Former market maker, futures trader, securities at
Post# of 5282
Posted On: 10/14/2014 10:01:10 AM
Former market maker, futures trader, securities attorney, underwriter, investment banker, securities analyst, “quant,” venture company president, venture capitalist.", writes:
Excerpt:
"It seems obvious to us that many, probably most, of the posters on these sites are actually paid shills with no personal interest in the stock. Why do we surmise this? At least as to those making negative comments, if they were bona fide holders of the stock, they would presumably sell and go away. Yet most of them continue making negative remarks for years, often with wild accusations without any proof. Who else but a paid shill would have an incentive to do this?"
http://otcshortreport.com/blog/john-lux/secti...peculator/
Section 17(b) and the speculator
johnlux — October 8, 2014 — Leave a comment
Section 17(b) of the Securities Act of 1933 provides important protections for investors, especially penny stock investors. Violations of this rule are frequent today.
A study of the violations of this rule will explain much to many investors, especially penny stock speculators who follow promotions.
Here is the entire rule:
SECURITIES ACT OF 1933, Section 17(b)
(b) It shall be unlawful for any person, by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof.
Simply put it is unlawful to make any communication, though not purporting to offer a security for sale, that describes the security for a consideration without fully disclosing the receipt of consideration and the amount thereof.
Now please note that this article is not legal advice to you or anyone else. Unless you retain me to advise you specifically for specific matters, you are on your own. Seek qualified counsel.
Note also that various courts and various regulators, even individual regulators in any one regulatory agency, have different opinions about the rules. This means that even if there was one decision or allegation in a case discussed, these matters are not final and may change.
Further, the rules and their interpretation are constantly evolving. One of the tricky things in securities regulation is that what was normal today may be outside the rules tomorrow. You rely on any opinion or ruling at your own risk.
Even having a legal opinion to protect you may not be enough, if in the opinion of the regulator the opinion is wrong.
In our discussion of these cases, we consider here that the allegations of the SEC were eventually proven to be correct. Please note that in these cases, actually these are mere allegations, and the persons mentioned are not guilty of any violations unless they were proven to be so. We simply take the allegations as though they were proven because we are not even interested in being charged with anything wrong, so we avoid those things that the regulators consider to be improper.
Necessity for Promotion
Whatever merit a small company may have, it is obvious that small companies are not well known and need stock promotion to get investor attention. This level of attention is not the same as the mad promotion of the typical pump and dump, relying as it does on out of this world predictions and spam. The old adage is that “stocks are not bought, they are sold,” holds true for all securities, with the possible exception of undervalued securities which are sought by value investors. It is interesting to note that during the time of the Internet bubble, major underwriters paid hundreds of thousands of dollars to other NYSE houses to do research reports on their recent IPOs. IPOs are the subject of a relatively large amount of promotion and comment. If these IPOs need promotion, so do smaller companies. Our purpose here is to show where the proper boundaries are for that necessary promotion.
Third Party Payments
Naturally we suspect that if a large shareholder is paying to induce buying into a stock, it is for the purpose of increasing the price and volume of the stock so the shareholder can sell.
How Investor Relations Firms Get Hit
The SEC can find 17(b) violations in connection with a pump and dump scheme, particularly one involving fraud, and especially where the IR firm knew, should have known, or have reason to suspect fraud.
They can get cited for violating 17(b) if they are not specific as to the source and amount of the consideration you received. This includes the type of consideration (cash, stock or combination of cash and stock). They should also say if the consideration has been paid or will be paid or is contingent in some way.
Use of Stock Forums and Chat Sites
Every security we can think of gets commented on in stock chat sites. Rarely if ever is the position or bias of the person posting a comment on the stock revealed.
If the person doing the commenting is receiving remuneration for the comment, they would be violating 17(b) not to reveal the fact, source, and the amount and type of the consideration.
It seems obvious to us that many, probably most, of the posters on these sites are actually paid shills with no personal interest in the stock. Why do we surmise this? At least as to those making negative comments, if they were bona fide holders of the stock, they would presumably sell and go away. Yet most of them continue making negative remarks for years, often with wild accusations without any proof. Who else but a paid shill would have an incentive to do this?
While it is less easy to deduce, we presume that the longs also hire shills to post favorable remarks.
There are reports out there of college students being paid per post to make comments.
Now this conduct is so prevalent and so seldom hit by the regulators that some presume it is exempt from 17(b).
This is not the case. The SEC in the past has brought cases against people posting comments on stock chat sites for violating 17(b).
For examples of 17(b) violations in stock chat sites, see below under The 1998 SEC Crack Down, and In the Matter of John Black. As you will see, 17(b) does apply to stock forums.
Example of Inadequate Disclosure
This report is for information purposes only and based on public data from sources we consider to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. This report is not to be construed as a representation or as an offer or the solicitation of an offer by us to sell or buy any security. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives it should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed in this report are subject to change without notice. [Investor relations company] receives compensation from [name of issuer] for providing shareholder and broker communication. This firm and/or its directors, officers, employees or others associated with it may have positions in or effect transactions in the security or its derivatives. Annual report, 10K and other information upon request.
This is inadequate because it fails to state with regard to the particular issuer what is the amount and type of compensation paid.
Note also that the compensation that has to be disclosed could be paid in the past, paid in the present, or promised to be paid in the future. In fact, you could be liable even if the promised compensation was never paid.
Specific Cases
I believe that a review of specific cases will assist you in discovering where the boundaries are in Section 17(b).
The 1998 SEC Crack Down
In a 1998 crack down on Internet Stock Fraud, the SEC announced 23 enforcement actions against 44 individuals and companies for committing fraud over the Internet. All of the cases involve alleged illegal touting of securities in violation of Section 17(b) of the 1933 Securities Act. In all of these cases, the Internet promoters gave ostensibly independent opinions about Microcap companies that in reality were bought and paid for. Not only did they lie about their own independence, some of them lied about the companies they featured, then took advantage of any quick spike in price to sell their shares for a fast and easy profit.
The 23 cases involve a range of Internet conduct including fraudulent spams (Internet junk mail), online newsletters, message board postings and Web sites. The allegations include violations of the anti-fraud provisions and the anti-touting provisions of the federal securities laws. The authors of the spams, online newsletters, message board postings and Web sites unlawfully touted more than 235 Microcap companies, by either: (1) lying about the companies; (2) lying about their own “independence” from the companies; and/or (3) failing to disclose adequately the nature, source and amount of compensation paid by the companies. The creators of the Internet touts purported to provide unbiased opinions in their recommendations, but failed to disclose that they had received in total more than $6.3 million and nearly two million shares of cheap insider stock and options in exchange for touting services. In some instances, the fraudsters sold their stock or exercised their options immediately following their recommendations, a deceptive practice commonly referred to as “scalping.”
All twenty-three cases involve allegations of illegal touting of securities under Section 17(b) of the Securities Act of 1933. The SEC said that 17(b) provides that it is unlawful to publicize a security, if you are being paid to do so, unless you disclose three things. The first thing that is required to be disclosed is nature of the compensation you are receiving, whether it is cash, or whether it is stock. The second is the amount of compensation you are receiving. The third is the source of the compensation.
The SEC added that, “17(b) does not prohibit free speech. It does not prohibit spamming, online newsletters, posting on message boards, without other activity as well. But lying to investors, or failing to disclose compensation, does violate the law.”
The SEC featured the case of SEC v. The Future Superstock, Inc. and Jeffrey Bruss, (U.S.D.C., N.D.Ill., Case No. 98-C-6772, filed October 27, 1998.) In this case the SEC sought a permanent injunction, disgorgement, civil penalties and other relief against The Future Superstock, Inc. (FSS) and Jeffrey Bruss. The complaint alleged that an Internet newsletter called The Future Superstock, is published by FSS and researched and written by Bruss. It further alleged that the newsletter and website have recommended to the over 100,000 subscribers that they purchase about 25 microcap stocks which it predicted would double or triple in the next three to twelve months. In most instances, the prices increased for a short period of time after a recommendation was made, but then dropped substantially.
