Tag Archives: securities lawyer

What is the Penny Stock Rule?

SEC Penny Stock Rule

The Penny Stock Rule refers to the requirements of Section 15(h) of the Securities Exchange Act of 1934 (“Exchange Act”), under which broker-dealers must follow a series of compliance measures in order to effect transactions in penny stocks.

The term “penny stock” usually refers to a security issued by a very small company trading at less than Five Dollars ($5.00) per share.

Penny stocks are sometimes known as OTC Markets stocks and are typically quoted over-the-counter on OTCMarkets.com  operated by OTC Markets Group, Inc. or on FINRA’s Bulletin Board (“OTCBB”).

Section 15(h) of the Exchange Act

Because of the inherently speculative characteristics of penny stocks, Congress prohibited broker-dealers from effecting transactions in penny stocks unless they comply with the requirements of Section 15(h) of the Exchange Act, which states that broker-dealers  must

  1. approve the customer for the specific penny stock transaction and receive a written agreement to the transaction;
  2. furnish the customer with a disclosure document describing the risks of investing in penny stocks;
  3. disclose to the customer the current market quotation, if any, for the penny stock;
  4. disclose to the customer the amount of compensation the firm and broker will receive for executing the trade; and
  5. after executing the trade, a broker-dealer must send to its investing customer monthly account statements that show the market value of all penny stock held in the customer’s account.

Transactions Exempt from the Penny Stock Rule

Some transactions in penny stocks are exempt from the Penny Stock Rule. Examples of exempt transactions are those with an established customer, who has either done business with the brokerage for greater than one year, or who has made at least three penny stock purchases.  Likewise, transactions with institutional investors may also be exempt.

Some Companies with Low Stock Prices are Not Penny Stocks

Companies quoted on the OTCQX, the highest market tier of OTCMarkets.com, are not considered Penny Stocks even if they have low stock prices because they must meet one of the exemptions to the Penny Stock Rules involving minimum net tangible assets or revenue.

Brokerages Specialize in OTC Markets Penny Stocks

An experienced securities attorney like Matheau J. W. Stout, Esq. can refer shareholders to one of the few brokerage firms which specialize in OTC Markets stocks.

These OTC brokers have streamlined the process of opening accounts for penny stock investors.  Their compliance and legal departments are familiar with penny stocks and the Rule 144 legal opinions needed to deposit OTC stocks.

Interested OTC stock shareholders can review SEC Schedule 15g for further information or contact Matt Stout, microcap securities attorney at (410) 429-7076 or via email at mstout@otclawyers.com.

What is an SEC No Action Letter?

OTC Markets companies that are uncertain if a proposed course of action may be a violation of federal securities law can work with their securities attorney to request a “no-action” letter from the SEC staff.

Experienced Securities Attorneys Draft Requests for No Action

SEC No Action Letters are drafted by experienced securities attorneys, and detail the Issuer’s request, provide an analysis of the particular facts  and discuss the applicable laws and SEC rules which support the Issuer’s position.

SEC Staff Grants a Request for No Action

If the SEC staff grants the request for no action, this effectively states that the Commission would not take enforcement action against the Issuer based on the particular facts and representations as they appear in the request.

The SEC May Issue an Interpretive Letter in Response

The SEC staff may provide an interpretive letter in response to requests before issuing an SEC No Action Letter if clarifications of certain rules and regulations are necessary.

SEC No Action Letters are Limited to Specific Facts

It is important to note that the scope of the no-action relief is limited to the Issuer making the request and subject to all of the representations made in the request, such as the specific facts and circumstances involved.  Because of this an Issuer is wise to word the request correctly, so that the actual facts and circumstances of the proposed action are carefully set forth in detail.

Lastly, an SEC No Action Letter does not create a legally binding precedent, and the SEC staff reserves the right to change positions from those reflected in prior SEC No Action Letters.

