Want to deposit and sell those OTC shares? Better get a court order

I have written a lot over the last couple years about the SEC and FINRA cracking down on brokerages accepting deposit and clearing shares of companies that trade over the counter. And there are a large number of FINRA actions against brokerages in the penny stock space that I never wrote about simply because I didn’t follow FINRA enforcement actions prior to 2017. Following are most of the FINRA & SEC actions I have written about in the last year or so:

4/23/2018 – FINRA reaches decision against microcap broker Wilson-Davis & Co

4/26/2018 – SEC fines Aegis Capital Corporation after it admits to failing to file SARs

7/11/2018 – More SEC & FINRA actions for failing to file SARs: Chardan Capital, ICBC Financial Services, and Schwab [Schwab’s failures did not relate to penny stocks]

10/25/2018 – COR Clearing leaves penny stock deposit business

11/27/2019 – FINRA Enforcement files complaint against Lek Securities

2/21/2019 – SEC Sues Spartan Securities Group and Island Stock Transfer for involvement in “Microcap Shell Factory Fraud”

3/6/2019 – FINRA Fines broker TriPoint Global Equities LLC for penny stock-related failings

4/10/2019 – SEC Fines clearing firm Vision Financial Markets LLC $625,000 for failures to file SARs about suspicious penny stock deposits and sales

4/19/2019 – FINRA Fines microcap broker Glendale Securities

6/13/2019 – Wilson-Davis settles with SEC for failures to file SARs

7/24/2019 – FINRA Enforcement files complaint against microcap broker Wilson-Davis for alleged market manipulation of promoted stock Nugene (NUGN)

See also The Gatekeeper Wall of Shame, which is more comprehensive but still only goes back two years or so. It doesn’t include huge actions such as the SEC and FinCEN $20m combined in fines against Oppenheimer in 2015.

All this enforcement activity has had a couple main effects. First, some brokers have either been forced to abandon accepting penny stocks for deposit or they have willingly abandoned that business (e.g., Cor, Brown Brothers Harriman (pdf), Vision Financial). For years market participants have been talking about this. From the report of the 2013 SEC Government-Business Forum on Small Business Capital Formation (a group of industry participants that give annual recommendations to SEC):

“Forum participants report that many broker-dealers will not accept, deposit, clear, sell and/or trade low-priced stocks. They note that the Financial Industry Regulatory Authority (“FINRA”) and the Depository Trust Company (“DTC”) are requiring broker-dealers to take inordinate responsibility and liability for possible counterfeit certificates, tracking the origin of prior share transfers and monitoring the placement of restricted legends. This issue seriously impacts the participation of investors in financing micro-cap issuers.”

This may have begun in 2009 or even earlier. For example, here is a excerpt from a 2009 letter (pdf) by the Securities Transfer Association in response to FINRA Regulatory Notice 09-05 (pdf):

Brokers are refusing to accept for deposit penny stocks across the board, not making any distinction about where they trade or the transparency in filings they have supplied to the marketplace. It appears to our members that rather than undertake the due diligence and “meaningful investigation” that the FINRA directive requires, brokers are simply refusing to accept deposits of certificates for any penny stocks.

FINRA OHO hearing panel reports over the last few years involving the brokers that remain in the business have indicated that they have increased scrutiny of deposits of penny stocks.

One potentially new trend is brokers sometimes refusing to accept the deposit of certain stocks from certain account holders unless the account holder provides a federal court order declaring the shares exempt from registration under the Securities Act of 1933. This exemption from registration comes from Section 3(a)(10) of the Securities Act of 1933. For a good explanation of Section 3(a)(10) and its most common uses, see Laura Anthony’s article on it. See also the SEC’s bulletin on it from 1999.