The complaint also alleged that FSS and Bruss violated federal securities laws by failing to provide adequate disclosure in several areas: (1) neither the newsletter nor the website disclosed that Bruss or FSS received compensation, in cash and stock, from nearly every issuer profiled; (2) FSS and Bruss failed to disclose that in many instances they sold the stock shortly after a recommendation in The Future Superstock caused its price to rise; (3) FSS and Bruss represented that they performed independent research and analysis when, in fact, little, if any, research was conducted; and (4) statements regarding the success of past stock picks made in The Future Superstock were false and misleading. The complaint alleges that FSS and Bruss have violated Sections 17(a) and 17(b) of the Securities Act of 1933 and 10(b) of the Securities Act of 1934 and Rule 10b-5.
All of the cases in the SEC sweep had a common thread. They all alleged fraudulent touting of securities, which violate Section 17(b) of the 1933 Act.
Section 17(b) provides that it is unlawful to publicize a security, if you are being paid to do so, unless you disclose three things. The first thing that is required to be disclosed is nature of the compensation you are receiving, whether it is cash, or whether it is stock. The second is the amount of compensation you are receiving. The third is the source of the compensation.
The SEC noted that 17(b) does not prohibit free speech, that it does not prohibit spamming, online newsletters, posting on message boards, without other activity as well. However, lying to investors, or failing to disclose compensation, does violate the law.
The SEC went on to note that Section 17(b) applies to any person who publicizes a security through any means. When it comes to the Internet, that includes publicizing securities over World Wide Web pages, online investment newsletters, bulletin boards, chat rooms, or through Internet junk mail, which is popularly known as spam.
Section 17(b) is important because investors have a right to know if information is objective, or whether someone is paying to provide that information to investors.
There is nothing illegal about companies paying fees to touters. The law requires the touters have to disclose. The law does not cover the companies themselves who make the payments.
Five of the cases involved the practice known as scalping. Scalping occurs when, unbeknownst to investors, a person making a positive recommendation about a security, sells that security shortly after making the positive recommendation, without making a disclosure to other people.
Six of the cases involved misrepresentation, either about the companies themselves, or about the touter’s independence and track record.
All of the cases involved either partial disclosure, or no disclosure at all, about the nature and source of the compensation received.
In the 1998 Crack Down the question was asked as to what kind of penalties do the scammers face in the cases that were filed. The SEC replied that many of cases will be litigated cases and penalties will be up to a court, or an administrative law judge. In these cases, the SEC sought injunctive relief, to enjoin people from violating the law, cease and desist orders, and penalties where appropriate. The SEC stated that there were going to be a wide range of different penalties, depending on the conduct involved. No dollar figures were given.
In the Matter of John Black
In this case, an employee of an investor relations firm touted stock on an Internet bulletin board, Raging Bull, without disclosing that he was being compensated for the posts by his employer. He failed to disclose that he was promised thousands of shares of stock as a bonus for assisting his employer in promoting the stock of Snelling Travel, Inc. (“SNLV”).
On December 30, 1999, Black started a subject area for SNLV on Raging Bull, an Internet bulletin board. Using a screen name other than his own, Black posted the first message in the SNLV subject area. Black’s message compared SNLV to two highly successful companies that sell electronic commerce software applications, Commerce Once, Inc. (“CMRC”) and Ariba Technologies (“ARBA”). Black’s message stated:
This is THE new CMRC and ARBA!!! Merger to be complete on Jan. 6. This baby is going to rock!!! I hear they are looking for $30.00 by Mar. 15!!! We will just have to wait and see!!! The sky is the limit!!!
Black did not disclose his agreement with Fleming Financial, which entitled to him to receive 5,000 shares of SNLV as reimbursement for promoting SNLV.
On December 31, 1999, Black posted a second message in the SNLV subject area, using a different screen name. Black’s message stated:
When will the company finish the merger? How many shares are out? What are the similarities between Plus Solutions and ARBA and CMRC? When will they be “in the money”? These are questions that MUST be answered by somebody! Anybody know a # to call?
As in the first message, Black did not disclose that he was entitled to receive remuneration for touting SNLV.
The SEC cited two other cases of posting on message boards without complying with 17(b): In the Matter of David A. Wood, Jr. et al., 68 SEC Docket 631 (Oct. 27,1998) (respondent violated Section 17(b) by posting messages on Internet message board touting company without disclosing compensation received) and In the Matter of Eugene B. Martineau, 68 SEC Docket 629 (Oct. 27, 1998) (respondent violated Section 17(b) by posting messages on Internet message board touting company without disclosing expected compensation).
Black committed or caused violations of Section 17(b) by failing to disclose the agreement to receive, indirectly from the issuer, compensation for touting SNLV stock.
No mention was made by the SEC as to the legal significance of Black using another user name on the chat site. Would this be another 17(b) violation even if he had used given the disclosure as to the source and amount of compensation? Could it be fraud to use a false user name?
Donner Case
Donner was a broker dealer that issued 48 research reports of stocks below $5.00. This was 70% of Donner’s business.
Under a typical agreement between Donner and an issuer, Donner received an initial retainer fee of $2,500, $2,000 per month for services provided, and $2 to $3 for each investor package mailed to potential investors. Some agreements also provided that Donner would receive stock if the company’s share price exceeded a certain level after Donner initiated coverage of the company. One of the individual defendants, Uberti, testified that, he received fifty percent of the amounts generated by [Donner's] relationship with the company.
For FINRA members, 17(b) violations are also violations of FINRA rules.
The reports simply stated that Donner “may from time to time perform investment banking, corporate finance, provide services for, and solicit investment banking, corporate finance or other business ” from the company. Several of these reports added the words “for a fee” after this description of services.
The record established that Donnor violated Rule 17(b) by failing to disclose the compensation received by Donner in violation of Securities Act Section 17(b).
In order to violated section 17 B, a person must use a means of interstate commerce, to make a communication which describes a security, for consideration received, without full disclosure of the consideration received in the full amount. The consideration can be past, current, or prospective, and it can be direct or indirect consideration. Section 17(b) was designed to protect the public from publications that purport to give an unbiased opinion but which opinions and reality are bought and paid for.
The SEC pointed out that the Donnor research reports stated only that Donner “may from time to time perform investment banking, corporate finance, or provide services for the issuer” sometimes adding that Donner might perform the services for a fee. They did not disclose that Donnor in fact received compensation in exchange for writing and making public the research reports and for the type of consideration of the amount of compensation received.
Gorsek
Gorsek was a Federal Court decision. In Gorsek, the Court found that the disclaimer was inadequate as is insufficient under Rule 17(b) because although it gave the fact that there was compensation, it failed to list the amount of compensation and the type of consideration (e.g. stock, cash, or combination of cash and stock).
Other SEC Cases
In an SEC complaint against Christopher Wheeler and his OTCstockexchange.com, the SEC alleged a pump and dump scheme orchestrated by Wheeler involving securities of several thinly traded penny stocks. Wheeler recommended investors purchase the securities without disclosing that he had received millions in shares as compensation for his promotions and was simultaneously liquidating the shares. In total he profited at least $2.95 million.
At various times during 2007 and 2008, Wheeler used the website to promote the issuer stock in return for undisclosed compensation in the form of millions of shares. Wheeler featured the issuer stock in the website and posted lofty price targets for the stock without any reasonable basis for those targets. These promotional efforts often resulted in dramatic, but temporary, increases in the volume of shares traded in the price of the issuer securities. These temporary increases in volume and trading allowed Wheeler to sell the shares in the issuers for a large profit, totaling approximately $2.95 million.
Wheeler and the website failed to disclose in each instance that Wheeler had received stock, directly or indirectly from the Issuers as compensation for his promotional efforts were the amount of stock he received in compensation, as required under the federal securities laws. Instead, the website contained a representation that its was compensated by one or more third parties on behalf of the companies listed, followed by a list of several companies and the websites’ compensation arrangement with those companies. During the relevant period this never included the issuers. Website thereby falsely represented that Wheeler had received no compensation for its promotional activities with respect to the issuer in question.
