OTC popularity proves
double-edge VSE sword
The Vancouver Sun
David Baines, Sun Business Reporter Vancouver Sun
The cleanup of the Vancouver Stock
Exchange has herded the paper pushers
from one neighbourhood to another.
Scoundrel stock promoters from
Vancouver have shifted their business to
the OTC bulletin board in the U.S., a
penny-stock forum that resembles the
VSE in the late 1980s, when Forbes
magazine branded it "The Scam Capital
of the World."
John Kaiser, a stock analyst based in San
Francisco, says the bulletin board has
been a magnet for Howe Street promoters
and U.S. promoters who previously
brought their dirty deals to Vancouver.
"The bad guys are now doing OTC deals,"
Kaiser said in an interview.
The shift in venue has a double-edge for
B.C. investors. While the VSE is now a safer place to do
business, local investors are now turning to bulletin-board stocks,
which are largely unregulated and beyond the purview of local
regulators.
It also has a double edge for the VSE. While the exchange is
slowly rehabilitating its image, the emigration of schlocky stocks
to the bulletin board has robbed it of an important, albeit
nefarious, segment of its business.
Last year, VSE trading volume slumped 26 per cent to 5.3 billion
shares while trading value dropped 58 per cent to $3.8 billion.
The VSE index has crashed from a high of 1,352 in 1997 to its
current level of 400.
Bulletin-board business, meanwhile, is booming. Since 1995,
annual trading volume has nearly tripled to 29 billion shares.
Trading value increased o $44.5 billion in 1997 from $32 billion in
1995 (1998 results are skewed by the removal of American
Depository Receipts from the quotation service).
There are now about 6,500 companies quoted on the bulletin
board, compared with only about 1,250 on the VSE.
Analysts attribute much of the VSE's woes to a general
disaffection for exploration stocks and slumping metal prices.
Some VSE members -- noting the flight of speculative business
to the bulletin board -- also believe it's the result of too much
regulation, and they want the clock wound back to recapture
some of the more speculative, and lucrative, elements of the
VSE.
"In my opinion, the VSE is over-regulated," says Max Meier,
president of Pacific International Securities. "People buy junior
stocks because they go up and down.
"If you try and control every little upward move, they will find other
places to do business."
The cleansing up of the VSE started in earnest in 1995, when
Michael Johnson was appointed president and given a mandate
to improve the quality of its listed companies.
In ensuing months, Johnson's staff ran interference with scurrilous
promoters and forced their shoddier promotions off the
exchange.
Many moved to new playgrounds. One venue has been the
Alberta Stock Exchange, which boasts a relatively quick and easy
listing process for junior companies and is less diligent in
supervising its listed companies.
Another has been the OTC bulletin board, which has no listing
requirements or surveillance staff to monitor the companies'
activities.
Until this week, the only rule was that any company quoted on the
bulletin board must have a market maker (a brokerage firm that
ensures there is an offer to buy or sell the company's stock).
On Tuesday, the U.S. Securities and Exchange Commission
announced that any new companies quoted on the board must be
registered, which means they must file financial and other salient
information on corporate affairs on a regular basis. Existing
companies will be be given time to comply.
Although this will give investors a better opportunity to assess a
company's viability, B.C. regulators are still nervous about bulletin
board stocks.
"We're very concerned about B.C. residents investing on the
bulletin board," says Gerry Halischuk, compliance director for the
B.C. Securities Commission. "It's a much riskier market than the
VSE due to its lack of regulation."
Halischuk said many OTC stocks lack liquidity; that is, sufficient
trading volume to enable investors to get in or out of the stock at
the quoted price.
"Your liquidity on the OTC depends on solely on your market
maker. If he loses interest, there goes your market."
Halischuk said the VSE trading system, unlike the OTC quotation
system, offers investors the opportunity to see all the bids and
asks, and asses the market for the stock.
"On the OTC, the price is established by market maker," he said.
