Penny stocks refused for
- why it's happening now, how to cope
Apr 13, 2012
- New fed war on fraud and money laundering
hits the innocent too.
- Penny stocks now more often refused
- SEC mounts combined attack with FINRA,
- Average investor normally OK - but new
paperwork, delay, costs
- Management, insiders, promoters undergo
- How to avoid some of the new headaches
A new government offensive against microcap
fraud and money laundering is aimed at crooks and evildoers.
But the attack is also creating problems for innocent people
who own low priced shares.
As brokers and clearing firms run for cover under a barrage of
new microcap compliance dictates, the collateral damage
inflicted by the federal assault ranges from inconvenience to
The list of bystanders who can be hit by errant regulatory shrapnel
- Consultants and service providers who
take stock for services
- Private placement investors (mainly
if they keep poor records or are insiders)
- Employees who get stock for pay, incentives
- Officers, directors, large shareholders
- IR pros, newsletter and website writers
- Folks who hold physical stock certificates
(subject to closer inspection now)
The crackdown started, or at least coalesced,
last year with formation of the SEC's Microcap Fraud Working
Group. (More on that in a moment.)
Since then, investors who want to deposit low priced
small cap stock into their accounts -- as distinct from simply
buying or selling it -- have routinely faced increased questioning.
There is more paperwork, scrutiny, delays for more compliance
approvals, and sometimes expense.
While the hurdles to be cleared are higher than before, penny
stock deposited by John Q. Public shareholder is still generally
accepted. But more than in the past, it also stands a real chance
While the new offensive may present added inconvenience for the
average investor, it promises much larger problems for company
executives, directors, and other insiders since their transactions
now face far more stringent examination.
And stock promoters, investor relations consultants, and some
newsletter and website writers -- because of their promotional
work -- may find their shares won't be accepted under any
Let's be clear. This isn't panic time for every investor
who decides to buy, sell or own microcap stock.
At our shop and others, most ordinary investors aren't
running into major roadblocks.
For instance, well-documented restricted stock from most private
placements hasn't been greatly impacted.
Transactions may take extra time and
work and minimum price requirements sometimes complicate things
(see below). However, at this point we generally see few major
problems for investors who deposit cheap stock like the following:
- U.S. restricted stock in reasonable quantity owned by non-insider investors
who can document acquisition
free trading stock
- Canadian restricted stock with documentation as to acquisition
- U.S. restricted or free-trading stock
of companies for which the broker submitted the FINRA Form
211 (this is the process to get a stock quoted on the OTCBB
and/or OTC Markets Group, formerly Pink Sheets)
But smooth sailing is not absolutely
guaranteed -- and certainly not for officers, directors, insiders,
promoters and others close to the issuing company, whose transactions
now face detailed examination.
The "new normal" is fluid
The "new normal" for microcaps traded on the OTCBB
and OTC Markets is changing and evolving even as you read this.
With the industry racing to comply, rules spawned by the crackdown
are new and quite fluid. They vary among brokers and over time,
often shaped by a firm's unique - perhaps unhappy - experience
in this area.
Our suggestion: always ask your broker first about the
rules currently in place before trying to deposit stock.
Following are the broad outlines of small cap stock deposit requirements
across the industry as we see them presently.
There may be some outliers that don't fit this general pattern
-- firms slow to adapt or trying to rig a workaround -- but government
power will almost inevitably bring them into line.
One key change is that expanded stock purchase documentation
is now generally required from owners before stock will be accepted
Often they must complete written questionnaires about the stock...
their purchase or other acquisition of it... and their relationship
to the issuing company.
The size and quality of their account may be considered. Legal
opinions may more often be required. New compliance review or
other fees may be charged.
The issuing company is also examined. There's a sharpened
focus on history, disclosure, management background, and stock
Some securities firms now use a price test as a first filter.
This helps them decide whether to take on the costs of compliance
review and the legal and regulatory risks that can shadow low
One big clearing outfit automatically rejects any stock priced
under a dime. Another sets the bar at 75 cents.
Or the bright line test can be minimum market capitalization.
At one firm, for example, that's now $25 million.
The type, quantity and quality of the issuing company's public
disclosure of financial information is important too -- for
instance, a firm might refuse any stock branded by OTC Markets
with a Stop Sign, Gray Market or Caveat Emptor indicator.
Sometimes the test(s) are quirkier, leaning
towards arbitrary, and including any or all of these and other
Pre-approvals for transfers
Pre-approval reviews for incoming accounts are also common.
More clearing firms do advance checks of new accounts transferring
in from other brokers (transfer of assets). They give thumbs
up or down only after eyeing the stocks.
In most situations, if the stock... the owner... the issuer...
the acquisition method... or anything else doesn't pass muster,
the deposit is refused.
Physical or electronic - no difference
Difficulty depositing physical certificates isn't
new. That got stickier some time ago with Wall Street's move
toward "dematerialization," but doesn't seem tied to
this new regulatory offensive. (We wrote an article about vanishing
paper certs last year. It's here
in pdf format.)
In contrast, the new changes generally apply no matter how you
give the shares to your broker - whether in physical form
or by electronic transfer.
Unlike dematerialization -- a move to improve efficiency -- this
new regulatory drive springs from the Patriot Act; the Bank Secrecy
Act; anti-money laundering regulations; fraud prevention initiatives;
and other government mandates.
FINRA Regulatory Notice 09-05 figures in this too. It concerns
unregistered resales of restricted shares and lists red flags
for brokers. You can read it here.