Wheeler and the website also concealed from investors that Wheeler was personally selling shares in the issuers’ stock while he was promoting the same stock in recommending that investors buy it. The website contained only general disclosure that the site may at any time have positions in the securities mentioned and may make purchases or sales in the securities featured on the website and may sell its shares. The SEC complained that Wheeler and the website never disclosed that in each instance Wheeler was reselling the issuer stock.
During the relevant period Wheeler the website never disclosed it really received shares as compensation for the promotion, and the amount of such compensation, or that Wheeler was selling stock while recommending the stock is a buy.
Wall Street Bulletin
In another complaint, the SEC said that a penny stock promoter named Gregory King crafted false and misleading tout sheets crafted to appear like independent investment newsletters and entitled them the Wall Street Bulletin. A spam campaign consisting of faxes was maintained.
The Wall Street Bulletin failed to disclose the amount of the compensation. Shares were paid to the defendant to prepare and disseminate these “Newsletters.” Further, the defendants were selling stock contrary to the Wall Street Bulletin’s strong buy recommendations and price targets.
The promoters misleadingly represented that the Wall Street Bulletin was paid by an unnamed third party, that the Wall Street Bulletin was based on independent research, that the Wall Street Bulletin and its employees had not and would not receive any and shares and that the Wall Street Bulletin and its employees would not buy or sell any and stock. These were false and misleading representations and/or omissions.
The SEC alleged that the defendants knew or were reckless in not knowing that the Wall Street Bulletin failed to disclose that shares had been paid to make the promotion.
Investment Advisor
In a case involving an investment advisor, the SEC alleged that the investment advisor solicited his advisory clients to invest in real estate developments after being promised compensation for raising investor money and promised title to a 5,000 square foot home. He did not disclose to his advisory clients or other investors this conflict of interest, namely that he had been promised compensation for fund raising efforts.
SEC v. Investsource
In the case of SEC v. Investsource, Inc. et al, the SEC alleged that in 2008 and 2009 defendants engaged in massive e-mail campaigns to promote penny stocks of their clients often sending such e-mails to hundreds of thousands of recipients.
These emails failed to disclose that defendants have been compensated for their promotions. Further defendants made misleading statements on Investsource’s website regarding the nature the compensation received for investors providing services to its penny stock issuer clients. Finally, both the e-mail thousand websites failed to disclose that defendants reselling the very securities they were recommending that investors buy.
Invest source was a penny stock website. From January 2008 and March 2009 Invest source had 85 clients, almost all penny stock issuers. was client stated securities cash. Investor sent is daily digest e-mails to addresses in its database nearly every weekday. By the Autumn of 2008 Invest source was routinely sending messages to several hundred thousand addresses.
Undisclosed to the e-mail letter recipients, Investsource and its principal repeatedly sold the stock of the issuer it promoted while engaged in the promotional activities. They did not disclose the compensation received in their securities trading in any of the e-mail newsletters. Instead each e-mail included the a disclaimer link to their website. The link took investors to their “Main Disclaimer” website page which stated in relevant part:
The companies listed on the ‘Featured Companies’ section of our website may have compensated the Company [InvestSource] to be profiled on this website. These companies (or some of these companies) have retained us to perform public relations, or media relations or even investor relation services including promotional services that consist of the placement of the profiled companies on our website. Such compensation has been or will be made in cash and or [sic] issuance of securities of the profiled company. The specific compensation type and amounts that the company has been paid from each respective company is set forth on the transcript box accessible from each respective company page within our site. We may liquidate any securities that we receive as compensation when deemed appropriate to do so, however, we attempt to liquidate such securities upon receipt thereof prior to performing any services for such company. Such liquidation may have a negative impact on the securities being liquidated.
The SEC attacked the disclaimer sections stating that the companies may have compensated the website, that such compensation will be made in cash or securities, and that the website attempted to liquidate such securities upon receipt thereof part of performing any services for such company.
In fact, Investsource or its principal were always compensated. Investsource claimed in its disclaimers that it attempted to liquidate securities it received as compensation for services upon receipt thereof prior to performing any services. In fact, it sold the securities after several recommending their purchase and profited thereby. The statement that Investsource planned to sell securities before promoting them was materially false because its practice was to sell securities while promoting them.
Their website contained additional disclosure. Each of the client companies had a profile sections that included many tabs from which to select. One of these tabs was labeled “disclaimer.”
The SEC found that these company-specific disclaimers were inadequate. When the defendants were contacted by the SEC during the SEC’s investigation, they revised the company-specific disclaimer website pages to list the number of shares sold and the amount of sales proceeds.
However, they still failed to disclose that they were continuing to sell the securities while promoting them. The defendants similarly failed to correct the main disclaimer website page to adequately disclose that defendants were always compensated for promoting the securities, that the compensation was almost always in securities, and that defendants promoted the purchase of the stock to potential buyers before, during and after their sales of those same stocks.
Thus, it was not enough that the defendants stated that they may be compensated where they were actually always compensated. Further, they did not state that they would be selling the stock they received before, during and after their promotional campaigns.
SEC v. Shrewder et al
In this case the SEC alleged that the defendants manipulated the market in at least two securities and inundated the public with millions of faxes or “fax blasts” that contained materially false information in order to mislead people into buying the stocks described.
The faxes in question were alleged to be from the bioTech Report and contained identical disclaimers that they had been contracted by a “third party” to research and issue the report and that the publication expected to receive $30,000 to distribute the report.
The SEC alleged that the bioTech Report is a pseudonym used to mask the fact that the defendants were paid by the company for the promotional campaign and the publication is not an independent investor awareness publication is stated in the faxes.
The disclaimer misrepresented the compensation that the defendants received, the fact that they had already received as compensation, and the fact that their services had been contracted by an agent of the company and not a third-party.
The SEC also alleged that the faxes failed to disclose and that Shrewder was actively selling the shares while he was recommending that investors include accumulate the shares. Shrewder also engaged in day trading to falsely create the appearance of trading volume during his fax blasting campaign. Shrewder also engaged in scalping. He sold into the rising price and increase in volume caused in whole or in part by his faxes and his manipulative trading, which the SEC said is a practice commonly known as scalping.
Shrewder also manipulated other stocks. He used a pseudonym for the publisher of this fax, this time the US Oil Reporter, misleadingly stating that it is an independent investor awareness publication.
As with the other faxes that Shrewder disseminated he misrepresented the compensation he received from promoting a stock in a disclosure statement of the factors stated that this entity is “is expected to receive $25,000 to issue this report on [the stock]. . . .”
In fact Shrewder had already received 260,000 shares of stock with a value at the time of $0.91 for a total of $236,000. The market value of the stock received at the time he sent the fax blast was approximately $226,000 far more than the $25,000 stated in the disclosures. He engaged in day trading and he recommended accumulating the stock up to $2.00 and exiting the stock at $5.00. As with the other stock, he sold this stock at far less than the price he was recommending in his faxes.
SEC v. Courtney D. Smith
In SEC v. Courtney D. Smith, the defendant received cash and stock to promote the company’s stock. He promoted the stock a number of times on television. At one time he on TV he stated that he had a big chunk of stock and thought it was worth twice the current market price. This was misleading as the impression was that he had purchased the stock when in fact it had been given to him for stock promotion.
Payments for IPO Research
Larger companies are not immune from 17(b) violations. In a series of cases that were brought after the Internet boom, the SEC charged several large firms with receiving payments for research reports on IPO stocks underwritten by other broker-dealers and not disclosing them as required by 17(b). The firms charged included Deutsche Bank Securities, Morgan Keegan, and Janney Montgomery. The payments were in the hundreds of thousands of dollars.
In these cases, the underwriters were apparently willing to pay hundreds of thousands of dollars to support their IPO underwritings in the after market.
