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Microcap & Penny Stocks : SEXI: Mostly Fact, A Little Fiction, Not Vicious Attacks -- Ignore unavailable to you. Want to Upgrade?

To: Skeeter Bug who wrote (12454)	12/2/1997 12:48:00 AM
From: Urlman	Respond to of 13351

How come I don't hear about old Walther Wallpaper, our favorite CIA operative from Barundi anymore???? -URLMAN

To: Skeeter Bug who wrote (12454)	12/2/1997 12:58:00 AM
From: Urlman	Respond to of 13351

Federal Document Clearing House Congressional Testimony September 22, 1997, Monday SECTION: CAPITOL HILL HEARING TESTIMONY LENGTH: 15120 words HEADLINE: TESTIMONY September 22, 1997 ARTHUR LEVITT CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION SENATE GOVERNMENTAL AFFAIRS PERMANENT SUBCOMMITTEE ON INVESTIGATIONS SECURITIES FRAUD BODY: TESTIMONY OF ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING FRAUD IN THE "MICRO CAP "MARKET BEFORE THE PERMANENT SUBCOMMITTEE ON INVESTIGATIONS COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE SEPTEMBER 22, 1997 U.S. SECURITIES AND EXCHANGE COMMISSION 450 FIFTH STREET, N.W. WASHINGTON, D.C. 20549 TESTIMONY OF ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING FRAUD IN THE "MICRO CAP " MARKET BEFORE THE PERMANENT SUBCOMMITTEE ON INVESTIGATIONS, COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE Chairman Collins and Members of the Subcommittee: I appreciate this opportunity to appear before the Permanent Subcommittee on Investigations on behalf of the Securities and Exchange Commission ( "Commission "), to discuss fraud in the micro capital ( "micro cap ") and "penny stock " markets and the Commission's efforts to combat such fraud. Summary We are living in an era of tremendous expansion in our capital markets. Last year, the Dow broke 6,000, and then 7,000, and this year broke 9,000. Daily volume on the New York Stock Exchange and Nasdaq is also at an all-time high, and initial public offerings are running at a record pace -- as shown in 1996, $50 billion was raised for new businesses. It is not surprising then that public participation in our securities markets has grown to record levels. Mutual fund assets ($135 million in 1980) are now a record $3.7 trillion, surpassing the $2.6 trillion that Americans have on deposit at commercial banks. As recently as 1980, only one in 16 households invested in mutual funds; today that number is more than one in three, as we have evolved from a nation of savers into a nation of investors. With this vast expansion in our markets and in public participation in those markets, we would expect to see an increase in the incidence of fraud. We have particularly seen an increase in abuses in the market for micro cap securities, which provides opportunity for small businesses to raise capital, but also provides opportunity for fraudsters to prey on innocent investors. Despite the record-setting pace of our markets, the Commission's resources have remained relatively constant. We must, therefore, rely increasingly on innovative and efficient ways of minimizing fraud and of maximizing the deterrence achievable with the Commission's limited resources. The Commission's campaign against fraud in the micro cap market is an example of such innovation. The three parts of our strategy are prevention, enforcement and regulatory initiatives. Prevention Obviously, the Commission recognizes that preventing securities fraud is far more effective than seeking to punish wrong-doers after the fact. We prevent fraud through our programs involving broker-dealer inspections, market and Internet surveillance, and investor education. Enforcement The Commission's Division of Enforcement has been working in partnership with the criminal authorities to lock up recidivist brokers and deter wrongdoers. Indeed, in the past year alone, at least 80 individuals have been charged or prosecuted through the coordinated efforts of the Commission and the Department of Justice. The Commission has also coordinated its activities with other securities regulators to maximize our resources and stop micro cap fraud at its earliest stages. Regulatory Initiatives Over the last several months, the Commission's staff has worked with the New York Stock Exchange, Inc. ( "NYSE ") and the National Association of Securities Dealers, Inc. ( "NASD ") to develop rules that address the vulnerabilities in this sector of the market, such as a rule that increases the responsibility of clearing firms for notifying regulators of problems with introducing firms. The Commission is also studying how best to increase the amount of public information available regarding companies that are quoted on the NASD's over-the counter ( "OTC ") Bulletin Board and in the National Quotation Bureau's "Pink Sheets. " I. Introduction The terms "micro cap " stock and "penny stock " have been used to describe a particular segment of the securities market. As both terms suggest, these stocks are generally low-priced securities issued by small companies. A penny stock is generally a security that is priced at less than $5 per share and is not traded on Nasdaq or listed on a stock exchange. 