Don't let these companies hide in the dark!

Imagine for a minute that you had a brilliant idea for a product and needed some capital.  To launch your company with this masterpiece product you need capital, so you find some partners who believe in you and they contribute equity to the new venture.  The product does well, there's growth and everything is going well as you work to build the company.  Years pass, the original investors move on happy with their returns.  New investors come along, ones you don't know as well, but they're happy to collect their dividend checks and talk at the annual meeting.  Eventually these investors even stop coming to the meetings or calling, you are running the company on your own.

Slowly you start to become somewhat resentful of your faceless investors.  They are cashing their dividend checks derived from your hard work, but they aren't involved in the business at all.  They don't even seem to care what's happening with the business.  You adapt to their disinterest and start to release news less often.  Eventually you don't file financial statements as often because you don't think the investors care all that much.  They continue to receive dividends in exchange for no effort, so why should you give them any extra?

This relationship disintegrates to a point where eventually you actively hide information from your investors and pay yourself richly.  You're doing all the work, the investors aren't doing anything, plus they get dividends and don't make a fuss.

Does this story seem right?  Or when you read it does it seem wrong?  Does it make you made or angry?  It should and unfortunately it's not just a story, it's something that is happening throughout the market with companies both large and small, but primarily small.  

Shareholders are the rightful and legal owners of companies they are invested in.  As shareholders they're entitled to returns from the company, either dividends or the assets in a liquidation.  But there is a strange twist to shareholding, outside shareholders contribute nothing towards the success of the company yet reap the rewards.  After a company's initial capital has been contributed outside shareholders are simply trading ownership interests between each other.  It's easy to see how a company's management, or employees could see this as a negative.  The company's management and employees work hard every day to put money in someone else's pocket.  It's also not hard to see how some employees might think "I should take just a little extra for myself and department, we work hard and shareholders will hardly notice."

In financial textbooks shareholders should have power over their ownership interest by virtue of their voting rights for the Board of Director.  Shareholders elect the Board, and the Board makes sure the company is managed in the interest of the shareholders.  The problem is this scenario is only true in textbooks.  Boards consist of people who interact monthly/weekly/daily with management teams, and with that level of interaction it's hard to not become colleagues or friends with management.  It's much harder for the Board to stand up for faceless and nameless shareholders who own 100 shares with the certificates stuffed in savings deposit boxes in Dubuque, Iowa.

The idea that the Board is on friendly terms with management and neutral at best or usually on adversarial terms with shareholders isn't new. This relationship has been well known by investors for at least 100 years.  In theory the Securities Exchange Commission (SEC) was created to combat this problem as well as further promote transparency and fairness in the markets.

Unfortunately the SEC is swamped with leads, both real and imagined and they don't have the staff or inclination to pursue most of them.  A second confounding problem is that the SEC is staffed by people for whom the SEC is a career.  These SEC employees have families, friends and hobbies and earning a paycheck and a promotion is only a portion of how they spend their day.  SEC employees (rightfully so from their perspective) are focused on bagging the biggest cases because high profile or political cases can result in promotions, which means a nicer car, or a better boss, or a window office, or a bigger house in the DC-burbs, or really anything else career related.  But none of those things are "upholding the fairness of the markets". And who could blame SEC employees?  How many employees at any company show up to work each day and while passing the mission statement in the hallway think "I'm going to make the customer #1 and provide value in all aspects of my job today!!"  Most people are thinking about where they want to go to lunch, or about some difficult project, or socializing with work friends.  That work gets done is incidental to the experience.

The area of the market where the lack of a visible regulator or Boards that care about shareholders is most apparent is in small stocks that have "gone dark."  These companies were at one point SEC filing companies that used a loophole in the SEC regulations as a way to cease filing financial reports.  To cease updating shareholders with details about THEIR company.  And to hide in the dark.

The SEC claims that any company with less than 300 registered shareholders (more for a bank) can cease filing financial statements and escape regulatory burdens.  This is called "going dark."  The theory is that a company this small should be considered privately held.  I don't disagree with the SEC's logic, except for one area, the type of shares the SEC counts as 'shareholders'. The SEC believes that only registered shares count as true ownership interests.  A registered share are shares held in certificate form.  These are the fancy certificates that are held in safe deposit boxes and need to be mailed to to sold.  The three day settlement period is an artifact of when everyone owned paper certificates.  Three days gave investors enough time to mail their certificate to their broker after instructing a sale.

Since the markets have modernized most shareholders keep shares in street name at their broker.  The brokerage has a giant digital lookup with each holder's name and the number of shares they own, which is called a beneficial interest.  There is a substantial amount of case law confirming that beneficial holders, investors with street name holdings have the exact same legal standing as a registered shareholding.  And it's because of this that beneficial shares receive dividends just like registered shares.

