On April 7, a long-standing and largely ignored Securities and Exchange Commission rule was underscored by the Commission in tough new interpretive language designed to protect investors from fraud and abuse in the penny stock market. Unfortunately, the very companies that the rule targets most directly seem to be ignoring it most flagrantly — making a mockery of the SEC's continuing efforts to crack down on securities fraud involving microcap stocks.
THE RULE IN question bans companies from using their own stock to pay stock promoters and investor relations companies for promotional services rendered on behalf of the companies themselves. The new interpretive language for the rule, issued in late February in connection with several amendments to Rule 701 of the Securities and Exchange Act of 1933, was designed to prevent companies that have little
or no value as investments from conjuring that value out of thin air.
The gimmick: hiring stock promoters to hype their companies to the public, while paying them with shares of the very companies being hyped. Such Ouiji board-type promotions are a common practice among companies on NASDAQ's so-called Over The Counter bulletin board market, where companies are either so small or worthless that they are exempted from having to file audited financial statements with their stockholders and the SEC.
The exemption from SEC filing requirements invites a type of abusive practice in the penny stock market that has become commonplace in recent years. The non-filing penny stock companies simply hire stock promoters to make outlandish claims for the companies, knowing that because the companies are non-filers, there is no way for investors to check out the claims before handing over their money.
In such situations, the SEC normally acts only after-the-fact, when an abusive or misleading stock promotion has already driven up a stock's price and investors have been victimized. Now, the SEC's decision to issue tough new interpretive language for Rule 701 of the 1933 Act has put companies on clear notice that they cannot use their stock as payment for the services of stock promoters and investors relations operators.
According to an SEC spokesman, companies found in violation of the rule will be required to buy back the stock in question for cash, and must carry the obligation as a balance sheet “contingent liability” until it is
discharged. The official said offending firms also are subject to civil enforcement actions by the Commission.
What's more, said the official, there are no “grandfather provisions” in the rule, meaning that any promoter who received stock for his services before April 7 cannot continue engaging in the services afterward.
These type of activities have not only now been specifically barred by the SEC since April 7 but are also banned by the Standards of Practice of the National Investor Relations Institute, the main trade organization for the financial P.R. field.
Taking note of the SEC action as early as March 5, the Institute issued an “Executive Alert” to its members, calling attention to the restated SEC rule and stressing that “consultants who provide investor relations or shareholder communications services” may not be compensated in stock or options in lieu of cash for their services.
Says the Institute's president and CEO, Louis Thompson, “the companiesthat engage in this sort of thing aren't investor relations firms at all. They're stock hypers and promoters trying to hide behind a veil of respectability. It's disgusting.”
Cleaning up this abusive practice is what the SEC's action regarding Rule 701 was all about. But no cases have been brought since its issuance, and an SEC official says the Commission's staff has not yet even issued any individual opinion letters on the matter.
Bottom line? For now at least, it's business as usual on the Internet, where behind every press release about some fast rising penny stock company may very well lurk the impossibly conflicted self-interest of a stock promoter who agreed to hype the stock only if given shares in the company beforehand. That is how
things have been done until now, and nothing seems to have changed since April 7 in any way.
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