1 "Micro cap " stock generally describes a somewhat broader universe of stocks than "penny stocks " -- the stock of any company with comparatively low capitalization, regardless of its price or where it is traded. 2 Thus, the term "micro cap " often includes "penny stock " as defined by the Commission. 1 Under the federal securities laws, penny stock is defined generally as: an equity security that is not listed on Nasdaq or a national securities exchange and either (a) has a price per share that is less than $5 or (b) whose issuer has net tangible assets that are less than $2 million, if the issuer has been in continuous operation for at least three years; or that are less than $5 million, if the issuer has been in continuous operation for less than three years; or whose average revenues are less than $6 million for the last three years. See Section 3(a)(51) of the Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(51), and Rule 3a51-1, 17 C.F.R. 240.3a51-1, promulgated thereunder. When the Commission adopted the $5 threshold for penny stocks it cited three reasons: 1) the perceived difficulty of manipulating higher valued stocks; 2) the fact that $5/share was the threshold for the ULOR/SCOR -- a uniform, streamlined state registration form for companies raising less than $1 million under the Rule 504 exception under Regulation D; and 3) the perception that legitimate small businesses could still raise capital and the liquidity for their shares would not be impaired. Exchange Act Release No. 30608 ( "Penny Stock Rule Release "), 57 Fed. Reg. 18,004 (Apr. 28, 1992). 2 The term "micro cap " is not a term defined under the federal securities laws. Lipper Analytical Services, a mutual fund rating organization, generally categorizes micro cap companies as companies with market capitalizations of less than $300 million. LipperDirectors' Analytical Data, Investment Objective Key, 2d ed. 1997. in general, securities of micro cap companies are quoted on Nasdaq's OTC Bulletin Board, in the National Quotation Bureau's Pink Sheets and on the Nasdaq Small Cap Market. Fraud in the "micro cap " stock market follows a fairly predictable pattern. We find two different, but often related problems: - The first problem is aggressive, and sometimes fraudulent, sales practices, such as unauthorized trading in a customer's account. - The second problem involves manipulation of micro cap stocks by brokers, issuers and promoters to benefit themselves while harming innocent investors. Micro cap stock fraud presents a difficult challenge: to control the fraud without damaging the market for securities issued by legitimate small businesses. In this effort, the Commission is guided by three principles: - First, we must try to prevent fraud before it happens through early intervention and investor education. - Second, we must vigorously enforce the securities laws against con men and criminals who take advantage of investors. - Finally, we must continue to encourage legitimate capital formation through flexible regulation, especially for small businesses. II. Background A. What is Micro Cap Stock Fraud? Before expanding upon the Commission's response to micro cap fraud, it may be useful to briefly consider the nature of the problem. Stock manipulators need stock. They usually get it in one of two ways. One way is to find a "shell " company that already has issued publicly trading securities. This shell company typically has little or no operating history; few assets; few, if any, employees; and slim prospects for financial success. The shell is sometimes merged with a privately-held company. The other vehicle for these individuals to get stock is to take advantage of exemptions from the federal registration requirements. The securities involved are usually traded in portions of the OTC market where public information is limited and a small number of brokers control the market. The securities are usually sold through hype or high pressure tactics, often involving "boiler room " operations where a small army of sales personnel cold call potential investors using scripts to induce them to purchase the "house stocks " -- those stocks in which the firm makes a market or has a large inventory. The information conveyed to investors often is at best exaggerated and at worst completely fabricated. increasingly, stocks also are being t outed on the Internet by unregistered promoters who work to raise interest in the stock. Once they have lured investors, the unscrupulous brokers employ a variety of inappropriate practices, from "bait and switch " tactics, unauthorized trading, "no net sales " policies (where investors are discouraged or actually prevented from selling their stocks) to churning (excessive trading in their accounts in order to generate commissions for the