There is a great deal of abuse going on in the OTC Bulletin Board Market and a lot of money is being made as result of it. Regulators are trying to deal with the problem but are unable to put a halt to it, unless they take drastic steps which will be detrimental to the small and micro-cap market.
The small and micro-cap market is an essential part in bringing small and mid-size companies public through Reverse merger and Regulation D (504) offering, these are the two most popular methods used by small and mid-size companies to go public.
This two avenues are prefer by small and mid size companies because they simpler and less expensive than the traditional IPO, It can be refer to as a simplified fast track method by which a private company can become a public company.
I described the process in detail how small and mid-size companies can go public in previous articles, if you miss them, you can email me and I will be happy to explain it.
I have over 25 years of experience in the securities industry as market maker and trader. In my own brokerage firm and with a couple of the largest wholesalers in Wall Street. I believe my experience qualify me to write on the subject with clarity and honesty from a birds eye view.
I believe in short selling as a legitimate way of providing liquidity to the market as an essential part market making, that is not what I am referring to.
A short position is established when somebody sells a stock they do not own hoping to be able to buy it bac at a later day for a lower price.
There are several reasons why selling short the stock of companies that have gone public through a reverse merger is profitable and easy, I will identify them and suggest ways that this can be stopped once all for all without affecting the legitimate short seller who are willing to sell and bear the risks associated with carrying a short position. Reason number one (1). Corporate shells, in order for an operating private company to go public in a Reverse merger it must merger with a public shell. A public shell is what remains when a public company is bankrupt or liquidated, also some shell are created as Blank Check companies,
A Blank Check company has shareholder and maybe some cash in its books but nothing else, they are created by enterprising entrepreneurs for the sole purpose of merging an operating private company into it.
What happens is that when the shell owner sell the shell to the private company he retains 5-15% of the shares for himself, on top of collecting any where upward of $500,000.00 for himself. And even if he signed and agreement not to sell for a year, most of these people can not be trusted and will at some point dump the stock or have somebody create a short position in their behalf.
Solution: The shell owner must be made to sell the entire position and be content with the money, which in most cases represents an enormous profit. I don’t have anything against anybody making a lot of money, I am all for it because I also stand to make a lot of money, I am against the way they do it.
(2). The shareholder base: In order for a company be listed on the NASDAQ Small-Cap market or the OTC Bulletin Board it must have a specified number of shareholders to qualify for listing.
(2A). Improper due diligence: Prior to purchasing a shell the private company along with the consultant that they retain to assist them in the Reverse merger should do a complete review of the shareholder list. some of those shareholder may have excessive number of shares and the true beneficial owner may be the shell owner or the consultant himself, there are a lot of smooth talking wolves posing as consultant who are operating in conjunction with the shell owner.
Solution: First run the consultant’s named and his previous employer through google and see if he has been convicted of any securities related crimes and has been barred from participating in any stock related transactions. Second write the regulator and request that consultants be required to have a website with their name on it, most of this unscrupulous character operate in a stealth manner so that regulators can’t detect their activities.
Petition the Securities and Exchange commission requesting a reduction in the number of shareholders require for listing, and if a shell has too many shares outstanding don’t buy it!
(3), Market Makers: Market makers in OTC Bulletin Board Securities are permitted to maintain a short position in securities that they are acting as market makers, but what some trader do is they register for a stock and go out sell stock on the bid (the price other market makers are willing to pay) and immediately cease to make a market in the stock and keep the short position.
Technically when a trader does this, he is circumventing the intent of the rule which allows market makers to short a stock in his role as a market maker.
Solution: Require traders to remain acting as market makers until they purchase the stock back, also regulators must make clearing agent to enforce the rules concerning the delivery of the securities on settlement or execute a buy in (buy the stock back and charge the seller) if the seller fails to deliver the stock within the prescribed period of time.
I believe that these reforms will go a long way in altering the climate for participant in Reverse merger, and in removing the vultures the prey on unsophisticated business owner from the market place.
But until the regulators act the responsibility is on the business owner to perform the proper research, if I sound like a crusader maybe that is because the industry has been good to me and I hate to see the vultures taking it over.