Sales of Private Company Securities
In an SEC complaint against The Investors Registry, LLC (TIR) and Michael J. Southworth, the SEC alleged that Southworth oversaw the sale of at least 650 memberships in TIR which he marketed as an exclusive investment community where members would be provided with opportunities to invest in pre-IPO companies. He represented that TIR researched thousands of early-stage companies and culled them down to only a handful of promising issuers that TIR profiled as investment opportunities.
From 2007 to 2011 Southworth touted five issuers by e-mail and by posting offering and subscription materials on TIR’s website. He also helped structure terms of the offerings. He was not registered as a broker-dealer but contracted for and received cash and stock from issuers in exchange for acting as a broker in recommending and selling their securities and he failed to fully inadequately disclose this consideration the TIR memberships. Thus, here we have a case that involves the private sales of securities and not securities trading in the public market.
Failed Defenses
Some defendants claimed that they were using the “industry-standard” disclaimer and that if all the broker-dealers were using that, it that must be accepted by the industry even though the rule says you have to put the specific amount of compensation in the claimer. This does not work, as the courts and the Commission have repeatedly held a practice may be prevalent in the industry and still be fraudulent.
Further, note that in order to show a 17(b) violation, the SEC need not show that anyone read the communication, need not show that anyone relied on the communication, and need not show that the communication was in any other way false, other than as to the compensation received.
In fact, 17(b) requires only a “description” of a security, not even a recommendation.
Restricted Stock
In cases involving the most ruthless stock manipulators, very often these miscreants obtain fraudulent opinions under SEC Rule 144 to improperly remove restrictions from lettered securities.
For example, in the case of SEC v. Recycle Tech, et al, the attorney did little or no due diligence into the company whose stock was the subject of his opinion and ignored the several “red flags.” The attorney had information that should have told him that the company was a shell company ineligible to use Rule 144. He miscalculated the holding period. The company was delinquent on its required filings and thus the current information requirements of Rule 144 were not satisfied. The opinion relied on falsified or backdated documents and this would have been revealed by simple due diligence. The issuance relied on an old resolution and no attempt was made so see if it was still in effect. The shares to be freed up from the debt conversion would double the outstanding stock. The attorney should have known that one of the sellers was an affiliate of the company and yet he did not in his opinion letter apply the restrictions on manner of sale, amount that could be sold, and notice of sale.
The newsletters touting the stock offered only general disclaimers and did not report that they were selling into their buy recommendation.
Moreover, the newsletter only contained a general disclaimer. The newsletter disclosed:
[w]hen Pennypic.com receives free trading shares as compensation for a profiled company, Pennypic.com may sell part or all of any such shares during the period in which Pennypic.com is performing such services.”
It then specifically disclosed that it “has received from a third party non-affiliate 2.325 million free trading shares of [Recycle Tech] for advertising and marketing.”
The SEC charged that the newsletter did not, however, disclose the third party’s identity or the stock sales of Pennypic’s principal.
Thus, we see here that the SEC found this disclaimer was inadequate even though it disclosed that the newsletter “may” sell, and that the stock was from a third party and the number of shares.
One violation that we note in some of these cases is that the promoters, who are themselves control persons, buy restricted stock, and in order to assist in the making the stock unrestricted, place the securities not in their names, but in the names of others who are not control persons. From there, the securities can be handed out for stock promotion or simply sold with most of the proceeds of sale remitted to the promoter.
Possible Accompanying Charges
______
Investor relations firm that are charged with violating Section 17(b) are sometimes hit with other charges as well.
Section 17(b) violators are often also charged with fraud violations under Section 17(a) of the Securities Act of 1933 and Rule 10b-5 of the Securities and Exchange Act of 1934. Section 17(a) is an anti-fraud provision as is 10b-5.
Naturally, if people are doing wrongful promotion and not abiding by 17(b), they are probably making false statements in the content of the promotion as well.
It is important to note that stock promotion companies have also been charged with insider trading for selling stock based on negative insider information not available in the market.
In the case of SEC v. Packetport.com, Inc. et al, the SEC charged IP Equity with violating 17(b) and insider trading. By virtue of its agreement with PacketPort.com to provide publicity services, IP Equity, its officers, and its employees obtained material non-public information about PacketPort.com, including but not limited to information about the company’s true financial condition, its customers, and its private offerings, as well as about the undisclosed securities transactions of its officers and directors. IP Equity, its officers, and its employees owed a duty of trust and confidence to PacketPort.com to refrain from using for personal gain any confidential information they obtained by virtue of their work for PacketPort.com.
On or about December 10, 1999, IP Equity initiated a campaign to generate positive publicity for PacketPort.com. IP Equity’s Internet Stock News, which purported to be “the Web’s leading source for information about Internet investment opportunities,” published what it claimed to be “an investment opinion to notify analysts, brokers, market makers, institutional and retail investors, as well media representatives that IP Telephony company PacketPort.com, Inc. has started trading . . . under the symbol ‘PKPT’.” Internet Stock News falsely stated that its press release contained “independent commentary about Internet stocks.”
On December 13, 1999, IP Equity’s Internet Stock News issued a recommendation for PacketPort.com. IP Equity stated that it had added PacketPort.com to its “Ones to Watch in 1999 group of Internet companies.” IP Equity claimed that PacketPort.com was “now fully restructured, debt-free, and poised to capitalize on the IP-based solutions market.” IP Equity claimed that its “Ones to Watch” group of companies was “up 200% year-to-date and, to [its] knowledge, . . . beat every single money management and mutual fund company in existence.” IP Equity also falsely and misleadingly claimed that its announcement contained “independent commentary about Internet stocks” and that it held “up to four hundred thousand shares of mPhase and PacketPort.com Inc.” On this same date, the transfer agent had delivered IP Equity’s 1.2 million restricted Linkon shares reissued as 400,000 PacketPort.com shares in an unlegended stock certificate.
IP Equity’s statement that PacketPort.com was debt-free was false and misleading. In fact, PacketPort.com remained liable for at least $802,500 in judgment debt. IP Equity’s statement in its recommendation that it held “up to” 400,000 shares of mPhase and PacketPort.com was false and misleading. At the time, defendant IP Equity actually owned 400,000 recently-acquired PacketPort.com shares and beneficially owned another 1,000,000 shares through its option to acquire 1,000,000 PacketPort.com shares at a privately offered price.
On December 21, 1999, defendant IP Equity exercised its private offering option and purchased 1,000,000 PacketPort.com shares at $0.13 per share. After buying PacketPort.com shares at $0.13 per share, IP Equity continued to recommend PacketPort.com to public investors on its Internet website and in subsequent press releases and continued to sell PacketPort.com shares to the public at an average price of about $9.58. About half of IP Equity’s total sales to the public occurred after it exercised this option. IP Equity did not disclose to the public the private offering of PacketPort.com shares at $0.13 per share, its purchases of PacketPort.com at $0.13 per share, or its essentially contemporaneous sales of PacketPort.com shares to the public at prices averaging $9.58 per share.
IP Equity’s officers caused IP Equity to sell PacketPort.com shares and benefited from the sales proceeds. While IP Equity sold PacketPort.com shares in December 1999 and at times thereafter, IP Equity’s officers were in possession of material nonpublic information about the company, including but not limited to: the true financial condition of the company; the private offering price of shares; the paid-for publicity arrangement between itself and the company; and the scheme of the defendants to pump up the market price and sell their shares.
What does this mean to you?
If the stock promoter does not give give the exact specific source of any compensation, if it does not give the exact amount of compensation – past, present or promised in the future, and it does not give the type of consideration (e.g. stock, cash, or combination of cash and stock), it may be violating the rule. The stock promoter cannot say it is independent if it is not independent.
Stock promoters may be scalping your buying – watch out!
