Monthly Archives: January 2014

What Does Caveat Emptor or Skull & Crossbones Mean on OTC Markets?

caveat-emptor The Caveat Emptor or “Buyer Beware” warning on OTC Markets means that there is  a public interest concern involving the Issuer, its Management or Securities.

Although the skull and crossbones implies that there is something possibly toxic about the stock, and looks scary, it really functions to alert the Issuer to provide documentation requested by a regulatory authority like the SEC in order to clear up what might just be a misunderstanding.

Caveat Emptor is Inevitable When Issuers Ignore SEC Inquires

In many cases, the existing Management or prospective Buyers of Caveat Emptor pubic vehicles will discover that the source of the skull and crossbones is a matter easily explained when a securities lawyer takes the time to follow the process.

Another way of looking at a Caveat Emptor is that the skull and crossbones is the inevitable result when an Issuer ignores an SEC inquiry, even if there is nothing whatsoever wrong.

Issuers Should Respect the Process and Hire Counsel to Respond

The difference between having a skull and crossbones for a few days or forever comes down to whether an Issuer respects the process enough to respond properly.  Hoping it will go away doesn’t work.  Management hiding their heads in the sand won’t remove it.

It is not the goal of the SEC, OTC Markets or any other organization to blacklist companies for life; those with good management and transparent numbers, that take the time and demonstrate good faith by cooperating fully are often rewarded quickly.  There is nothing to lose by responding and Shareholders have a lot to gain if the stock can start trading again.

Even if there was a legitimate public interest concern which caused the Caveat Emptor warning, once the Issuer takes affirmative steps to address past problems, it can distance itself from bad actors or past mistakes.   This process is all about disclosure, and more transparency is always better for both Management and Shareholders.

Pink Current Issuers who suddenly find themselves saddled with the Caveat Emptor badge should pick up the telephone and hire experienced securities counsel, who can coordinate the process of providing the regulatory authority with the information they need.

When is the Caveat Emptor Warning Removed By OTC Markets?

OTC Markets quoted companies may have the Caveat Emptor warning removed by providing their investors with detailed disclosures following the Alternative Reporting Standard.  This is accomplished by using either the OTC Markets Disclosure & News Service or, if the Issuer is an OTCQB, by becoming current again in their SEC filings.  Even after filings are brought current, OTC Markets may continue to mark an Issuer as Caveat Emptor if it believes there might still be a public interest concern.  For this reason, Issuers should specifically address any public interest concerns in their disclosures rather than trying to pretend it didn’t happen.

Experienced Securities Counsel for Caveat Emptor Vehicles

OTC Markets Issuers facing a Caveat Emptor situation should contact experienced securities legal counsel to discuss what is required to remove the skull and crossbones.  There are many reasons why the Caveat Emptor warning can be added to an Issuer’s trading symbol and the proper actions in response depend on why the Issuer was flagged.

Caveat Emptor May Create An Opportunity for Buyers of Public Vehicles

When existing Management of a Caveat Emptor vehicle gives up in frustration or chooses not to respond properly to an SEC inquiry, this can create an opportunity for a group with the money and patience to deal properly with any lingering public interest concerns.  Due diligence is essential in evaluating the difficulty of removing the Caveat Emptor warning, and this should be factored in when looking at a skull and crossbones vehicle that is for sale.

Management or Shareholders of OTC Markets skull and crossbones public vehicles can contact securities attorney Matt Stout at (410) 429-7076 for further information.

What is the Alternative Reporting Standard for OTCQX Issuers?

Most public companies that qualify for the OTCQX market tier are SEC reporting companies and already file the typical 10-Q, 10-K and 8-K forms.  In other words, they are the same fully reporting Issuers you would see on the OTCQX or OTC Bulletin Board….but they make more money and have more assets.

However, even when SEC registration is not required, OTCQX companies must still make information publicly available pursuant to Rule 10b-5 under the Securities Exchange Act of 1934 (“Exchange Act”) and pursuant to Rule 144(c)(2) under the Securities Act of 1933 (“Securities Act”).

In order to comply with these requirements, OTC Markets Group offers the Alternative Reporting Standard for companies that elect to make material information publicly available to investors.

