Readers of the BrokeAndBroker.com Blog are regularly admonished by publisher Bill Singer to do their due diligence before investing. Ask for the paperwork that supports all the important claims by the issuer. If you are given the paperwork, don't just take it at face value: make an effort to confirm what's on the pages. This Hugh Moreon guy, who is supposedly the CEO and graduated Harvard and is considered the world's leading authority on something that you don't even remotely understand -- have you spoken to him and verified he is who the filings say he is? Did you physically visit the factory where they make the next-generation, microbionic, xEiCHodescent, cytolysitic widget? Has the Central Asian Commercial Bank of Uppah Yuess confirmed the existence of the company's eight-figure balances? Unfortunately, even if you do your due diligence, you might not get all the answers and, more troubling, the answers you get might not be verifiable. As recent SEC cases demonstrate, there's more to due diligence than going through the motions.
Cases In Point
Let's consider this corporate disclosure recently provided by the Securities and Exchange Commission ("SEC"):
Flaster is a Delaware corporation with its principal executive offices located in Wilmington, Delaware, and its operating offices located in Daugavpils, Latvia. Flaster OIP at 1. Flaster filed a registration statement on June 26, 2014, in connection with an initial public offering of 500,000 shares of common stock. Id. Flaster amended the filing, which has not become effective, on August 21, 2014. Id. The Commission declared the registration abandoned in an order issued August 31, 2015. Div. Ex. 1 at Ex. C; Div. Ex. 4. 1
iLOAN Inc. is a Delaware corporation with its principal executive offices located in Kiryat Yearim, Israel. iLOAN OIP at 1. iLOAN filed a registration statement on November 22, 2011, in connection with an initial public offering of one million shares of common stock. Id. iLOAN amended the filing, which has not become effective, on December 27, 2011. Id.
Zubra Inc. is a Delaware corporation with its principal executive offices located in Wilmington, Delaware. Zubra OIP at 1. Zubra filed a registration statement on February 27, 2014, in connection with an initial public offering of 400,000 shares of common stock. Id. Zubra amended the filing on March 26 and April 7, 2014. Id. Zubra's registration statement was declared effective on April 17, 2014. Id.
Instride, Inc., is a Delaware corporation with its principal executive offices located in Miami, Florida. Instride OIP at 1. Instride filed a registration statement on November 27, 2013, in connection with an initial public offering of 400,000 shares of common stock. Id. Instride amended the filing on January 27 and February 27, 2014. Id. Instride's registration statement was declared effective on March 12, 2014. Id.
[E]ach Respondent filed with the Commission a registration statement, as amended, that contained material misstatements and omissions relating to the identities of Respondents' officers, directors, promoters, and/or control persons. The OIPs also charge Respondents with failure to cooperate with Commission staff examinations conducted pursuant to Securities Act Section 8(e) by failing to respond to subpoenas issued in 2015 and 2016.
indicating an intent to defend against the charges.
Out of Control
Given Respondents' deafening silence, the Administrative Law Judge ("ALJ") handling the consolidated cases proceeded to adjudicate the matters by default. In finding that the Respondents had defaulted, the ALJ noted that [Ed: footnotes omitted]:
Each Respondent's registration statement names a person or persons as directors or officers of the corporation when in fact (1) those persons do not control the corporation, and (2) the corporation is actually controlled by undisclosed persons and/or promoters. OIPs at 1-2; Div. Exs. 2-3, 5-12 (Respondents' forms S-1 and amended forms S-1); Tr. 29. Indeed, at the request of the Division, Latvian and Israeli securities officials located and interviewed six of Respondents' seven purported officers and directors, each of whom denied serving in such capacity. Tr. 21-29; Div. Exs. 25-31. The evidence shows that the electronic signatures of those purported officers and directors on each registration statement were forged. Also, the attorney who issued opinion letters in connection with Respondents' registration statements testified during the Division's investigation that he never actually met or even spoke by telephone with any of the purported officers or directors. Div. Ex. 1 at 6.
In addition, each Respondent has failed to respond to subpoenas (and courtesy copies of the subpoenas), and three Respondents also failed to respond to revised subpoenas for the production of documents issued by the Division during its investigation. OIPs at 2; Div. Ex. 1 at 3, 6; Div. Exs. 13-24; Tr. 32.
Pages 2 -3 of the Initial Decision on Default
In accordance with her findings, the ALJ ordered that the effectiveness of each Respondent's Registration Statement be suspended.
Bill Singer's Comment
By way of a brief recap, let's consider what was alleged and what was not refuted. Purported control persons did not, in fact, control the companies. Some purported control persons denied serving in such capacity. The electronic signatures of purported officers and directors were forged. The companies were controlled by undisclosed persons or promoters. The attorney who issued the Opinion Letters didn't actually meet with or speak by telephone with any purported officer or director. When offered an opportunity to respond to the allegations, the companies didn't even respond to subpoenas.
Even more sobering, although two of the Respondent companies had registration filings that were never declared effective by the SEC, the fact remains that two did! How could this happen, you wonder. Well, consider this commentary in "Fast Answers: Registration Under the Securities Act of 1933" (Securities and Exchange Commission Website, last updated September 2, 2011):
[T]he SEC's Division of Corporation Finance may examine a company's registration statement to determine whether it complies with our disclosure requirements. But the SEC does not evaluate the merits of offerings, nor do we determine if the securities offered are "good" investments.
While our rules require that companies provide accurate and truthful information, we cannot guarantee the accuracy of the information in a company's filings. In fact, every year we bring enforcement actions against companies who've "cooked their books" or failed to provide important information to investors. Investors who purchase securities and suffer losses should know that they have important recovery rights if they can prove that there was incomplete or inaccurate disclosure of important information . . .
If you thought that the SEC conducted a meaningful investigation of the bona fides of companies filing registration statements, think again. What has always impressed me as a somewhat ludicrous and cynical bit of advice, the SEC counsels investors who have been defrauded by corporate fraudsters that you "have important recovery rights." Now there's an great bit of reassurance. In more basic terms, the SEC is acknowledging its impotency and telling those who are victims of fraud to go out and hire a lawyer and try to get your money back from some con artist who has likely vanished into thin air.
Then again, I'm one of those lawyers who charges the big bucks to help victims of investment fraud, so, I'm not exactly complaining about the often useless role of the SEC when it comes to protecting the public. Come to think of it, with the looming prospect of deregulation and more scrutiny of enforcement, I may actually be looking at a booming business. Tell you what, ignore today's column. Don't do any due diligence. Rely upon the SEC to vet every issuer. Sure, rely upon big government to get between you and the bad guys. How's that been working out for you?
While you're re-thinking the SEC's role as a investor's advocate, perhaps you will yet again consider my warning that you MUST do your own due diligence. You worked hard to put that nest egg together. How about you make some effort to confirm what you've been told and verify what seems unclear? Oh, you say that it's a lot of work. You ask how you could possibly protect yourself if dubious companies can get registered with the SEC in 2014 and only first get suspended in 2017. In response, I answer that if it's too much work to do due diligence, then don't complain when you get ripped off. If the SEC can't detect corporate fraud with all its resources, then maybe you should take that as the clanging of a very loud alarm. If you don't have the time to do your due diligence, go back and re-read the introductory paragraph of today's blog. Did you catch the hidden meaning of the names of the fictitious CEO and of the make-believe bank? Read the names slowly. Pronounce them carefully. Ahhh . . . now you're beginning to understand the effort you will need to put into doing meaningful due diligence.