As guidance, the SEC provides a compilation of Staff No Action, Interpretive, and Exemptive Letters from the Divisions of Corporation Finance, Investment Management, and Trading and Markets, and the Office of the Chief Accountant in the “Staff Interpretations” section of SEC.gov.

This SEC compilation is searchable by category, which is helpful when discussing possible options with securities lawyers.

Matt Stout, securities compliance and regulation lawyer, represents OTC Issuers and large Shareholders in the process of seeking SEC No Action Letters.  Mr. Stout can be reached at (410) 429-7076 or via email:  mstout@otclawyers.com.

What is Schedule 13D?

Schedule 13D is known as a Beneficial Ownership Report

The term “beneficial owner” is defined under SEC rules, and is basically any person who directly or indirectly shares voting power or the power to sell the security.  For example, this would include individuals who are the majority member of an LLC and the Trustee of a Trust.

Schedule 13D Must Be Filed By Shareholders of Greater Than 5%

When a person or group becomes the beneficial owner of greater than Five Percent (5%) of a voting class of an Issuer’s equity securities registered under Section 12 of the Securities Exchange Act of 1934, the beneficial owner is required to file a Schedule 13D with the SEC.

Under certain circumstances the shorter Schedule 13G may be used.  Shareholders owning more than 5% in non reporting companies such as voluntary filers and Pink Sheets are not required to file a Schedule 13D or Schedule 13G.

Who Has the Obligation to File a Schedule 13D?

It is important to note that the beneficial owner has the obligation to file a Schedule 13D, not the public company, since the nature of “beneficial ownership” might prevent the Issuer from knowing which individuals are behind all of its corporate entity shareholders, such as LLCs or Trusts.

Schedule 13D filings for most publicly traded companies are searchable in the SEC’s EDGAR database system.

Matt Stout, OTC securities attorney, works with shareholders to issue Rule 144 legal opinions and to assist with SEC filings, such as Schedule 13D and SEC Forms 3, 4, and 5.

Can the SEC Revoke a Stock’s Registration?

Yes, the SEC can revoke the registration of a stock under the Securities Exchange Act of 1934 (the “Exchange Act”).

If a public company remains out of compliance with federal securities laws, Section 12(j) of the Exchange Act  authorizes the SEC to revoke the registration of its stock, in which case broker-dealers may not execute trades in that stock.

What are the Penny Stock Rules?

The Penny Stock Rules refer to the requirements of Section 15(h) of the Securities Exchange Act of 1934, under which Congress prohibited broker-dealers from effecting transactions in penny stocks unless they are in compliance.

Under the Penny Stock Rules Broker-Dealers Must Do the Following

  1. Approve the shareholder for the specific penny stock transaction; and
  2. Receive from the shareholder a written agreement to the transaction; and
  3. Provide a disclosure document which describes the risks of investing in penny stocks; and
  4. Disclose the current market quotation, if any, for the penny stock; and
  5. Disclose the amount of compensation the firm and its broker will receive for executing the trade; and
  6. After executing the sale, the broker-dealer must also send monthly account statements to the shareholder, which detail the market value of each penny stock in the shareholder’s account.

What is a Penny Stock?

Most investors believe a Penny Stock must be trading for under one cent, but the term can refer to any microcap public company’s securities that are not listed on a national exchange, like the NYSE or NASDAQ, if those shares are trading for under $5.

 Exclusions from Penny Stock Rules

SEC Rule 3a51-1 allows exclusions for public companies that have
  1. Net tangible assets greater than $2 million if they have been in business at least three years; or
  2. More than $5 million if in business less than three years or
  3. Average revenue of at least $6 million for the last three years.

Penny Stocks are not just Pink Sheets

In fact, under this definition, unless the asset or revenue requirements are met, even those SEC filers with audited financials, quoted on the OTC Bulletin Board (OTCBB), or OTC Markets OTCQB or OTCQX market tiers can be considered penny stocks.

