Trading shares over the counter – the legal way

Buying and selling shares through matching mechanisms is a process regulated by the Financial Services Board. Three year ago the FSB announced that Over-The-Counter market operators were trading illegally. These were mainly companies who facilitated trading in their own securities. The FSB was concerned about investor protection and systemic risk, and dealt a blow to companies who had been operating OTC facilities responsibly. They were forced to regularise their affairs by listing on the JSE, or by obtaining an exchange licence, or shutting down their trading operations and finding ways to trade outside the definition of an “exchange” in terms of the Financial Markets Act. For some companies, none of these options were viable. Singular Systems, the company that built South Africa’s leading OTC platform, Equity Express, has created a solution. It’s a mechanism that allows companies to remain unlisted while giving their shareholders a framework to trade shares legally in compliance with FSB rules. It’s called OTC Express. David O’Sullivan spoke to Singular Systems CEO, Anthony Wilmot, about the system.

Anthony, what are we talking about when we refer to Over-The-Counter trading?

David, over the counter trading is a term that refers to shareholders that want to trade their shares but they are not trading their shares in a listed instrument. What I mean by that is the share is not listed on any recognised exchange, but you’re a shareholder all the same and you wish to exchange your shares for cash and trade your shares with somebody else, so that is what over-the-counter trading is. It’s all shares that are effectively exchanged outside of the listed environment.

Now, round about 2011 when Equity Express started, there were two options available. You could become a listed company, trade shares on the JSE, or remain unlisted and trade on an OTC basis and that was quite a popular option wasn’t it?

Yes and it still is. What happened is when the FSB brought out the ruling in 2011, effectively the waters were muddied in terms of people understanding what a legal OTC was, or what an illegal OTC was and what was the exchange function. In essence, I can summarise it as follows. To the extent that there is any matching, what we mean by that is where a computer system or an infrastructure nurtures buyers and sellers, if that is what is taking place then you need to be a licensed stock exchange. You are not allowed to match shareholders in terms of bid and offers without a stock exchange licence. That falls directly within the definition of an exchange according to the Financial Market’s Act.

An employee holds South African Rand notes in this arranged photograph in London, U.K. Photographer: Jason Alden/Bloomberg

When the Financial Services Board released its directive in July 2014, it came down hard on what they referred to as illegal exchanges. Did that put an end to OTC trading for a while?

Yes, that’s entirely correct. Effectively, what happened is we sought permission from the FSB to conduct our service on the basis that we were conducting. Then the FSB came out with a ruling which essentially said the permission that they’d given us to trade on that basis, they had examined the act and they felt that the activities that we were conducting fell within the definition of an exchange, so they instructed us, well, not actually us, instructed our clients to regulate their affairs and they were given four choices. The choices were: change the basis on which you trade so that you no longer fall within the definition of an exchange, either OTC Express or the new OTC way of doing things, list on a recognised exchange, or apply for a stock exchange licence. Those were the four choices our clients were given.

This was obviously problematic for a lot of the BBBEE schemes who had a large number of shareholders who were largely unsophisticated first time investors.

Absolutely correct and at that time we were not only looking after the Multichoice counters, which is Phuthuma Nathi, which we still do today, we were also looking after the Sasol scheme and we were looking after the YeboYethu scheme, so in total it was about 450,000 shareholders that were affected by this. I don’t know my figures exactly, but I’ve been told the total number of shareholders on the JSE amongst all the brokers is only about 230,000. So we are talking about a significant number of shareholders that were affected by this ruling and the reason why we’d been successful in this space is because all of these schemes have rules around which membership is curtailed or controlled.

Essentially most BEE schemes, it’s a race-based rule, so you have to be an authority to survive in South Africa and to participate in these schemes and one has to vet these shareholders before they can trade and that was the service that we effectively were offering our clients and hence the desire to work with us and provide a seamless share trading mechanism for the shareholders to exchange their shares.

I suppose for some companies listing was the option, but with that comes all sorts of regulatory, possibly expensive requirements.

It wasn’t only the regulatory and expenses requirements, it was a very real problem of how do you control who becomes a shareholder in my scheme in an open public market? So, that was really the essential problem they had. The only way you can enforce that in the JSE type environment is for every single broker that wants to buy and sell those shares to enforce the rule on all the brokers and that can become a situation where you’re putting in enforcement of your rules across many multiple parties rather than holding one party accountable and that was really the attraction that we held for some of our clients because they could hold us as a company responsible for the entire rule set of their schemes and they were then hoping that because one party was doing it, there was more consistency applied than a client who was ruled over many and potentially having no dilution of the rules or some parties enforcing the rules  in a different manner to others.

So, for an OTC operation to function properly, do they require a licence?

That’s a very good question. That question can be answered in two ways. OTC is not regulated by the FSB. You do not require a licence. If you conduct your affairs in such a manner that you fall within the definition of exchange in terms of the Financial Markets Act then you require a licence and because we have clients that said to us, “We have been informed by the FSB, that we have to change the mechanism on which we trade our shares, please come up with an option so that we can trade our shares and fall outside of the definition of an exchange in terms of the FMA”.