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John E. Lux – Former market maker, futures trader, securities attorney, underwriter, investment banker, securities analyst, “quant,” venture company president, venture capitalist. Degrees in quantitative analysis and law. Author of “How to Find a Home Run Stock,” “How to Pick Hot Reverse Merger Penny Stocks,” “How the Shorts Raid Your Stock, Destroy Your Company and What to Do About It,” and “Bash the Stock Bashers.”
original post by 2bornot2b
Excerpt:
"It seems obvious to us that many, probably most, of the posters on these sites are actually paid shills with no personal interest in the stock. Why do we surmise this? At least as to those making negative comments, if they were bona fide holders of the stock, they would presumably sell and go away. Yet most of them continue making negative remarks for years, often with wild accusations without any proof. Who else but a paid shill would have an incentive to do this?"
http://otcshortreport.com/blog/john-lux/secti...peculator/
Section 17(b) and the speculator
johnlux — October 8, 2014 — Leave a comment
Section 17(b) of the Securities Act of 1933 provides important protections for investors, especially penny stock investors. Violations of this rule are frequent today.
A study of the violations of this rule will explain much to many investors, especially penny stock speculators who follow promotions.
Here is the entire rule:
SECURITIES ACT OF 1933, Section 17(b)
(b) It shall be unlawful for any person, by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof.
Simply put it is unlawful to make any communication, though not purporting to offer a security for sale, that describes the security for a consideration without fully disclosing the receipt of consideration and the amount thereof.
Now please note that this article is not legal advice to you or anyone else. Unless you retain me to advise you specifically for specific matters, you are on your own. Seek qualified counsel.
Note also that various courts and various regulators, even individual regulators in any one regulatory agency, have different opinions about the rules. This means that even if there was one decision or allegation in a case discussed, these matters are not final and may change.
Further, the rules and their interpretation are constantly evolving. One of the tricky things in securities regulation is that what was normal today may be outside the rules tomorrow. You rely on any opinion or ruling at your own risk.
Even having a legal opinion to protect you may not be enough, if in the opinion of the regulator the opinion is wrong.
In our discussion of these cases, we consider here that the allegations of the SEC were eventually proven to be correct. Please note that in these cases, actually these are mere allegations, and the persons mentioned are not guilty of any violations unless they were proven to be so. We simply take the allegations as though they were proven because we are not even interested in being charged with anything wrong, so we avoid those things that the regulators consider to be improper.
Necessity for Promotion
Whatever merit a small company may have, it is obvious that small companies are not well known and need stock promotion to get investor attention. This level of attention is not the same as the mad promotion of the typical pump and dump, relying as it does on out of this world predictions and spam. The old adage is that “stocks are not bought, they are sold,” holds true for all securities, with the possible exception of undervalued securities which are sought by value investors. It is interesting to note that during the time of the Internet bubble, major underwriters paid hundreds of thousands of dollars to other NYSE houses to do research reports on their recent IPOs. IPOs are the subject of a relatively large amount of promotion and comment. If these IPOs need promotion, so do smaller companies. Our purpose here is to show where the proper boundaries are for that necessary promotion.
Third Party Payments
Naturally we suspect that if a large shareholder is paying to induce buying into a stock, it is for the purpose of increasing the price and volume of the stock so the shareholder can sell.
How Investor Relations Firms Get Hit
The SEC can find 17(b) violations in connection with a pump and dump scheme, particularly one involving fraud, and especially where the IR firm knew, should have known, or have reason to suspect fraud.
They can get cited for violating 17(b) if they are not specific as to the source and amount of the consideration you received. This includes the type of consideration (cash, stock or combination of cash and stock). They should also say if the consideration has been paid or will be paid or is contingent in some way.
Use of Stock Forums and Chat Sites
Every security we can think of gets commented on in stock chat sites. Rarely if ever is the position or bias of the person posting a comment on the stock revealed.
If the person doing the commenting is receiving remuneration for the comment, they would be violating 17(b) not to reveal the fact, source, and the amount and type of the consideration.
It seems obvious to us that many, probably most, of the posters on these sites are actually paid shills with no personal interest in the stock. Why do we surmise this? At least as to those making negative comments, if they were bona fide holders of the stock, they would presumably sell and go away. Yet most of them continue making negative remarks for years, often with wild accusations without any proof. Who else but a paid shill would have an incentive to do this?
While it is less easy to deduce, we presume that the longs also hire shills to post favorable remarks.
There are reports out there of college students being paid per post to make comments.
Now this conduct is so prevalent and so seldom hit by the regulators that some presume it is exempt from 17(b).
This is not the case. The SEC in the past has brought cases against people posting comments on stock chat sites for violating 17(b).
For examples of 17(b) violations in stock chat sites, see below under The 1998 SEC Crack Down, and In the Matter of John Black. As you will see, 17(b) does apply to stock forums.
Example of Inadequate Disclosure
This report is for information purposes only and based on public data from sources we consider to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. This report is not to be construed as a representation or as an offer or the solicitation of an offer by us to sell or buy any security. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives it should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed in this report are subject to change without notice. [Investor relations company] receives compensation from [name of issuer] for providing shareholder and broker communication. This firm and/or its directors, officers, employees or others associated with it may have positions in or effect transactions in the security or its derivatives. Annual report, 10K and other information upon request.
This is inadequate because it fails to state with regard to the particular issuer what is the amount and type of compensation paid.
Note also that the compensation that has to be disclosed could be paid in the past, paid in the present, or promised to be paid in the future. In fact, you could be liable even if the promised compensation was never paid.
Specific Cases
I believe that a review of specific cases will assist you in discovering where the boundaries are in Section 17(b).
The 1998 SEC Crack Down
In a 1998 crack down on Internet Stock Fraud, the SEC announced 23 enforcement actions against 44 individuals and companies for committing fraud over the Internet. All of the cases involve alleged illegal touting of securities in violation of Section 17(b) of the 1933 Securities Act. In all of these cases, the Internet promoters gave ostensibly independent opinions about Microcap companies that in reality were bought and paid for. Not only did they lie about their own independence, some of them lied about the companies they featured, then took advantage of any quick spike in price to sell their shares for a fast and easy profit.
The 23 cases involve a range of Internet conduct including fraudulent spams (Internet junk mail), online newsletters, message board postings and Web sites. The allegations include violations of the anti-fraud provisions and the anti-touting provisions of the federal securities laws. The authors of the spams, online newsletters, message board postings and Web sites unlawfully touted more than 235 Microcap companies, by either: (1) lying about the companies; (2) lying about their own “independence” from the companies; and/or (3) failing to disclose adequately the nature, source and amount of compensation paid by the companies. The creators of the Internet touts purported to provide unbiased opinions in their recommendations, but failed to disclose that they had received in total more than $6.3 million and nearly two million shares of cheap insider stock and options in exchange for touting services. In some instances, the fraudsters sold their stock or exercised their options immediately following their recommendations, a deceptive practice commonly referred to as “scalping.”
All twenty-three cases involve allegations of illegal touting of securities under Section 17(b) of the Securities Act of 1933. The SEC said that 17(b) provides that it is unlawful to publicize a security, if you are being paid to do so, unless you disclose three things. The first thing that is required to be disclosed is nature of the compensation you are receiving, whether it is cash, or whether it is stock. The second is the amount of compensation you are receiving. The third is the source of the compensation.
The SEC added that, “17(b) does not prohibit free speech. It does not prohibit spamming, online newsletters, posting on message boards, without other activity as well. But lying to investors, or failing to disclose compensation, does violate the law.”
The SEC featured the case of SEC v. The Future Superstock, Inc. and Jeffrey Bruss, (U.S.D.C., N.D.Ill., Case No. 98-C-6772, filed October 27, 1998.) In this case the SEC sought a permanent injunction, disgorgement, civil penalties and other relief against The Future Superstock, Inc. (FSS) and Jeffrey Bruss. The complaint alleged that an Internet newsletter called The Future Superstock, is published by FSS and researched and written by Bruss. It further alleged that the newsletter and website have recommended to the over 100,000 subscribers that they purchase about 25 microcap stocks which it predicted would double or triple in the next three to twelve months. In most instances, the prices increased for a short period of time after a recommendation was made, but then dropped substantially.
