“The panel discussion tonight is going to be the State of the Union on today’s capital formation process. What I want this to be is an open discussion, please, you have a very good panel here. And about what is going on in capital formation in the over-the-counter market and the mini caps, in the small-cap stocks, and what we face, in the future, and day to day in our businesses. We are at a crucial time, I can tell you that.“
“And so we can come together as a group, face what is going on, and move forward, or I think the world of capital formation for the small-cap, mini-cap, OTC stocks (over-the-counter stocks), will be permanently changed.”
Damon Testaverde Introduces the Panel
“First of all, I think you have to know who I am, my name is Damon Testaverde. I am chairman of the board of Network 1 Financial Securities, we are a full-service broker-dealer. Been in business since 1983, I am personally an investment banker and the firm is an investment banking firm for small-cap and mid-cap companies.”
“You still have to know who I am so let me tell you, let me start off with this one, I took my RR (registered representative) test in August of 1968. Did anybody beat me? Did anybody take it before August of 1968? 59? Okay 69, so that is 50 years ago. I did my first IPO in, I do not know the month, but it was 1975, I was working with a company called D.H. Blair & Company, does anybody know the name D.H. Blair & Company? And that was 40 years ago, I mean, it is amazing how long ago.”
“So I have been involved for a long time. In the last two and a half years, Network 1 has underwritten 18 IPOs, a dozen private placements, a couple of Regulation A’s, and a couple of 506 C’s, so we do everything, we are not only an investment banking firm, but it is certainly where my heart is and what I love to do. “
Things in the Business Are Changing
“Now the reason why I am saying that is I really believe things are changing. Eleven years ago there were 7.200 broker-dealers, today there are 3.600 broker-dealers, and who is left the business? The little guys. The little guys have left the business. The big guys are still here but the little guys, the people who are interested in this capital formation process in this market, are gone. We used to have something called a stockbroker, today we have managers, money managers.”
“The reason why I bring that up is that stock brokers helped in the capital formation process in the dreams of what was going forward and money managers preserve and protect capital. So there are a lot fewer people out in our markets, helping to raise money. Most of the BDs (broker-dealers) that still exist, if you want to do an OTC stock under five dollars, it would be very difficult to get your compliance officer to approve the transaction. Again a problem. Also, the cost of maintaining a broker-dealer this size is four times more than when I first got involved in working with broker-dealers, basically compliant courses.”
The Panel Discussion Theme
“What I think we have to do is realize that a lot has changed, a lot of the economics of the market has changed and some things for very good reasons, and some things for not such intelligent reasons. So what do we have to do about that? I think together, we have to work together and try to move this market forward and that is what this panel wants to discuss.”
“Congress recognized there was a problem. They very recently promulgated new Regulation A (Reg A) rules and 506 C rules which meant we could generally solicit private placements. Good ideas. It is what this country needs. Remember, most new jobs, new industries, and new sciences come from small-cap companies. So we needed Congress that recognize there was a regulatory onslaught, to make some changes. They forgot to tell the regulators. So we are kind of in a position where it is still difficult for us.”
“And finally, I just want (to share) the one story I remember. If I had an IPO to do, I could take my prospectus and start a Trinity Church on Wall Street, and walk to the water, and on the way down, I was able to sell the deal out because there were so many small brokerage firms on Wall Street. Now, on Wall Street, I could buy a Mercedes or have a cup of coffee and rent an apartment but the broker-dealer that was there, that funded the dream, is less and less.”
“The latest onslaught has been on stock certificates, because of bad people and bad things. FINRA’s put a lot of pressure on the ability to deposit and clear over-the-counter stocks, and I do not know if any of you in here have experienced it, but I am sure you have, but it is very hard for you to do a Regulation A if you can’t deposit the stock certificate and clear it afterward. It is very hard to do a 506 C if you can not deposit the stock certificate and clear it later.”
“So they made moves to protect the market, protect the investment public. Nobody asked anybody in here what to do. So I think there are some unintended consequences to what they did. And again I want to talk about this, and we have some experts here to talk about it today, and what we can all do to revive our markets and to build for the future.”
