The National Association of Securities Dealers is planning more crack downs on trading scams in non-Nasdaq, over-the-counter securities.
But the NASD's attempts to drive the sleaze artists out of the non-Nasdaq, OTC market could end in disappointment. About 8,000 stocks qualify as non-Nasdaq, OTC securities, trading on the NASD-owned, electronic OTC Bulletin Board, and the manually-traded, independently-run pink sheets.
While the vast majority of OTC stocks are issued by legitimate entities supported by honorable market makers, a small minority give traders a black eye and rouse the NASD's enforcement machine.
The OTC Bulletin Board, in particular, seems to attract much of the criticism.
"The biggest problem in the area of small-cap fraud has been with the OTC Bulletin Board," said Phil Feigin, securities commissioner for the state of Colorado. "There's not very good enforcement of the bulletin-board market."
The OTC Bulletin Board, a somewhat secretive world where the bid and asked spreads can be gargantuan, is perceived as a breeding ground for some of the market's most unscrupulous personalities.
With stock markets scaling new heights, Feigin and others believe that investors' temptations to parlay their capital gains to even greater heights could motivate sinister traders to find avenues to perpetrate their fraud, in the face of new enforcement regulations.
"You can make enforcement harder, but it's not going to decrease the level of fraudulent activity," Feigin said. "These are people with sky-high egos that honestly believe that they won't get caught."
NASD regulators have proposed three initiatives designed to protect investors from being ripped-off by fraudulent broker dealers.
In a release, the NASD said the initiatives proposed:
* Allow only those companies that report their current financial information to the Securities and Exchange Commission, and banking or insurance regulators, to be quoted on the OTC Bulletin Board. (About 50 percent of the OTC companies currently report their financial results to the SEC.)
*Require brokers, before they recommend a transaction in an OTC security, to review current financial statements on the company they are recommending.
*Require that investors receive a standard disclosure statement emphasizing the differences between OTC securities and other market-listed securities prior to the initial purchase of an OTC security.
"There has been a dramatic increase in the number of micro-cap securities in the public market place," said Frank Zarb, NASD chief executive, in a prepared statement. "These measures are designed to ensure that the level of integrity that exists in other parts of the market is achieved in the smaller-capitalized section as well."
At the same time, the SEC has its own proposals on non-Nasdaq, OTC securities that would put more responsibility for investor protection on market makers. At press time, the NASD's proposals are expected to be submitted to the SEC for final approval and public comment.
Investor scams have been around for as long as Wall Street has existed. But today's scams may be more menancing, as evident by well-publicized reports of organized crime infiltrating the OTC market.
Mob tactics on the market-making side allegedly have included the intimidation of legitimate market makers who have refused to artificially inflate the value of stocks. Naked short-selling is reportedly another favorite tactic.
On the retail-brokerage side, scam artists have used the infamous three-call, cold call. A broker blindly throws out feelers, asking investors whether they would be interested in positive news affecting a security, calls a second time to reinforce that interest among naive investors, and closes the sale when the purported positive news develops.
Some brokers dupe a "reload list" of investors snared in the past; others dupe affinity groups or associations. Another tactic is sales of stocks in companies registered out of state, making it difficult for investors to get specific information about a company's operations.
When investors do purchase a stock and later decide to sell, corrupt brokers either won't be available or will require the investor to purchase a different stock in order to get out of their current position, Feigin said.
To be sure, the NASD has generally been tightening listing standards in the full universe of OTC stocks to help fight sleaze. And many investors are happy with how their small-cap and non-Nasdaq OTC holdings are traded and perform. Indeed, many good companies have no option but to go public on the OTC market.
"We really had no choice," said Gary Placek, head of syndicate operations at Robert W. Baird & Co., a Milwaukee-based firm, which placed OTC offerings for Tarpon Coast Bancorp (OTC:TCBA) and Macatawa Bank (OTC:MCBC), two new names on the OTC Bulletin Board in 1998.
"These are de novo banks that wouldn't have been able to qualify for Nasdaq Small-Cap listing, and certainly not for National Market System listing," Placek said. "They're not projected to make any revenues for a couple of years."
The initial listing of all stocks trading on the OTC Bulletin Board requires sponsorship by an NASD-affiliated broker dealer.
At press time, market makers in Tarpon included: Alan C. Ewing & Co.,Tampa; Hill, Thomson, Magid & Co., Jersey City; and Paragon Securities, New York. Market makers in Macatawa included The Ohio Company, Columbus, Ohio; Herzog, Heine, Geduld, Jersey City; and Monroe Parker Securities, Rochester, N.Y.
"It's turned out to be a real nice market for [the two banks]," said Placek. Both of the companys' stocks have benefited from investor appetite for community banks, Placek noted. Tarpon closed trading April 28 at 15 3/8, 53.75 percent above its Jan. 26 debut at $10 a share. Macatawa closed the session April 28 at 15 3/4, 57.5 percent above its April 1 debut, also at $10 a share.
All told, 1,200 new companies made the pink sheets and the OTC Bulletin Board their home last year. Of that number, 14 companies went public via the OTC Bulletin Board, raising $102.4 million in new capital. These include four banking entities; three healthcare-related companies; two issuers from the high-tech and telecommunication sectors; two food wholesalers; two miscellaneous holding companies; and one foreign entity.
The average return above offering for these companies through the close of trading April 28 was 6.86 percent.
While market sources believe the NASD initiatives give investors more protection, others suggest additional steps may need to be taken.
"After being in this business for 30 years, you realize there's no silver bullet," Feigin said. He suggested that closer cooperation, including reciprocity agreements between federal regulators and state regulators, might help.
"The NASD and the SEC could beef up their enforcement actions if they were permitted to take into account an order issued in a particular state," he said. Under the current laws, individuals convicted of security fraud in Colorado by Feigin's office can escape detection by moving to any of the other 49 jurisdictions.
Michael Robinson, a spokesman for NASD Regulation, the NASD's regulatory arm, declined to comment on these laws, but he did note that federal regulators are considering at least one other alternative, potential authority for the NASD to halt trading in OTC Bulletin Board securities under certain circumstances.
