ASLEEP AT THE SWITCH
By CHRISTOPHER BYRON
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April 19, 2004 -- A strange little company called YP.Net has been getting the attention of investors lately - quite a lot of attention. Too bad the Securities and Exchange Commission doesn't seem aware of it.
YP.Net Inc. is in the business of providing various sorts of "yellow pages" services via the Internet, which may or may not be a big idea, but is certainly not a new one. Yet the Mesa, Ariz.-based company, which trades on Nasdaq's over-the-counter bulletin board for penny stocks, has soared nearly 3,300 percent in the last year to a closing price Friday of $4.94.
In the process, this 119-employee outfit has been throwing off sparks of a sort that one might normally expect to arouse the curiosity of the SEC's Enforcement Division. With revenues of barely $30 million per year, this obscure little operation turns out to be a veritable romper room of related-party dealings.
In the resulting grope-fest of transactions, roughly 25 percent of top-line revenues have been winding up in the pockets of corporate insiders and shareholders - the two biggest of which turn out to be offshore shell companies in the tax-haven island nation of Antigua.
But none of this seems to have drawn even a glance of curiosity from the SEC, which also seems to have missed the implications of a 13D filing by a San Francisco investment fund called Husic Capital Management. The fund's head, Frank Husic, went on a CNBC cable TV show late last month to tout YP.Net - without revealing that his fund had seemingly just acquired more than 40 percent of the stock's public float.
How did the SEC miss all this? Easy. It wasn't (and isn't) looking, since neither penny stocks nor offshore shell companies have much appeal at the moment for the investigators and lawyers of the SEC's overworked and outgunned Enforcement Division. The hot button at the SEC these days is the mutual fund arena, and everything else comes later (or never).
It's too bad, because the SEC's ruggedly handsome chairman, William Donaldson, started off with the wind at his back and plenty of goodwill supporting him as an SEC reformer when he was tapped to replace the preposterous Harvey Pitt as chairman a little more than a year ago.
A top-to-bottom makeover of both the 70-year-old commission and its enforcement powers was certainly in order. Silly procedures and toothless punishments needed to be scrapped. Best example: allowing miscreants to escape the consequences of their actions by promising not to repeat their behavior without ever having to acknowledge that what they did was wrong in the first place.
And the whole idea of financial crime also needed to be rethought. After all, the courts of this nation have no trouble sending a black man to prison for sticking up a liquor store. But when a white hedge-fund millionaire from Greenwich, Conn., or Far Hills, N.J., steals 10,000 times as much money via a Wall Street swindle, he almost always gets away with it.
A typical scam: habitually failing, year after year, to file accurate "13D" investment reports with the SEC. When the swindler is finally called to account, the "punishment" normally amounts to nothing more than correcting the earlier false filings and bringing the reports up to date.
This sort of wrist-slap treatment is usually justified by prosecutors on the grounds that "criminal intent" (what is known as scienter) is too hard to prove in court. Yet the law could easily be amended to make the mere failure to file the required documents evidence of criminal intent per se - and Donaldson could have been a powerful voice for reform in this area.
Yet since taking over as chairman, Donaldson has delivered little in the way of reform and instead has spent much of his time fighting off turf encroachments from New York State's feisty attorney general, Eliot Spitzer.
If you go to the SEC's Web site you'll find the commission's A-list of "topics of current interest." These include such worthy subjects as mutual fund reform and hedge fund regulation, and cracking down on international money laundering by financial institutions.
But if you look to see what the commission is actually doing regarding these matters, the answer is not much - except for diverting SEC resources into the mutual fund arena to play catch-up with Spitzer.
The commission's only real signs of life as an engine of reform turn out to be the endless, viscous flow of panel discussions, town meetings, hearings and roundtables - the functional equivalent of bureaucratic phlegm-clearing to justify the one thing the commission really does know how to do well: adopt yet more edifice-bolstering rules and regulations that don't get enforced.
It is impossible to assess the SEC's current enforcement efforts because the commission's latest data on the matter is by now more than a year and a half out of date.
SO one is left with little but random snapshots of information to suggest the level of activity within the Enforcement Division. One such guidepost: so-called "trading suspensions." These occur when the SEC detects what appears to be hanky-panky in a stock and halts public trading in its shares.
Since Donaldson began as chairman 13 months ago, the SEC has suspended trading in just seven companies - less than half the number of the previous year, when Pitt was running the show. And Pitt's total was nothing to be proud of either.
As a result, zero-to-hero penny stocks like YP.Net, which jumped by nearly 25 percent just last week, scoot under the SEC radar easily enough.
YP.Net, formed out of the 1999 reverse-merger of a privately held Internet yellow pages company and a failed Nevada penny stock in the software game, has two separate shell companies in Antigua that presently own roughly 40 percent of the company's stock.
The most recent annual report to the SEC by YP.Net, for the 2003 fiscal year that ended last September, show that the two Antiguan shell companies collectively hold some $2.1 million in "advances" from YP.Net. But YP.Net's CEO, Angelo Tullo, recently told the Wall Street Journal that he has no idea who actually owns the two shell companies to which YP.Net has advanced so much money.
And there is likewise the question of who has been buying the company's stock on the open market, and why.
Institutional trading data from the Nasdaq automated quotation service shows that at year-end 2003, a San Francisco investment fund called Husic Capital Management had recently sold 1.3 million shares of its position in YP.Net, reducing its stake to just under 1 million shares.
On March 22, the fund's chairman, Frank Husic, who holds stakes in several casino companies and various media properties, went on CNBC's Kudlow & Cramer talk show and declared his support for a "little stock" he liked called YP.Net, without disclosing whether his fund held a stake in it or not.
A week later, on March 31, Husic's company filed an SEC report showing that its stake in YP.Net had in fact been dramatically replenished. Instead of the less than 1 million shares disclosed at year's end, Husic Capital now held slightly more than 7.5 million shares, or 15.5 percent of YP.Net's total shares outstanding. That amount is greater than all the company's shares that had been traded since Husic had appeared on the show, and it clearly indicated that he had already begun building up his fund's position (and may in fact have held all 7.5 million shares) when he touted it on TV. Husic's company declined to comment on the matter for this story.
In all this there may be nothing wrong at all - or there may be little that is right. Either way, the last folks to enlighten you will be the SEC. On America's street of dreams, the watchword is now more than ever: caveat emptor.
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