|By Joseph B. LaRocco, Esq.|
Manging Member of MicroCap Net Profits
April 15, 2006
Pink Sheets LLC, which is run by former Wall Street trader Cromwell Coulson, operates www.pinksheets.com (“Pink Sheets”). Pink Sheets provides quotes on approximately 5,000 public companies most of which do not and are not required to file their financials on EDGAR, which is located on the Securities and Exchange Commission’s (“SEC”) website.
Pink Sheets recently announced that it is launching a premium quotation, trading and disclosure service for companies quoted on the OTC as Pink Sheet companies also known as Other OTC. This new service will not include what are known as OTC Bulletin Board Companies, while Pink Sheet companies not qualifying for, or opting not to utilize, the premium service will still be quoted on the Pink Sheets main website.
The reasoning behind this premium service is to encourage more disclosure concerning unregulated Pink Sheet quoted companies, while the people who operate Pick Sheets I’m sure are also interested in the additional revenue they can generate from this new service. What Pink Sheets is attempting to do is create a middle level between companies that are not reporting financial information at all and those listed on the OTC Bulletin Board, as well as Nasdaq, New York Stock Exchange or American Stock Exchange (“Regulated Exchanges”). The Regulated Exchanges have stringent reporting guidelines and must also comply with the Sarbanes-Oxley Act that was enacted in 2002. Sarbanes-Oxley is a sweeping body of legislation that applies to public corporations and places significant internal controls, compliance, and responsibilities on officers and directors, which in turn greatly increases their accountability and liability.
As a result of the enactment of Sarbanes-Oxley, public companies required to comply with its regulatory framework have incurred additional cost and expense in order to meet its compliance mandates. This cost and expense is easily met by the larger companies, but what about the smaller companies, that is, the microcaps that trade below $5.00 per share and have less than $300 million of market capitalization. The estimated compliance cost of upwards of $100,000 has in many cases a significant impact on these microcap companies, especially those in their development stage. As a result, a fair number of microcap companies remain on the Pink Sheets while some have voluntarily left the OTC Bulletin Board and opted to be quoted on Pink Sheets or Other OTC.
These companies felt the burden and expense of being listed on the OTC Bulletin Board outweighed the benefits. Besides, if shareholders could still get stock quotes from various websites and continue to follow the financial filings of the company on the SEC’s EDGAR website, they could save money that could be put to use elsewhere, such as marketing, sales and growth. These companies could then re-apply to be listed on the OTC Bulletin Board or Nasdaq at a later date when the expense would not be prohibitive.
Pink Sheets Offers a Two Tier Approach
Companies that meet certain qualifications will now be eligible to enter the tier for which they qualify. These two tiers will be carried on a service run by Pink Sheets and knows as OTCQXsm, which should not be confused with a stock exchange. In fact the SEC is monitoring the progress of Pink Sheets OTCQXsm to make sure it doesn’t accidentally become, or give the impression that it is, a stock market. According to Pink Sheets, they believe this premium tier system will:
• Increase the quality, quantity, and availability of information to OTC Investors;
• Improve OTC Issuer compliance with federal disclosure requirements under Rule 144, 10b-5, 15c2-11 and state Blue Sky Laws;
• Distinguish the higher quality OTC Issuers that are making adequate current information available; and
• Create a community of broker-dealers and securities counsel that provide trusted advice on a continuing basis to OTC Issuers regarding their disclosure obligation and capital markets access.
The qualification for the OTCQXsm premium tiers will be as follows:
PremierQXsm – Designed to identify issuers that are of the size and quality to list on a National Stock Exchange. Listing in this tier requires:
• A minimum bid price of $1
• Financial Qualifications of a national stock exchange
• Annual shareholders’ meetings
• Meets all of the requirements of the PrimeQX Tier below PrimeQXsm
• Designed to identify issuers that are operating companies with audited financials but not of sufficient size to be PremierQX.
Entry to the PrimeQX tier requires:
• Management disclosure and annual management certification
• Ongoing quarterly and annual financial reports posted on OTCQX.com, a premier website for qualifying companies (SEC Registered issuers can use EDGAR)
• Interim material event disclosure of any information that may affect the stock price
• Annual GAAP Audit
• 100 round lot beneficial shareholders
• Ongoing operations (no shells, blank check or special purpose acquisition companies)
• Inclusion in the S&P or Mergent Manual, which satisfies the Blue Sky requirements for secondary transactions in many states, together with a list of any other states in which the security is Blue Sky compliant and eligible to be sold by brokers in those states.
• Opinion letter upon application and annually thereafter to Pink Sheets LLC by a designated advisor that the issuer has made adequate current information publicly available and meets the tier inclusion requirements.
