Very interesting story.
SEC Proposes New Measures to Combat
Microcap Fraud
By Rusty Szurek - 2/21/98
Over the past several years, the Internet has
evolved into a powerful medium for the
personal investor. Through Internet message
boards, microcap stocks such as TVSI,
BAAT, SEXI, ACCY, BNTI , ADGI, and
many others have gained large followings.
Unfortunately, some individuals have abused
message boards and other Internet resources
to hype and manipulate these types of
stocks. In an attempt to combat these
fraudulent practices, the Securities &
Exchange Commission recently proposed
several regulatory measures. What are the
possible implications of these regulations?
Overview
Microcap companies are predominantly
thinly capitalized stocks that are often not
required to file periodic reports with the
SEC. The securities of these companies are
quoted on three mediums: the
Over-the-Counter Bulletin Board (OTC BB)
under the supervision of the National
Association of Securities Dealers, Inc.
(NASD), in the Pink Sheets under the
supervision of the National Quotation
Bureau, and on the Nasdaq Small Cap
Market. Microcaps, because of infrequent
press releases and hype, often trade on high
volumes with large price spreads and
fluctuations. The SEC has recently become
more concerned about microcap fraud as the
aforementioned trading mediums have
assisted individuals, brokers, and companies
in their efforts to control the markets for
these securities.
The "pump and dump" scheme is one of the
most common types of microcap fraud.
Brokerage firms use their personnel to "cold
call" potential investors to purchase "house
stocks" (stocks in which the brokerage firm
holds a large inventory or makes the
market). Often, the information disclosed to
investors is slightly exaggerated, or it can be
completely fabricated. Message boards on
the Internet have made it very easy for
"pump and dump" schemes to operate.
Promoters or insiders of a company, holding
many shares, commonly post messages
citing the great potential for a company on
these boards. After investors "pump" up the
stock, the insiders and promoters "dump"
their shares, realizing healthy profits.
An example of this scheme involves the
security, Systems of Excellence (SEXI). The
CEO, Charles Huttoe, was convicted of
paying an electronic newsletter to hype his
company's stock. Huttoe pleaded guilty to
making $12 million in illegal profits, and he
is currently serving a 46-month sentence.
The SEC recently made the following
proposals aimed to decrease fraudulent
scams similar to the "pump and dump"
schemes in microcap trading:
NASD Surveillance Proposal
The most recent proposal by the SEC is to
have the NASD implement an automated
surveillance system that will search Internet
message boards, company home pages,
investment sites, and other on-line sources
for fraudulent claims about Nasdaq and
OTC securities. The NASD plans to
investigate companies with large message
followings, suspect postings, and large
fluctuation in daily closes. The surveillance
system has taken a year to develop, and it
will alert the NASD to certain phrases like
"the next Microsoft, hot tip, etc." posted on
the Internet. After being alerted, the NASD
will investigate those companies it feels may
be fraudulent. Mary Schapiro, President of
NASD Regulations, has said that an
"automated technology might have raised
earlier red flags about Comparator Systems
Corp., whose stock rose thirty-fold in a
three-day period in May 1996 before it
collapsed."
However, the NASD does see two problems
with this new system. First, the anonymity of
those posting the messages, and second, the
vastness of the Internet. Despite these fears,
the SEC feels that this system will allow
them a better opportunity to alert the public
and brokerages of possible scams even
though it may not know who exactly is
posting the fraudulent information. The
SEC's enforcement director, William
McLucas, has said "investors need to be just
as wary of the information they read
electronically as they are about a flier they
are handed on the street."
Form S-8 Proposal
Form S-8 is used to register securities for
offer and sale to employees of the issuer in a
compensatory or incentive context. Revised
in 1990, the form has since been used
improperly as a means to sell securities to
the public without the correct investor
protections outlined in Section 5 of the
Securities Act. Fraud occurs in the following
manner: The issuer of Form S-8 registers the
securities to consultants or market-makers
(market-makers: dealers who match buyers
and sellers and help finance trades) who
then act as statutory underwriters to sell the
securities to the general public. As
compensation, the registrant issues the
consultants securities for promoting or
hyping the registrant's securities. This
practice promotes fraud by compensating
market-makers who hype the issuer's stock.
A secondary problem is that often times the
market-makers know little or nothing about
the security they are trading and as a result
provide a disservice to the investor.
The SEC proposals would deter Form S-8
abuse by:
Clarifying that Form S-8 status is not
available for sales to market-makers who
directly or indirectly promote or maintain a
particular company's securities.
Disclosing to the public those advisers who
are receiving stock from Form S-8 clauses.
Microcap Capital Raising Proposal
Although nothing has been formally
proposed yet, SEC officials are seriously
considering regulating ways in which small
companies raise seed capital by selling their
companies securities privately to friends and
family. The current rule, 504 of Regulation
D, allows public and private companies to
sell as much as $1 million worth of stock
without registering the securities with the
SEC. The SEC added this rule to Regulation
D to help small companies raise capital
without having to pay the expensive costs of
federal registration.
The SEC plans to amend this rule by forcing
companies that avoid federal registration of
the security to register the stock sale with a
state's security regulator. This proposal
would also require companies to file
financial statements with state regulators.
The proposal would also recommend that
the owner of the shares be required to hold
the securities for one full year before any of
them can be traded, and two years before all
of the securities can be sold. Under current
SEC law, the securities can be sold
immediately and investors have no access to
a company's financial information.
How will these regulations affect
Investors?
Although the Internet provides a wealth of
information, investors should realize that
much of the information can be false, and
that they themselves, should confirm any
claim made on the Internet. If passed, these
new regulations will help the personal
investor. It should help remove some of the
fraudulent microcaps and hopefully lessen
the hype found on message boards.
However, because the Internet is so vast it is
impossible to curb all fraudulent schemes.
The new regulations should not be
cumbersome for legitimate small companies.
Stanley Keller, co-chairman of the American
Bar Association's task force of small issuers
said, "This won't be particularly burdensome
to small companies and shouldn't interfere
with legitimate small-business financing
efforts." Investors should realize that the
SEC does not require companies that are
raising less than $1 million to formally
register with the SEC. Therefore, these
companies do not have to file reports with
the SEC. Investors should be extra careful
with companies that fit this description.
Investors should research as much as
possible about a company before they invest.
Never rely solely on information from
on-line sources to make an investment
decision.
Investors interested in visiting the SEC's
guidelines to "INVESTigating before you
INVEST" should visit:
sec.gov.
Mr Metals
PS. This article has NOTHING to do with IPMCF. It's just a warning/education for ALL of us. |
