become aware of your proposed rule changes for OTCBB stocks. From its macro implications, I find it one of the poorest, least thought out proposals that I have ever seen. Not so much that any of its specifics cause problems, but more its overall longrun implications in my opinion will hurt the market for small thinly traded securities. The thing that is most evident is that the SEC plans to implement rules which require the individual trading firms to increase their costs with no apparent benefit. While these rules might reduce fraud, they will definitely reduce the number of firm's making markets in these thinly traded securities. This is almost an inverse of what an financial economist would like to see. We would like to see rules to increase the number of firms making a market in securities as the competition will drive down trading costs to the investor making markets more efficient. While the immediate cost will be borne by the trading firms. It will not take long before the number of traders making a market for an individual security will start to decrease. Hence the cost of trading to investors will increase. This will occur over probably a couple of years though with todays world of electronic trading it might be much quicker. After the reduction period, those still trading a specific stock will be making more money per trade on probably smaller trading volumes. The transferring of cost to the firms and eventually to the investors to reduce fraud costs is a minor adjustment. The major loss is in the overall markets for IPOs. With the higher trading costs individual investors are going to be less willing to purchase IPOs. This will hurt the formation of new businesses. In particular it will hurt those starting new businesses with less personal capital, most likely those of minority groups. It will also hurt Venture Capitalists and the resulting high tech firms which they invest in since the cost of going public will increase. I saw this situation while I was the Alexander Hamilton Chair in Hungary 3 years ago. Venture capital firms, specifically the Hungarian-American Fund which our government funded made some very good investments. These firms went public with the Fund still holding most of their position. I asked why hold? Sell and invest in more new businesses. Their answer was that selling more than 100 shares a week drove down the price. Thus the thin markets slowed the economic growth. While the current proposals will not cause this great of decrease in liquidity, it will have a similar result. My next thought is how much fraud is being observed in these markets? Further how much of the fraud being observed can be traced to trading firms? A recent article in Fortune this past week talked about "front running." Here insiders trade in front of large institutional orders from insider information. The article made this sound like a major problem and cost to institutions buying and selling securities. From what I have observed with BB trading this could not be a consideration. Institutions do not invest in these firms and the volume is too thin to front run. (This does not mean that order flow to specific traders is not a potential problem, but there is little incentive to front run on their small volumes.) Finally it should always be remember who has the greatest incentive to maintain these markets: the trading firms! It is their industry and it operation requires that investors have trust in the market place. They have every incentive to maintain investor confidence in their markets. In today's world investors could sell their securities directly on the internet if they feel that the market is "rigged against them." If after more research, it is determined that fraud is a major cost in these markets, I would propose an empirical study. Select 500 firms to trade under the proposed system. These would be matched with 500 other firms. (The other 6,000+ firms will continue to trade as before with no special tracking of spreads, frauds, etc.) After say two years, compare the fraud rates and transaction spreads to determine the cost/benefit ratio of the new rules. Hopefully, you will consider my comments. They represent my ideas and not necessarily those of Rutgers University or any trading company. Further I never received any consulting work from a securites trading company. Sincerely, Michael S. Long Associate Professor of Finance Rutgers University 180 University Ave. Newark, NJ 07102