OTC securities harder to deposit and trade

DSV Consulting works with micro-capitalized companies (under $50,000,000 in equity, most of the time much less than $1,000,000) structuring for growth – that means reorganization, raising funds (both debt and equity), while keeping the next step in mind (how do they harvest that equity in the future. From 1998 till 2015, we believed that the harvest event was most likely a “go public scenario“, and we proceeded in taking 17+ companies public through various means as well as work on over 50 reorganizations to get ready for such events. The key to harvesting your equity, if you’re an investor or founder, is to own securities are have a mature market for their sale – the public markets served that purpose until recently. Now Over-The-Counter securities (“OTC securities”), don’t serve that purpose since there is almost no means to dispose of shares that you’ve invested in, unless you’re a tech unicorn doing an IPO.

Depositing OTC securities 5 years ago

For the last 5 years, brokerages across this nation have been tightening compliance to such a point that no one can deposit share certificates into their brokerage accounts, even if they can show that they paid for them. Take this requirement from a second tier brokerage:

• The shareholder must supply all paperwork associated with the purchase and holding of any security (right, this is justified).
• The shareholder must supply an tradability opinion by a legal counsel within a law firm with at least 10 lawyers (this just about guarantees that the opinion letter will cost at least $5,000).
• The issuer must be eligible for DTC of the shares into the account (a little less than 25% of the OTC securities and their transfer agents have this capability).
• The shareholder must hold at least $50,000 in the brokerage account in cash or blue chip stocks.

Other requirements from FINRA required brokerages to hold a penny ($0.01) for each share of stock traded for the entire 3 day settlement period, even if the shares were trading at the lowest number of $0.0001. This almost guaranteed that the smaller brokerages would not allow account holders to trade in penny stocks, no matter what the parameters – we believe this was because FINRA is a self policing organization made up of the representatives of the large brokerages, which make a majority of their trading revenue off of the OTC markets. These large brokerages had the excess capital reserves that made that requirement a moot point.

There were a number of brokerage houses that would work under these terms & conditions:

• TD Ameritrade
• E*Trade
• Scottrade
• Charles Schwab – only if you had an account with over $150,000
• Merrill Lynch – if you had a number of other banking accounts with them and a balance
• Interactive Brokers (IB)
• Glendale
• Alpine or Scottsdale (I wouldn’t have suggested them except as a last resort)

This meant that anyone holding shares worth less than $25,000 was basically S.O.L. (I really mean something other than “Sure Out of Luck“) – but wait, this meant that small investors were stranded with their shares. Not able to harvest the capital that they provided to growing organizations. And then something wonderful happened…

Crowdfunding and Regulation A+

Regulation CF for Crowdfunding and Regulation A+ that allowed companies an easier path to Securities and Exchange Commission (SEC) mandated reporting, every 6 months instead of every quarter and a simplified format, meant that capital formation was simplified. But capital harvesting was still limited – the J.O.B.S. Act didn’t really address the secondary market (Upgraded Crowdfunding). Many Reg CF platforms like StartEngine.com or Microventures.com have begun to offer limited secondary markets, but they are still not there. The answer was for a company to progress through capital formation using Reg CF and then Reg A+ to get a trading symbol that would allow for that secondary trading and allow all of those stranded Reg CF and Reg A+ investors to harvest the precious capital that they provided to these growing enterprises.

And then FINRA and the SEC tightened the nose around micro-caps once again, ensuring that capital formation at the micro-cap stage was strangled out of existence…

Trading in OTC securities today

Today, compliance has been handed even more onerous requirements that make it almost impossible for investors and founders to harvest their invested capital in OTC securities. Now, there are very few brokerages that will allow investors or founders to deposit shares – to our knowledge only Glendale and then only if you have an account with $150,000 of cash or blue chips in it. The requirements also include:

• an opinion with a firm over 20 lawyers (yup, that’s a fee of usually $10,000 or more),
• the security must have current information on OTCMarkets.com, and
• the security must be DTC eligible.

Read this tidbit that came from E*Trade about OTC securities just recently – https://us.etrade.com/l/f/disclosure-library/otc. So how do we go forward in the public markets? Here are some of our thoughts:

• Only use top tier Regulation CF and Regulation A+ platforms like StartEngine.com or Fundable.com for investments since they have built in mechanisms for a secondary market.
• Ensure that the company you invest in has current information OTC Markets and that they have sufficient capital to continue reporting for at least 2 years – enough time for an investor to be able to reasonably harvest their capital.
• Make sure that the companies seeking capital use the path that provides them time to mature their administration capabilities and be ready for the public markets – see our process at our Crowdfunding Consulting page.

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Updates

• November 11, 2020 – A vice president at Interactive Brokers just told one of business associates that they now do not trade stocks less than $5 [penny stocks] period, unless the opinion is from a legal firm with over 40 lawyers and the account must have $5M or more (and then it is not guaranteed to be allowed to trade penny stocks).

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