Kaiser Express 2000-02
Copyright 2000 John a Kaiser
March 8, 2000
Special Editorial: The CDNX Bottleneck War on Bottom-Fish
After a brutal three year bear market during which investors watched the value of their shares in Canadian juniors dwindle to a fraction of
what they paid for them, and the people who run these juniors wondered what they could possibly do to restore shareholder value, things are
finally looking up for everybody. But there seems to be a conspiracy afoot which perhaps unwittingly seeks to bestow on the beleaguered
Canadian brokerage industry one last advantage at the expense of the investing public. During the past couple weeks a stealth war on mid
to late life cycle juniors has turned into an overt war. At stake is the Canadian institution that has historically fostered the
recycling of failed public ventures. Traditionally a new life cycle has been created through a reorganization involving a rollback, but
thanks to the Internet a rollback that wiped out the public float is no longer a necessary condition. A new model for recycling failed
ventures has emerged that takes advantage of the liquidity and promotional leverage implicit in a large public float. The new model can
operate perfectly well without the involvement of the brokerage industry, and that seems to be the problem. The CDNX is
aggressively pushing a policy which inadvertently (some say deliberately) restores power to the brokerage industry at the immediate expense
of the investing public and at the expense of the long term viability of CDNX as a venture capital market. That policy is the attempt to turn a
change of business by an existing listing into the equivalent of a low priority IPO or reverse takeover. This policy makes the recycling
of failed ventures so time consuming, expensive and aggravating that an entrepreneur is better off floating a new IPO or venture capital
pool, both of which require the involvement of the brokerage industry. The change of business policy as it is currently evolving is an attack
on bottom-fishing, the only investment strategy for speculative stocks where the investing public has success odds similar to those of brokers
and corporate insiders. It is also an attack on the independence of the entrepreneurial community behind the thousand or so CDNX listings
struggling to get themselves back on track.
CDNX: the halt happiest exchange in the world
Many people have expressed frustration over the frequency with which CDNX is halting stocks that are moving too quickly according to the
flags in the surveillance system. My readers, of course, are aggravated about the extended trading halt affecting Meteor Technologies
Inc, which was halted on February 11 when a surge of buying popped the price from $1.40 to $2.10. It turned out that Meteor had
requested the Calgary-based listings department of CDNX to halt the stock so that it could complete its change of business paperwork
and nail down some strategic transactions involving 35% owned Thoughtshare Communications Inc. However, the Vancouver-based
surveillance department had already noted the stock?s move, and based on Meteor?s classification as a resource listing was forced to halt
the stock for clarification of market activity. The logic that prevails within the CDNX is that if a listing is a resource stock, a jump in price
and volume must either be the result of inside information leaking out about a spectacular world class discovery, or the junior must be
contemplating a switch into the technology sector. The possibility that speculators might suddenly take a shine to a resource junior
because it has a great project does not compute at the CDNX. And somehow a change of business carries a smell the CDNX does not like.
Monster logjam of paperwork at CDNX
The frustration among the many embattled resource sector juniors who are trying to keep their listings alive by switching into a new
business not related to mineral exploration is huge. They have run into a monstrous logjam of paperwork at the CDNX created by an
onerous change of business review process and a woefully inadequately staffed corporate listings department. There are stacks of filings
at the Calgary headquarters of CDNX which are months old and have not even been touched. This bottleneck is compromising corporate
opportunity. On top of this mess, CDNX CEO Bill Hess and VP Gerry Romanzin has come out in the media with quotes that suggest the
situation will become considerably worse.
Gerry Romanzin: ?Only IPOs and VCPs please?
