WSJ: "SEC Bolsters Safeguards Against Penny-Stock Fraud"

For the past year, Oddball investors have been worried about a proposed SEC rule change that threatened to make it more difficult to trade in opaque micro cap companies. Over a hundred people wrote in to comment, almost all in opposition, including well-known investors, firms, and funds like: Mitchell Partners, the OTC Markets Group, and the Oddball land company Aztec Land and Cattle Company, Ltd..

The astute comment letter writers raised important objections and proposed workable alternatives. Unfortunately, the investor feedback seemed to fall on deaf ears at the SEC, and the rule change seems to have been approved with little modification:

Still, the proposal drew opposition from critics who said the SEC was going too far in its effort to protect investors, by effectively barring people from investing in small, unlisted companies.

Dozens of public comment letters were filed in opposition to the plan, many of them from value investors who look to the OTC market for opportunities overlooked by others in the market. Such investors will sometimes seek financial data from companies directly, even if the companies don’t post it publicly.

There is a long history of investors seeking undervalued stocks in the OTC markets, where prices were once quoted in a publication called the Pink Sheets.

It is sad because some micro-cap companies are keeping investors in the dark - in violation of their obligations under state law - and this does not address that problem in any way. In fact, it may encourage companies to be even more opaque in order to shut down the OTC trading market in their shares (which they don't control) and more readily enable them to squeeze out shareholders.

Some other highlights:

  • The amended Rule has a compliance date that is nine months after the effective date of the amended Rule, and the compliance date for paragraph (b)(5)(i)(M) of the amended Rule is two years after the effective date of the amended Rule. Prior to the compliance date, broker-dealers may continue to publish quotations in reliance on the piggyback exception even if an issuer’s paragraph (b) information is not current and publicly available.
  • However, the Commission understands that market participants may have unique facts and circumstances as to how the amended Rule affects their activities, and the Commission will consider requests from market participants, including issuers, investors, or broker-dealers, for exemptive relief from the amended Rule for OTC securities that are currently eligible for the piggyback exception yet may lose piggyback eligibility due to the amendments to the Rule (217).
  • In considering whether an exemption from the Rule (pursuant to Section 36 of the Exchange Act and paragraph (g) of the amended Rule (218) under these circumstances is necessary or appropriate and in the public interest, and is consistent with the protection of investors, the Commission may consider a number of factors, such as whether, based on data or other facts and circumstances provided by requestors, the issuers and/or securities are less susceptible to fraud or manipulation.
  • In this regard, the Commission may consider, among other things, securities that have an established prior history of regular quoting and trading activity; issuers that do not have an adverse regulatory history; issuers that have complied with any applicable state or local disclosure regulations that require that the issuer provide its financial information to its shareholders on a regular basis, such as annually; issuers that have complied with any tax obligations as of the most recent tax year; issuers that have recently made material disclosures as part of a reverse merger; or facts and circumstances that present other features that are consistent with the goals of the amended Rule of enhancing protections for investors, particularly retail investors.
  • The Commission encourages requests to be submitted expeditiously during the nine month transition period of the amended Rule to avert potential interruptions in quotations in such securities that may occur on or after implementation.
  • Issuers and investors that may be interested in requesting any such exemptive relief may coordinate with broker dealers to submit requests. Because the amended Rule governs publications or submissions by broker-dealers, the requirements of the amended Rule and any conditions of any such exemptive relief would likely be undertaken to be complied with by a broker-dealer rather than an investor or issuer.
  • See infra Part II.L. Paragraph (g) of the amended Rule states that “[u]pon written application or upon its own motion, the Commission may, conditionally or unconditionally, exempt by order any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of this section, to the extent that that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.”

We will be continuing to cover this regulatory change in the Oddball Stocks Newsletter. If you haven't yet, give us a try.

State Farm to Acquire GAINSCO ($GANS)

From a press release today:

State Farm Mutual Automobile Insurance Company, America’s largest property and casualty insurance provider, and GAINSCO, Inc. announced today that they have entered into an agreement pursuant to which State Farm will acquire GAINSCO for approximately $400 million in cash.

The transaction is expected to close in early 2021, subject to approval by GAINSCO’s shareholders, the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, obtaining regulatory approvals, and satisfaction of other customary closing conditions.

GAINSCO concentrates on the non-standard personal automobile insurance market, specializing in minimum-limits personal auto insurance.

The transaction is the first acquisition of an insurance company by State Farm in its 98-year history. [...]

Under the definitive merger agreement, upon closing State Farm Mutual will acquire 100% of the stock in GAINSCO, Inc., the holding company of MGA Insurance Company, Inc., a Texas-domiciled insurance company, and GAINSCO shareholders will receive approximately $107.38 per share in cash. GAINSCO will continue to operate as a separate company and brand with continued focus on its current objectives. Over time, the parties expect to provide State Farm agents the opportunity to distribute GAINSCO products in addition to State Farm products and services.

Shares of GANS had been trading in the mid-$30 range. We mentioned Gainsco in Issue 25 of the Oddball Stock Newsletter back in June 2019. Here is what we said at the time:

GANS is a Texas-based holding company with an insurance company subsidiary (MGA Insurance Company, Inc.) that specializes in minimum-limits personal auto coverage. The company apparently also owns and operates a Hyundai dealership in Dallas! It had been a public company until 2011 when it terminated its SEC registration and went dark. The company had shareholders' equity of $102.7 million as of the end of 2018, on which they had comprehensive income of $14 million in 2018 compared to $15 million in 2017.

Of course, for an insurance company that's earning double-digit returns on equity, you are going to have to pay up... at the ask price of $38 a share the company market capitalization is $182 million, a price-to-book ratio of 1.77 times. Management seems to think that this is cheap because they repurchased 292,958 net shares of stock in 2018, which was 5.8% of the outstanding. The average price paid, though was $25 – the share price chart over the past five years has been parabolic. There is actually a pretty small public float on this – as of the last proxy statement filing (which was in 2010) the directors and officers as a group owned 74% of the stock.

Minimum-limits policies are obviously a different breed than GEICO. One of the many one-star Yelp reviews says, “Pray you never get hit by someone insured by this company.” It is crazy that anyone is allowed on the roads with the bare bones $25,000 of coverage that Texas allows.

Go figure - you would have almost tripled your money buying the minimum-limits car insurer (with its own Hyundai race car) at a P/B of 1.77x (and a ROE of 14%). Maybe the clue was the aggressive share repurchase?