Panel Guests
“I am here today and I sponsored this panel because more than ever we need to work together. We need to ensure that the capital markets continue to exist and that the American dream for smaller companies is still there. So what I am going to do is: we have Richard Friedman here. He is a partner at Shepard Mullin, a leading securities firm, legal firm specializing in what we are talking about today. We have Dan Zinn in here, general counsel of OTC Markets, they have done a great job so far in trying to put a team together to face the problems and explain the problems to the regulators that we have. And we have Robert Giordano here who is an investment banker with Network 1, who has been doing capital raises in our market for 30 years, specializing in the life sciences. So with that, I am going to ask each person to just introduce themselves, make some comments, and open it up for discussions.”
“This is for you to talk, not me to talk, so I will shut up. This is for us to open up ideas and how we can work together, and move our business forward. By the way, let me just leave off with this: there’s a lot of money for us to be made. This market is not going away. From 1970 to 1973 there were no new issues in the United States. It was a disaster. Economic reasons, if we remember, 15% interest rate, it was a disaster, and yet out of that came Hambrecht & Quist, Drexel Burnham, Alex Brown. We are there again. There is a big future. We are seeing better companies, we just have to get the system working right. So with that, Richard would you say something?”
Richard Friedman Introduction
“Thanks, Damon. Hi, Richard Friedman, I am a partner at Sheppard Mullin. I have been a corporate and securities lawyer since 1987. Not quite the years you are saying, but I did my first IPO back in 1987. And from 1987 to 1989 I did 18 blind pull public offerings before Rule 419 was enacted. So companies, that used to go public with an idea to acquire a business, go down the hall, list their company on the Pink Sheets, and raise just a little bit of money to be nothing more than a public shell.”
“Flash forward, I have seen a lot of changes. Rule 419 is now called a SPAC, it is a big fancy instrument that all the money managers put their money in. But somewhere in between, I have worked with private and public companies. Companies that are going public, companies that are small and are looking to raise money with an idea to get investors and hopefully climb the ladder, from the OTC BB or Pink Sheets up to NASDAQ, New York Stock Exchange. I am a partner now at Sheppard Mullin. It is an AM Law 100 firm, a very large firm with about 900 lawyers, with 15 offices in the US. I am based here in New York, but we have five offices in California, we are in Dallas, Chicago, and DC and we are international as well.”
Changes in the Market
“I have seen a lot of changes in the market myself as well and so, at the end of the day, the SEC, and he is talking about Bill Hambrecht, did not change as we have seen. There are a lot of things that have changed and the markets themselves. The size, the number of public companies, the way deals get done, there are so many things to cover in one area. But come back to the simpler process, which is what I think we are focusing on here, about capital formation and low-price stocks.“
“Today if you are doing a public offering and you want to get listed and you are doing a Regulation A deal or a lower price deal, you may not be able to deposit your stock, and where you deposit your stock, depending on which brokerage firm, which clearing firm, which procedures, it is not so easy to do it. If you are doing a public offering and listing on the NASDAQ or New York Stock Exchange, everything is smooth, everything is easy if you can get yourself listed and everybody understands it. But the first Regulation A deal that got done, which was this Elio Motors deal, was great. Everybody bought their stock, everybody got it and then they all realized they had nowhere to deposit it because nobody understood Regulation A. Some of that has been cured, there have been a number of Regulation A deals. Some people think they now have solutions to getting stock deposited into the system or into their system, maybe not into the full system, and then you have 506 C deals which people are still trying to figure out, how does that stock, how is that like anything else, and where do you get that deposited.”
“There are a lot of different issues that relate to the different kinds of deals. Going back a few years to when the JOBS Act was adopted, people thought it was a big panacea that would change everything, and make it easier for smaller companies to raise capital again. It did because of the rate of change, and the way things happen these days, people raise money in a different manner. Maybe they do not use stock brokers, maybe they go online, maybe they do advertising or different ways, but at the end of the day, when they, if they can raise the capital, where they can get traded, and how they trade, there are a lot of different pieces here.”
