Legal Definitions - due-diligence information

Due-diligence information, in the context of securities, refers to the essential financial and operational details about a company whose shares are traded "over-the-counter" (OTC) rather than on a major stock exchange like the NYSE or Nasdaq.

Before a brokerage firm can propose or quote prices for these types of securities to potential investors, it is legally required to collect, maintain, and make this information available. The primary purpose is to ensure that investors have access to sufficient, reliable data to make an informed decision about buying or selling these less-regulated stocks. This requirement helps protect investors by ensuring transparency in markets where companies might not have the same rigorous reporting obligations as those listed on major exchanges.

Here are some examples illustrating due-diligence information:

• Example 1: Investing in a speculative startup

  Imagine "Quantum Leap Innovations," a new, unproven technology startup, has its shares traded on an OTC market. A broker-dealer wants to facilitate trading for these shares and offer them to clients. Before the broker can quote prices or recommend Quantum Leap Innovations' shares, they must gather due-diligence information. This would include Quantum Leap's latest financial statements (even if showing losses), details about their experimental products, biographies of their management team, and any known business risks. This information must be on file and readily available to potential investors so they fully understand the speculative nature and specific risks of investing in such a new venture.

• Example 2: Trading shares of a foreign company

  "Global Energy Solutions," a renewable energy company based in another country, has its shares available for trading in the U.S. through an OTC market. A U.S. brokerage firm wants to enable its clients to buy and sell these shares. To comply with regulations, the U.S. broker-dealer must collect due-diligence information about Global Energy Solutions. This would involve obtaining the company's financial reports (translated into English if necessary), information about its business operations, leadership, and any relevant regulatory filings from its home country. This ensures that U.S. investors considering Global Energy Solutions shares have access to the same type of fundamental information they would expect for a domestic company, despite it being traded OTC.

• Example 3: A company that was delisted from a major exchange

  "Heritage Manufacturing Co." was once listed on a major stock exchange but was delisted due to failing to meet listing requirements (e.g., consistently low stock price, insufficient market capitalization). Its shares now trade on an OTC market. A broker-dealer wishes to continue offering these shares to clients. Even though Heritage Manufacturing Co. was previously a public company, its current trading on the OTC market triggers the due-diligence information requirement for the broker-dealer. The broker must ensure they have up-to-date financial statements, information on why the company was delisted, any ongoing operational challenges, and future plans. This information is crucial for investors to understand the increased risks associated with a company that no longer meets major exchange standards.