In the OTC Bulletin Board Market, there is a lot of wrongdoing, and a lot of money is made as a result. Regulators are trying to solve the problem, but they can't stop it without taking drastic steps that will hurt the small and micro-cap market.
The small and micro-cap market is an important part of how small and mid-size companies go public. The most common ways for small and mid-size companies to go public are through Reverse mergers and Regulation D (504) offerings.
Small and medium-sized businesses like these two options because they are easier and less expensive than the traditional IPO. It can be thought of as a simplified fast-track way for a private company to go public.
In previous articles, I went into detail about how small and medium-sized businesses can go public. If you missed them, you can email me and I'll be happy to explain it.
I've been a market maker and trader in the stock market for more than 25 years. In my own brokerage firm and with a few of Wall Street's biggest wholesalers. I think my experience makes me qualified to write clearly and honestly about the subject from a bird's eye view.
I think short selling is a legitimate way to give the market liquidity, which is an important part of making markets. But that's not what I'm talking about.
Someone takes a short position when they sell a stock they don't own in the hopes of being able to buy it back later for less money.
There are a few reasons why it's easy and profitable to sell short the stock of a company that went public through a reverse merger. I'll talk about those reasons and suggest ways to stop this once and for all without hurting legitimate short sellers who are willing to sell and take the risks that come with having a short position. The first reason (1). In a Reverse merger, a private company that is already in business must merge with a public shell in order to go public. A public shell is what's left after a public company goes bankrupt or is liquidated. Some shell companies are also set up as "blank check" companies.
A Blank Check company has shareholders and maybe some cash on its books, but nothing else. They are made by enterprising people who want to merge an operating private company into it.
When the owner of the shell sells it to a private company, he keeps 5–15 percent of the shares for himself and gets anywhere from $500,000 to $1,000,000 for himself. Even if he signed a contract saying he wouldn't sell for a year, most of these people can't be trusted and will dump the stock or have someone create a short position on their behalf at some point.
Solution: The owner of the shell must be forced to sell the whole position and be happy with the money, which is usually a huge profit. I don't have anything against people making a lot of money, because I could also make a lot of money. What I do have a problem with is how they do it.
(2A) Not doing enough due diligence: Before buying a shell, the private company and the consultant they hire to help them with the Reverse merger should look at the shareholder list in detail. Some of these shareholders may own too many shares, and the real owner may be the shell owner or the consultant. There are a lot of smooth-talking wolves who pose as consultants and work with the shell owner.
Solution: First, Google the consultant's name and the name of his previous employer to see if he has been convicted of any crimes related to securities and has been banned from any stock-related transactions. Second, write to the regulator and ask that consultants be required to have a website with their name on it. Most shady people work in secret so that regulators can't find out what they're doing.
Ask the Securities and Exchange Commission to lower the number of shareholders needed to get listed, and don't buy a shell that has too many shares out there.
When a trader does this, he is technically going against the point of the rule that says market makers can short a stock as part of their job.
Solution: Require traders to keep acting as market makers until they buy the stock back. Also, regulators must appoint a clearing agent to enforce the rules about the delivery of securities on settlement or execute a buy-in (buy the stock back and charge the seller) if the seller doesn't deliver the stock within the time limit.
I think that these reforms will do a lot to change the environment for people who want to take part in reverse mergers and get rid of the vultures who prey on small business owners who aren't very smart.
But until the government takes action, it is up to the business owner to do the right research. If I sound like a crusader, it may be because the industry has been good to me and I hate to see the vultures take it over.
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