SEC Microcap Fraud Working Group
The sparkplug that fires this new regulatory engine is the
recently formed SEC Microcap Fraud Working Group, assembled during
the past year or so.
The SEC says the powerful new task force is composed of elements
drawn from many parts of the agency:
"staff from the SEC's headquarters
in Washington D.C., each of its 11 regional offices, and from
the Office of Market Intelligence, Division of Corporation Finance,
Division of Risk, Strategy, and Financial Innovation, Office
of General Counsel, Division of Trading and Markets, and the
Division of Investment Management."
The SEC also explains -- in words worth
a careful reading -- that the group:
"... is pursuing a strategic
approach to combating microcap fraud by focusing on recidivists
and insiders, and on the attorneys, auditors, broker-dealers,
transfer agents and other gatekeepers that facilitate a large
volume of the fraud in this sector."
The precise legal parameters of the new
"strategic approach" remain to be defined. Who are
the "other gatekeepers?" What exactly does "facilitate"
Regulators apply pressure
The U.S. Securities and Exchange Commission (SEC)
and the Financial Industry Regulatory Authority (FINRA)
are leading the charge and leaning on clearing firms to
enlist in the new offensive.
And risk management and compliance staffs at clearing outfits
are doing so... sometimes zealously.
Depository Trust & Clearing Corporation (DTCC) has
also joined the crusade. The clearing, settlement and custody
giant electronically touches nearly every security in the country.
It has power to "chill" and thus restrict transfer
of stock almost at will. You can read DTCC's embrace of the program
on page 19 of its pdf newsletter here.
Of course brokers too are swept up in this offensive --
like drafted grunts choppered into a jungle firefight on orders
from the brass, scrambling to stay alive.
SEC round table
You can get some feel for the power of the new government
push by watching a round table discussion held by the SEC last
October. The webcast is on the SEC website here.
Chaired by SEC head Mary Schapiro, participants came from government,
regulatory agencies, clearing and settlement companies, law firms
and private industry.
As the SEC explained, the meeting covered "...key regulatory
issues, including anti-money laundering monitoring, compliance
challenges, and potential changes to the microcap regulatory
Since the discussion lasted over three-hours, you may find
it more convenient to skim the transcript instead. It's here.
It's hard to find anybody who is in favor of stock fraud...
or money laundering, for that matter. But there seem to be two
quite different views on the likely outcome of this new regulatory
Utopians expect the end result to be a sanitized small cap market
largely free of fraud... populated by better-capitalized and
more transparent small companies that offer investors a better
Cynics believe the new initiative will inflict more damage on
small firms already crippled by costly regulations, injure innocent
investors and entrepreneurs, and hurt good companies along with
bad... producing a we-had-to-destroy-the-village in-order-to-save-it
Time will tell. But for the immediate future, you can bet that
depositing cheap stock will be more complicated than it ever
Small cap U.S. and Canadian mining and resource stocks and
other microcaps are part of our business, so we're keeping a
close eye on developments.
Based on what we see right now, here are points to keep in mind
about depositing microcap stock. We assume the stock passes any
price or market cap test.
These factors can make deposit easier
- Talk to your broker first. This
is key. Compliance rules are changing faster than Idaho weather,
so you should find out what rules apply currently at your
- You have an established account. The
longer you've been with a firm, the more likely your request
will be viewed favorably. If you opened an account yesterday
and want to deposit a big pile of five-cent stock today, you
may face problems.
- Your portfolio also has some high-value
shares or significant cash. Clearing firms aren't crazy about
accounts that hold only microcaps.
- Your documentation is thorough, showing
how you acquired the stock and your exact relationship with the
company - are you an insider or just average Joe investor? (Especially
important: copies of private placement memorandums and subscription
agreements; service and/or consulting contracts; employment or
- The company's public financial disclosure
is of good quality and quantity.
These factors can make it tougher
- You're a company insider -- officer,
director, 10% shareholder or otherwise exercise control.
- You're a stock promoter, IR consultant,
financial newsletter or website writer.
- The company has a history of name changes,
industry changes or securities problems.
- Company management or large shareholders
have a record of prior securities violations or serious legal
- Stock ownership is concentrated in few
- The company's public financial disclosure
is of poor quality or quantity.
- Your stock came from a debt to equity
conversion. (Extra tough.)
A last word
Our best advice, once again:
before you try to deposit cheap stock into your account or transfer
a portfolio of cheap stock to a new firm, be sure to contact
your broker or new firm in advance.
This will simplify your life in the evolving new normal, save
you time and spare you some headaches and disappointment -- and,
we hope, help you make a lot of money in the volatile small cap
Thanks for reading. We'll see
you next time.
"In politics stupidity is
not a handicap."
-Napolean Bonaparte (1769-1821)
Editor Tom Wobker holds degrees in journalism and law from the
University of Kansas.
in 1926, Pennaluna trades stocks on all U.S. and Canadian exchanges,
Nasdaq, OTCBB and Pink Sheets.
Phone 800-535-5329 or visit www.pennaluna.com.
For online trading see www.penntrade.com.
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Disclosure: Pennaluna & Company
is a FINRA broker-dealer and market maker. As such, it frequently
buys or sells stocks for its own account, or in order to make
a market. Consequently, Pennaluna may at any time buy or sell
or make a market in any stock mentioned herein, and associated
persons may also buy, sell or hold such stock at any time. The
firm and/or associated persons may also engage in private placements
or other investment banking activities with any company mentioned.
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to more risk than stocks of larger companies, including greater
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some may be foreign securities and subject in addition to currency,
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