I first came across a court case seeking to use that exemption nearly a year ago while researching a microcap broker. I must not have chosen the right search terms because I only found three such cases. Then a few weeks ago I came across a couple other such lawsuits when reading the OTC Market Research report on Clic Technology (CLCI). I then searched CourtListener’s Recap database of federal court cases for [“3(a)(10)” brokerage] and found 148 matching cases. Not every case is relevant — if a shareholder was promised payment in stock and a company refused to pay that lawsuit would also show up in my search results. Many SEC lawsuits also show up in this search. After my initial search I conducted “party” searches at CourtListener for every party named in the lawsuits below. Following are my analysis of the cases and a listing of relevant cases. These are listed in reverse chronological order. Unless otherwise noted, the quotes below are from the initial legal complaint in each case. The links in each case are to the court docket on CourtListener.com.

Important note: I found these cases by searching the CourtListener Recap database. This database includes dockets obtained from Court RSS feeds, documents uploaded by those who use the Recap browser plug-in, and documents bulk-uploaded by donors or partners of CourtListener (a 501(c)3 US-based non-profit). This database is not comprehensive and the documents are not representatively distributed across court or time or party. Therefore, I cannot draw any conclusions about how frequent these actions have been or whether they have become more frequent over time. There are likely a number of similar actions that my search did not find.

Livingston Asset Management LLC v. Saddle Ranch Media, Inc. ( 1:19-cv-00901 in D. Maryland 2019)

due to delinquent financials, brokerage will not accept deposit of SRMX

Manus v. Players Network ( 1:19-cv-00007 in D. Maryland 2019)

PNTV’s history of falling behind in its SEC filings, its volatile stock price, and its misleading press releases, makes it virtually impossible for Plaintiff to deposit PNTV stock into a brokerage account without a federal court order recognizing an exemption from registration under Section 3(a)(10)

Stout Law Group, PA v. VNUE, Inc. ( 1:18-cv-03614 in D. Maryland 2018)

VNUE’s history of falling behind in its SEC filings, and its volatile stock price, (which has languished well below a penny, even following a 1 for 10 reverse stock split implemented by CEO Zach Bair effective on August 7, 2017), makes it impossible for Plaintiff to deposit VNUE stock into a brokerage account without a federal court order recognizing an exemption from registration under Section 3(a)(10), and thus Plaintiff cannot recoup its losses without relief under Section 3(a)(10).

Stout Law Group, PA v. Integrated Cannabis Solutions, Inc. ( 1:18-cv-03488 in D. Maryland 2018) This lawsuit is to force payment but also mentions that no broker would accept deposit of shares without a court order:

Due to the difficulties in depositing stock for cannabis related companies in the United States at the present time, and due to IGPK’s three year delinquency in its public filings, Plaintiff knows of no stockbroker which will allow Plaintiff to deposit IGPK stock into a brokerage account without a federal court order recognizing an exemption from registration under the Securities Act of 1933, and thus it is impossible for Plaintiff to recoup its losses without relief under Section 3(a)(10).

Sunny Isles Capital, LLC v. Clic Technology, Inc. ( 1:18-cv-03432 in D. Maryland 2018)

Because the S-1 Shares are already issued to Plaintiff without restricted legend, and yet cannot be deposited into Plaintiff’s brokerage account and sold into the public market, the S-1 Shares are effectively nothing more than a claim against Defendant (“Claim”), such that Plaintiff has suffered a considerable loss which can only be remedied under Section 3(a)(10), which necessitates this present action.

One Investment Capital, Inc. v. Clic Technology, Inc. ( 1:18-cv-03410 in D. Maryland 2018)

Because the S-1 Shares are already issued to Plaintiff without restricted legend, and yet cannot be deposited into Plaintiff’s brokerage account and sold into the public market, the S-1 Shares are effectively nothing more than a claim against Defendant (“Claim”), such that Plaintiff has suffered a considerable loss which can only be remedied under Section 3(a)(10), which necessitates this present action.

SDN Investments, LLC v. Capital Financial Global, Inc. ( 1:18-cv-02995 in D. Maryland 2018)

SDN’s brokerage will not allow SDN to deposit CFGX stock into its brokerage account in settlement of the Debts without a “federal court order” recognizing an exemption from registration under the Securities Act of 1933, despite the best efforts of CFGX to assist SDN with the removal of restricted legends and/or the deposit of such common stock with SDN’s brokerage, such that it is impossible for SDN to recoup its losses without relief under Section 3(a)(10).