What is a Blank Check Company?

A Blank Check Company is defined by the SEC under the Securities Act of 1933, Rule 419, as a company that has

  1. no specific business plan or purpose, or
  2. has indicated that its business plan is to engage in a merger or acquisition with an unidentified operating business, and
  3. is issuing “penny stock.”

These blank check companies are sometimes referred to as 419 shells.  Blank check companies are similar to a special purpose acquisition company (SPAC) in that both are created to consummate a business combination with an unidentified target company.

S-1 Registration Statements and Blank Check Companies

When filing an S-1 Registration Statement for a development stage start up company, is it not uncommon for initial SEC comments to question whether or not the registrant is a blank check company.  If the company is not a blank check under Rule 419, then the response to the SEC would include information supporting the company’s specific business purpose and a bona fide plan of operations.

Companies that are concerned about being incorrectly labeled a blank check company or 419 shell should take care to draft the business plan portion of the S-1 with sufficient detail so that the question answers itself.

Entrepreneurs considering taking their companies public via S-1 Registration Statement can contact securities attorney Matt Stout with questions at (410) 429-7076 or via mstout@otclawyers.com.

Debt Conversions Under Rule 144

Debt holders of Promissory Notes and other claims in OTC Markets microcap public companies often ask what is necessary to draft a legal opinion under Rule 144 or Section 4(1) for shares issued in a debt conversion.

The following is an outline of documents which are helpful in determining the validity of the debt.  As is usually the case in life, more documentation is better.

If the debt arose from services performed, these documents will be important:

  1. Invoices and/or correspondence showing communication between the debt holder and the Issuer;
  2. Consulting Agreement or other written evidence like an email chain, showing services were performed for an agreed upon amount of money, giving rise to the debt obligation.  (The date the services were performed is likely the date the holding period starts under Rule 144, unless the language states otherwise.)

If the debt is due to a loan of money to the public company, these documents are helpful:

  1. Proof of payment either in the form of bank statements, wire transfer confirmations, or cancelled checks.  (The date of this payment is likely the start of the Rule 144 holding period, which could be after an agreement was signed.);
  2. Promissory Note and any Amendments which should show the principal amount, interest rate and default or conversion mechanisms;

Regardless of the source of the debt obligation, if invoices or a Note is going to be converted into shares, at some point there will likely be a

  1. Conversion Agreement, under which the Issuer and debt holder might agree to a conversion strike price or formula which was not present in the prior documents.  This is often a compromise.
  2. Notice of Conversion, under which the debt holder gives the Issuer and the Transfer Agent notice of the amount of debt being converted, the conversion price, the total shares due, and the amount of debt remaining after such conversion.

Perhaps most helpful of all will be evidence that the Issuer acknowledged the debt and voted to allow the conversion.  If so, there may be a

  1. Board Resolutions or Written Consents which demonstrate the Company’s Board of Directors voted on the services, debt and/or conversion;
  2. Transfer Agent Instructions which specify the number of shares to be issued.

In every case, the Shareholder seeking the legal opinion under Rule 144 or Section 4(1) will benefit by having his or her

  1. Broker’s Shareholder Representation Forms filled out, which will specify the Shareholder’s non-affiliate status, the total number of shares beneficially owned by the Shareholder and the holding period.

Finally, the holy grail of Rule 144 would be a specific and detailed mention of the debt obligation and the debt holder in the company’s OTC Markets or SEC filings.

If this is the case, the Shareholder would benefit by making a copy of the filing(s) and including those in the PDF package he or she emails to the securities lawyer drafting the Rule 144 or Section 4(1) legal opinion.

Matt Stout is a microcap securities lawyer representing OTC Markets public companies and their shareholders in a wide range of securities regulation, SEC compliance, FINRA corporate actions and DTC eligibility matters.