“One of the people we are missing, who was supposed to be on the panel with us, is Seth Farbman, who is at Vstock Transfer. You have an investment banking firm on the one end, that raises the capital, you have a law firm on the other end that may help you with your documents, and drafting, you have an accounting firm somewhere in the process and then you have an exchange where you want to list and trade. You still need a transfer agent and a clearing firm for all that stock so there is no one solution, there is no one group that is going to walk in and help with the regulation that has happened. It takes all the groups to get together and have what we’ll talk about. The OTC Markets have put together some conferences and some panels where we’ve had discussions about trying to get some standardized procedures. And while the regulations may have gone, and when I talk about regulations I am probably a little bit all over the place, FINRA has put out some guidance that has resulted in broker-dealers and our clearing firms either being regulated more or being actions against them where they have either stopped or maybe gotten out of the low price stock business. And that is just because they do not want to be in an area of risk that results in more investigations, more regulation or more oversight. And there has got to be some balance as to how they can have procedures in place that everybody around here can put together that maybe give them the best standards, the best way to do business so that when the regulators look at it they do not think everybody is doing bad business. That there are business that can be done by proper issuers with proper standards and proper broker-dealers with proper standards where the stock that is being deposited can be in the system normally. I think I will let Dan and then it will come back more of this discussion.”
Dan Zinn Introduces OTC Markets
“So I am Dan Zinn, the general counsel of OTC Markets. Thanks to Damon and NIBA for having me and hosting this panel. I think both Damon and Richard set up the discussion really well.”
“Just to give some background and context for those who may not be aware, OTC Markets is the company that was years ago known as the Pink Sheets, the Pink Paper Phone Book. Now, our subsidiary, OTC Link LLC, is a FINRA member broker-dealer.”
“We operate two alternative trading systems registered with the SEC: OTC Link ATS, which is the traditional system that people associate us with. It is a quotation and messaging system for about 90 broker-dealer subscribers, and more recently, OTC Link ECN, which is a matching engine, what you might generally think of as an electronic communications network.”
“Within that framework, we support trading in roughly 10.000 securities, ranging from Roche, Adidas, and Heineken, and those ADRs, down to penny stocks and everything in between. Over the years, we have done a lot of work to categorize and designate those securities so that people can have a better idea of what they are looking at. OTCQX is what we call our top market, which is around 415-416 companies as of now.”
“These are companies that are making full disclosure, meeting either an international disclosure standard, they are SEC-registered, or they are otherwise providing PCAOB audited financials on an annual basis, making current disclosure, doing the things you would typically expect to see a top-tier public company do.”
“They are also meeting a set of financial standards. It is not a listing because we are an ATS and not an exchange, but it is the same idea. It is a set of criteria that these companies need to meet to get categorized into OTCQX.”
“Our middle market is called OTCQB, more of a venture stage market. So, same obligations in terms of disclosure and making that current information available and audited financials, but the financial standards are more in line with what you would think of as a smaller, growing company, maybe one that is trying to work its way up to OTCQX or ultimately to an exchange, and we celebrate when companies do that.”
“The remainder of the market we call the Pink market, clearly a nod to the Pink Sheets days. Within Pink, we further categorize companies based on how much information they’re putting out into the world: current information, limited information, or no information. The best kind of reaction I get on any of these panels is when we talk about the skull and crossbones and the caveat emptor companies where there is a public interest concern and not a lot of information out there.“
“All of these are part of a process of incentivizing disclosure, trying to get more transparency into the market so that the more companies are doing the things you would expect the public company to do, the higher up the chain they are eligible to go. And again, ultimately, if they choose to list on an exchange, we support that as well. That is background on the market generally.”
The Regulatory Pressure and What Can Be Done
“In terms of the issue that we are really talking about today, which is, I think, the industry reaction, some of the gatekeepers in the industry, having a reaction to regulatory pressure that goes back to probably 2009, 2010, and in some cases before that, from both FINRA and the SEC, where they are looking at specific instances, often of more egregious conduct in low-priced securities, so unregistered distributions and certainly pump-and-dump and fraud type schemes. They have promulgated a set of more or less interpretive rules or actions that we are now starting to see more and more, clearing firms and broker-dealers, act on by saying, “You know what? It is not worth doing a nuanced review of the company and seeing if I can tell which companies I should be accepting deposits in, and which companies I should be clearing for. I am just going to start cutting out that end of the business.” That is clearly the cause of concern and what I think drives everybody, as talented and good-looking as we all are, to come and listen to this panel.”
