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October 24‚ 2011
SEC’s Microcap Fraud Working Group Roundtable Airs
Problems, Offers Suggestions
By Megan N. Gates
and C. Quincy Ewell
On October 17, 2011, the Microcap Fraud Working Group
(Working Group) hosted a public roundtable to discuss the regulatory issues
involved in the execution, clearance, and settlement of microcap
securities. The Working Group is a joint initiative of the Securities and Exchange
Commission’s Division of Enforcement and its Office of Compliance
Inspections and Examinations, and is charged with the primary
responsibility of detecting and deterring fraud involving microcap
securities.
The roundtable was split into three panels: (1) Compliance
Challenges Associated with Microcap Securities; (2) Anti-Money Laundering
Monitoring; and (3) Potential Changes to the Regulatory Framework
Concerning Microcap Securities.
The panelists included representatives from the Depository
Trust & Clearing Corporation (DTC) and FINRA, as well as securities
lawyers and executive officers from capital market firms.
Two themes pervaded the three panels: communication and
transparency. Several of the panelists conveyed issuer frustration with the
lack of consistent communication from the SEC as to how issuers should
tackle their securities compliance obligations when circumstances suggest
that they may be participating in illegal resales of restricted securities.
Similarly, it was suggested that the DTC was less than transparent in
providing issuers and transfer agents with specific reasons that a
transaction is flagged. However, despite complaints about the SEC and DTC’s
inconsistent communication and lack of transparency, a DTC representative
informed the audience and panelists that there has been a steady increase
in the filings of suspicious activity reports (SARs) — due, in part, to
Section 314(b) of the Patriot Act and FINRA Notice 09-05. Since 2003, SAR
filings have increased from only 32 to an expected 1,800 reports in 2011.
Notably, Section 314(b) permits financial institutions, upon notice to the
Department of the Treasury, to exchange information with one another to
identify and report to the federal government activities that may involve
money laundering or terrorist activity. And FINRA Notice 09-05, generally,
is a reminder to broker-dealers of their responsibility to ensure
compliance with the federal securities laws and FINRA rules when
broker-dealers are participating in the sales of unregistered securities.
When asked for suggestions to improve the regulatory
framework concerning microcap securities, the panelists named several.
First, it was suggested that there needed to be greater communication among
the SEC, DTC, and market-makers in determining whether trading in a
security should be halted. Other panelists suggested that the SEC shore up
its controls related to the purchase and sale of securities in the public
markets where there is little to no current information available for the issuers
of such securities. Other panelists believed that the SEC should consider
reforming its rules that are designed to prevent fraud. For example, one panelist
suggested that the definition of “investment adviser” under Section
202(a)(11) of the Investment Advisers Act be revised to be more
encompassing. Another panelist suggested that the SEC should consider an
annual review of the clearance controls provided for in Rule 15c2-11 under
the Securities Exchange Act of 1934, as amended, which generally imposes
certain information review and maintenance obligations on broker-dealers
that publish quotations in a quotation medium for securities that are
quoted on the OTC Bulletin Board and Pink Sheets. More specifically,
Rule 15c2-11 proscribes broker-dealers from submitting a quotation for a
covered OTC equity security before it has gathered and reviewed current
information about the issuer whose security is the subject of the
quotation.
The burden to monitor and control illegal, unregistered
distribution of securities falls on the shoulders of all the players
involved, including the SEC, DTC, financial institutions, and issuers,
among others. But securities firms potentially bear the biggest
responsibility to ensure that they have written procedures in place that
are reasonably designed to detect the sale of unregistered securities. And
while these procedures and controls will vary from firm to firm depending
on the circumstances surrounding the proposed distribution and resale, all
such firms must be prudent in acknowledging this obligation and
implementing procedures.
Mintz Levin will continue to provide information about the
SEC’s ongoing effort to detect and deter fraud involving microcap
securities and other such complexities facing issuers and regulated
entities. If you have any questions about this alert, please contact one of
the authors or your Mintz Levin Securities attorney.
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