08 Jul OTCMarkets’ R. Cromwell Coulson testifies before Congress
On 12 June, R. Cromwell Coulson, founder and CEO of OTC Markets Group, testified before a House of Representatives subcommittee on “Reducing Barriers to Capital Formation.” Other speakers were Joseph Ferraro of Prospect Capital Corporation, a publicly traded business development company; Shane B. Hansen, of the Alliance of Merger and Acquisition Advisors; David Weild, head of Capital Markets at Grant Thornton LLP; and Donald C. Langevoort of the Georgetown University Law Center.
Cromwell Coulson is familiar to everyone interested in penny stocks. He and a group of investors purchased what was once the National Quotation Bureau in 1997. Under his stewardship, the once-despised service changed from a provider that still saw to the execution of trades by telephone to the organized, technologically sophisticated public company it is today. Coulson is proud that he's introduced transparency and efficiency to the marketplaces he oversees. He opened his testimony with an explanation of what OTCMarkets does, and what contributions it makes to our equity markets in general.
Moving on to the body of his presentation, he offered 15 recommendations he hopes will make our public markets more open and inclusive, more transparent, and more efficient. He would also like to see what he calls “unneeded regulatory burdens” removed, to reduce costs and complexities for smaller public companies. He is, however, not at all opposed to meaningful regulation, when necessary to prevent violations of the securities laws or punish miscreants.
First, as a tip of the hat to the Congressmen who were his audience, he praised the bipartisan effort made to pass the JOBS Act, enthusiastically endorsing the bill. (Many critics believe portions of the JOBS Act constitute an engraved invitation to fraudsters, but Coulson does not share their views.) Coulson claims that the new law will “bring sunlight into the previously dark worlds of private securities offerings under the SEC’s Regulation D and Rule 144A, while creating new opportunities for transparent capital raising by U.S. and global companies.” Again, not everyone would agree that allowing companies to advertise private placements to the general public is a good thing, for Coulson, evidently the Act's good points outweigh the bad. The thrust of his Jobs Acts comments was to encourage Congress to demand that SEC finish its rulemaking changes. The agency has indeed been delaying interminably, and is now nearly a year late with the new formulations.
Not all of Coulson's recommendations are of interest to most retail investors or traders, but some merit discussion. Penny stocks are his bread and butter, and perhaps because of that he is, as he says, “hyper-aware of the risks of fraud, particularly in the microcap space.” He and his staff worked up some statistics:
Last year, the SEC ordered 10-day suspensions on 672 microcap and shell securities. We analyzed those suspensions focusing on the dollar volume of trading in each of the suspended securities for the 90 days leading up to their suspension. The suspensions included only 16 companies that were current in their reporting to the SEC. Yet, those 16 securities accounted for the vast majority, nearly 80%, totaling $230 million, of the total dollar volume of all suspended securities in the 90 days prior to their suspensions. We urge the SEC staff, in seeking to demonstrate their enforcement oversight, to focus on the quality of enforcement actions and not just the total number of suspensions.
That's interesting, but fails to take into account the fact that by the time the SEC gets around to suspending, the stocks targeted have been dead for months, usually many months, and the reasons for the suspension are of mostly historical interest. Stock price and volume have by then declined dramatically.
It also fails to take into account the agency's concern about corporate hijackings. Hijackings are a very real threat. The perps research and target dormant public shells whose corporate status has been revoked in their home states. They then bring custodianship or receivership actions in local courts. Their pleadings usually contain deliberate falsehoods, but the judge rarely asks pertinent questions. And so the shell is taken over. The hijackers then inform the transfer agent, begin updating OTCMarkets or even making Edgar filings, and later pump the stock with a lucrative promotion. SEC enforcement actions intended to removed these shells from the marketplace, either by delisting them to the Grey Market or by revoking registration, are an easy, inexpensive and quick remedy.
Coulson is most certainly correct, however, when he says:
Unfortunately, a company with little revenue and no assets can be an SEC reporting company with minimal cost and effort. The SEC needs to recognize this all too easy path to fraud and take pro-active steps to focus on the companies that are causing the largest investor losses. We should encourage the SEC to focus their limited enforcement efforts on the most highly promoted SEC reporting micro-cap companies that are heavily advertised on the Internet. These companies and their brazen promotional activities make a mockery of the regulation of our securities markets.
While the SEC has shown more interest in taking action against major promoters in the last few years, those actions, coming as they do long after the touts and their backers have walked off with tens of millions, are thought by some to have been ineffective. Coulson suggests that the agency focus on officers, directors, affiliates and major shareholders of reporting companies. Readers of PSS will see the sense of that. He proposes that the SEC conduct background checks of company officers and shareholders as part of the registration process, and that they request and review shareholder lists and the history of share issuances from transfer agents, which might enable them to stop fraud before it happens.
Coulson would also like to see enhanced disclosure requirements for stock promoters, noting that “investors should have the information to identify the people behind the promotional web site and those who are paying the website so much for the promotion...”
He also advocates better regulation of transfer agents and the share issuance process. Pointing out that the sale of stock that's been freed up through the issuance of fraudulent opinion letters is a problem, he states flatly that the “licensing regime for SEC registered transfer agents... is nearly nonexistent.” He recommends that:
The SEC should require transfer agents retain and provide to broker-dealers information on the issuance, ownership and transfer history of shares. Currently, transfer agents issue “clean” certificates that have no restrictive legend when directed by the company. They do not identify if the shares are currently owned, or were ever owned, by an affiliate of the issuer. Subsequently, the broker-dealer who receives those certificates from a customer has no indication if the holder is an affiliate of the issuer and no information regarding the issuance and transfer history of the shares. Placing information sharing requirements on transfer agents in these securities would allow broker-dealers and regulators to more quickly identify promoters and prevent this type of micro-cap fraud before investors are harmed.
This is excellent advice. Anyone who follows the pennies is aware how easy it is for big shareholders, almost always affiliates, to get legends lifted so they can sell stock obtained in shady convertible debt deals.
Coulson also believes that insiders and affiliates of all public companies should be required to disclose their transactions. As things stand now, only insiders of companies registered under the Securities and Exchange Act of 1934 must do so. Insiders and affiliates of companies registered under the Securities Act of 1933 have no obligation to tell anyone when they buy or sell, unless the company is exchange-listed; the same is true of all Pink issuers. Coulson proposes that all insiders and affiliates be made to file Forms 3, 4, and 5, and—more important still—that promoters be considered affiliates, adding that “prior to depositing shares or initiating trades with a broker-dealer, insiders, affiliates and promoters should be required to provide written notification of their affiliation with the issuer or be liable for antifraud and recission of the transactions.”
Were his ideas adopted, it seems likely that both the promoter and the ubiquitous third party payor would need to be identified as real people with real names, because someone must sign those Forms 3, 4, and 5. Presumably Schedules 13 for the really heavy hitters would have to be filed as well.
The rest of Coulson's proposals are more technical, having to do with market mechanics and trading rules unlikely to have a perceptible effect on retail investors.
His recommendations for cutting back on fraud are interesting, and have merit. They are to some extent in line with the SEC's recently announced new enforcement initiatives, which include the creation of a task force to detect and combat microcap fraud by targeting "'gatekeepers,' such as attorneys, auditors, broker-dealers, and transfer agents, and other significant participants, such as stock promoters and purveyors of shell companies.”
Some of Coulson's ideas, sadly, would require rewriting of existing SEC rules and regulations, which as we know is a dauntingly time-consuming process. To return to his opening point: consider how long it's taking the agency to put new JOBS Act regulations in place.
Promoters probably won't be filing any insider trading forms anytime soon.