"If you buy a stock at one dollar, that may not be a free-market
price.
"It could simply be the market maker's price, which makes it so
much easier to manipulate the stock."
He said there are also no rules on how much stock must be in the
hands of the public, which makes it easier for insiders to corner
the stock and artificially boost the share price.
Also, there are no rules on how many options may be granted to
insiders, and no requirement to obtain regulatory approval before
entering into non arm's-length transactions.
"You can look at any of the policies that govern issuer and insider
behavior on the VSE, and they don't apply on the bulletin board,"
said Halischuk.
With so little regulation, the bulletin board has long been a refuge
for VSE issues that get into hot water with B.C. regulators.
In 1986, CHoPP Computer -- which became the first VSE stock
to break the $100-per-share mark -- became embroiled in
controversy and quietly delisted from the VSE. Ever since,
CHoPP chair Don Hutton, a disaccredited chartered accountant,
has been touting the company's stock on the bulletin board.
In recent years, the exodus to the OTC has accelerated as the
VSE and B.C. Securities Commission tighten regulations.
In 1995, Langley-based Thermo Tech Technologies, which found
itself in the media spotlight after it grossly exaggerated the
financial potential of its composting technology, delisted from the
VSE and turned to the bulletin board.
In 1997, VSE-listed Sungold Gaming International found new
currency on the bulletin board after VSE officials, skeptical it had
the financial capacity or management expertise to build a
$160-million racetrack in Richmond, forced it off the exchange.
The flight of these companies has taken business away from the
VSE. For example, Vancouver promoter Dan Scammell traded
140,000 shares of CHoPP last year through local brokerage firm
Jones Gable & Company. Rather than executing that trade
through the VSE, Jones Gable directed it through a U.S.
brokerage firm.
Statistics on how much OTC board business Vancouver
brokerage firms are doing are not available. Some industry
sources estimate it may account for up to half the total
commission revenue generated by some of the VSE's smaller
broker-members.
Meier said about 40 per cent of his firm's commission revenue
comes from trading stocks on U.S. exchanges, including the
bulletin board and the more senior Nasdaq market. That
compares to 10 per cent five years ago.
"We go where our clients want to go, and obviously in the last few
years a lot of clients have gone to the ASE, Canadian Dealing
Network and bulletin board," Meier said. "We don't recommend
stocks in those markets, but there seem to be a lot of people who
want to be involved in them.
"This is not a positive thing. I would prefer if all that business was
here. We have much better way of keeping in touch with what a
company actually does."
OTC business has been aided by the emergence of a new genre
of promoter, the cyberspace tout-for-hire, which has posed new
problems for securities regulators.
In late October, the U.S. Securities and Exchange Commission
announced its first coast-to-coast operation to combat internet
fraud, filing 23 enforcement actions against 44 individuals and
companies.
The SEC said the defendants purported to provide unbiased
opinions on more than 235 junior companies, most listed on the
bulletin board, but failed to disclose they had received more than
$6.3 million and nearly two million shares of cheap insider stock.
Aside from this action, there is no indication U.S. regulators are
about to declare war on OTC-related malfeasance.
"The problem is that they don't even know what exists," says
Kaiser.
"It's not like Vancouver, where the business was concentrated
and regulators could shine the light on one spot.
"Bulletin board companies are dispersed all over the country, and
they are so small and insignificant in the whole scheme of things
that the mainstream media has no reason to pay attention to
them."
Kaiser predicted, however, there will be a day of reckoning for
bulletin-board stocks.
"My speculation is that when we finally go into a bear market and
people have lost their shirts on things like these internet stocks, it
will unleash a knee-jerk action, where OTC stocks will be targeted
and there will be a massive regulatory clampdown," he said.
"This will actually be beneficial to Canadian companies, provided
they don't decide they have to slide back to the OTC way to
compete."
To date, U.S. enforcement action against bulletin board
companies has been selective and, given the high incidence of
illegal behaviour, serendipitous.
