On April 7, 1999 important revisions to two key SEC regulations took effect and almost nobody noticed. The new language* of these regulations makes it clear that an important revenue source for stock promoters is out of bounds. Specifically, the SEC disallowed the use of Form S-8 and Rule 701 stock as compensation for consultants who engage in promotion of such stocks. Fortunately there is a recent MSNBC article by Christopher Byron that describes the Rule 701 change and its potential impact. The full article can be found at msnbc.com
Some excerpts:
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. ...
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. ... (emphasis added)
The article goes on to note that a number of non reporting companies appear to continue to operate as they did before the change in the rules. The article also notes that no cases have been brought to date under the new rule 701 nor have there been any opinion letters issued regarding it. (However, it has been only seven weeks since the new rule took effect.)
The article discusses only the Rule 701 (compensation via stock for non reporting companies) changes, however, there is also corresponding language now in place for Form S-8 stock compensation by reporting companies. Indeed the key change in rule 701 in the area of consultant compensation was to harmonize the language between S-8 and 701.
The article notes that use of company stock created via Rule 701 for compensating promoters is not only now illegal but is also contrary to the standards of practice of the National Investor Relations Institute, described as the pricipal trade organization in the financial PR field. This group issued a statement in connection with the S-8 changes which can be found at niri.org
SEC's description of the Form S-8 and Rule 701 changes can be found at sec.gov and
sec.gov respectively.
* It should be noted that much of the new language simply codifies and clarifies pre-existing interpretations of the regulations rather than extending the regulations. In other words, much of the proscribed behavior was already out of bounds. |