Trillium Partners, LP v. Advanzeon Solutions, Inc. ( 1:18-cv-02130 in D. Maryland 2018)

Because the 4(a)(1) Shares are already issued to Plaintiff without restricted legend, and yet cannot be deposited into Plaintiff’s brokerage account and sold into the Case 1:18-cv-02130-DKC Document 1 Filed 07/12/18 Page 2 of 4 3 public market, the 4(a)(1) Shares are effectively nothing more than a claim against Defendant (“Claim”), such that Plaintiff has suffered a considerable loss which can only be remedied under Section 3(a)(10), which necessitates that present action.

Livingston Asset Management LLC v. Enzolytics, Inc. ( 1:18-cv-02088 in D. Maryland 2018)

“LIVINGSTON’s brokerage will not allow LIVINGSTON to deposit ENZC stock into its brokerage account in settlement of the Debts without a “federal court order” recognizing an exemption from registration under the Securities Act of 1933, despite the best efforts of ENZC to assist LIVINGSTON with the removal of restricted legends and/or the deposit of such common stock with LIVINGSTON’s brokerage, such that it is impossible for LIVINGSTON to recoup its losses without relief under Section 3(a)(10).”

Livingston Asset Management LLC v. Quantumsphere, Inc. (1:18-cv-02003 in D. Maryland 2018)

LIVINGSTON’s brokerage will not allow LIVINGSTON to deposit QSIM stock into its brokerage account in settlement of the Debts without a “federal court order” recognizing an exemption from registration under the Securities Act of 1933, despite the best efforts of QSIM to assist LIVINGSTON with the removal of restricted legends and/or the deposit of such common stock with LIVINGSTON’s brokerage, such that it is impossible for LIVINGSTON to recoup its losses without relief under Section 3(a)(10).

S&E Capital, LLC v. Vapor Group, Inc. ( 1:18-cv-00655 in D. Maryland 2018)

S&E has attempted on multiple occasions to convert some of the debt owed under the aforementioned Convertible Promissory Notes into free trading common stock of VGI under exemptions from registration under Rule 144 and Section 4(a)(1) of the Securities Act of 1933, but VGI and its Transfer Agent have been unable to assist S&E with the removal of restricted legends and/or the deposit of such common stock with S&E’s brokerage, such that it is impossible for S&E to recoup its losses without relief under Section 3(a)(10).

Probility Media Corporation v. Isen ( 3:17-cv-02583 in S.D. Cal. 2017) This lawsuit came after shares were issued and sold and is quite complicated — it is not like the above cases. It does explain the use of Section 3(a)(10) exemption. Relevant excerpt:

Isen presented a workaround, that would allegedly allow ProBility to concede to the SEC’s position, through an exemption under Section 3(a)(10) of the Securities Act, while continuing to market ProBility. A Section 3(a)(10) exemption of the Securities Act is meant to exempt securities transactions where a fairness hearing by a judge or government agency’s ruling replaces usual registration requirements. Isen represented that many over-the-counter traded securities (over-the-counter bulletin board or OTCBB), like ProBility, have been utilizing the exemption found in Section 3(a)(10) to convert all forms of debt into freely tradable common stock.

What Does this mean?

There are two distinct ways in which the SEC and FINRA have cracked down on brokers accepting deposits of microcap OTC stock over the last few years. The first is focusing on brokers’ responsibility to prevent their clients from selling unregistered shares into the market without an appropriate exemption (and thus violating Section 5 of the Securities Act of 1933). The second is ensuring that brokers report suspicious transactions to the SEC in Suspicious Activity Reports (SARs). I really have no good guess for the ultimate cause of why brokers are sometimes requiring a federal court order to allow the deposit of OTC shares, but the proximal cause is in my opinion either refusal of DTC to accept certain shares or fear that FINRA or the SEC will find fault with the brokerage for allowing the deposit.

Disclaimer: No position in any company mentioned. I currently have funds held at Vision Financial through the introducing broker Centerpoint Securities. This blog has a terms of use that is incorporated by reference into this post; you can find all my disclaimers and disclosures there as well.

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