Additionally, designation on the OTCQXsm requires companies to have a continuously retained designated advisor for disclosure (“DAD”) who will assist management and directors in meeting disclosure requirements and provide advice on how to comply with current securities laws. Advisors must be either securities attorneys or investment bankers. This advisory framework is very similar to the process used on the London Stock Exchange’s AIM market which uses a Nomad (Nominating Advisor) to assist and advise small companies looking for a public listing on the AIM market.
OTCQXsm Listing - Cost/Benefit Analysis
Companies that decide to list on the OTCQXsm will still have to provide audited financials, retain a DAD who will have responsibility and therefore exposure to liability, obtain an opinion letter upon application and then annually thereafter (again more responsibility and liability for the person providing the opinion letters), file for Standard & Poors or Mergent Manual inclusion and a pay a non-refundable application fee of $5,000 with an additional monthly listing fee of $950 beginning January 1, 2007.
The cost of listing on the OTCQXsm, although less expensive than complying with Sarbanes-Oxley, is nonetheless, an expensive and time consuming endeavor. Companies wishing to avoid the cost and hassle of Sarbanes-Oxley compliance or deciding never to apply for an OTC Bulletin Board or Nasdaq listing, but looking to provide investors with credible disclosure and information, will likely seek to be listed on the OTCQXsm. However, is this compelling enough reason to convince many companies to seek an OTCQXsm listing, since for a little extra effort and expense these companies can achieve an OTC Bulletin Board listing. Also, Pink Sheet quoted companies can voluntarily file their financials on EDGAR as some are already doing. The difference between being a voluntarily reporting Pink Sheet quoted company that files its financials on EDGAR and being an OTCQXsm listed company will probably be around $50,000 for the first year and about $30,000 per year thereafter.
PIPE Flow – An Incentive for Listing
A private placement also known as a private investment in public equity (“PIPE”) is the primary vehicle that microcap companies use to raise capital. Hedge funds and accredited private investors invest in microcap companies using numerous PIPE structures such as, common stock with a fixed discount, convertible preferred shares with a fixed or floating discount, convertible debentures with a fixed or floating discount, equity lines, convertible notes with Warrants, etc. One of the key ingredients to the PIPE structure, however, is getting the common stock underlying the PIPE investment registered so at some point the investor can sell his position and hopefully make a profit on the investment. A registration statement is a detailed filing made by a company with updated financials, a description of terms of the stock offering and other detailed information. After the PIPE investment is made, the common stock underlying the investment is restricted and can only be sold: (1) if the stock is registered with the SEC or (2) after a one year holding period, if the company is current on its financial filings with EDGAR and then, the number of shares that may be sold by that investor are limited to 1% of the number of shares of that company that are issued and outstanding.
Now if these Pink Sheet quoted companies want to raise capital, they may decide to file financials and list on the OTCQXsm to gain credibility with investors, however, as mentioned earlier, companies can voluntarily file their financials on EDGAR, as a small number are already doing and save money in the process. Also, if these microcap companies voluntarily file their financials on EDGAR they can file registration statements that will keep their PIPE investors happy.
Will the Pink Sheet Premium Service be Accepted?
The people that run Pink Sheets are trying to bring more credibility and legitimacy to the Pink Sheets arena. They believe that there is a market for companies that want something better that a Pink Sheet listing, but are not quite ready for the OTC Bulletin Board or Nasdaq, with their mandatory Sarbanes-Oxley compliance requirements. The problem with this however, is that as the public learns and understands Sarbanes-Oxley more, the public will realize that companies listed on the OTCQXsm, but not listed on the OTC Bulletin Board or Nasdaq, are not truly giving full disclosure when it comes to the independence and impartiality of the company’s officers and directors.
As with most business decisions the success of the OTCQXsm is going to be largely dependent upon the expense factor. The people at Pink Sheets will have to convince investors and microcap companies that the benefits of an OTCQXsm listing outweigh the burdens. It will be interesting to see how many companies decide to go for an OTCQXsm listing this year. The first year will surely have it hurdles, but it will be a welcome platform for the SEC regulators who have always expressed concern over Pink Sheet quoted companies that disclose nothing more than what they want to disseminate through overstated press releases with no financial statements to support the hype.
About the author
Joseph B. LaRocco, Esq. has represented and advised private and public companies, broker-dealer firms, investment bankers and financial consultants in the area of securities investments, private placements, compliance and due diligence. LaRocco has extensive experience advising investment managers on numerous trading, regulatory, compliance and anti-money laundering issues. LaRocco is also the founder and managing member of MicroCap Net Profits.
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