December 26, 2018
During the last few months the Securities & Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”) have made another major move against the capital formation process for Micro-Cap Stocks traded in the Over the Counter (OTC) Market.
For years, there has been a war by our regulators on the processing of securities in the OTC markets. These actions effectively throw out the baby with the bath water: The vague and subjective rules that have been promulgated and enforced by these authorities do little to advance the legitimate cause of preventing money laundering, pump and dump schemes, and other securities law violations in the OTC markets, while at the same time effectively shutting down capital formation for the entrepreneur, historically the source of invention and new job creation in America.
Of course when unscrupulous and manipulative individuals take advantage of markets, the full force of enforcement should be imposed by regulators authorized to protect our markets. And it is true that there has been no place more susceptible to these practices then in low priced, over-the-counter securities.
Individuals and hedge funds have used the regulations and interpretations of regulations to develop financial structures and market conditions that allow them to take advantage of the very important equity markets for these companies.
The actions of, and enforcement taken by, the SEC and FINRA are well deserved and necessary to protect investors in these markets but, appear to stop short of considering what these do to honest investors, and in my opinion, more importantly to the companies. Small innovative companies are the driving force of many of the new technologies, sciences and industries in the U.S. Economy.
Recent SEC and FINRA actions attack the broker/dealer’s ability to clear securities, and through up obstacles to an investor’s ability to buy, sell and invest, in any company that is low priced and not trading on a national exchange. Investors who, historically, have chosen, to invest in the next American Dream will no longer be able to invest their principal. But another side of the equation is adversely affected. Small innovative companies will be prevented from taking advantage of the capital and liquidity that these trading markets offer. In short, these markets are essential to providing the fuel for the capital needed by these companies and potential profit for investors.
CHOKING OFF capital for the country’s smallest business enterprises is the unintended consequence of these recent attacks by our securities regulators; and as Congress appears to be lax in its oversight responsibilities, no one is reviewing these damaging regulatory actions.
Should an American Investor want to invest in the new Cannabis industry offering
a powerful alternative to addictive and therefore dangerous opioid pharmaceuticals for
pain management, or in a new gene or immune system approach to combating cancer,
or maybe even a car that uses water as its main fuel for propulsion, few Broker/Dealers
remain that are capable and willing (because of being in the cross-hairs of regulators) to handle investments in these ventures. Fewer still, are the number of Broker/Dealers that will welcome low priced shares of these innovative small companies to be deposited and cleared for sale in the stock market.
The proof is in the pudding: SEC Rule 144 – the rule that qualifies all restricted stocks from trading in the secondary market – is now applied in a discriminatory way as a consequence of the recent regulatory assault that we have been describing. Even when holding periods and other SEC Rule 144 requirements are complied with, low priced company stocks that trade on NASDAQ and even the NYSE are accepted for deposit, clearing, and trading in the secondary market, but low price stocks that trade OTC in the overwhelming majority of broker/dealers are not.
For the last 40 years I have been explaining to my business associates in Europe, China and the Middle East that the main difference between their economy and ours comes down to this rags-to-riches story so typical of American success: two people working in their garage with little more than a dream, build a widget that no one else envisioned, find investors to finance their invention and with the help of an investment banker get their company’s securities into the public equity markets, benefiting both entrepreneur and investor. Many of our new technologies, industries and sciences have started this way (think Edison and the electric bulb). This is how things have always been done in America. This is what makes America Great. This is what makes America different from other economies throughout the world.
Without intending to do so, our regulators have found a way to kill the American
Dream by killing the American OTC markets. It is ironic. At the very moment when our
elected bodies passed legislation to jump start our economy that have directly resulted in bringing about Regulation A Offerings and improvements to Private Placement rules,
like 506(c), thereby bringing new investors into OTC markets, our regulators have used
their authority to suffocate the process of clearing low-priced securities of these
innovative small companies, by preventing investors from depositing and trading their
securities in these entrepreneurial enterprises.
There is no securities professional more concerned about the manipulation of the
low-price OTC securities markets than I am. Market Manipulation destroys public investors, public companies, and the essence, not just the reputation, of this vital market that has been the source of many major American Dreams.
That said, killing the market for these low priced securities is not the solution to a bona fide problem. Inevitably, such regulatory action will generate a larger problem for all of us and our society in the future.
Securities regulators receive their authority and powers from the Congress who in turn receive their authority and powers from the people who elected them. The American Investor is a subset of “the people”. The recent rule making actions of regulators, as well as enforcement, directed at assaulting the broker/dealer’s ability to deposit and clear low-priced securities of small innovative companies, in this writer’s opinion, exceed the legitimate powers that Congress entrusted to our securities regulators.
We urgently need a legislative or regulatory champion to explain to our Regulatory Authorities the full extent of consequences of their recent actions.
There are many ways to fix this pressing problem. Securities Regulators should ask the industry – What can be done to protect the public while energizing this OTC market? Specifically, regulators should listen to broker/dealers that act as investment bankers to smaller innovative and entrepreneurial companies.
I don’t mean to suggest that the larger firms have no expertise or interest in this sector.
But, the larger firms, whether wittingly or unwittingly, have acted in ways that put
pressure on the smaller B/D’s and smaller companies and threatened their very
In short, Regulators should seek out those industry players who have been at the
forefront of fighting to keep the American Dream of the true entrepreneur vibrant.
The solutions offered by regulators that address their specific concerns have shown themselves to be Draconian, and have been unable to prevent market manipulation while keeping the low-priced OTC capital markets vibrant.
I believe that we are at a turning point in our economy that also raises an important philosophical question: Are the American capital markets going to be made available exclusively for the larger companies or to individuals who have access to the larger investment banks? Or, will the American economy remain as it was founded – an all embracing market place where honest, hardworking, non-connected entrepreneurs are welcome, included in market discussion, and ultimately granted equal opportunity to avail themselves of investor capital.
To accomplish this, American investors should not be precluded from depositing and
clearing their low-price OTC securities for trading in the markets.
This is a call for help!
If we fail in this call for help, we will be left on the sidelines watching one of the most
important sectors of the US economy, along with the dreams of our boldest entrepreneurs, destroyed.
Damon D. Testaverde
Chairman of the Board