broker). The firm often charges excessive, undisclosed markups 3 and issues arbitrary stock quotations. Even if investors complain to the brokerage firm, it rarely disciplines its registered representatives or reports the investor complaints. are less than $5 million, if the issuer has been in continuous operation for less than three years; or whose average revenues are less than $6 million for the last three years. See Section 3(a)(51) of the Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(51), and Rule 3a51-1, 17 C.F.R. 240.3a51-1, promulgated thereunder. When the Commission adopted the $5 threshold for penny stocks it cited three reasons: 1) the perceived difficulty of manipulating higher valued stocks; 2) the fact that $5/share was the threshold for the ULOR/SCOR -- a uniform, streamlined state registration form for companies raising less than $1 million under the Rule 504 exception under Regulation D; and 3) the perception that legitimate small businesses could still raise capital and the liquidity for their shares would not be impaired. Exchange Act Release No. 30608 ( "Penny Stock Rule Release "), 57 Fed. Reg. 18,004 (Apr. 28, 1992). 2 The term "micro cap " is not a term defined under the federal securities laws. Lipper Analytical Services, a mutual fund rating organization, generally categorizes micro cap companies as companies with market capitalizations of less than $300 million. Lipper-Directors' Analytical Data, Investment Objective Key, 2d ed. 1997. in general, securities of micro cap companies are quoted on Nasdaq's OTC Bulletin Board, in the National Quotation Bureau's Pink Sheets and on the Nasdaq Small Cap Market. 3 Excessive mark-ups in boiler room operations typically occur when a broker-dealer acquires a supply of stock at low cost and resells it at a substantially higher price to retail customers. The promoters of these companies, and often company insiders, typically hold large amounts of stock and make substantial profits when the stock price rises following intense promotional efforts. Once the price rises, the promoters, insiders and brokers sell, realizing their profits, and the promoters cease their Promotional efforts. After the manipulation of the stock ceases, the stock price plummets and innocent investors not Only incur large losses, but may also lose their initial investments entirely. 4 4 This type of Manipulation frequently is referred to as a "pump and dump " scheme. B . The Commission's previous Response to Micro cap Fraud The last major outbreak of micro cap stock fraud occurred during the bull market of the 1990s. The Commission formed a Penny Stock Task Force in 1988 to coordinate its response to the Problem. In 1999, the Commission adopted Exchange Act Rule 150-6, which requires brokers to obtain relevant financial information about their customers, document their penny stock recommendations and obtain written agreements from the customer for the first three penny stock purchases. 5 The intent of the rule is to require and document customer suitability when penny stocks are recommended. Armed with this new rule, the commission devoted substantial resources to policing "Penny Stock " fraud, bringing 86 penny stock enforcement action' in 1990 alone that represented 28% of all enforcement actions brought that Year. 6 5 In 1993, the Commission redesignated Rule 15c2-6 as Rule 159-9, joining it with the other Penny Stock Rules. Exchange Act Release No. 32576 (July 2, 1993), 58 Fed. Reg. 37,413 (July 12, 1993). 6 1990 Annual Report of the U.S. Securities and Exchange Commission, at 6 and 156. In 1990, the Commission approved the NASD's pilot project to bring more accurate and current information to the OTC market, 7 where micro cap stocks generally trade. The vast majority of micro cap stocks are not listed on exchanges or traded on Nasdaq. Before 1990, the National Quotation Bureau's "Pink Sheets " were the primary source of information about the stocks for this large group of smaller companies. The Pink Sheets are daily lists of stocks, published by a private financial information vendor, advertising the brokerage firms that make markets in these stocks. They sometimes include indications of interest or nonfirm bid and offer prices for small quantities of stock. The Pink Sheets are not widely distributed and often contain stale information. In order to provide more public information about these stocks, the NASD created the OTC Bulletin Board, a centralized, automated alternative to the Pink Sheets that can provide real-time price and volume information. The pilot project was made permanent in 1997. 8 The OTC Bulletin Board has strengthened the NASD's ability to monitor those quotes that are displayed. 7 Exchange Act Release No. 27975 (May 1, 1990), 55 Fed. Reg. 19,123 (May 8, 1990) Corrected Order, Exchange Act Release No. 27975-A (May 30, 1990), 55 Fed. Reg. 23,161 (June 6, 1990)). 8 Exchange Act Release No. 38456 (Mar. 31, 1997), 62 Fed. Reg. 16,635 (Apr. 7, 1997).

