"Off Topic"
Interesting WSJ article for those that don't have access...
Penny-Stock Fraud 'Remedies'
Are Adding to Abuse Problem
By MICHAEL SCHROEDER
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- When cleaning up after
penny-stock scandals of the 1980s, federal regulators
acted aggressively to stamp out rampant bilking of mall
investors that amounted to $2 billion a year. By 1994,
the Securities and Exchange Commission boasted "the
current level of penny-stock activity is minimal."
But they're not saying that today. Fueled by the bull
market, new technology and regulatory loopholes,
penny-stock fraud has come roaring back -- bolstered
by some of the very remedies designed to prevent
abuses. Regulators now estimate annual losses to
investors at more than $6 billion, triple the 1980s peak.
Policing Penny Stocks
Options that regulators are considering for stocks listed
on the electronic Bulletin Board:
Hold market makers responsible for verifying
company financial information and require annual
updates.
Make publicly available the company information
market makers file with the National Association
of Securities Dealers.
Require all Bulletin Board companies to file
financial reports with the Securities and Exchange
Commission.
Update the penny stock rule, possibly raising the
definition of a "penny stock" to $10 or $15 a
share.
Give the NASD unilateral authority to halt trading
in stocks where fraud is suspected.
Revise the SEC's registration-exemption rules to
close loopholes.
"Let me be blunt: There are significant problems in the
[over-the-counter] market and a strong regulatory
response is needed," says Barry Goldsmith, head of
enforcement for the National Association of Securities
Dealers. The NASD is owner and operator of the
Nasdaq Stock Market and overseer of the "Bulletin
Board" market, which handles relatively cheap, thinly
traded "penny" stocks -- in practice, those selling for $5 a share or less. The new NASD chairman, Frank Zarb,
says one of his first initiatives is to clean up the Bulletin Board, an electronic stock listing created in 1990 to supplant the scandal-plagued "pink sheets" used in the 1980s. (That market was a primitive bid-and-ask
trading system that printed quotes on flimsy sheets of
pastel paper. The Bulletin Board gives brokers access to quotes by computer or phone.) The NASD and SEC
may announce other revisions by year end.
However, earlier changes exacerbated the fraud
problem by helping scam artists avoid scrutiny,
government and industry officials say. In the case of the most visible reform, creating the electronic Bulletin Board, few regulatory requirements apply to companies that use it, and its link to Nasdaq gives its listings credibility with unwary investors. At the same time, on-line technology simplifies the marketing of these stocks.
Neither the SEC nor the NASD knows exactly how
much fraud exists because few Bulletin Board
companies must file public financial statements. But
Harry Eisenberg, chairman of Walker's Manual LLC, a
Lafayette, Calif., company that tracks small companies,
estimates that no more than a quarter of the Bulletin
Board's 6,716 stocks are solid and stable. Philip Feigin, Colorado's securities commissioner, says many are "absolute shells or bogus listings."
Problems in New York
This has made it a playground for the unscrupulous.
Many problems arise in New York, which has no state
securities-registration requirements and is home to many small companies specializing in cheap stocks. For
example, prosecutors allege that loopholes allowed
broker Michael Lipkin and associates to sell $1 million
of stock in Mugs Plus Inc., a purported souvenir maker
-- even after its only asset, a New Jersey warehouse,
was gutted by fire and closed by its founders. Andrew
Kandel, New York state's assistant attorney general in
for most of the 4,300 complaints his office expects this year.
Such cases help explain why the NASD is considering
such revisions as seeking SEC authority to halt trading
instantly whenever stock prices and volume shifts
suggest fraud. Currently, that process can take weeks. It also may ask that all Bulletin Board companies be
required to file financial statements for the benefit of both regulators and investors. The SEC already monitors more than 13,000 traded companies and isn't eager to add nearly 7,000 from the Bulletin Board. However, SEC Chairman Arthur Levitt says, "If evidence shows that changes are needed, we won't hesitate to take quick action." Penny-stock fraud exploded in the 1980s, when such stocks generally sold for less than $1 a share, and in 1990 Congress ordered the SEC to stamp it out.