The complaint also alleged that FSS and Bruss violated federal securities laws by failing to provide adequate disclosure in several areas: (1) neither the newsletter nor the website disclosed that Bruss or FSS received compensation, in cash and stock, from nearly every issuer profiled; (2) FSS and Bruss failed to disclose that in many instances they sold the stock shortly after a recommendation in The Future Superstock caused its price to rise; (3) FSS and Bruss represented that they performed independent research and analysis when, in fact, little, if any, research was conducted; and (4) statements regarding the success of past stock picks made in The Future Superstock were false and misleading. The complaint alleges that FSS and Bruss have violated Sections 17(a) and 17(b) of the Securities Act of 1933 and 10(b) of the Securities Act of 1934 and Rule 10b-5.
All of the cases in the SEC sweep had a common thread. They all alleged fraudulent touting of securities, which violate Section 17(b) of the 1933 Act.
Section 17(b) provides that it is unlawful to publicize a security, if you are being paid to do so, unless you disclose three things. The first thing that is required to be disclosed is nature of the compensation you are receiving, whether it is cash, or whether it is stock. The second is the amount of compensation you are receiving. The third is the source of the compensation.
The SEC noted that 17(b) does not prohibit free speech, that it does not prohibit spamming, online newsletters, posting on message boards, without other activity as well. However, lying to investors, or failing to disclose compensation, does violate the law.
The SEC went on to note that Section 17(b) applies to any person who publicizes a security through any means. When it comes to the Internet, that includes publicizing securities over World Wide Web pages, online investment newsletters, bulletin boards, chat rooms, or through Internet junk mail, which is popularly known as spam.
Section 17(b) is important because investors have a right to know if information is objective, or whether someone is paying to provide that information to investors.
There is nothing illegal about companies paying fees to touters. The law requires the touters have to disclose. The law does not cover the companies themselves who make the payments.
Five of the cases involved the practice known as scalping. Scalping occurs when, unbeknownst to investors, a person making a positive recommendation about a security, sells that security shortly after making the positive recommendation, without making a disclosure to other people.
Six of the cases involved misrepresentation, either about the companies themselves, or about the touter’s independence and track record.
All of the cases involved either partial disclosure, or no disclosure at all, about the nature and source of the compensation received.
In the 1998 Crack Down the question was asked as to what kind of penalties do the scammers face in the cases that were filed. The SEC replied that many of cases will be litigated cases and penalties will be up to a court, or an administrative law judge. In these cases, the SEC sought injunctive relief, to enjoin people from violating the law, cease and desist orders, and penalties where appropriate. The SEC stated that there were going to be a wide range of different penalties, depending on the conduct involved. No dollar figures were given.
In the Matter of John Black
In this case, an employee of an investor relations firm touted stock on an Internet bulletin board, Raging Bull, without disclosing that he was being compensated for the posts by his employer. He failed to disclose that he was promised thousands of shares of stock as a bonus for assisting his employer in promoting the stock of Snelling Travel, Inc. (“SNLV”).
On December 30, 1999, Black started a subject area for SNLV on Raging Bull, an Internet bulletin board. Using a screen name other than his own, Black posted the first message in the SNLV subject area. Black’s message compared SNLV to two highly successful companies that sell electronic commerce software applications, Commerce Once, Inc. (“CMRC”) and Ariba Technologies (“ARBA”). Black’s message stated:
This is THE new CMRC and ARBA!!! Merger to be complete on Jan. 6. This baby is going to rock!!! I hear they are looking for $30.00 by Mar. 15!!! We will just have to wait and see!!! The sky is the limit!!!
Black did not disclose his agreement with Fleming Financial, which entitled to him to receive 5,000 shares of SNLV as reimbursement for promoting SNLV.
On December 31, 1999, Black posted a second message in the SNLV subject area, using a different screen name. Black’s message stated:
When will the company finish the merger? How many shares are out? What are the similarities between Plus Solutions and ARBA and CMRC? When will they be “in the money”? These are questions that MUST be answered by somebody! Anybody know a # to call?
As in the first message, Black did not disclose that he was entitled to receive remuneration for touting SNLV.
The SEC cited two other cases of posting on message boards without complying with 17(b): In the Matter of David A. Wood, Jr. et al., 68 SEC Docket 631 (Oct. 27,1998) (respondent violated Section 17(b) by posting messages on Internet message board touting company without disclosing compensation received) and In the Matter of Eugene B. Martineau, 68 SEC Docket 629 (Oct. 27, 1998) (respondent violated Section 17(b) by posting messages on Internet message board touting company without disclosing expected compensation).
Black committed or caused violations of Section 17(b) by failing to disclose the agreement to receive, indirectly from the issuer, compensation for touting SNLV stock.
No mention was made by the SEC as to the legal significance of Black using another user name on the chat site. Would this be another 17(b) violation even if he had used given the disclosure as to the source and amount of compensation? Could it be fraud to use a false user name?
Donner Case
Donner was a broker dealer that issued 48 research reports of stocks below $5.00. This was 70% of Donner’s business.
Under a typical agreement between Donner and an issuer, Donner received an initial retainer fee of $2,500, $2,000 per month for services provided, and $2 to $3 for each investor package mailed to potential investors. Some agreements also provided that Donner would receive stock if the company’s share price exceeded a certain level after Donner initiated coverage of the company. One of the individual defendants, Uberti, testified that, he received fifty percent of the amounts generated by [Donner's] relationship with the company.
For FINRA members, 17(b) violations are also violations of FINRA rules.
The reports simply stated that Donner “may from time to time perform investment banking, corporate finance, provide services for, and solicit investment banking, corporate finance or other business ” from the company. Several of these reports added the words “for a fee” after this description of services.
The record established that Donnor violated Rule 17(b) by failing to disclose the compensation received by Donner in violation of Securities Act Section 17(b).
In order to violated section 17 B, a person must use a means of interstate commerce, to make a communication which describes a security, for consideration received, without full disclosure of the consideration received in the full amount. The consideration can be past, current, or prospective, and it can be direct or indirect consideration. Section 17(b) was designed to protect the public from publications that purport to give an unbiased opinion but which opinions and reality are bought and paid for.
The SEC pointed out that the Donnor research reports stated only that Donner “may from time to time perform investment banking, corporate finance, or provide services for the issuer” sometimes adding that Donner might perform the services for a fee. They did not disclose that Donnor in fact received compensation in exchange for writing and making public the research reports and for the type of consideration of the amount of compensation received.
Gorsek
Gorsek was a Federal Court decision. In Gorsek, the Court found that the disclaimer was inadequate as is insufficient under Rule 17(b) because although it gave the fact that there was compensation, it failed to list the amount of compensation and the type of consideration (e.g. stock, cash, or combination of cash and stock).
Other SEC Cases
In an SEC complaint against Christopher Wheeler and his OTCstockexchange.com, the SEC alleged a pump and dump scheme orchestrated by Wheeler involving securities of several thinly traded penny stocks. Wheeler recommended investors purchase the securities without disclosing that he had received millions in shares as compensation for his promotions and was simultaneously liquidating the shares. In total he profited at least $2.95 million.
At various times during 2007 and 2008, Wheeler used the website to promote the issuer stock in return for undisclosed compensation in the form of millions of shares. Wheeler featured the issuer stock in the website and posted lofty price targets for the stock without any reasonable basis for those targets. These promotional efforts often resulted in dramatic, but temporary, increases in the volume of shares traded in the price of the issuer securities. These temporary increases in volume and trading allowed Wheeler to sell the shares in the issuers for a large profit, totaling approximately $2.95 million.
Wheeler and the website failed to disclose in each instance that Wheeler had received stock, directly or indirectly from the Issuers as compensation for his promotional efforts were the amount of stock he received in compensation, as required under the federal securities laws. Instead, the website contained a representation that its was compensated by one or more third parties on behalf of the companies listed, followed by a list of several companies and the websites’ compensation arrangement with those companies. During the relevant period this never included the issuers. Website thereby falsely represented that Wheeler had received no compensation for its promotional activities with respect to the issuer in question.