To: Skeeter Bug who wrote (12454)	12/2/1997 12:59:00 AM
From: Urlman	Read Replies (1) \| Respond to of 13351

...CONTINUED.... Congress also has previously worked to address micro cap fraud. In 1990, the Subcommittee on Telecommunications and Finance of the House Commerce Committee took up the issue of penny stock fraud, 9 and ultimately Congress enacted the Penny Stock Reform Act of 1990 (,,Penny Stock Act ") as part of the Securities Enforcement Remedies Act ( "Remedies Act "). 10 The Penny Stock Act expanded the Commission's authority over such previously unregulated persons as promoters who associate with broker-dealers to sell penny stocks, and it required the creation of a toll-free hotline investors could call to obtain the disciplinary history of brokers. The Act also placed significant restrictions on so-called "blank check " offerings and required broker-dealers to disclose more information to customers when selling penny stocks. Finally, the Act called for the creation of an automated quotation system for OTC stocks, which the NASD and Commission already had underway with the OTC Bulletin Board. 9 Penny Stock Market Fraud: Hearings on H.R. 4497 Before the Subcommittee on Telecommunications and Finance of the House Committee on Energy and Commerce, 101st Cong. 27 (1990) (Statement of Richard C. Breeden, Chairman of the Commission). 10 Securities Enforcement Remedies and Penny Stock Reform Act of 1990, Pub. L. No. 101-429, 104 Stat. 931. After the enactment of the Penny Stock Act, the Commission adopted new rules to implement the statute. 11 Among the requirements are rules requiring brokers to give customers specific information before the sale about the market for penny stocks and the broker's compensation. After the sale, the broker must provide clients with monthly statements reporting the market value of the client's penny stocks. The goal of these rules is to provide information to investors and provide prospective investors with an opportunity to consider whether to make a purchase without the pressure of boiler room tactics. 11 Penny Stock Rule Release, surpa, at fn. 1. In 1993, the Commission amended Exchange Act Rule 15c2-1 1. That rule requires a broker-dealer to review financial and other issuer information before publishing a quotation in the issuer's stock in a quotation media such as the OTC Bulletin Board or the Pink Sheets. The rule also requires brokers to have a reasonable basis for believing the information is accurate. Finally, the amended rule requires broker- dealers to obtain a copy of any trading suspension order in the issuer's Stock for the previous twelve months. 12 12 Exchange Act Release No. 29094 (Apr. 17, 1991), 56 Fed. Reg. 19,148 (Apr. 25, 1991). In 1993, the Commission conducted an extensive examination sweep with the NASD and state regulators to determine whether firms were complying with the Penny Stock Rules. The sweep found widespread adherence to the Penny Stock Rules, along with generally diminished activity in stocks covered by the Penny Stock Rules. 13 13 Joint Regulatory Penny Stock Examination Sweep (June 1994). Only 14 of the 129 broker-dealer examinations disclosed violations serious enough to warrant consideration of enforcement or disciplinary action. C. How Micro Cap Fraud Has Changed Although the Penny Stock Act and Rules and the creation of the OTC Bulletin Board have by and large curbed certain abuses in the market for securities priced under $5, we are now finding that promoters and broker-dealers have adjusted their schemes so that the securities fall outside these measures. The simplest way around the Penny Stock Rules, for example, is to offer or sell securities that do not meet the technical definition of "penny stocks ". The Commission today sees more fraud in mostly lower- priced Nasdaq-listed securities and in securities valued at $5 or more. In addition, the Internet is being used as a new vehicle to perpetrate securities fraud, especially in the micro cap market (including touting in "chat rooms ", bulletin boards and on e- mail). The Commission has already brought enforcement actions involving fraudulent securities offerings, stock manipulations, 14 and investment advisers fraud through Internet newsletters. 15 The fraudulent securities offerings often promise unreal returns and include everything from interests in an eel farm, 16 an ethanol plant, 17 gold and diamond mining enterprises 19 and a coconut chip enterprise, 19 to more sophisticated offerings of sham promissory notes 20 and bonds purportedly issued by a nonexistent offshore company. 