Securities Clearing Firms

Road Blocks to Small Business Capital

If you, as an investor, own shares in any micro- or small-cap company trading on the non-listed markets of PinkSheets or the OTC Bulletin Boards you have probably been experiencing a myriad of problems of late. Due to a previously unforeseen consequence of FINRA Release 09-05 in January of 2009, many securities brokerages and clearing firms, as well as the Depository Trust & Clearing Corporation, have denied deposits of these shares into accounts. In the original release, FINRA warned their brokerages to perform additional due diligence to ward against problems of fraud and to prevent unregistered resales of low priced, low volume stocks trading in the non-listed markets – basically the stocks typically known as “penny stocks”. Unfortunately, the individual brokerage and clearing firms took it one step further. Rather than perform incomplete or incorrect due diligence and risk being fined by FINRA, firms all across the nation decided to create internal policies preventing the deposits of these securities in entirety. This move is against the Securities Exchange Act of 1934 that requires the promotion of fair and equitable trading practices. On the contrary, this move has decimated the public small and micro-cap industry. FINRA was contacted but has yet to respond.

American economy is built on the “small guy”. All of the NYSE and AMEX companies were, at one time, small companies. Small companies, in volume, provide the most support for national employment and product usage. At a time when President Obama wants support for small businesses to help the fallen economy rebound, this unforeseen consequence of the FINRA 09-05 release is preventing this support from taking hold.

Last November, the 28th Annual Small Business Capital Formation Forum was presented by the Office of Small Business of the SEC’s Division of Corporate Finance at the SEC headquarters in Washington, D.C. Attendees included attorneys from many securities law firms, some brokerage firms, a securities market maker, at least two transfer agents, representatives from PinkSheets, small capital investment advisors and investor relations firms. All were in attendance to discuss and make recommendations to the Office of Small Business regarding policies for small businesses to create capital going forward.

The morning session included opening remarks by Chairman Mary L. Shapiro with continuing remarks by Commissioner Troy Paredes and panel discussion topics: The State of Small Business Capital Formation and Academic Perspectives on the SEC’s “Accredited Investor” Definition. After lunch, the attendees divided into four separate Breakout Groups, one of which was the Smaller Publicly Traded Companies Breakout Group.

Prior to, but in anticipation of the forum, the Securities Transfer Association had also written a letter to those in charge of the Forum, documenting the STA concerns about the fact that many of the smaller issuers who make up the client base of smaller transfer agent members have been denied access by the Depository Trust & Clearing Corporation to the DTC’s FAST electronic shares system, and in some cases, have been denied DTC trading eligibility altogether. During this breakout session, additional data was also presented, culled from numerous transfer agents on behalf of the small cap issuer companies they represented, that reflected the difficulties both issuers and individual investors were having making deposits into their individual brokerage firms. This problem, originated in good faith by FINRA in 2009, has taken on a life of its own penalizing all small cap companies who want to use the lower markets to trade their stock and raise capital.

Some of the data presented at the Breakout Session included the results of a questionnaire posed to just a few smaller transfer agents in attendance at one session of the STA Annual Conference in October. Keeping in mind that the total membership of the Securities Transfer Association represents about 150 transfer agents, and the following data is therefore skewed to be under-represented, the information was still quite alarming. Of all of the answers, the most obviously disturbing was that nine separate issuers were actually denied basic trading ability, via DTC Eligibility, after being granted the ability to trade when their respective registration statements were approved either by FINRA or the SEC. Twelve issuers had been outright denied acceptance into the FAST system, with three reported as still pending. And, of those agents who reported on behalf of their issuers, 37 issuers were having maximum difficulty with brokerages accepting their shares for deposit and trading. This data was shared at the Forum.
The SEC Division of Corporate Finance had not been previously involved in these issues. Authority in these kinds of matters would normally be the responsibility of the Division of Trading and Markets. However, the Division of Trading and Markets had been previously apprised and had not progressed toward a resolution. Since the Corporate Finance Division’s Office of Small Business was currently attempting to make recommendations to enhance the trading ability of smaller businesses, the Forum attendees found it very relevant.

The reported data sparked tremendous and sometimes heated discussion at the Breakout Session. Some attendees admitted they had been unable to deposit shares of smaller cap companies into their own brokerage accounts. A representative from one well-known small cap company, PinkSheets, Inc., which completed their own IPO earlier in the year, stated that many of their shareholders had been unable to deposit these shares into brokerage accounts. The Depository’s actions of denying new companies the ability to trade by denying eligibility after the company’s registration statement had been made effective by the SEC, was also viewed as a major concern by all attendees as it was viewed as a usurping of the authority of the SEC and of FINRA.

Recommendations were given at the end of the Breakout Session for voting at a later time. Seven of the recommendations referred to other topics discussed during the session. However, the one recommendation holding the most impact was this:

Using the SEC’s authority with regard to self-regulatory organizations covered by the Exchange Act, the SEC’s Office of Small Business Policy, together with the SEC’s Division of Trading and Markets, should immediately require from DTC understandable and transparent rules and standards with strict timeframes for consideration of applications for trading eligibility with DTC and the similar rules and standards should be adopted by DTC with respect to providing electronic book-entry transfer services for smaller public companies.

However the recommendation only referred to the actions of The Depository Trust & Clearing Corporation and nothing was yet recommended for FINRA. Because there was no voluntary movement by FINRA on this grave issue by February 12, 2010, another meeting was held at the SEC, this time directly with Chairman Shapiro. She expressed concern and related the similarity to a time in the 1990s when the SEC sanctioned the NASD for allowing unfair and inequitable trading practices. She requested this be resolved quickly.

A working group is now being set up to work toward this resolution but FINRA is not yet on board. There are members willing to come to the table from DTC, the Office of Small Business from the Corporate Finance Division of the SEC, and from the Division of Trading and Markets. There are issuers, market makers and representatives of clearing firms that want to be present. But no one from FINRA has volunteered. Since it was FINRA’s Directive that started this snowball effect, one would hope for more willingness and accountability from this self-regulatory organization. Where is it?