“So, Richard made the point: we have started to bring together the players in the industry. We are a central point, and we recognize that, and I think we can do a lot, clearly in terms of facilitating disclosure and information and communication among all the players.”
“So, we started, in the fall, with a round table for transfer agents and their advisors, typically attorneys, to start talking about their role in the process. To Richard’s point, Regulation A is a wonderful example to look at, where there are companies interested in raising capital that way, there are affinity investors and others who really want to contribute to those offerings. What we found with the Elio deal, as a great example, as the first one, was clearing firms and brokers who had no idea what Regulation A even was, so how do you get a transfer agent to provide information to a broker so that the broker then becomes comfortable with the security they’re getting? They understand the legal aspects, the compliance aspects of the exemption that they’re relying on. All of those parts of the process are the beginning of the solution to what I think you know the common problem is.”
“So, we started by talking to transfer agents. We followed that up just a few weeks ago with a roundtable really intended for brokers and clearing firms, and some of their advisors, to try to take a collaborative approach, which is really where Damon started this discussion. From the issuance, if the banker who is working with the company to raise capital is following appropriate processes and procedures and is documenting their diligence, then the transfer agent is going to have a much easier time understanding what the securities look like when they have it on their books. They are going to be able to communicate that in a more efficient way, in a more transparent way, to the broker, to the clearing firm, and it sort of works its way through the process from there.”
“So, the feedback that we have been getting from all of these constituents of the deal and all of these various parts of the trading community are really that they all want a way to determine which companies should be “whitelisted,” what is an easy way for them to tell which companies are doing things the right way, and how do you then, on the flip side, tell which companies we should spend a little more time focusing on. It is seldom, I think, part of the trick is it is seldom about the company; it is much more about the players involved in all aspects of the deal. So, how do you have enough information that you can have transparency of insiders and affiliates and things of that nature? So, we are looking to again facilitate a solution, or at least an approach, that brings the industry together as a whole, that has everybody understand what role they can play.”
“Certainly, OTC again can act as that central point, maybe a central information depository, maybe a place to bring commentary together and bring that to regulators. But if we all do what Damon said at the start, if we all work together on that, people will have a much better result than if we wait or individually wag our fingers at FINRA and the SEC. I will leave it there, and I think we will come back to most of these points.”
Robert Giordano Breaks Down the Issue
“Hi everyone, I am Robert Giordano, an investment banker with Network One Securities. As Damon suggested, my area of specialization is life sciences.”
“This all started about two or three months ago when Damon wrote a letter to over 100 retail brokers laying this problem out and asking for help. When he did that, I said, “Damon, that is a great idea. Why don’t we try to multiply our voice by 50 voices?” That would be the approximate 50 broker-dealers that are part of the NIBA constituency. So, we collaborated and got in touch with Emily, and she was kind enough to get the board to convene, and that is why we are here now.”
“My primary role was as a facilitator in getting it going, but looking at it, I have said to the panel in our earlier discussions and our one telephone call, “Okay, how can we identify what is actually the problem, what are the potential solutions, and more importantly, what can I do as an intermediary to move it forward and ensure ongoing communication with the various NIBA members, leading to some possible solutions that NIBA can co-author of?” I am thinking in terms just generally, all of you who go back to 2010, to 2011 when we first started with third-party due diligence, what was it? Why did we need it? How did it become popular? And there is that universe out there of people doing that. Can NIBA be part of a situation where we can create a process that NIBA stands in for, that gives some additional credentializing to the company and the constituents going forward, and can we, as a NIBA member and NIBA as a whole, lend our voice to it? So, I commit myself to being part of that process going forward, a facilitator and an intermediary.”