Rule 144 and Selling Stock in Former Shell Companies

As many shareholders in OTC Markets companies know, Rule 144 is the most common exemption for clearing and selling restricted stock.   But how does Rule 144 apply to the shares in former shell companies?

The Evergreen Rule and Rule 144

Rule 144 is only available for the sale of stock in a former shell company when the following requirements are met:

  1. The former shell must be subject to Exchange Act filing requirements; and
  2. The Issuer must have filed “Form 10 Information” with the SEC, although this could be accomplished through the filing of a Super 8-K, or any filing including all of the information found in a Form 10 filing, including audited financials of the operating company which was the subject of the reverse merger (which caused the vehicle to cease being a shell); and
  3. The Issuer must be current and have filed SEC reports (10-Q, 10-K, 8-K, etc.) for Twelve (12) months since the Issuer ceased to be a shell.

(This last requirement is known as the Evergreen Rule, because if the Issuer misses a filing it is not “current” and the requirement is not met).

The Issuer Must Approve Rule 144 Restrictive Legend Removal

When the public company is a former shell, under some circumstances, it can actually “veto” a Rule 144 opinion letter which requests the removal of a restrictive legend, even if the shareholder is a non affiliate, and has satisfied the holding period…and even if the requirements above are met.   How?

The Issuer Could Miss a Filing and Run Afoul of the Evergreen Rule

The argument to “veto” a request to remove a Rule 144 restrictive legend is that it cannot be removed from the shareholder’s certificate unless the shares are to be deposited immediately for sale with a broker, since in theory, if the Issuer missed the next filing, it could ceased to be “current” and in compliance with the Evergreen Rule.

Shares Must Be Deposited for Sale Immediately

For this reason, most Transfer Agents will spot this and insist that the shares be DWAC’d for deposit and sale at the broker, and that the shareholder rep forms detail this fact.

Alternatives to Rule 144 for Clearing Restricted Stock

This is just one of the many nuances of drafting securities law opinion letters under Rule 144. Shareholders and OTC Markets Issuers with questions about the Evergreen Rule, or alternatives to Rule 144 for clearing restricted stock, such as Section 4(1) or 3(a)(10) can contact Matt Stout, securities lawyer at (410) 429-7076 or mstout@otclawyers.com



What is a Voluntary SEC Filer?

What is a Voluntary SEC Filer?

A voluntary filer is a public company which is not required to file reports such as the 10-Q, 10-K and 8-K under the Securities Exchange Act of 1934.  The companies will still file those reports, but without the obligation to do so under Section 15(d) or Section 13(a) of the Exchange Act.

How are Voluntary Filers Created?

Often, a microcap public company will file an S-1 Registration Statement under the Securities Act of 1933 in order to “go public” but will not later file a Form 10 or Form 8-A under Section 12(g) to register that class of securities under the ’34 Act.   When this happens, an issuer can be an OTCQB, and appear initially to be “fully reporting” but its holding period under Rule 144 will not be the 6 months which shareholders expect.

What is the Holding Period for Voluntary Filers Under Rule 144?

Surprisingly to many shareholders, the holding period under SEC Rule 144 for voluntary SEC filers is the same 12 months as for a non reporting company or Pink Sheet.

How Can I Tell if an Issuer is a Voluntary SEC Filer?

The easiest way to tell whether a public company is a voluntary SEC filer is to do a Company Filings search at SEC.gov.  Look for the filing of a 10-K or 10-Q.   If the SEC File Number in the right-hand column of that entry begins with 333, the issuer is a voluntary filer.  In contrast, an SEC mandatory filer will have an SEC File Number that begins with the prefix 000.  Note that this  SEC File Number is not the same as a CIK number, which may begin with 000 even for a voluntary filer.

This can be confusing, but is a question easily resolved by an experienced securities lawyer.   Shareholders with questions regarding OTC Markets voluntary filers and Rule 144 can contact Matt Stout, microcap securities lawyer at (410) 429-7076 or mstout@otclawyers.com.