To qualify for OTCQX, U.S., companies not already fully reporting to the SEC can follow the Alternative Reporting Standard.  These companies submit information to OTC Markets per the OTCQX U.S. Disclosure Guidelines and are then subject to the eligibility requirements, terms and conditions of the OTCQX Rules for U.S. Companies.

Under the Alternative Reporting Standard, OTCQX Issuers provide investors with all material information necessary for the investor to make an informed investment decision.  This essentially amounts to the same information SEC reporting companies put in their Form 10 filings.

How Does A Trading Halt Affect the OTC Issuer’s Stock?

Who Can Place a Trading Suspension or Trading Halt on an OTC Security?

Only the SEC or FINRA can suspend or halt trading in a public company’s stock quoted on the OTCQX, OTCQB or OTC Pink Sheet marketplaces.  OTC Markets does not suspend trading or stop publishing quotations for any Issuer on its own accord.

A trading suspension or halt has nothing to do with whether or not an Issuer has continued to subscribe to the OTC Markets Disclosure and News Service, to OTCIQ, or even if the Issuer’s filings are not current on OTC Markets.  Pink Sheet Stop Signs can, in theory, remain Pink No Information forever without having trading in their stock suspended or halted.

What happens if the SEC or FINRA Issues a Trading Halt in an OTC Markets stock?

When trading in an OTC stock is suspended by the SEC or halted by FINRA, OTC Markets Group removes all quotes from its inter-dealer quotation system and displays a “Halted/Suspended” message.

How Long Do Trading Suspensions Last?

SEC suspensions for OTC Markets OTCQX, OTCQB and OTC Pink Sheets last Ten (10) business days.

Once the suspension has ended, market makers may re-enter their bid and ask quotes if a new Form 211 is filed with FINRA that includes the Issuer’s current financial information.

Without the new 15c2-11, the trading symbol will remain a Caveat Emptor or skull and cross bones.

What Can Caveat Emptor Issuers Do About SEC Suspensions or FINRA Trading Halts?

Management or Shareholders of OTC Markets Caveat Emptor or skull and cross bones Issuers can contact Matt Stout, securities lawyer, with questions on the process of addressing SEC trading suspensions or FINRA trading halts, and to discuss the 15c2-11 process at (410) 429-7076 or mstout@otclawyers.com

 

What Happens to Stock When a Company is Delisted from an Exchange?

If an Issuer is “Delisted” from the NASDAQ or NYSE, Does This Affect its Shares?

No.  If a Shareholder owns stock in an Issuer that was delisted from a national exchange like the NYSE or NASDAQ and is now being quoted on OTC Markets, nothing changes regarding the shares themselves.

A Shareholder will remain the beneficial owner of the stock even after the Issuer is delisted and that stock can be traded through any broker-dealer that regularly deals in the Over-the-Counter Markets or in OTC securities.

Which Brokers Accept Delisted Stock?

Will the delisted stock be accepted by E-Trade or TD-Ameritrade?  Probably not, but those are not your broker of choice for OTC Bulletin Board or OTC Markets Pink Sheet stocks anyway.

Can companies get “delisted” from the OTCQX, OTCQB and OTC Pink marketplaces?

No. OTC Markets quotes stocks but is not an exchange so there are no “listings.”  The only way a public company’s stock stops being quoted in either the OTCQX, OTCQB and OTC Pink Sheet marketplaces is if every broker-dealer stops quoting the stock.

In those rare circumstances when public companies shares no longer exist, but they still have a trading symbol, and are still being quoted, the Issuer has an obligation to notify FINRA.  FINRA will investigate and, if warranted, eliminate the trading symbol, and inform OTC Markets that the ticker is no longer valied. OTC Markets  will then remove the quotations in that stock from OTCMarkets.com.

Shareholders needing referrals to brokers who specialize in the OTCBB, OTCQB, OTCQX and Pink Sheet stocks can contact Matt Stout, securities attorney, for a referral at (410) 429-7076.

What is Beneficial Ownership Under SEC Rule 144?

Beneficial Ownership under Rule 144 essentially means that although a Shareholder doesn’t legally own the Shares in his or her own name, the Shareholder can nevertheless exercise control over them.