21 The Internet can be used for scams because it provides anonymity, broad circulation and the appearance of legitimacy at low cost. Accordingly, the Commission has been developing an effective surveillance strategy for the Internet. 22 However, the Commission is committed to the legitimate use of the Internet by honest market participants. 14 SEC v. Huttoe, Litigation Release No. 15237 (Jan. 31, 1997), 63 SEC Docket 2383 (Mar. 4, 1997). 15 SEC v. Chelekis, Litigation Release No. 15264 (Feb. 2.5, 1997), 63 SEC Docket 2900 (Mar. 25, 1997). 16 SEC v. Odulo, Litigation Release Nos. 14591 (Aug. 7, 1995), 59 SEC Docket 3105 (Sept. 5, 1995), and 14616 (Aug. 24, 1995), 60 SEC Docket 122 (Sept. 19, 1995). 17 SEC v, Spencer, Litigation Release Nos. 14856 (Mar. 29, 1996), 61 SEC Docket 1960 (Apr. 30, 1996), and 15042 (Sept. 12, 1996), 62 SEC Docket 2409 (Oct. 8, 1996). 18 SEC v. Wye Resources, Inc., Litigation Release No. 15073 (Sept. 26, 1996), 62 SEC Docket 2762 (Oct. 22, 1996). 19 SEC v. Frye, Litigation Release Nos. 14720 (Nov. 15, 1995), 60 SEC Docket 2123 (Dec. 12, 1995), 15139 (Oct. 29, 1996), 63 SEC Docket 422 (Nov. 26, 1996). 20 SEC v. Sellin, Litigation Release No. 15012 (Aug. 12, 1996), 62 SEC Docket 1749 (Sept. 10, 1996). 21 SEC v.Octagon Tech. Group. Inc., Litigation Release No. 14942 (June 11, 1996), 62 SEC Docket 377 (July 9, 1996). 22 See discussion at pp. 14-15. III. The Commission's Program to Prevent Fraud in the Micro Cap Markets The Commission's program to prevent fraud in the micro cap market involves: - early detection and intervention; and - investor education. A. Early Detection and Intervention The Commission's program of early detection and intervention includes: (1) regular examination of broker-dealers; (2) surveillance of the Internet and the markets; (3) imposition of trading suspensions; and ( 4) an increasing resort to emergency litigation to stop active and on-going frauds. The Commission's Office of Compliance Inspections and Examinations ( "OCIE ") examines broker-dealers and oversees the examinations which the Self Regulatory Organizations ( "SROs ") -- the national securities exchanges and the NASD -- conduct of their members. Over the past several years, OCIE has focused its review of broker-dealers on their sales and trading practices. About 20% of examinations lead to referrals to the Commission's Division of Enforcement. OCIE is currently working closely with the NASD to focus on micro cap fraud through intense examination of broker-dealers. The examination staff also periodically conducts "sweeps " to determine if particular violations are widespread and then it issues recommendations and reports. For instance, in 1994 the Commission staff with the NYSE and NASD conducted a review of the hiring, retention and supervisory practices of nine of the largest brokerage firms. Two years later, the Commission, together with the NASD, NYSE and the North American Securities Administrators Association, Inc. ( "NASAA ") conducted a joint sweep to review the sales practices of selected registered representatives employed by small and medium-sized firms as well as the hiring, retention and supervisory practices of the brokerage firms that employ them. The second sweep revealed that some firms employ registered representatives with a history of disciplinary actions and customer complaints, use only minimal hiring procedures, and have supervisors in branch offices who fail to review customer transactions adequately to detect sales abuses. We also found that almost one-half of the branches that engage in cold calling violated federal cold-calling rules. 23 As a result of the sweep, the Commission, NYSE, NASD and NASAA prepared a public report making specific recommendations designed to correct these problems. 24 For example, the report recommends more stringent hiring procedures for registered representatives; heightened supervision of registered representatives with a history of customer complaints, disciplinary actions or arbitrations; and training and supervision of cold-calling techniques. 23 In 1991, Congress passed the Telephone Consumer Protection Act, Pub. L. No. 102243, 105 Stat. 2394 (1991), codified at 47 U.S.C. 227. The Federal Communications Commission enacted rules which, among other things, restrict the hours unsolicited calls can be made and require telemarketing firms to have "do-not-call " lists. 47 C.F.R. 64.1200. 