The problem is these dark companies get to have their cake and eat it too.  They can pay dividends to beneficial shareholders but then hide behind their dark non-filing designation and claim they don't need to provide legally required information to shareholders.  

Companies go dark for a variety of reasons.  For some it's to save costs.  The cost of being public can be onerous to a small company.  Companies that go public for cost reasons often continue to update shareholders with news and their financial condition through the mail and on their website.  The cost savers are the exception.  The majority of dark companies are literally hiding in the dark.  Either management is hiding nefarious dealings with themselves and at times outright theft from shareholders, to other management hiding just how good the company is doing from shareholders.  In both cases management is lurking in the dark and escaping through an SEC loophole.

I own shares in a number of dark companies, they range from the cost savers mentioned above who are good stewards of shareholder capital to a number of cockroaches hoping shareholders never realize they exist.  One company I own, Kopp Glass, decided this year that as a beneficial shareholder I have ceased to exist.  It's almost a comical dance, the company claims I'm not a shareholder and have never been.  Which is ironic because I've been to two annual meetings, and at one the CEO told me he'd looked to see how many shares I owned.  It's worth noting that I have continued to receive my dividends quarterly just like I should.  But if I ask for an annual report I'm "not a shareholder according to our records."  The CEO acknowledged in the past I was an owner, but suddenly I'm not. At a dark company hiding in the shadows away from the SEC they can bend rules to fit whatever they want.

Kopp Glass isn't an exception either, they're just one of many companies that play this game.  The problem is the game is illegal.  In Pennsylvania (where Kopp is incorporated, but this rule also stands in Delaware and other states) it's illegal to grant different rights to shareholders of the same share class.  This means you can't pay dividends to only some of the company's shareholders and not others if they all own the same class of shares.  This also applies to information, a company can't distribute material financial information to a few shareholders and not everyone.  While doing so is illegal it could also be construed as to giving certain shareholders an inside advantage.  In the dark market these sort of occurrences seem normal, but they shouldn't be.  The public would be outraged to find out that GM executives were mailing out pre-released financial figures to a select group of their friends, those executives would probably end up in jail.  Yet with dark companies the SEC has implicitly approved the distribution of material information to whomever a company wants, not everyone by failing to act and take action against this blatantly wrong behavior.

Going dark doesn't mean a company can do anything they want.  It just means they aren't burdened with quarterly SEC filings.  To make an analogy a company that goes dark is acting like a person who moves from a city with zoning and a full time police force to a rural area without zoning and a local sheriff.  Moving out of a city doesn't mean the person can start to distribute drugs, sell weapons, open a brothel and do anything they want because there isn't a full time police force anymore.  They just moved from one form of structure to a different form, but the person would need to abide by the law of the land in both places.  Unfortunately dark companies have decided that they are above the law and since the SEC has failed to enforce the law these companies are getting away with it.

We now have an area of the marke that's lawless and a complete mess.  This is the breeding ground for pump and dump operations, unethical managers and anyone else who wants to hide in the dark.  Is it any surprise that pink sheet and non-SEC filing companies are universally derided as scams and dangerous to investors?

As investors there isn't much we can do to change this.  I have made it a point to write about companies that flaunt their dark status as a ticket to steal from shareholders, but writing can only do so much.  At some point the SEC needs to step in and enforce their own rules.

Investors have a very unique opportunity in that right now the SEC has an open comments period on financial information requests.  I know some investors who have let the SEC know their thoughts on dark companies, and I plan to as well.  I hope you will also write a letter, no matter how long or short telling the SEC that companies need to treat beneficial shareholders the same as registered shareholders in doing dark transactions.  The SEC should also ensure that going dark isn't a license to steal from shareholder pockets either directly or by giving out inside information to select parties.

So how do you decide if it's worth investing in a company that's purposefully hiding info from shareholders? I cover this in my free Investing System course. Get it here.


  1. This is great! Thanks for posting Nate

    FYI the SEC is accepting comments until July 21 so people should get them in soon. Beyond that I'd encourage everyone to continue sending them messages because you just have to keep pushing it in their face.

    I have written in to the SEC on this matter and written about this on my blog. My post includes my letter to the SEC in case anyone wants to use parts of it or stats, etc. My post also includes information on how to contact the SEC on this matter.

    The Wall Street Journal recently wrote an article about the SEC's ridiculous definition of "shareholders of record." Hopefully we're getting some traction on this issue.


    1. Thanks for commenting Dan as it helped me find your blog. looks Interesting, I'll add it to my feed.


  2. Hello Nate I am an attorney who is also interested in investing and I love your work. You might consider a derivative action against companies that refuse to act in the best interests of shareholders. There are also statutes in many states that require corporations to disclose financial information to their shareholders and legal remedies if such companies refuse. Maybe in the future I could help with one of these cases. Best Andrew

    1. I have often thought that an enterprising attorney could build a practice going after these dark companies. A company HAS to disclose financial information to share holders under state law. If they don't, sue them. If the company is compelled under the law to comply, they have to pay attorney fees.