Gerry Romanzin is quoted by Claudia Cattaneo and Carol Howes in a recent National Post article as stating that CDNX is ?tightening the
rules to ensure such transformations are motivated by sound business practices?. He goes on to say that ?the exchange is stepping up its
due diligence and will make more detailed management checks and business plan reviews?. Furthermore, from March 1 ?the
exchange will make investment dealers more accountable for the companies they sponsor, ...change of business transactions and
reverse takeovers will require the same onerous reviews as those currently done for IPO?s and capital pools?. Bill Hess is quoted by Peter
Kennedy in the March 6 edition of the Globe and Mail that ?we plan to put these companies through the wringer a bit so that people
aren?t flipping back and forth on the flavour of the month just to attract investor interest?. From what I hear the CDNX staff is
undergoing functional breakdown because it is way over its head in handling the volume and type of transactions. By trying to shift the
burden to the brokerage industry Romanzin is putting many of the CDNX listings into a deep freeze. Ironically, the brokers don?t want the
responsibility, but if it is dumped on them, they will exploit it to their advantage. The brokers like IPOs and venture capital pools because
these have to go through their turnstiles and they can control all aspects of them. The don?t like dealing with existing companies which the
entrepreneurs are trying to resurrect with a new story because they don?t have any leverage over them. In a recent article in the Vancouver
Sun David Baines describes a classic example of how the brokerage industry is turning itself into a venture capital machine that controls all
aspects of a public venture. Yorkton?s Scott Patterson gave Baines some very blunt quotes about Yorkton?s involvement with
Book4Golf.com, a high flying dot-com concept play with a market cap of $500 million. I won?t argue with Patterson?s logic, but I also
agree with Baines? counterpoint that venture capitalism and brokerage services for retail and institutional investors combined pose a huge
conflict of interest. My complaint is that the Canadian brokerage industry is structured so that the investing public does not have an efficient
alternative.
Change of Business Rule: a legacy of the IPO shell machine
The change of business policy has its origins in the abuses of the eighties when the VSE operated as a manufacturer of resource sector
IPO?s that went public with flimsy mineral plays that were quickly abandoned in favour of nebulous non-resource projects that became
the basis for big stock promotions. During the eighties the brokerage industry, which controlled the VSE and was supposed to act as its
gatekeeper, worked hand in hand with promoters to get themselves plugged in cheaply and finance the promotions at higher prices. The
subsequent fallout involved tough new rules designed to make it difficult to switch business focus. It is no surprise that during the
nineties the VSE produced very few non-resource juniors, a business that was taken over by the ASE?s junior capital pool system which
formalized the process of floating a shell IPO and finding a story for it. The crowning achievement of the ASE?s capital pool system
was YBM Magnetics, the Russian money laundering vehicle quoted most frequently in the United States as an example of Canadian
regulatory due diligence. During the nineties the resource sector cycle was hot thanks to the Asian boom and a slew of world class
discoveries and frauds, so the change of business rule was not a problem for VSE resource juniors. But now that the junior resource
sector is not only suffering from the worst slump in decades, but has also been displaced by technology plays as the preferred vehicle
for pie-in-the-sky speculation, the change of business rule is turning into a problem. There are far too many resource listings trapped in a
market that has no interest in financing new mineral plays, and there is an abundance of private sector technology projects that would love
to tap into the growing appetite for technology plays. One would think that this situation should have a happy resolution, but the complexity
of the change of business paperwork and the processing bottleneck at the CDNX is creating a very unhappy situation that is playing into the
hands of the brokerage industry.
Canadian brokerage industry clinging to the past as it fades into
irrelevancy
The Canadian brokerage industry has a serious problem. Technology and the Internet are turning the Canadian brokerage industry as it
presently operates into an irrelevant institution. The current boom in Canadian stocks is a temporary reprieve that will prevent the
brokerage industry from adapting to a new reality in time to prevent its own demise. The traditional role of a broker is to execute trades,
advise investors, and act as a go between for ventures and capital. These roles evolved because brokers had a monopoly on access to
the order execution system, information, and the mechanisms by which public companies raise money. Electronic order execution
systems and near universal online access for the public today make it technologically possible for in individual to execute orders without any
help from a broker. The availability of disclosure documents on the Internet as well as real-time market data make it possible for the
investor to know what is going on to the same degree as any broker. Electronic filing of disclosure documents, a regulatory infrastructure that
enforces disclosure, and the existence of sophisticated investor exemptions for private placements now make it possible for public
companies to raise substantial money without the involvement of a broker. The clock will not be rolled back on these developments, but in
Canada the public investor is not yet able to fully enjoy the benefits thanks to rules and systems which persist only to preserve the
brokerage industry?s stranglehold on a doomed cash cow.
