Regulation A+ investors are sailing on one large ship. There's a storm coming though, and the people on deck can't see it. However, the few of us perched high up in the crow's nest see the approaching hurricane very clearly.
When Regulation A+ (Reg A+) received a green light from the SEC in June of 2015, it was hailed as a new opportunity for small companies in need of investor capital. Reg A+ is a shortened registration process that allows companies to conduct public offerings of their stock to both accredited and non-accredited investors as long as certain criteria are satisfied. In addition to the benefit of pre-offering test-the-waters communications, informational and financial statement requirements have been scaled back from the traditional S-1 registration process . Post-offering SEC reporting requirements have been simplified as well.
Issuers are also permitted to use social media and the internet to market the offering,
The bold investors who fund these pioneering private companies, particularly less established companies, receive shares of stock which are often deemed "penny stocks" by the SEC. These shares are priced at less than $5.00 and generally trade on an alternative market such as the OTC Market.
The storm that is building strength started out as nothing more than a headwind. It has been increasingly difficult for investors to deposit penny stocks with broker-dealers for years. Our more cautious economic environment has intensified this resistance, and speculators who put hard-earned dollars into the growth and development of visionary industries may end up holding stock certificates that cannot be deposited with broker-dealers, cleared and ultimately traded, without experiencing strong opposition.
This complication escalated on October 9, 2014, when the SEC announced a settlement of charges against E*Trade Securities and E*Trade Capital Markets for selling billions of shares of unregistered and otherwise restricted penny stocks for their clients.
Andrew J. Ceresney, Director of the SEC's Division of Enforcement, stated, "Broker-dealers serve an important gatekeeping function that helps prevent microcap fraud by taking measures to ensure that unregistered shares don't reach the market if the registration rules aren't being followed. Many billions of unregistered shares passed through gates that E*Trade should have closed, and we will hold firms accountable when improper trading occurs on their watch."
According to the SEC, a penny stock is any equity security that: (a) isn't listed on a national exchange (the OTC Markets is not a national exchange); (b) has an inside bid of less than $5.00; (c) whose issuer has: (i) net tangible assets in excess of $2 million, if the issuer has been in continuous operation for at least three years, or $5 million, if the issuer has been in continuous operation for less than three years; or (ii) average revenue of at least $6 million for the last three years; or (c) certain futures and options products.
Penny stocks are considered speculative high-risk investments. Congress enacted the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the "Penny Stock Act"), requiring brokers or dealers to provide disclosures to customers effecting trades in penny stocks. The rules prohibit broker-dealers from effecting transactions in penny stocks unless they comply with some very complex rules.
These penny stock rules make effectuating trades difficult, and Section 4(a)(4) of the Securities Act makes depositing securities difficult as well. Section 4(a)(4) allows broker-dealers to deposit client stocks into trading accounts if, after reasonable inquiry, the broker-dealer is not aware of any circumstances indicating that the customer would be violating the federal securities laws. The broker-dealer is obliged to independently determine if the customer is complying with all applicable securities laws. Since Reg A+ is new, broker-dealers are being exceptionally careful in their review, and have expressed uncertainty regarding their exact obligations when depositing penny stocks on behalf of clients.
FINRA (Financial Industry Regulatory Authority), the self-regulatory organization that regulates broker-dealers, has also applied continuous pressure on brokerage firms that trade penny stocks.
Since broker-dealers now face catastrophic exposure, the popular consensus is that handling penny stocks just isn't worth it.
Elio Motors is a company that is developing a low-cost, fuel-efficient, three-wheeled motor vehicle; two wheels in front, one in the back. It is also the first and only company that has successfully completed a Reg A+ offering, meaning that their stock is currently trading (OTCQX ticker symbol ELIO).
According to a press release issued by Elio on December 3, 2015 "Potential investors were able to make non-binding expressions of interest in the company from June 19 to Nov. 20. More than 11,000 people expressed interest during this period."
Despite the large number of investors, Elio's shares are currently thinly traded. These shares would potentially be more liquid, but Elio has thousands of small investors who invested less than $2,500. Since broker-dealers charge $500 to $1,000 for a legal review fee before these shares can be deposited, the process is financially prohibitive.
Ironically, Elio's shares are technically not a penny stock. As of April 15, 2016 the share price was $17.20.
Regulation A+ has paved a smooth pathway for companies to sell qualified, unrestricted securities. Tens of millions of penny stock shares are being issued to tens of thousands of investors who are unaware of the roadblocks they will encounter when attempting to deposit and liquidate their positions.
The security industry's response to the E*TRADE debacle was reactionary in nature, as is typical when faced with an unexpected event. The obstacles Regulation A+ investors must overcome were constructed spontaneously.
Now that the dust has settled it is only equitable that Reg A+ investors experience the same level of convenience when liquidating their shares as the corresponding companies did when issuing them. As of today, this is not the case.