“My own practices are significantly removed from the day-to-day activity that these gentlemen are talking about, except at the end of the day, if we raise money and we can’t get stock cleared, I hurt as much as everybody else does. I am very excited, I look around the room now; there’s a half dozen people we are in current collaboration with, and I am very excited about Network 1 becoming a very active part of that process on all levels, whether it is a unique way to syndicate early deals, which some of you know has been sort of my pet peeve, or moving this forward. that is the process that I want to be part of, and I thank Emily and the board for giving us the time to do this.”
Reflecting on the Previous Changes
“Bringing it back, just a little bit more background to this, because it is not all low-priced stocks can’t deposit, it is not all doom and gloom, but just in terms of background history, it is pendulum.”
“So, going back when I said I did all these blind pool public offerings, that was before Rule 419. SEC adopted Rule 419; everybody thought you couldn’t do it. Guess what? Flash forward, you can do SPACs twenty years later.”
“Then there were these convertible debentures deals; everybody did convertible debentures, death spirals, floorless, toxic convertibles. SEC tried to put Rule 415 there and stop people from registering stock and selling stock. Well, at some point, they backed off, stepped back, companies do financing, people do even toxic financing now, but it is not talked about the same way; there’s less of it, and it is just more moderation, although you will see some that are crazy.”
“The reverse mergers, there are people who did all kinds of reverse mergers before they adopted the rules. You could do a reverse merger and not file an 8-K for 75 days; there was no information except for press releases.”
“The SEC changed those rules; full Super 8-Ks get filed now, people do reverse mergers, there’s more transparency, there’s more information, and things get done normally.”
“Same thing with the JOBS Act. The JOBS Act, at some point, great idea, you just need people behind it. It took a long time from the JOBS Act being adopted to finally having Regulation A deals, let alone figuring out how Regulation A really works, which people are still working on.”
“And so, the part about the broker-dealers, back in the 90s, there were so many small broker-dealers. Now, a lot of them are out of the business for a lot of good reasons, but the rest of you, they got gobbled up or ended up going somewhere or whatever. And so, that brings you to this thing, the issue which I think stems from a combination of low-priced securities, these toxic deals, where people got too much stock, sold too much stock that people didn’t have information about, or maybe blocks of stock that broker-dealers, supposedly should have now been gatekeepers, which is the issue that we face generally in the market today. Who’s a gatekeeper for what? Who sees what’s going on and who’s supposed to report or say there’s something going on that they should be suspicious about?”
“NASD Notice to Members 09-05, I think that is where it goes back to, and I think that is what we are talking about here, in reaction to a notice to members that put out that affected broker-dealers that in turn affected clearing firms because they’re a gatekeeper too, and who knows how far the gatekeeper issue goes, and if we can make the gates and have standard procedures or something that is of a higher standard can help; maybe you can’t help one hundred percent of it, but you can help seventy, eighty, ninety percent. Because if there are companies that want to act responsibly, you might have a starting place to go. So that is where I think we are with that.“
Audience Questions and Discussion
“Let’s open it up for questions. Does anybody have any comments or questions?”
Blockchains and Security Tokens
“Yes, sir, we’ve tried blockchain and how it works, and it is extremely interesting. Security tokens are extremely interesting, but right now, it is so cloudy. Is it a security? Is it a commodity? So, if it is a security, we have rules we have to follow, and we do not think the token is a security.”
“I do not think it is anything special personally. People do not understand blockchain or what’s, crypto is a different story. When I say crypto, I mean currencies. I am not a currency CFTC lawyer, but when you buy common stock or preferred stock, you understand what it is. Tokens are no different, other than being digital. The problem with it is, apparently, I can have it in my wallet and trade it to your wallet. that is a problem, the SEC is never going to like that, nor the exchanges. There has to be some central mechanism through which that digital thing can get tracked, traced, and reported. As long as you can have that, and the blockchain records it, it should be more transparent than ever because you can’t even change it. So, everybody should understand it has to be built a certain way, and everybody’s racing to build the right mousetrap.”
“that is the problem in general: the entrepreneurs and the investors are much smarter than the regulators, so they always move much faster and have solutions that are way ahead of the regulators. The regulators are just trying to catch up. it is about trying to educate the regulators and then have them actually adopt rules for us to figure out how to interpret to help you. that is where we are, I think.”