Canada?s high transaction value based commission structure hinders
liquidity
One of those cash cows is the ridiculously high Canadian commission structure which bases the fee for executing an order on the
value of the transaction. There is no economic basis for charging 3% of an order?s value. Whether an order is worth $1,000 or $10,000 it
costs the same amount of money to process the order. With three day settlement and inevitably same day settlement there is minimal
capital risk. The existence of a punitive commission structure is an example of shortsighted broker greed at the expense of developing a
robust market with an international audience. During the past couple weeks I have seen articles in the mainstream media about domestic
stock exchanges in Argentina and Israel bemoaning the flight of listings to more liquid markets. Lower commissions encourage liquidity, the
key to all successful markets. The determination of the Canadian brokerage industry to preserve a high commission structure will
eventually choke the Canadian exchanges to death.
Protecting the broker?s monopoly on online day trading
The broker as an investment advisor is obsolete because this role has been replaced by professional fund managers. The securities market
has become too globalized and complex for a broker to successfully service the needs of a broad spectrum of retail clients. At best the
broker can be efficient as a pseudo hedge fund manager for a small number of high net worth clients. Despite this structural
incompetence, which is not anybody?s fault, the Canadian brokerage industry has not let die a paternalistic rule which stipulates that some
clown must personally review the suitability of every client?s order before allowing it to proceed into the state of art electronic order
execution systems of the Canadian exchanges. There is a self-serving reason for this rule. Online trading remains the exclusive privilege
of the brokerage industry and perhaps a few lucky clients allowed into secret rooms equipped with VCT terminals. How many people realize
that the Canadian brokerage industry has instant access to market depth and can execute orders with a few keystrokes? And that it can do
this for its own accounts? This situation gives the brokerage industry a significant day trading edge over the public in hot markets such
as the current one. The Canadian securities industry (the Toronto Stock Exchange excepted) has the best trading technology, but Canadian
investors are denied access to it on the fraudulent grounds that they are too stupid or irresponsible to trade online intelligently. Canadian
discount brokers are an order execution joke because they have been forced by the full service brokerage industry to enforce the trade
suitability rule and thereby create a trading bottleneck. I call this a fraud because the real reason the suitability rule still stands is so as
to postpone the inevitable day when the broker?s ability to extort unreasonable commissions collapses. That will also be the day when the
market is no longer populated by predatory brokers exploiting the handicapped public. That will be the day when every participant in
the market becomes a predator, and the winners will no longer be determined by who controls the order execution system.
IPOs need a broker, reorgs don?t, so let?s handcuff the reorgs
The broker as a matchmaker between public venture capital and corporate ventures is also a remnant of the past. Strong regulatory
systems and the Internet make the broker?s due diligence role unnecessary, especially in an exchange that encourages recycling of failed
speculative listings. The CDNX requirement that an IPO or reverse takeover have the sponsorship of a brokerage firm was designed to
create a legal liability that supposedly would compel brokerage firms to restrain their compulsion to let anything through the gates so long
as they were pieced off with cheap paper. The brokers grumbled mightily about this burden of responsibility during the nineties, but now
that everybody has a great technology idea and every resource junior is eager to abandon unfinanceable mineral plays in favour of a
technology story, the brokerage industry, which ultimately dictates the rules of CDNX, is not wholly unhappy with the change of business
rules. Of course, if you ask anybody in the brokerage industry they will tell you off-the-record that the change of business rule is the
obsession of the CDNX staff, which has become an out of control tyranny with a life of its own.