We came up with our solution, which is our OTC Express option and effectively that is not regulated by the FSB, you don’t have to – we do not have an exchange licence and that operation provided the share planning services on a similar basis to the old Equity Express structure, but the essential difference is there is no matching, so effectively, what OTC Express is like an advertising bulletin board. People advertise the shares that they wish to buy or sell, then we create an environment in which it is easy for them to meet with one another.

I don’t mean physically, I mean over the telephone or via email or whatever basis I want to negotiate. They negotiate the price at which they want to buy and sell their shares and once they have concluded their negotiations, they come back to the platform and capture what they’ve agreed. In essence, it’s pretty similar to what it was before. The only difference is the parties must negotiate between themselves and are not bound by their adverts. Their adverts merely give an indication of the price at which they wish to buy and sell their shares.

What kind of volumes are you doing?

On our OTC platforms, we’ve seen a small fall off on volumes from what we had before, but we’re typically doing in the region of R30 000.00 to R50 000.00 a day on our two OTC platforms, on our two counters that are trading on that OTC basis. The one is Lenmed and the other is Assupol and both companies that have a market capitalisation of round about R2bn and for the moment, it is the best solution that we can come up with without needing a stock exchange licence. These counters are not listed; they are merely just trading their shares on the basis that has always been legal, which is OTC.

The OTC Express system, what kind of company does this appeal to?

This really appeals to any company that wants tradability of their shares, but they do not want to be listed. One of the benefits of listing, of course, is institutional support and we’ve had three different organisations been granted, stock exchange licences and are fully within the regulated space. The benefit of the OTC space is there are no real regulations and it means that you can conduct your affairs as a company in any manner that you deem appropriate, but if you are not showing the right levels of corporate governance and everything in terms of how you conduct your affairs, your shareholders themselves are not going to be happy with it, so I don’t think OTC means free for all. What OTC basically means is you are allowing the shareholders to trade their space in an environment that is not regulated by any third party in the South African context; that would be the FSB.

So, clearly the OTC Express is not for all companies, but it has significant advantages for companies who feel comfortable trading in this way?

Yes, and it certainly means that companies can set rules, so while these analogies express a product being quite nicely adopted, is it means that companies can tell us, for example, there have been quite a few of these agri companies and the only people that can buy shares are farmers, so they will say only farmers may become shareholders of my exchange, so where any company wants to control who may become a shareholder or rules about how many shares they may own or if they’ve invested in shares, they own shares, but they can’t sell them for a certain period of time, any rule of that nature can be enforced by a trading platform. Most unlisted companies, typically say, have more than 400 or so shareholders get to the position where the chairman of the board will say, “I have a shareholder who chooses to sell his shares, who should he sell them to, or how can he sell them” and it always becomes the company secretary’s problem.

Read also: What is Legal Over-The-Counter Trading?

So, just because the OTC Express exists and it’s a formal way of doing things, doesn’t mean that there aren’t lots of unlisted South African companies that wish to have the ability to have some shares traded because fundamentally, that problem always ultimately sits with the company secretary, so we’re targeting any sort of fairly large unlisted company where the company secretary is spending a disproportionate level of his time involved in share dealing activities and wants to get rid of it on a basis that it’s well controlled and he knows that those buyers are going to get their shares and the sellers are going to get their cash and the entire environment is well controlled.

The company secretary is quite close to the process and the company stays in control every step of the way?

Correct, exactly right and so effectively, after the shareholders on our OTC Express platform have negotiated and agreed a price, then we as Singular Systems at OTC Express ensure that the buyers get their cash, the sellers get their shares or they maintain the register for the company and that entire process now falls outside the control or the worry of the company secretary. That’s what we bring to the party.

What are the other key features of OTC Express?

We also are a registered Transfer Secretary, so we can fulfil all those functions and then lastly at OTC Express we also do all the payment of the dividends and all the core productions associated with the company. Effectively, it’s like being listed, but there are no rules that are enforced by a third party being the FSB or an exchange, so you as a company have a lot less rules that you have to adhere to, but the tradability of your shares is made very, very easy for your shareholders and the other huge benefit of course is when you have an open market where people can trade their shares, price discovery occurs.

What we’ve seen with our clients, is a lot of the times they don’t know what their shares are actually worth, how they’re going to be priced by the market and allowing your shareholders to trade their shares OTC, price discovery occurs. So, companies obviously get to understand exactly, how the market wants to value their shares. I’ve yet to meet any companies or company secretary that’s happy with the price, they always say the price is too low, but it’s interesting how the price is set by the buyers and sellers.

How do people get more information about OTC Express, how do they start trading on OTC Express?

Well, the relationship is a strong relationship between us and the issuer, so typically, if you’re a company that would approach us and say, “Could you help us with our OTC share trading?” the moment that process has begun and we accepted you have put the share register on an online share trading platform, then normally there’s a campaign to go out to all the existing shareholders to inform them of what the process is and how it all works and that’s how the shareholders then are aware that they can trade their shares. In terms of contacting us, it’s very simple, you just go to and there’s an information page you can fill in and contact us and our telephone numbers are there too.