Affiliates Are Those Who Beneficially Own Greater Than 10%

Rule 144 considers Shareholders who “beneficially own” greater than 10% of an Issuer’s outstanding stock, of any class, to be an Affiliate, or Control Person, which subjects them to volume trading limitations.

Being an Affiliate means that the Shareholder must file Form 144 every time he or she sells securities, and worse still, that the Affiliate may not sell more than 1% of the Issuer’s issued and outstanding shares during any three month period.

How to Avoid Being Classified as an Affiliate

With that in mind, many large Shareholders wonder how they can avoid being classified as an Affiliate.  The answer is clear under Rule 144.

Affiliates are those who occupy positions of control in an Issuer, such as an officer or director, and those who beneficially own greater than 10% of the issued and outstanding.

So the key, then, is to ensure that the Shareholder does not beneficially own greater than 10%.  This sounds simple, but in practice is often difficult for many Shareholders, especially those who may exercise debt conversions that inadvertently bring their ownership above 10% by not including “blocker” provisions.

Beneficial Ownership Under Rule 144 is a Test of Substance Over Form

To say that the concept of beneficial ownership is a matter of substance over form, means that the SEC cares about who actually controls the Shares rather than who might appear to control them. For this reason, it is much better to own 9.99% than to try and hide ownership through relatives or corporate entities.

Owning Shares in the Names of Corporate Entities and Relatives?

Many insiders of OTC public companies own shares not only in their personal names, but for estate planning purposes might also hold shares in the names of trusts, corporations, and LLCs, not to mention the names of spouses and other relatives.  There is nothing inherently wrong with this as long as this is disclosed by an Affiliate.   Rule 144 looks at all of this beneficial ownership to see who really owns greater than 10%.

Examples of Affiliate Status By Beneficial Ownership

So if a Shareholder owns 3% in his own name, controls 5% in a family trust, and owns another 3% in an LLC…the Shareholder is an Affiliate…in the aggregate.   3+5+3 = 11

If a Shareholder owns 8% and his mother owns 3%, the Shareholder might be an Affiliate….if his mom lives in the same household.   If the Shareholder does not live with Mom, he’s not an Affiliate.   This is checked against the Transfer Agent’s Shareholder List, which shows the addresses of residence.

Finally, if a Shareholder owns 5% in his own name, and his brother (who lives in another household) owns 6%, neither one of them is automatically an Affiliate.  But if the two of them formed an LLC that owned all 11% they would both end up classified as Affiliates.   Sound confusing?

A Special Caveat to Holders of Convertible Notes Without Blocker Clauses

Here is the most important example: if a Shareholder owns 9.99% in his own name, he is not an Affiliate.   And if that Shareholder sells stock this month, and then later converts more debt such that he replenishes what was sold….but never goes over the 9.99%, he is not an Affiliate, unless the Note from which he is converting does not contain a “blocker” clause which would prohibit conversion beyond 9.99%.

If a “blocker” clause is not inserted into the Note, a circumstance could potentially arise under § 240.13d-3 whereby the Shareholder would theoretically become the “beneficial owner” of greater than 10% even if he does not exercise his right to convert.   Specifically, paragraph (d)(1)(i)(B) states, in relevant part, that

A person shall be deemed to be the beneficial owner of a security, subject to the provisions of paragraph (b) of this rule, if that person has the right to acquire beneficial ownership of such security, as defined in Rule 13d-3(a) (§ 240.13d-3(a)) within sixty days, including but not limited to any right to acquire: (A) Through the exercise of any option, warrant or right; (B) through the conversion of a security;

What does this mean?   If a Note, for example, becomes “due on demand” and does not contain a “blocker” clause which prevents the Note Holder from converting beyond 9.99% ownership, then it would seem arguable that the Note Holder “has the right to acquire”….”within sixty days”….greater than 10%.

So by this reading, it is not enough for a Shareholder to simply pay attention to Rule 144 and make sure that he stays in compliance–the Note also needs a “blocker” clause, just in case the Issuer’s stock price drops enough that in theory it would be possible for the Note Holder to exercise a conversion taking stock ownership beyond 10%.