These stocks let small investors ride the bull market
cheaply. But unscrupulous brokers, marketing by phone
and the Internet, can push unsophisticated investors into buying shares in companies without real products or operations. Brokers pump up prices long enough to
dump their own holdings, then move on to other shells -- leaving investors with worthless paper.
The SEC's first move was to make brokers obtain
signed releases from all new buyers of penny stocks
before a transaction could be completed. That was
supposed to make buyers realize they were choosing
especially risky stocks.
Second, the SEC endorsed the Bulletin Board as a
better-regulated and safer forum for thinly traded small stocks. Both brokers and regulators then could see real-time trading of the smallest companies on computer terminals. In theory, they could spot unusual volume or price spikes that might signal illegal activity.
Rule 504
In 1992, the SEC also promulgated "Rule 504 of
Regulation D," which allows small companies to sell up
to $1 million of stock without an SEC registration.
Designed to cut red tape for small business, this
exemption has become a popular loophole for fraud;
qualifying companies don't have to make financial
disclosures to regulators and their shares can be traded immediately without restriction.
The reforms, coupled with efforts to purge wrongdoers
from the brokerage business, helped for a while. In June 1994, officials said a survey of 129 brokerages found that their penny-stock trading accounted for less than 5% of total business, leaving only "traces" of past abuses. But others already were moving to exploit the Bulletin Board, where trading of U.S. stocks soared last year to $18 billion.
Companies can use it once a broker-dealer agrees to
quote their stock. Further, no corporate financial
standards apply, unlike Nasdaq's other listings. Although Nasdaq stresses the Bulletin Board isn't associated with its national and small-cap markets, unwary investors can be fooled.
Consider the case of Mr. Lipkin, a 50-year-old Russian
immigrant who has been charged three times in the past
two years with civil and criminal fraud. One case,
pursued by the New York state attorney general,
involved Mugs Plus, the souvenir company. Mr. Lipkin
in 1994 set up his own Manhattan firm, Hubert Rosche
Inc. In March 1995, his associates paid the founders of
cash-starved Mugs Plus $80,000 for a 51% interest,
state prosecutors say.
The Lipkin group planned to sell new stock to the public immediately, but needed to assure buyers the shares could be resold if desired. That's where the Bulletin Board came in; the group helped arrange for another brokerage to notify the NASD that it would quote Mugs Plus. In fact, the stock never was quoted, but the NASD notification was all the brokers needed to tell buyers that a market existed.
Then the company's factory was destroyed by a
chemical fire. The Mugs Plus founders -- who weren't
part of the scheme -- shut it down and New Jersey's
environmental agency took over the burnt building. But
that didn't stop the Lipkin group from selling shares.
Rule 504 meant they didn't need an SEC registration,
nor did they need signed releases from buyers because
they set the Mugs Plus price at $6 a share.
One prospect who heard from them was Robert F.
Miller, 76, a retired oil-plant worker and resident of
Apopka, Fla. He says he was told the Mugs Plus price
would soon hit $10 or more. Others were told the
company was building a new factory, was the biggest
U.S. mug supplier and might be sold to Hallmark Cards
Inc. An impressed Mr. Miller paid $18,000 for 3,000
shares.
All the claims were false -- and his investment proved
worthless. "The broker was so persistent and
believable," he says now. "I got suckered."
He wasn't alone. More than 200 investors from 26
states shelled out about $1 million for Mugs Plus stock. The money was sent to TriState Auto Market Corp., isted as an auto-parts dealer, according to New York state court records, but actually the address of a
Brooklyn apartment rented by one of the brokers. It
then disappeared from TriState accounts through checks
made out for cash, according to court records.
In July 1996, New York state filed civil charges against Mr. Lipkin and 11 others. In a settlement, the
defendants agreed to repay the $1 million in six monthly installments; they made one payment last year and none this year, prosecutors say.
Mr. Lipkin agreed to be banned for life from the
securities business. His lawyer, Maranda Fritz, says her client "was not involved in any way with Mugs Plus nor did he sell any Mugs Plus stock," and agreed to the ban because he already had left the securities business. This September, he faces a criminal trial on federal charges of tax evasion in an unrelated fuel-oil scheme. |