“I would say, from the market perspective. First, I would separate some of those ideas. I think, you know, the JOBS Act and crowdfunding are in one bucket, and crypto, to all the points that Richard made, is in another. From a market perspective, from a secondary trading perspective, which is really what we support, using Regulation A as an example of maybe the tip of that continuum, it was an education process just to get these clearing firms to accept Elio. Once they understood what it was and the fact that there was an exemption, we were able to get that moving. I think you see that a bit more in crowdfunding and in JOBS Act capital-raising.”
“Crypto is going to require all of the regulatory guidance that Richard is talking about. Then you also have the problem of everyone having built their own perfect blockchain, and so a lot of people that we talk to who want to be involved in even having us host their data for the companies or host their disclosure, they all say this will work and everybody will be able to trade as long as everybody adopts our blockchain protocol. Then everything will be fine. I have had 27 people tell me that, and so it is going to be a non-starter for a little while until, as an investor, you understand where your liquidity is going to come from and that you are not going to be beholden to your account with this one little blockchain firm.”
“I do not want to make it about tokens, but I am going to tell you that most lawyers who did this and said tokens aren’t securities, they were utilities, is where it started the problem. Nobody thought it through, and they did all this, and they were able to raise money. Telegram, I think that is the company, raised two billion dollars in four months late last year or two years ago. it is the most money ever raised in the shortest amount of time. it is crazy, but they didn’t think through the fact that most public companies, if you have ten million dollars in assets and two thousand shareholders, now you are a public company, you have to report. All these companies that raised money like that, are that, probably have to report, probably haven’t reported, and the few that have actually settled with the SEC have undertaken to file Form 10s and start reporting. I do not know why, but that is what the SEC wants them to do, and they haven’t filed those reports yet. I am sitting here watching every day, looking for how they are going to handle it. I do not know how it works, but I haven’t even started talking about Blue Sky and how that works. Nobody thought it through is the point.”
“I have two things: one, I do not know if you know, Dan, but we did the investment banking around Elio, yeah, and that was one of the first Regulation A’s that ever came about. We sold it to clients and then figured out, “Oh yeah, what do we do with the stock certificate?”, I mean, eventually we got it settled, but it was a tremendous effort. It would be impossible today, by the way, with what’s going on. So why promulgate Regulation A if you can’t process the tickets? that is one. Two, I think blockchain is the future, and I think blockchain does settle a lot of the problems, but we do not know; it is not defined yet. The regulatories have not given us a clear path yet. I mean, who wants to jump in first?”
“do not be so sure. I am not as sure, there’s some hybrid combination; you never know.”
“I think tokens that converted to common and common that converted to tokens might be just the way to float a new issue, float a new pot. I agree, we are working on it, but it is pretty scary to get something, you know. I am most scared about this; never mind.“
The Issues Regarding Regulation A
“So, any other questions? Yes, the New York Stock Exchange, my understanding is, shut the door for now. NASDAQ, you gotta have the right deal. I have seen some get approved; I do not know right now where they stand today. They just may say we do not like it as a Regulation A, come back as an S-1, and we’ll feel more comfortable. I think that is where you end up.”
“Regulation A pluses are so close to S-1s, right, Richard? To me, again, the regulators just put a crunch on a business, and they decided the legislative branch and the executive branch decided the solution was Regulation A to the problem that they created, which is there’s nobody around to do these deals, right? And I do not believe that was a solution. I think there was nothing wrong with S-1.”
“So it is easy for us to roll in the Regulation A disclosure, the ongoing requirements, or allow a company to go SEC full reporting and then maybe season before going on NASDAQ or New York if that is the path that they want to take. that is the way they should work. So, going through the Elio process and a few others, once everyone along the chain understood “Okay, this is where Regulation A is supposed to play”, it became a little bit easier to see deposits. The ones that went to an exchange just as companies, just as issuers, typically struggled in part because they weren’t ready to be exchange-listed. It was a more expedient way to raise capital, but if you have a little time to seize an OTC, you are likely to have a better experience when you do go to an exchange.”