      So the trick is finding shareholders that want information....

      I know of at least one company like this, they refuse financial information. I am a shareholder. I want it. I would be willing to sue...

  3. Darkness needs to be outlawed. Any company that at one time or another sold stock to the public must continue to report to their shareholders. All public companies have a fiduciary duty to maximize shareholder value. Dark companies do exactly the opposite. The SEC is violating the public trust and inviting a class action suit. Anyone interested in suing the SEC for being complicit by allowing public companies use this loophole in the law, claim they have fewer than 300 shareholders when in reality the shareholder base could be thousands. The SEC has ignored and helped public companies violate the law. Investors need protection here and now.

  4. Is thinking of a shareholding as "ownership" particularly helpful? Your assertion that shareholders are "rightful and legal owners" is certainly not true everywhere (e.g. shareholders do not own companies in a legally meaningful sense under English law) nor are the rights of shareholders (that you describe well) a good match for common sense definitions of ownership.

    In practice, it seems to me shares are more like another class of bond: shareholders provide funds to companies (we are creditors more than we are "owners") in exchange of perpetual profit-linked coupons (dividends), with rights to residual assets as a form of principal payback. The right to vote to replace management plays the role of a bond covenant, triggered in emergency circumstances, should the right of shareholders for a fair coupon-dividend be at risk.

    Further reading:

    1. In the US case law has confirmed that shareholders are owners in the ownership sense. For example, a shareholder is allowed to visit the company and look through any papers or records. At one point a company tried to sue a shareholder who showed up, the court determined it was impossible to trespass on your own property.

      The separation between public and private shareholders is due to the inside information threat. If one asserts their ownership they could become privy to insider information, or alleged insider information and won't be able to sell shares. Investors are deathly afraid of inside information and will do anything to avoid it.

      A problem is that while shareholders have these rights, no one uses them. Legally one can request salary information, request customer lists, request call records from a company they own. If management isn't agreeable it requires a court order to obtain this, and that's costly and out of reach beyond most.

      I think for most larger companies it's convenient to view stocks are nothing more than a piece of paper. The market doesn't, and it makes it 'easier'.

  5. I'm guessing that these companies probably make up a small fraction of the total invested capital in the country. So while it sucks for us, it doesn't make that much of a difference to the country whether they are well run or not which is why the SEC doesn't spend much time on it.

    On the other hand there is definitely opportunity here for an investor with either money or a platform to reach people (like your blog/twitter) to hold some of these people accountable. We saw that with SODI and I suspect there are many more.

    I agree a lot of these managements are pretty aggravating. I can't count the number of times I've been told "we're private" or "we were bought out". Really, that's funny, because I am sitting here watching you trade on otcmarkets as we speak.

    1. Maybe a better way to think of this is like speeders on a side street. In theory drivers are supposed to obey the law. And there are police who are there to enforce it. But they can't spend all of their time with speed traps on side streets. But the point we're at in the market with this is the side street has become known for drag racing and racers have mowed down more than a few kids. It's still a side street, but one with problems that needs to be policed for a while.

    2. At some point a big company will do it. Look at the stats Zweig wrote on the WSJ. Lumber Liquidators with only 8 shareholders of record. "More than one-fifth of the 1,500 largest companies in the U.S. have fewer than 300 official shareholders". Incredible. I think his main point was this happens with tiny companies and no one cares but some day it'll happen with a big company. Of course people don't care until it affects them so here we sit.

      At least we are getting some traction. My fingers are crossed

  6. Thanks Nate and NoName - I sent my comment in today. It's a snap.

  7. Thanks...if anyone owns ZNCM or UPGI (both related), please get in touch with me. These companies are in need of spotlights

    1. Both those companies look interesting. I emailed Zunicom asking for annual and quarterly reports. Universal Power does share it's reports on their website though (also recent ones). What is you problem with them?

    2. I've owned ZNCM for years. You can email me at

  8. I've had the experience of watching one of my companies (BAMM) get taken private by its controlling family and, as explicitly stated in the proxy statement, they didn't spend a dime to do it. In addition to related party transactions and possibly undervalued real-assets, the LBO was entirely funded by the companies pre-existing credit line.

    This was as bad as if it went dark in order to go private on the cheap. I've had other bad experiences as I'm sure many reading this blog have had, too.

    In addition to the SEC not having the resources to follow these microcap companies, a private market solution is likely more effective anyway. Many involved in these companies go on to other companies taking the gameplan with them.

    A website or other media that provides a depository of information on deemed "bad actors" in public markets could be profitable and serve as a public good. Beyond retail investors in microcaps, many investment funds would be interested.

    Just a thought.