Wheeler and the website also concealed from investors that Wheeler was personally selling shares in the issuers’ stock while he was promoting the same stock in recommending that investors buy it. The website contained only general disclosure that the site may at any time have positions in the securities mentioned and may make purchases or sales in the securities featured on the website and may sell its shares. The SEC complained that Wheeler and the website never disclosed that in each instance Wheeler was reselling the issuer stock.
During the relevant period Wheeler the website never disclosed it really received shares as compensation for the promotion, and the amount of such compensation, or that Wheeler was selling stock while recommending the stock is a buy.
Wall Street Bulletin
In another complaint, the SEC said that a penny stock promoter named Gregory King crafted false and misleading tout sheets crafted to appear like independent investment newsletters and entitled them the Wall Street Bulletin. A spam campaign consisting of faxes was maintained.
The Wall Street Bulletin failed to disclose the amount of the compensation. Shares were paid to the defendant to prepare and disseminate these “Newsletters.” Further, the defendants were selling stock contrary to the Wall Street Bulletin’s strong buy recommendations and price targets.
The promoters misleadingly represented that the Wall Street Bulletin was paid by an unnamed third party, that the Wall Street Bulletin was based on independent research, that the Wall Street Bulletin and its employees had not and would not receive any and shares and that the Wall Street Bulletin and its employees would not buy or sell any and stock. These were false and misleading representations and/or omissions.
The SEC alleged that the defendants knew or were reckless in not knowing that the Wall Street Bulletin failed to disclose that shares had been paid to make the promotion.
Investment Advisor
In a case involving an investment advisor, the SEC alleged that the investment advisor solicited his advisory clients to invest in real estate developments after being promised compensation for raising investor money and promised title to a 5,000 square foot home. He did not disclose to his advisory clients or other investors this conflict of interest, namely that he had been promised compensation for fund raising efforts.
SEC v. Investsource
In the case of SEC v. Investsource, Inc. et al, the SEC alleged that in 2008 and 2009 defendants engaged in massive e-mail campaigns to promote penny stocks of their clients often sending such e-mails to hundreds of thousands of recipients.
These emails failed to disclose that defendants have been compensated for their promotions. Further defendants made misleading statements on Investsource’s website regarding the nature the compensation received for investors providing services to its penny stock issuer clients. Finally, both the e-mail thousand websites failed to disclose that defendants reselling the very securities they were recommending that investors buy.
Invest source was a penny stock website. From January 2008 and March 2009 Invest source had 85 clients, almost all penny stock issuers. was client stated securities cash. Investor sent is daily digest e-mails to addresses in its database nearly every weekday. By the Autumn of 2008 Invest source was routinely sending messages to several hundred thousand addresses.
Undisclosed to the e-mail letter recipients, Investsource and its principal repeatedly sold the stock of the issuer it promoted while engaged in the promotional activities. They did not disclose the compensation received in their securities trading in any of the e-mail newsletters. Instead each e-mail included the a disclaimer link to their website. The link took investors to their “Main Disclaimer” website page which stated in relevant part:
The companies listed on the ‘Featured Companies’ section of our website may have compensated the Company [InvestSource] to be profiled on this website. These companies (or some of these companies) have retained us to perform public relations, or media relations or even investor relation services including promotional services that consist of the placement of the profiled companies on our website. Such compensation has been or will be made in cash and or [sic] issuance of securities of the profiled company. The specific compensation type and amounts that the company has been paid from each respective company is set forth on the transcript box accessible from each respective company page within our site. We may liquidate any securities that we receive as compensation when deemed appropriate to do so, however, we attempt to liquidate such securities upon receipt thereof prior to performing any services for such company. Such liquidation may have a negative impact on the securities being liquidated.
The SEC attacked the disclaimer sections stating that the companies may have compensated the website, that such compensation will be made in cash or securities, and that the website attempted to liquidate such securities upon receipt thereof part of performing any services for such company.
In fact, Investsource or its principal were always compensated. Investsource claimed in its disclaimers that it attempted to liquidate securities it received as compensation for services upon receipt thereof prior to performing any services. In fact, it sold the securities after several recommending their purchase and profited thereby. The statement that Investsource planned to sell securities before promoting them was materially false because its practice was to sell securities while promoting them.
Their website contained additional disclosure. Each of the client companies had a profile sections that included many tabs from which to select. One of these tabs was labeled “disclaimer.”
The SEC found that these company-specific disclaimers were inadequate. When the defendants were contacted by the SEC during the SEC’s investigation, they revised the company-specific disclaimer website pages to list the number of shares sold and the amount of sales proceeds.
However, they still failed to disclose that they were continuing to sell the securities while promoting them. The defendants similarly failed to correct the main disclaimer website page to adequately disclose that defendants were always compensated for promoting the securities, that the compensation was almost always in securities, and that defendants promoted the purchase of the stock to potential buyers before, during and after their sales of those same stocks.
Thus, it was not enough that the defendants stated that they may be compensated where they were actually always compensated. Further, they did not state that they would be selling the stock they received before, during and after their promotional campaigns.
SEC v. Shrewder et al
In this case the SEC alleged that the defendants manipulated the market in at least two securities and inundated the public with millions of faxes or “fax blasts” that contained materially false information in order to mislead people into buying the stocks described.
The faxes in question were alleged to be from the bioTech Report and contained identical disclaimers that they had been contracted by a “third party” to research and issue the report and that the publication expected to receive $30,000 to distribute the report.
The SEC alleged that the bioTech Report is a pseudonym used to mask the fact that the defendants were paid by the company for the promotional campaign and the publication is not an independent investor awareness publication is stated in the faxes.
The disclaimer misrepresented the compensation that the defendants received, the fact that they had already received as compensation, and the fact that their services had been contracted by an agent of the company and not a third-party.
The SEC also alleged that the faxes failed to disclose and that Shrewder was actively selling the shares while he was recommending that investors include accumulate the shares. Shrewder also engaged in day trading to falsely create the appearance of trading volume during his fax blasting campaign. Shrewder also engaged in scalping. He sold into the rising price and increase in volume caused in whole or in part by his faxes and his manipulative trading, which the SEC said is a practice commonly known as scalping.
Shrewder also manipulated other stocks. He used a pseudonym for the publisher of this fax, this time the US Oil Reporter, misleadingly stating that it is an independent investor awareness publication.
As with the other faxes that Shrewder disseminated he misrepresented the compensation he received from promoting a stock in a disclosure statement of the factors stated that this entity is “is expected to receive $25,000 to issue this report on [the stock]. . . .”
In fact Shrewder had already received 260,000 shares of stock with a value at the time of $0.91 for a total of $236,000. The market value of the stock received at the time he sent the fax blast was approximately $226,000 far more than the $25,000 stated in the disclosures. He engaged in day trading and he recommended accumulating the stock up to $2.00 and exiting the stock at $5.00. As with the other stock, he sold this stock at far less than the price he was recommending in his faxes.
SEC v. Courtney D. Smith
In SEC v. Courtney D. Smith, the defendant received cash and stock to promote the company’s stock. He promoted the stock a number of times on television. At one time he on TV he stated that he had a big chunk of stock and thought it was worth twice the current market price. This was misleading as the impression was that he had purchased the stock when in fact it had been given to him for stock promotion.
Payments for IPO Research
Larger companies are not immune from 17(b) violations. In a series of cases that were brought after the Internet boom, the SEC charged several large firms with receiving payments for research reports on IPO stocks underwritten by other broker-dealers and not disclosing them as required by 17(b). The firms charged included Deutsche Bank Securities, Morgan Keegan, and Janney Montgomery. The payments were in the hundreds of thousands of dollars.
In these cases, the underwriters were apparently willing to pay hundreds of thousands of dollars to support their IPO underwritings in the after market.