24 Joint Regulatory Sales Practice Sweep, A Review of the Sales Practice Activities of Selected Registered Representatives and the Hiring, Retention, and Supervisory Practices of the Brokerage Finns Employing Them (Mar. 1996). These joint sweeps have resulted in greater coordination among the regulatory authorities. The Commission's compliance staff meets quarterly with the NASD and NYSE to discuss how to improve our combined examination procedures. In addition, the Commission's regional examination staff meet regularly with their state counterparts and local NASD offices to determine how to better craft regulatory solutions. To combat securities fraud on the Internet, the Commission's Division of Enforcement, with the assistance of other Commission staff, has assembled a group of professionals who devote more and more resources to Internet surveillance. These professionals use the latest browsing software to monitor the Internet, including such message areas as newsgroups and bulletin boards. The on-line Division of Enforcement Complaint Center also provides an easy means for investors to send complaints to the Commission staff. Currently, the Commission receives between 50 and 70 on-line investor complaints a day. Suspicious activities are investigated, with enforcement action initiated where appropriate. In addition, the Commission staff has helped states develop their own Internet surveillance programs and meets regularly with the states, both individually and as part of regional and national conferences, to coordinate our surveillance and investigations. The Commission recently implemented a pilot program in our Florida regional office to intervene as soon as a potential sham micro cap offering is identified, which has already resulted in six trading suspensions. 25 The staff reviews regulatory filings for irregularities, or "red flags ", that suggest the company may not be legitimate. After determining that the public interest and protection of investors require it, the Commission can suspend trading in the stock. Trading suspensions can be a very potent remedy because: 25 In the Matter of Amquest International, Ltd.. Exchange Act Release No. 38695 (May 30, 1997), 64 SEC Docket 1862 (July 1, 1997); In the Matter of Green Oasis Environmental, Inc., Exchange Act Release No. 38588 (May 9, 1997), 64 SEC Docket 1395 (June 10, 1997); In the Matter of Genesis International Financial Services, Inc., Exchange Act Release No. 38565 (May 1, 1997), 64 SEC Docket 1259 (May 27, 1997); In the Matter of Historic Hotel Holdings, Inc., Exchange Act Release No. 38492 (Apr. 10, 1997), 64 SEC Docket 761 (May 6, 1997); In the Matter of OmniGene Diagnostics, Inc., Exchange Act Release No. 37966 (Nov. 19, 1996), 63 SEC Docket 709 (Dec. 17, 1996); In the Matter of Home Link Corp., Inc., Exchange Act Release No. 37292 (June 10, 1996), 62 SEC Docket 288 (July 9, 1996). - Investors are put on notice of a potential fraud, hopefully encouraging more informed decision- making; and - Promoters and brokers are hit where it hurts most: in the pocketbook. The financial reward of a micro cap scheme depends on selling all the stock at the height of the manipulation. A trading suspension often leaves the promoters holding worthless stock before they are able to dump it on unsuspecting investors. Although a trading suspension only halts trading for a ten- day period, the suspension triggers application of Exchange Act Rule 150-11, which requires a market maker to have current and accurate financial information about the issuer before trading resumes. In other words, it is difficult for a broker-dealer to lawfully resume trading. B. Investor Education The Commission continually works to educate investors about how to avoid and report securities fraud through its Office of Investor Education and Assistance (OIEA). A well-educated investor is one of the most important defenses against securities fraud. Through Investor Alerts, an Internet Web Site 26 and a toll-free information line, 27 OIEA provides investors with practical tips on how to spot securities fraud. Numerous pamphlets and brochures have been developed to warn investors about scams, stating in "plain English " what every investor should know about investing. All of our publications are available free of charge on the Commission's website as well as through our toll free number. 26 sec.gov 27 ( 800) SEC-0330 To educate investors and listen to their concerns, the Commission has coordinated -and will continue to hold -- Investors' Town Meetings throughout the country. The town meetings are typically well