Change of Business sponsorship: yet another toll booth for the brokerage
industry
Not too long ago the brokerage industry was bemoaning the flight of business to the unregulated OTC Bulletin Board. Now that public
sentiment is swinging against the American fraud facilitation system, a shift that will be no doubt hastened by the graphic metaphors of the
new Boiler Room movie, the appeal of a properly regulated system like CDNX is becoming apparent. Just when the Canadian junior
market is coming alive the brokerage industry is allowing a bottleneck to develop that is controlled by the brokerage industry. The change
of business rule as it now stands is ostensibly in place to prevent speculators from being exploited by pump and dump operations that only
borrow a technology story until insiders have blown out their paper. But in reality this rule limits the number of technology plays
available for the public, and allows the brokerage industry to shake down any resource junior who wants to adopt a technology play.
This is not to protect the public, but to allow the brokerage industry to extort hefty fees from the juniors as well as cheap paper. I know
of one case where a prominent brokerage firm laughed at a technology junior looking for financing in the $0.30-$0.40 range and declared,
?why didn?t you come to us when you were trading at $0.15??
A financing model for technology startups that makes sense
The change of business rule is bad news for bottom-fishers because it makes it tough for worn out companies to get a new spec cycle with a
non-resource focus going. It is designed to force project founders to seek out the junior capital pools manufactured by the brokerage
industry rather than pursue mineral play style funding models such as that which Meteor has employed. By this I mean a funding model
where a public company uses its cash to earn a stake in a private startup company through a series of staged investments. For
example, in the case of Meteor the junior earned 35% of the Thoughtshare startup venture by investing $500,000, and will probably have
to invest several million dollars to earn another 15%, an increased cost justified by the risk that the earlier investment helped take out of
the project. The final stage of this model is a takeover bid for the remaining interest in the startup venture owned by the founders, who end
up with an exit strategy and a control block in the public company as their reward for delivering on the business plan. This model allows the
junior to fund the startup only as long as it seems viable. It also allows the junior to fund a number of startup projects in order to diversify
the failure risk. It is superior to the RTO model because it leaves control of fund-raising in the hands of the public company, and it leaves the
founders with the ability to seek additional funding elsewhere if the public company gives up or runs out of steam. A new control block
should not be created until the founders have used the public company?s money to demonstrate progress in the development of a startup
venture. To do so right from the start is to shift the funding responsibility to the founder group and encourage the public company
insiders to blow off their paper and hand the keys to the new control group. I am 100% in favour of a tough review process for proposals
to issue large amounts of stock for non-cash assets. But when the junior is raising money from the market and reinvesting it for a direct
stake in a private company, I think we should trust the judgement of management.
Fight abuse by ensuring that the smell of a bad track record lingers
The obvious criticism of this model is that the stock promoters will not do their homework and simply borrow a story to help pump and dump
their stock. Or worse, they will raise the money from investors, and funnel it through the front door of the private company and out through
the back door into their own pockets. Yes, this is a risk. But rather than treat every entrepreneur as a crook and try to stop them at the
gate, why not give them all a chance and if they abuse their responsibilities, let their public track record be their punishment? The reason
I am so adamant that CDNX provide full disclosure of the identities of all parties receiving treasury stock through private placements, debt
settlements and asset acquisitions is so that everybody can see who was associated with a public company in some sort of privileged
manner. If the deal turns out to be a bad one, the smell will cling to those people. If a pattern of involvement with stinky plays emerges, the
smell will turn into an irremovable stench. The ASE and TSE endorsed disclosure policies that guaranteed time would very quickly blow
away the smell created by any bad deals. In the United States the SEC does little to regulate public companies, but when one of them steps
out of line badly the SEC goes ballistic. The Canadian regulators should pursue a system where it enforces extensive people disclosure,
lets the market and media mete out punishment for a bad track record, and go ballistic on the obvious frauds. When the investing public
can see who is all involved with a company, and the company turns into an abuser, the regulators will receive plenty of tips regarding
where to look in order to build a case that will let them crucify the abusers.
