Investor Relations Compliance For The OTC Markets

Investor Relations Compliance
What Regulations Apply to Investor Relations Activity?

Many companies hire third party investor relations firms to generate investor awareness. Investor relations firms are generally hired to publish favorable information about a public company to increase its stock price and trading volume. This favorable information is published using email and direct mail publications, newsletters, stock websites, press releases, stock message boards and phone rooms. Depending upon how the investor relations materials are written and published, investors may be misled into believing that a company funded promotion is from an independent source when, in reality, it is a paid advertisement. Investor relations firms that fail to comply with the securities laws, are referred to as “Stock Touts”.

Enforcement actions involving investor relations activity frequently stem from violations of the anti-fraud and registration provisions of the federal securities laws.

Stock scalping refers to secretly selling shares while telling others to purchase. Investor relations providers should make full disclosure of any intended sales during promotional campaigns in all materials published to avoid violations of the anti-fraud provisions.

The Anti-Fraud Provisions

Section 17(a) of the Securities Act prohibits fraud and misrepresentations in the offer or sale of securities. The rule has often been used against investor relations providers and those engaging their services. The rule provides,

“It shall be unlawful for any person in the offer or sale of any securities or any security-based swap agreement by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly.

(1) to employ any device, scheme, or artifice to defraud, or

(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or

(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.”

Most courts have interpreted subsections (a)(1) and (a)(3) covering “scheme” liability and subsection (a)(2) covering misrepresentation and omission liability.

Section 10(b) provides that,

“It shall be unlawful for any person, directly or indirectly…. To use or employ, in connection with the purchase or sale of any security … any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Securities and Exchange Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”

Rule 10b-5, largely mimics the language of section 17(a) while applying to both the sale and purchase of any security: It shall be unlawful for any person, directly or indirectly … (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

It should be noted that while section 17(a) is similar to Rule 10b-5, claims under Section 17(a)(2) and (a)(3) can arise from negligent conduct, while Rule 10b-5 claims require scienter.

Disclosure Requirements

Section 17(b) is an anti-fraud statute that requires publishers of information about public companies to provide disclosure of their compensation with specificity.  The rule requires that the Publisher disclose his or her compensation in all investor relations materials, including but not limited to press releases, emails or faxes.

Section 17(b) requires Publishers of information to disclose the following:

  • Type of compensation (securities or cash) received;
  • If the compensation is in securities, whether the securities are restricted or unrestricted;
  • Amount of securities received or cash paid;
  • If a corporate entity is the publisher of the information, the control persons of the corporate entity must be identified; and
  • Source of compensation (directly and indirectly) and if compensated by a third party shareholder or corporate entity, the shareholder or control persons of the entity must be identified by his or her individual name.

Section 5 of the Securities Act – Paying Promoters With Stock

Section 5 of the Securities Act makes it unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy any security, unless a registration statement has been filed as to such security.”

Stock Promoters are often paid for their services in securities of the public companies they promote. Stock Promoters receive free trading shares through a variety of methods; however, the shares are rarely issued in compliance with the securities laws. These methods include the issuance of free trading shares under Rule 504, transfers from third parties, debt and promissory note conversions. If an issuer participates in investor relations activity or arranges for a third party shareholder to pay for investor relations services with its shares, the shares are restricted securities.

The issuance of shares to Stock Promoters under these circumstances becomes an offering made on behalf of the issuer and unless the shares are registered, they are restricted securities. In the case of Stock Promoters paid in securities, they must either obtain registered stock or sell their shares in compliance with Rule 144.

Many stock promoters fail to recognize that Section 5 imposes strict liability for sellers of unregistered securities even where they have obtained a legal opinion from a securities attorney to opine their securities are “free trading”.

Conclusion

To comply with the anti-fraud provisions, investor relations providers should avoid stock scalping activity and disclose compensation with specificity including: (i) the nature of the compensation received, whether it is cash, or whether it is stock, (ii) the amount of compensation received, and (iii) the source of the compensation.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton Florida, (561) 416-8956, by email at info@occupyotcmarkets.com or visit www.occupyotcmarkets.com.   Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
www.securitieslawyer101.com
www.occupyotcmarkets.com