Sales of Private Company Securities
In an SEC complaint against The Investors Registry, LLC (TIR) and Michael J. Southworth, the SEC alleged that Southworth oversaw the sale of at least 650 memberships in TIR which he marketed as an exclusive investment community where members would be provided with opportunities to invest in pre-IPO companies. He represented that TIR researched thousands of early-stage companies and culled them down to only a handful of promising issuers that TIR profiled as investment opportunities.
From 2007 to 2011 Southworth touted five issuers by e-mail and by posting offering and subscription materials on TIR’s website. He also helped structure terms of the offerings. He was not registered as a broker-dealer but contracted for and received cash and stock from issuers in exchange for acting as a broker in recommending and selling their securities and he failed to fully inadequately disclose this consideration the TIR memberships. Thus, here we have a case that involves the private sales of securities and not securities trading in the public market.
Failed Defenses
Some defendants claimed that they were using the “industry-standard” disclaimer and that if all the broker-dealers were using that, it that must be accepted by the industry even though the rule says you have to put the specific amount of compensation in the claimer. This does not work, as the courts and the Commission have repeatedly held a practice may be prevalent in the industry and still be fraudulent.
Further, note that in order to show a 17(b) violation, the SEC need not show that anyone read the communication, need not show that anyone relied on the communication, and need not show that the communication was in any other way false, other than as to the compensation received.
In fact, 17(b) requires only a “description” of a security, not even a recommendation.
Restricted Stock
In cases involving the most ruthless stock manipulators, very often these miscreants obtain fraudulent opinions under SEC Rule 144 to improperly remove restrictions from lettered securities.
For example, in the case of SEC v. Recycle Tech, et al, the attorney did little or no due diligence into the company whose stock was the subject of his opinion and ignored the several “red flags.” The attorney had information that should have told him that the company was a shell company ineligible to use Rule 144. He miscalculated the holding period. The company was delinquent on its required filings and thus the current information requirements of Rule 144 were not satisfied. The opinion relied on falsified or backdated documents and this would have been revealed by simple due diligence. The issuance relied on an old resolution and no attempt was made so see if it was still in effect. The shares to be freed up from the debt conversion would double the outstanding stock. The attorney should have known that one of the sellers was an affiliate of the company and yet he did not in his opinion letter apply the restrictions on manner of sale, amount that could be sold, and notice of sale.
The newsletters touting the stock offered only general disclaimers and did not report that they were selling into their buy recommendation.
Moreover, the newsletter only contained a general disclaimer. The newsletter disclosed:
[w]hen Pennypic.com receives free trading shares as compensation for a profiled company, Pennypic.com may sell part or all of any such shares during the period in which Pennypic.com is performing such services.”
It then specifically disclosed that it “has received from a third party non-affiliate 2.325 million free trading shares of [Recycle Tech] for advertising and marketing.”
The SEC charged that the newsletter did not, however, disclose the third party’s identity or the stock sales of Pennypic’s principal.
Thus, we see here that the SEC found this disclaimer was inadequate even though it disclosed that the newsletter “may” sell, and that the stock was from a third party and the number of shares.
One violation that we note in some of these cases is that the promoters, who are themselves control persons, buy restricted stock, and in order to assist in the making the stock unrestricted, place the securities not in their names, but in the names of others who are not control persons. From there, the securities can be handed out for stock promotion or simply sold with most of the proceeds of sale remitted to the promoter.
Possible Accompanying Charges
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Investor relations firm that are charged with violating Section 17(b) are sometimes hit with other charges as well.
Section 17(b) violators are often also charged with fraud violations under Section 17(a) of the Securities Act of 1933 and Rule 10b-5 of the Securities and Exchange Act of 1934. Section 17(a) is an anti-fraud provision as is 10b-5.
Naturally, if people are doing wrongful promotion and not abiding by 17(b), they are probably making false statements in the content of the promotion as well.
It is important to note that stock promotion companies have also been charged with insider trading for selling stock based on negative insider information not available in the market.
In the case of SEC v. Packetport.com, Inc. et al, the SEC charged IP Equity with violating 17(b) and insider trading. By virtue of its agreement with PacketPort.com to provide publicity services, IP Equity, its officers, and its employees obtained material non-public information about PacketPort.com, including but not limited to information about the company’s true financial condition, its customers, and its private offerings, as well as about the undisclosed securities transactions of its officers and directors. IP Equity, its officers, and its employees owed a duty of trust and confidence to PacketPort.com to refrain from using for personal gain any confidential information they obtained by virtue of their work for PacketPort.com.
On or about December 10, 1999, IP Equity initiated a campaign to generate positive publicity for PacketPort.com. IP Equity’s Internet Stock News, which purported to be “the Web’s leading source for information about Internet investment opportunities,” published what it claimed to be “an investment opinion to notify analysts, brokers, market makers, institutional and retail investors, as well media representatives that IP Telephony company PacketPort.com, Inc. has started trading . . . under the symbol ‘PKPT’.” Internet Stock News falsely stated that its press release contained “independent commentary about Internet stocks.”
On December 13, 1999, IP Equity’s Internet Stock News issued a recommendation for PacketPort.com. IP Equity stated that it had added PacketPort.com to its “Ones to Watch in 1999 group of Internet companies.” IP Equity claimed that PacketPort.com was “now fully restructured, debt-free, and poised to capitalize on the IP-based solutions market.” IP Equity claimed that its “Ones to Watch” group of companies was “up 200% year-to-date and, to [its] knowledge, . . . beat every single money management and mutual fund company in existence.” IP Equity also falsely and misleadingly claimed that its announcement contained “independent commentary about Internet stocks” and that it held “up to four hundred thousand shares of mPhase and PacketPort.com Inc.” On this same date, the transfer agent had delivered IP Equity’s 1.2 million restricted Linkon shares reissued as 400,000 PacketPort.com shares in an unlegended stock certificate.
IP Equity’s statement that PacketPort.com was debt-free was false and misleading. In fact, PacketPort.com remained liable for at least $802,500 in judgment debt. IP Equity’s statement in its recommendation that it held “up to” 400,000 shares of mPhase and PacketPort.com was false and misleading. At the time, defendant IP Equity actually owned 400,000 recently-acquired PacketPort.com shares and beneficially owned another 1,000,000 shares through its option to acquire 1,000,000 PacketPort.com shares at a privately offered price.
On December 21, 1999, defendant IP Equity exercised its private offering option and purchased 1,000,000 PacketPort.com shares at $0.13 per share. After buying PacketPort.com shares at $0.13 per share, IP Equity continued to recommend PacketPort.com to public investors on its Internet website and in subsequent press releases and continued to sell PacketPort.com shares to the public at an average price of about $9.58. About half of IP Equity’s total sales to the public occurred after it exercised this option. IP Equity did not disclose to the public the private offering of PacketPort.com shares at $0.13 per share, its purchases of PacketPort.com at $0.13 per share, or its essentially contemporaneous sales of PacketPort.com shares to the public at prices averaging $9.58 per share.
IP Equity’s officers caused IP Equity to sell PacketPort.com shares and benefited from the sales proceeds. While IP Equity sold PacketPort.com shares in December 1999 and at times thereafter, IP Equity’s officers were in possession of material nonpublic information about the company, including but not limited to: the true financial condition of the company; the private offering price of shares; the paid-for publicity arrangement between itself and the company; and the scheme of the defendants to pump up the market price and sell their shares.
What does this mean to you?
If the stock promoter does not give give the exact specific source of any compensation, if it does not give the exact amount of compensation – past, present or promised in the future, and it does not give the type of consideration (e.g. stock, cash, or combination of cash and stock), it may be violating the rule. The stock promoter cannot say it is independent if it is not independent.
Stock promoters may be scalping your buying – watch out!
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John E. Lux – Former market maker, futures trader, securities attorney, underwriter, investment banker, securities analyst, “quant,” venture company president, venture capitalist. Degrees in quantitative analysis and law. Author of “How to Find a Home Run Stock,” “How to Pick Hot Reverse Merger Penny Stocks,” “How the Shorts Raid Your Stock, Destroy Your Company and What to Do About It,” and “Bash the Stock Bashers.”
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