So what if mining promoters turn into dot-com promoters?
There is no special reason why the promoters of Canadian juniors shouldn?t switch from one focus to another depending on the market
conditions, so long as the projects are not fraudulent. The mainstream media is really hung up on the idea that there is something silly
about mining promoters turning into dot-com promoters. What they don?t realize is that your typical promoter is no more able to
recognize a world class mineral play than the next eBay story. So what is wrong if promoters start vetting technology plays instead of
mineral plays? Their success will depend on how lucky they get and what sort of technical talent they attract to their team. Furthermore,
while promoting a mineral play well beyond the value justified by the scope of the target and the stage of the discovery cycle will not
make the target turn into a deposit if it isn?t already there, the same constraint does not apply to technology plays. So long as a promoter
uses an expanding market cap to raise money, promoting a technology play to fantasy levels might actually be the key that pulls in the
resources needed to turn the technology into a winner. This construct is not a self-serving fabrication of the Canadian penny stock industry;
it is the model driving the American technology bull market. The CDNX obsession with the change of business paperwork is misguided
because it grants the brokerage industry a monopoly on the process of moving private venture startups into the public arena. This monopoly
is not only at the expense of the investing public, but it is also at the expense of the corporate side of the securities industry. The
change of business rule is the means by which the brokerage industry gets to behave like the bureaucrats in a third world country whose
palms have to be greased before anything constructive can get underway. If the power of these toll collectors is not soon stopped, we will
see a return to the Cartaway/First Marathon trend of the nineties where the brokers pushed aside the entrepreneurs in favour of plays
where they controlled every aspect of a public company with no controls in place to protect the public interest. If the brokerage firms don?t
want this change of business sponsorship monopoly, they should do something about getting rid of it.
Introducing the self-generating pump and dump play
The brokerage industry is frightened to death about what is happening to the market. Despite all the roadblocks and bottlenecks
erected by the brokerage industry, the structure of the market has changed thanks to the transparency created by the Internet, which not
only allows the investing public to see the market action on a real time basis and track down all the fundamentals quickly, but also allows
every member of the public to operate as promoter of the company in which he or she owns shares. The old model where the brokers and
promoters collaborate to create a rig job in which they own most of the paper, invent a story, and then stalk the public prey on a selective
basis only works in archaic markets such as the OTC Bulletin Board. You have all heard of the concept of a ?pump and dump? operation. In
the old pre-Internet days one the insiders would have orchestrated a pump and dump play. But these days with the high visibility that the
Internet gives to the market it is no longer necessary for management to be engaged in any stock pumping for a big pump and dump play to
break out. What we are seeing on the CDNX and with the cheaper companies on the TSE is a new phenomenon I call a self-generating
pump and dump play. There was nothing good to say about the old pump and dump model because the brokers and insiders collected
the money and the investing public got hung with the paper. But the new self-generating pump and dump play has a fertile dimension
that was a rarity in the pre-Internet days. Here is how a self-generating pump and dump play works.
The psychology of self-generating pump and dump plays
The current market is populated by mid to late life cycle juniors that have a fairly large public float, a condition brokers and promoters
have traditionally despised and dealt with by conducting a rollback and repapering themselves with post-rollback debt settlement
and private placement stock. Today we are seeing swarms of investors on the prowl for reasonably liquid juniors whose management does
not have a reputation as sticks in the mud, but who for whatever reason may currently be on their knees. These roving predators look for a
cheap and liquid stock, check out the financials at SEDAR to make sure the company is not on the verge of bankruptcy, and quite
anonymously start buying the stock. The market action shows up on the radar screen of technical analysts or even speculators perusing
the volume leader lists or something like Andrew Muir?s Morning Coffee, who in turn jump into the market to buy some stock. Management,
who may be busy elsewhere or perhaps even asleep at the wheel, finds itself deluged with calls from investors and regulators asking what
is going on. They truthfully answer that nothing is going on, which of course nobody believes because everybody ?knows? that stock
promoters are liars and stocks don?t trade if nothing is going on. The market action catches the attention of professional traders in the
brokerage industry, who move into the market with much bigger orders and crank the stock beyond the level thought possible by the
original predators. Management is so overwhelmed by this unexpected attention that it begins to consider a technology play. Private
sector groups with startup ideas get wind of management?s possible change of focus and forward their business plans. The original
predators, who knew perfectly well that the market action started as an arbitrary hijacking of the stock, start to wonder if perhaps they
had unwittingly jumped the gun on a big game plan being cooked up and in the process gotten very lucky. So instead of dumping their stock
they turn into promoters and start buying more. The street pros dump their stock and go short only to find that the audience for this stock
play keeps getting bigger. They start to doubt their own analysis that the market action was just a local pump and dump, and,
succumbing to the natural awe the street feels for unexplained power, they are knocking on the junior?s door in search of corporate
finance opportunities. Where management is not asleep at the wheel or hopelessly opposed to success, a new market star is born.