“So Regulation A, in terms of the listing, there’s no over-allotment; there haven’t been a firm commitment deal; there could be just nobody’s done them that way. So it doesn’t lend itself to aftermarket or support or trading, which is why NASDAQ and New York actually do not like it because the stocks haven’t performed as well, plus the valuations might have been a little higher. Easier to sell the deal to retail people at a higher valuation, but an institution is going to say no way. Regulation A is unnatural for the OTC markets, and there’s a panel next door talking about Regulation A right now, and the reason Regulation A should work should be: any OTC company that wants to raise money and stay on OTC, just do an in-between deal, can do a Regulation A and doesn’t have to follow Blue Sky. Nobody can do that on an S-1. If you file an S-1, you have to go file state-by-state; there are less than ten states you actually can file in, and then the rest are accredited investors. Yet, with Regulation A, you get a 50-state exemption, and nobody, I do not understand it, nobody’s talking about it.”
“Well, I again do not mind if I take the opposite side, because there’s no underwriter in a Regulation A, right? In a lot of them, there’s no underwriter, so they price it the way the company wants to price it. If you price something four times what it is worth, that is the way stocks go down, you know. The second thing, if there’s no underwriter to support the opening market for these things, which there isn’t on a Regulation A, it is no surprise that they’ve been going down in price. The system has to be refined; it has to have someone on the other side protecting the public, asking if it is well-priced, what are we going to do in the aftermarket, what’s the future of this company. I mean, that helps all of us; it helps the companies, it helps the next deal, and the next guy that wants to raise money. The broker is supposed to qualify the guy—should he buy the stock or not? Could they really take the loss? Not you put it on the internet, and some person in Wisconsin buys a thousand shares that maybe they shouldn’t be buying. Again, that is just my feeling.”
“So, you mentioned Bill Hambrecht. Hambrecht was a big champion of Regulation A. And so I think in his mind, he had Regulation A pictured as he was going to do an auction process. And then they overprice themselves.”
“Yes, that is right, it doesn’t work.”
A Few Words on FINRA Rules
“Yes, that is a great question. Look, I agree with you; I think it is a great question and a great point. This is a place where, when we talk about the issue more generally, we are focusing on a full industry solution. There are a lot of moving parts to that. For this kind of issue, we are happy to, and to your point, we do take the lead on pushing back with FINRA. I mean, the rule itself, and Richard and I can talk all about the laws, it only matters what happens in practice. But SEC rule 15c 2:11 says a qualified Regulation A offering statement is the appropriate disclosure under which to publish a quote. So, we’ve been pushing FINRA and the SEC, for that matter, to get them to acknowledge that once a regulator, the SEC, has signed off on this disclosure, that should be it. It should go back to that three-day notice, even a week, you know, something reasonable where there is a clear path for you to take.”
“We’d love to take all the advocacy we can get on that issue. I can send the number of fascinating letters that I have written on this topic.”
“We are starting to make progress there. I think the best advocacy work that we were able to do there was on a retail investor fraud panel that the SEC hosted last year, where I got to be on a panel with the woman from FINRA who runs the 211 group, folks from the SEC, to sort of raise these kinds of issues. So the SEC understands; chairman Clayton chimed in on our panel. What they’re really focused on is what access does retail have to things that go sour, basically. They’re focused on, “What if I get a call from the media saying, ‘Why did grandma lose all her money on this OTC stock?'” And the way that they think about addressing that is by creating some barrier between retail and whatever type of security they’re concerned about. I do not think Regulation A specifically is part of that concern. It gets caught up, and it is similar to what we are talking about with deposit problems. It gets caught up in the industry saying “it is easier for me to just cut this out than actually try to understand it; it is cheaper for me to cut this out”. So, that is even with the SEC, we talk about our compliance data and whatever you can do to elucidate that problem and let them understand that there is a 10% of this market that you do want to be concerned about, but everything else that is Regulation A, that is fully disclosed, it may not be a great company, it may not be the right issue, doesn’t matter, it is fully disclosed, and an intelligent investor can make that choice. There’s a little bit more headway when you sit with the SEC and FINRA, which I think is your point, but it is a long, slow process.”