Beneficial Ownership Under Rule 144 Is a Broad Concept

Beneficial ownership includes not only those Shares held in the Shareholder’s own name, but also those in the name of a trust, corporation or LLC that the Shareholder controls, and Shares in the name of his or her spouse, and other relatives living in the same household. The list can also include those Shares owned by corporate entities controlled by the Shareholder’s spouse and other relatives living within the same household.   That is quite a long list.

Pink Sheet Issuers Must Disclose Owners of Greater Than 5%

Pink Sheet Issuers who want to maintain the OTC Markets Pink Current designation must disclose in their filings the names and addresses of all parties that “beneficially own” greater than 5% of their Shares, even though these Shareholders are not considered Affiliates under Rule 144 unless they own greater than 10% of the issued and outstanding.

With this in mind, large Shareholders that would rather not have their names and addresses in an OTC Markets Information and Disclosure Statement should stay at 4.99%.   Likewise, those who do not wish to provide the SEC with notice of their beneficial ownership, must also stay at 4.99%.

Affiliates of OTC Bulletin Board (OTCBB) and OTC Markets OTCQB, OTCQX and Pink Sheet Issuers with questions on Affiliate sales of stock under Rule 144, or how to draft debt conversion documents with “blocker” clauses to ensure that a Shareholder does not inadvertently go over 9.99% (or 4.99%) can contact Matt Stout, securities lawyer at (410) 429-7076.

Issuer Tips on Presenting Securities for DTC Eligibility

Once an OTCBB, OTCQB or Pink Sheet’s securities are DTC eligible, it is important to focus on a few key requirements that can help DTC promptly process the Issuer’s securities and make sure these transactions are accurately reflected within the records at DTC.

CUSIP Number Assignment

The first key requirement to ensure that DTC eligible securities are processed correctly is for the Issuer’s securities lawyer to obtain a new CUSIP number from Standard & Poor’s CUSIP Service Bureau for each new issuance.

New CUSIP Required for Every Corporate Action Event

A new CUSIP number must be obtained for every “corporate action event” that either generates a new class of shares, or which causes a material change to an existing class of shares.

New CUSIP is Required Before a Reverse Split Becomes Effective

The classic example of a corporate action event requiring a new CUSIP is a reverse stock split., which cannot be declared effective by FINRA until a new CUSIP has been assigned.   This new CUSIP number is then printed on each new stock certificate, and helps shareholders, transfer agents and DTC keep track of the new issuance.

DTC Chills Are Tracked Under a Specific CUSIP

The CUSIP number becomes very important when questions of a DTC chill arise, since the way DTC checks for a chill is by CUSIP number.

When an Issuer’s securities lawyer calls or emails DTC to inquire about a DTC chill that a market maker believes was placed on an Issuer’s stock, the first question DTC will ask is “what is the CUSIP?”  With the proper CUSIP number, it is possible to get an answer on the status of DTC eligibility or a DTC chill quickly.

Certificate Format

The certificate format for DTC registered securities is a matter best handled by the Issuer’s Transfer Agent.  Issuers are encouraged not to be too creative with their certificate design, since DTC requires that the certificates comply with American National Standards Institute (“ANSI”) standards.

Proper Placement of Stamps and Labels on Certificates

Compliance with the ANSI ensures the processing is not delayed due to improper placement of stamps, bar code labels or other processing marks and materials.  By requiring that these processing stamps and labels stay within the “standard assignment area” Issuers can help DTC streamline processing time, which helps shareholders.

Avoid Having to Revalidate or Guarantee Certificates

When stamps, labels and bar codes are placed outside of the standard assignment area, the face of the certificate could be considered “mutilated” and require a revalidation or guarantee of the certificate by the Issuer or the Transfer Agent, which can take considerable time.

As a securities attorney with expertise representing OTC Bulletin Board (OTCBB), OTCQB and OTC Pink Sheet Issuers, Matt Stout can recommend Transfer Agents that also specialize in the over-the-counter market.

Restrictive Legends

Most stock certificates for DTC eligible OTC Issuers initially bear a restrictive legend noting that the securities are subject to SEC Rule 144.

