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.

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