U.S. ‘microcap’ charges highlight debate over small-firm capital raising

December 5, 2011

By Stuart Gittleman

NEW YORK, Dec. 6 (Thomson Reuters Accelus) – Federal charges filed last week in a suspected kickback scheme to sell thinly traded stocks highlight concerns over investor safety as Congress making it easier for small business to raise capital. Boston federal prosecutors filed fraud and conspiracy charges last Thursday against 13 people: corporate officers, a lawyer and stock promoter. They were accused of a kickback scheme in which payments hidden by phony consulting contracts were made to an undercover FBI agent, who posed as a hedge-fund representative, in exchange for having the fund buy stock in certain small companies.

The charges were filed as the Senate Banking Committee met to consider changing federal securities laws to permit Internet-based “crowdfunding” and other moves that critics said could weaken longstanding  protections for stock investors. “Small business investment has the potential to be a very positive economic force and a major driver of wealth and jobs when done in the right way. But when done incorrectly and without appropriate oversight, these investments have the potential to become costly failures,” Jack Herstein, president of the North American Securities Administrators Association, told the committee.

“The challenge for Congress today is to balance the legitimate interests of investors with the legitimate goals of entrepreneurs,” said Herstein, whose group represents state securities regulators and opposes some of the steps Congress is considering. The kickback charges followed a year-long investigation focusing on preventing fraud involving the stocks of “microcaps,” or small publicly traded companies. The market for these shares has proven to be fertile ground for fraud and abuse.

Accurate information on small-company stocks may be hard for average investors to find, since many of the issuers are not required to file financial reports with the Securities and Exchange Commission, U.S. Attorney Carmen Ortiz office said in announcing the charges. The SEC suspended trading in seven microcaps that were allegedly involved in the schemes. The SEC in October 2010 and June 2011 pursued similar cases against over a dozen companies and penny stock promoters for similar kickback-for-investment schemes.

But Congress, seeking action to promote job creation going into an election year dominated by a weak economy, is looking at ways to reduce regulations for small companies that want to raise money by issuing stock. “Firms that are in a position to grow will seek to raise more capital if the process of selling stock is made easier and less costly. If they succeed, this can lead to more jobs and economic prosperity,” said Senate Banking Committee Chairman Tim Johnson, a South Dakota Democrat.

The panel is considering two bills that would promote the use of “crowdfunding” websites to let individuals invest in entrepreneurial start-ups and small businesses. Another proposal would restrict the century-old role of state securities regulators in overseeing small-company offerings. Herstein, who is also deputy director of the Nebraska state Bureau of Securities, said states are best able to protect investors while ensuring small-businesses access to capital.

Lona Nallengara, director of the SEC Division of Corporation Finance, said the SEC is studying how to reduce the regulatory burdens on small-business capital formation without jeopardizing investor protection. Factors being considered include requirements for shareholder numbers and other thresholds for public-reporting requirements, as well as the impact of restrictions on how companies seeking to raise money can communicate and solicit investors.

(Editing by Randall Mikkelsen)

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus.  Compliance Complete (http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/)



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