“Exactly, that is exactly the issue. He said, “Which group?”
“The SEC understands.”
“Well, if you ask, even within the SEC, if you ask the Corp Fin folks, who were the ones who really drafted Regulation A, and really put that into place, they see it, they understand what it would take for that to work. If you talk to trading and markets, who implement those rules and who really exert influence over FINRA in that area, they are much more focused on that investor protection aspect, to an overbearing degree.”
“They are closer to enforcement.”
“Corp Fin gets it, so I do not think it is just Regulation A. I mean, if you filed an S-1 for an OTC deal, you have the same problem.”
“I think that is right. There is the disconnect even further between Congress, who passes the rule, and then the SEC, who is forced to implement something, and there are folks in CorpFin, to their credit, who got it and are championing it, but you lose some of that when it wasn’t their idea.”
“It’ll be a private company that is technically public until it can come back into a deal and list on NASDAQ, and then everybody will accept it, but they will wonder where all that stock came from because it was Regulation A stock.”
“Now, on a corollary issue, for those issuers that may be here, contemplating doing a Regulation A without a broker-dealer, I think we will see in the not-too-distant future the impact of being a company exposed to endless individual litigations in small claims court and otherwise, as opposed to a broker-dealer-sponsored transaction where the average investor has opened an account with a broker-dealer and submitted himself to arbitration. There’s a potential for a tremendous difference, which I think will come home to roost over a period of time as these innocent people investing little bits of money and direct issuers coming up to the companies individually, which they can’t do.”
“I want to move it a little bit away from Regulation A, because this was a solution that they came up with for a problem that started before I said, “Let’s have this presentation.” The capital formation process, as it were, has worked for as long as I have been involved. it is broken, not Regulation A, S-1, raising money for the guy, you know. Kodak was a pink sheet stock, Microsoft was a pink sheet stock; they were pink sheet stocks when I got involved. Polaroid was a pink sheet stock, right? What happened was that the market is being thrown out, they threw the baby out with the bathwater. Let’s bring it back; we can do it together if we all work together.”
“Now, 80% of what I do is on NASDAQ or the New York Stock Exchange, but I recognize that it is just the first pick at it. We got it, those dreams that people started are something worth defending, not only as a group, not only for our own pockets but for our country. I really firmly believe that.”
“So, have you guys, as everybody, been experiencing the problems that we are talking about in doing their underwritings or anything? No? Yes? Yes, okay.”
“A NASDAQ company gets delisted. So what does he do? It goes out of business, the guy? And it could be a fully reporting company, completely transparent.”
“And as the OTC guys will point out, you will see it, there are NASDAQ companies that have many of these issues as well. There is a NASDAQ company I just saw the filing recently that did, I do not know, a series of, I will underestimate, 10 plus convertible debentures financings, failed to disclose them all until they disclosed them a year and a half later, all on one filling. Even that happens, on NASDAQ.”
“So, what I am going to ask, I mean, we are just about out of time, any more questions before we go?“
“They do not necessarily get listed on NASDAQ, if that is what you are asking.”
“You got to qualify the initial listing standards. The sub has to requalify. So if they do a spin-off and it is just going to be trading over the counter, they won’t take the paper. It has got to be in that; they have to take that sub and register it to be a NASDAQ company.”
“I say you would have to file 211 and get listed. “
“Right, you have brokers that have compliance policies built around our structure, the OTCQX, and OTCQB, and you will see it even with an OTCQX spin-off that it has to show that it requalifies; it meets the standards, discloses in the same way so that it gets the same treatment as the parent.”
“You are going to hear from Dan, Richard, and myself about helping us. By the way, I agree with Keith; I think we need to reach out to the legislative branch to break the logjam. If you know someone on the Finance Committee at Congress, that would be very helpful.”
“We will circulate petitions or statements, and I am concerned about being the only one signing them. You do not want to be the only broker-dealer out there signing it. However, if we could sign as a group, to get them to listen, it would be very worthwhile for us and for these companies. We can keep moving forward. Any other questions? Thank you very much for showing up, I appreciate it.”