When these stock certificates are accepted for deposit by DTC they are sent back to the Issuer’s Transfer Agent for re- registration into the name of Cede & Co., as nominee for DTC.  At that time, the restrictive legend is removed from the certificate and the DTC legend must  appear on the certificate that is then registered in the name of Cede & Co.

Once the certificate is in the name of DTC’s Nominee, Cede & Co., when these securities are transferred by book- entry in the DTC system, DTC Participants (broker-dealers) and the beneficial owners of the stock will not be aware of any restrictive legend.

Each stock certificate registered in the name of Cede & Co. will bear the following DTC Legend:

Unless this certificate is presented by an authorized representative of The Depository Trust Company, a New York corporation (“DTC”), to Issuer or its agent for registration of transfer, exchange, or payment, and any certificate issued is registered in the name of Cede & Co. or in such other name as is requested by an authorized representative of DTC (and any payment is made to Cede & Co. or to such other entity as is requested by an authorized representative of DTC), ANY TRANSFER, PLEDGE, OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL inasmuch as the registered owner hereof, Cede & Co., has an interest herein.

OTC Bulletin Board and OTC Markets Issuers with questions on the DTC eligibility process, or on the the process of clearing restricted stock for OTC shareholders can contact Matt Stout, securities lawyer for further information at (410) 429-7076.

What is Cede & Co in Relation to DTC?

When Issuers of OTC securities are reviewing their Shareholder lists, the free trading securities held by Shareholders that have already “cleared” and are in “the system” are shown as owned by Cede & Co.  Because of this, Issuers often wonder what Cede & Co is and how it is related to DTC.

Cede & Co is DTC’s Partnership Nominee

Once a certificate has cleared and deposited deposited by Direct Participants with DTC, all subsequent transfers of those securities are registered in the name of DTC’s partnership nominee, Cede & Co.

Cede & Co Does Not Affect Beneficial Ownership

The deposit of Securities with DTC and their registration in the name of Cede & Co. does not change beneficial ownership.   However, DTC has no knowledge of the beneficial owners of the securities once they are in Cede & Co’s name.

Instead, DTC’s records reflect only the identity of the broker-dealer, bank, trust company, or clearing firm to whose accounts the securities are credited.

While DTC does not track beneficial ownership, it is still the responsibility of the Direct and Indirect DTC Participants to maintain an account of their holdings on behalf of customers.

What is the DTC?

DTC eligibility is a concern of both OTC Issuers and their Shareholders since it determines whether or not an Issuer’s securities can be electronically traded through “book-entry” rather than through the movement of actual paper stock certificates.

If an Issuer’s securities are not DTC eligible, it is difficult to find a market for its shares.  Securities lawyers who practice OTC securities law are often asked questions about DTC eligibility and perhaps the most often is “What is the DTC?”

DTC is the World’s Largest Securities Depository

The Depository Trust Company (“DTC”)  is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation (“DTCC”).  DTC describes itself as “the world’s largest securities depository” and is structured as a limited-purpose trust company and classified as a “banking organization” under the New York Banking Law.

DTC is also a member of the Federal Reserve System, and a  “clearing corporation” under the New York Uniform Commercial Code, and a “clearing agency” registered under the Securities Exchange Act of 1934.

DTC Works With Broker-Dealer Participants Not Directly With Issuers

DTC holds securities of DTC eligible Issuers, provides asset servicing and also facilitates the post-trade settlement among Direct Participants of sales in deposited securities, through electronic computerized book-entry transfers and pledges between Direct Participants’ accounts.

DTC does not work directly with OTC public companies, but rather works through its participating broker-dealers, who sponsor the OTC Issuer’s for DTC eligibility.  These broker-dealers are known as DTC Participants.  Among this list of DTC Participants includes every major broker-dealer, and some smaller or lesser known broker-dealers which specialize in OTC Bulletin Board and OTC Markets securities, both in the US and abroad.

DTC Eliminates the Need to Deliver Physical Certificates

DTC’s book-entry transfers of securities essentially eliminates the need for physical movement of stock certificates for OTC Issuers that are DTC eligible.  Instead, DTC Participants essentially book the transactions electronically between one another and no transfer of physical certificates is necessary.   In addition to brokers and dealers, Direct Participants include both U.S. and non-U.S. securities banks, trust companies, clearing corporations, and certain other organizations.