In July 1997, the SEC filed a formal complaint against Beverlee
Kamerling a.k.a. Beverlee Claydon, who was banned from
trading in B.C. in 1988 for securities violations relating to
VSE-listed Ultra Glow Cosmetics.
The SEC alleged Kamerling manipulated the share price of
United Fire Technology, a Seattle-are bulletin board stock, and
provided kickbacks to brokers who recommended the stock to
their clients.
The intervention action came too late, however, for several B.C.
residents who invested several hundred thousand dollars in the
company.
"The marketing is very directed," said Kaiser. "You find your
victim, set him up and close on him. It's like the old VSE guys
sweet talking wealthy investors."
In November and December, The Sun wrote about three
Vancouver investors who lost more than $165,000 US investing
in International Indigo in 1997-98.
Indigo is a Seattle-area company purported to be searching for
sunken treasure and was being promoted by Kamerling and her
then-boyfriend, Nik Markovina. The SEC has taken no action in
this case.
Meanwhile, the proliferation of bulletin board stocks has caused
new headaches for B.C. regulators.
In March 1997, the commission intervened in American
Technology Exploration Corp., a Vancouver-based company that
soared to $8.75 US on the basis of a gold property in California
that purportedly had more gold than Bre-X claimed to have.
With 150 million shares outstanding, the company's total
stock-market value was more than $1.3 billion. However, this
value was highly theoretical as stock fluctuated on extremely thin
trading volume.
The company's chair was 79-year-old Philip Lieberman, who was
already under two suspension orders for similar stock scams.
When the commission learned he was promoting American
Technology over the internet, it banned him for life.
Also in 1997, Vancouver promoter Frank Balfour, already under a
trading suspension for securities violations, was charged in
connection with his promotion of Jackson Tech, a bulletin-board
stock he was running out of his Kerrisdale home.
He pleaded guilty to unregistered trading and was sentenced to
30 days of electronic monitoring.
In October 1997, the commission issued a cease-trade order
against Abbotsford-based H&R Enterprises, a bulletin-board
stock it said had "the appearance of a classic stock
manipulation."
The commission alleged that Michael Mitton, who has a history of
criminal fraud and is already the subject of a 20-year trading ban,
was behind the scheme.
According to commission documents, H&R shares were being
traded through Wolverton Securities and Georgia Pacific
Securities, two VSE members who, along with Union Securities,
are believed to be trading large volumes of bulletin-board stocks.
In March, the VSE imposed a lifetime ban on Union Securities
broker David Gilbert for securities violations involving four
bulletin-board companies: Remington Financial Group,
Performance Nutrition Inc., Omnet Corp. and Members Services
Corp.
Union Securities admitted it had failed to properly supervise
Gilbert and two other brokers, and agreed to pay a $125,000 fine
and $25,000 in investigation costs.
Many Vancouver brokers are ambivalent about the flight of
speculative stock business to the bulletin board.
"Being tough on bad actors, that's a good thing. I don't have a
problem with that," said Meier.
"Forcing companies to issue news releases, or to say they know
nothing [to account for price fluctuations], I've been part of all
those changes.
"That to a fair degree, that is the right thing to do, it's just that
we've gone too far," he said. "I think the VSE believes that, unless
a company's earnings have just increased, the stock shouldn't go
up.
"But stocks don't always work like that. Internet stocks, for
example --there's no way to justify a stock price of $322 for
Amazon.Com on the basis of earnings."
Meier said VSE red tape has also been driving business to other
exchanges.
The recently-formed Listed Company Association, led by mining
promoter Bruce McLeod, has been working with the VSE to
streamline and harmonize rules with other exchanges.
Both Meier and Kaiser believe one answer is to consolidate the
VSE, ASE and Canadian Dealing Network (the Toronto Stock
Exchange's junior market) into a single venture-capital market.
"We need to create one filing and regulatory system that
eliminates inter-provincial competition and covers all companies
with the same standards," said Kaiser.
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