SEC'S MICROCAP FRAUD AGENDA

SEC Examinations

In 1997, the SEC conducted over 70 examinations of microcap broker-dealers in New York, South Florida, and Colorado/Utah, representing about 43 percent of all cause examinations conducted there. More than two-thirds of those examinations were referred to the SEC's Division of Enforcement or to the NASDR for further investigation. In January 1998, the SEC's Office of Compliance, Inspections and Examinations (OCIE) initiated an examination sweep of the microcap market that resulted in several high-profile prosecutions. During 1999 SEC examiners scrutinized the transfer agents' records of microcap issuers located predominantly in Utah and Nevada. The SEC is determined to monitor the microcap market, with emphasis on the geographic regions noted above, and has announced its intention to scrutinize Internet activity.

In microcap cases, the SEC seeks immediate relief, such as temporary restraining orders and asset freezes, as well as permanent industry bars, registration revocations and fines. In many Microcap cases, the SEC works closely with federal, state, and local criminal authorities. In addition, the SEC has increased its use of trading suspensions to minimize investor harm by intervening early in ongoing market manipulations. More recently, issuers, officers, directors, promoters, accountants, attorneys, broker-dealers and transfer agents have been charged.

In recent months the prototypical SEC microcap action has contained allegations that defendants purported to be giving independent stock recommendations in on-line newsletters, spams (Internet junk e-mail), message board postings, and websites, when, in fact, their opinions had, been bought and paid for. Such promoters are frequently alleged to have received millions of dollars in payments and millions of cheap insider stock shares and options from the companies whose stocks they touted. In some instances, promoters sold their own stocks immediately after recommending that investors purchase ("scalping").

Consultants, Promoters, and Form S-8

Form S-8 is the short-form Securities Act registration statement for offers and sales of securities to employees. Unlike other Securities Act registration forms, Form S-8 does not contain a separate disclosure document called a "prospectus." Instead, Form S-8 relies on documents otherwise provided by the employer to satisfy the disclosure obligations of the Securities Act. This abbreviated disclosure was initially deemed appropriate in consideration of its likely use as "compensation" to an issuer's employees (rather than the more traditional out-of-pocket investment) and because of the assumption that employees would generally have significant information concerning the nature of the employer's business. In 1990, the SEC expanded the applicability of Form S-8 to offers and sales to consultants or advisors who provide legitimate services to the issuer that do not involve the offer or sale of securities in a capital-raising transaction.

Since adoption of the 1990 revisions, some companies used Form S-8 improperly to compensate consultants whose service to the company was the promotion of the company's securities. This practice essentially resulted in the distribution of such shares to the public because the stock promoters dumped the securities on the unsuspecting as soon as possible. Regulators perceived that abuses in this regard fueled the upswing in microcap fraud.  In response to such misconduct, in 1999 the SEC amended Form S-8 to specifically preclude its use for sales to consultants and advisors who directly or indirectly promote or maintain a market for the company's securities. Additionally, the SEC is considering several additional amendments to Form S-8 to require companies to meet preconditions of timely filing of Exchange Act reports and to ensure that reporting "shell" companies file an annual report with updated audited financials.

40 Days in the Reg S Wilderness . . . no, make that 365 days

Regulation S provides a safe harbor from the registration requirements of the Securities Act for offers and sales of securities by both foreign and domestic issuers that are made outside the United States. During the 1990s, Regulation S was frequently used as a guise for distributing microcap securities into the U.S. markets without the protections of registration under the Securities Act. As a result of such abuses, Regulation S was amended to largely mimic the Regulation D exemptions from registration.

• Equity securities placed offshore by domestic issuers under Regulation S will be classified as "restricted securities" within the meaning of Rule 144, so that resales without registration or an exemption from registration will be restricted. Rule 905, which classifies these securities as "restricted securities," will not be applied retroactively;

• To avoid confusion between the holding period for "restricted securities" under Rule 144 and the "restricted period" under Regulation S, the term "restricted period" will be renamed the "distribution compliance period";

• The distribution compliance period for these domestic equity securities will be lengthened from 40 days to one year;

• Certification, legending and other requirements will be imposed on these equity securities; and

• Domestic issuers will be able to report sales of equity securities pursuant to Regulation S on a quarterly basis, rather than on Form 8-K.

The SEC is seeking to eliminate piggybacking and would require any broker-dealer publishing a priced quotation for a microcap security to review current information about the issuer and to undertake an additional annual review. Broker-dealers would be required to document their Rule 15c2-11 reviews and make a record of any significant relationships they have with the issuer or others, including the receipt of any compensation to make a market. Although the information required to be reviewed about reporting companies is readily accessible through the SEC's EDGAR system, for non-reporting companies, broker-dealers will have to obtain more information than Rule 15c2-11 currently requires, including more information about the issuer's insiders, control persons, and promoters, and about recent significant events involving the issuer. Broker-dealers will have to provide the information to customers and other broker-dealers upon request, as well as to any information repository. The proposals have proven controversial and have generated significant industry opposition. This promises to be a heated battle for the future.