Indirect Participants Also Have Access to DTC

DTCC is the holding company for DTC, National Securities Clearing Corporation and Fixed Income Clearing Corporation, all of which are registered clearing agencies. DTCC is owned by the users of its regulated subsidiaries.

In addition to access by DTC Direct Participants, access to the DTC system is also available to others such as smaller U.S. and non-U.S. securities brokers and dealers, banks, trust companies, and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (“Indirect Participants”).

For this reason, even though Shareholders of OTC Bulletin Board and OTC Markets Pink Sheet stock might have a brokerage account at a little known firm specializing in over-the-counter stocks, these smaller firms clear shares through larger DTC Direct Participants.

The DTC Rules applicable to its Participants are on file with the Securities and Exchange Commission.  More information about DTC can be found at www.dtcc.com.

What are DTC Opinions of Counsel?

DTC Requests Legal Opinions from Outside Counsel

DTC evaluates securities for DTC eligibility on an individual, case-by-case basis.  After DTC has reviewed the information provided by the Issuer’s sponsoring broker-dealer/market maker (“DTC Particpant”), DTC decides whether or not a legal opinion from the Issuer’s outside counsel will be required to substantiate the legal basis for DTC eligibility.

Reasons DTC Can Request a Legal Opinion

DTC Opinions of Counsel are typically requested to confirm:
  1. that the registration requirements for the Issuer’s securities under the Securities Act of 1933 (“Securities Act”)  have been met; or
  2. that the securities are exempt from SEC registration under the Securities Act, under a recognized exemption that will not restrict the transfer and ownership of the Issuer’s securities; or
  3. that the Issuer’s securities are eligible for deposit for the appropriate DTC program under SEC Rule 144A or Reg S.

DTC Opinions are Required for all Securities With New CUSIP

DTC Opinions are also required for certain corporate actions or share reorganizations that result in the issuance of securities under a new CUSIP which will be held at DTC.

DTC can also request a legal opinion from outside counsel for any reason at its discretion in order to protect DTC and its DTC Participants from perceived risk .

DTC Eligibility Securities Lawyer

Matheau J. W. Stout, securities lawyer, drafts DTC Opinions of Counsel and DTC Eligibility Opinions for OTC Bulletin Board (OTCBB) and OTC Markets OTCQX, OTCQB and OTC Pink Sheets and can be reached at (410) 429-7076 with questions about the DTC Eligibility process.

Are S-8 Shares Free Trading?

S-8 Shares Are Free Trading When Form S-8 Is Filed

One reason why employees and consultants of OTC Bulletin Board or OTC Markets OTCQB Issuers like to receive S-8 Shares is that  an S-8 is immediately effective upon filing. This means that S-8 stock is free trading upon filing Form S-8 for employees and consultants who are not Affiliates.   S-8 stock is still subject to the Rule 144 volume limitations if owned by officers, directors and other Issuer control persons.

SEC Reporting Company Requirements To Use S-8

In order to meet the requirements of S-8 Shares, the OTC Issuer doing an S-8 offering must meet every one of the SEC’s requirements for S-8 stock.  The Public Company Issuer MUST:

  1. be “fully reporting to the SEC,” subject to the reporting requirements under Section 13 or 15 (d) of the Exchange Act;
  2. have filed all SEC reports for the past year (or for whatever shorter period the Issuer was required to file SEC reports);
  3. show that the consultant provided “bona fide services” to the Issuer;
  4. show that the services provided by the consultant were not “in connection with the offer or sale of securities in a capital raising transaction”;
  5. show that the services provided by the consultant were not “in connection with directly or indirectly promoting or maintaining a market for the Issuer’s securities”;
  6. The consultant must be a natural person (an individual) since Form S-8 cannot be used to issue stock to a corporation or other entity;
  7. The consulting agreement must be between the Issuer and the natural person; and
  8. The Issuer must issue the stock directly to the natural person as opposed to a corporate entity.

All SEC reporting companies, including OTCBB and OTC Markets OTCQB issuers can discuss the process of creating and registering S-8 Shares for employees and consultants by contacting securities lawyer Matheau J. W. Stout at (410) 429-7076 or mstout@otclawyers.com.