Brokers cannot call the shots when the public gives new life to an old
stock
The brokerage industry does not like this situation because they are faced with hot stories in which they do not have a cheap position. The
corporate insiders don?t mind because they usually have large positions and lots of options, albeit a much smaller percentage of the
fully diluted capitalization than is typical for a rig job. They don?t complain because they no longer have to work so hard to track down
and close potential investors as new shareholders. They can deal with the market as an aggregate and concentrate on project
development and fund-raising. They don?t need brokers anymore to keep tabs on the shareholders and prevent them from selling. In the
Internet world a shareholder is more than likely to drum up new buyers before he or she eventually gets around to selling. The most obvious
example of the modern investor are stock forum posters that go by names like ?Rocket Red?, who buy stock and then tout it on the
Internet. For each Rocket Red who posts to a public forum there are many more who privately tell all their relatives, friends and co-workers
about this hot company. In the pre-Internet age few people paid attention to self-appointed touts, but in the Internet age it is very easy to
check up on the market action and underlying story. It is a very contagious environment and it is beyond the control of the brokerage
industry. This unprecedented structure of the market helps render the brokerage industry irrelevant. That is why the brokerage industry is
not really unhappy that the CDNX has in place the change of business rule. It is a bottleneck that serves the brokerage industry and nobody
else.
Gold at $500 would relieve the change of business bottleneck
All this change of business fuss would die down if we suddenly got a hot metals and energy market. Then all those resource sector
juniors forced onto the sidelines by the brokers? change of business rule would swing back into action. If the brokerage industry were not so
naturally short-sighted it would force CDNX to lighten up on the change of business rule so that the people who run existing public
companies would have greater flexibility in choosing the type of venture they wish to fund. In a hot market like this there is a risk that
some companies will launch simple pump and dump plays. The solution to this problem is not to try to stop them at the gate, but to continue
the extensive disclosure system pioneered by the VSE which makes highly visible the process of paper creation and its participants. The
punishment for abuse should be a visible track record that stands out like a scarlet letter when it is bad. I am still shaking my head over
how blithely the ASE management gutted the VSE?s Bulletin Notice system when it took over the CDNX. Has anybody recently tried to use
the CDNX web site where supposedly all this juicy data was being stored in substitution? Probably not because the site is terribly
slow thanks to a security firewall that acts as a bottleneck. And if you tried to find the identity disclosures outside the Bulletin Notice
system that was partially restored last December after I kicked up a fuss, you probably didn?t find anything. Gerry Romanzin and Bill Hess
may have good intentions, but the bottlenecks at the CDNX create a vastly different outcome. It is not the exchange?s nor brokerage
industry?s responsibility to judge the merit of business investments that do not involve the issue of meaningful amounts of stock to
startup founders. Put the juniors through the wringer for reverse takeovers, but leave it up to their judgement as to what business
venture offers the best upside for existing investors and the new ones from whom they will raise money to fund the project.
[No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer to buy or sell the securities
mentioned. While we believe the sources of information to be reliable, we in no way re |
