The Fraud Industry part 2: Reverse mergers are scams + shady transfer agents

The SEC has a bunch of rules that make it more annoying to run a pump and dump.  This has spawned a mini-industry of professionals who help pump and dumpers exploit the loopholes in those rules targeting reverse mergers, which is the most common vehicle for pump and dumps to be listed.

The sketchy transfer agents will publish guides on their website about what they are and aren’t willing to do when it comes to their clients getting around regulations such as Rule 144.


Reverse mergers and shell companies

In a reverse merger, a worthless “shell” company will combine with another company with a sexy business (e.g. mineral exploration).  This allows the pump and dumpers to get their sexy company listed as a stock that can be sold to gullible investors.  Nowadays, legitimate companies do not go this route because it does not help them raise capital.  If a startup wants to raise capital in the stock market, it needs to go through the more expensive process of an IPO (initial public offering) or secondary offering.  So, all legitimate companies will skip the reverse merger and go straight to IPO.  Because legitimate companies avoid reverse merger and the illegitimate companies embrace it, all reverse mergers are scams.

Obstacles for reverse mergers

After the reverse merger finishes, the pump and dumpers will usually own unregistered shares that cannot be traded.  Through the legend removal process, these unregistered shares can be converted into freely-tradeable (registered) shares.  There are certain rules about when the legend can and can’t be removed.  People close to the company (e.g. CEO) generally cannot remove the legend on their shares until a certain amount of time has passed.  This is supposed to prevent pump and dumpers from immediately executing their pump and dump scheme and selling shares at inflated prices to their victims.

One way to get around these rules is to give shares to somebody that can be trusted.  Because that person is “not” an insider connected to the company, they can have the legend removed on their shares.  Then they can sell those shares and launder money back to the pump and dumpers.  To have the legend removed, they need to hire a lawyer to write an opinion letter.  They send that opinion letter to the transfer agent, which can accept or reject the legend removal request.

The shady transfer agents will have a guide on their website about legend removal.  Using Google, you can search their website with a query like

site:website.com  rule 144

A big, legitimate transfer agent like Computershare will not have such a guide on their website.  The small, shady transfer agents will have such a guide on their website.  It will go into detail about where they are and aren’t willing to bend the rules.  (This helps both parties save time when the transfer agent is upfront about sketchy opinion letters that it will not accept.)

OTCmarkets.com helps you research transfer agents

The OTC Markets website is “really interesting”.  They have a list of bad apples, which they refer to as “Prohibited Service Providers”.  If you click the legal order links, you will find some SEC document explaining what naughty things these people were up to.  They have been so naughty that OTC Markets no longer wants to do business with those people.  It’s worth reading a few to understand what these people did wrong and how they were caught.

They also have a list of people who they are willing to do business with.  Through their learn/service-providers page, you can find a specific transfer agent and get a list of most of their clients.  Click on “Service Provider Type” to filter by transfer agent.

One way to look for shorts is to research all of those transfer agents.

  • Does their website have a rule 144 guide?  How sketchy is that guide?
  • What is their mix of legitimate and illegitimate clients?  Some of the smaller transfer agents do have legitimate clients such as Whole Foods (the supermarket chain that was later bought by Amazon).  You should not assume that all of a transfer agent’s clients are sketchy just because some of them are.
  • Are the clients worth betting against?  For practical reasons, you want to look for companies with market caps above $75M.

Why is the OTCmarkets.com website so useful?

I don’t think anybody buying OTC Bulletin Board stonks actually cares about who the transfer agent is.  Investors and gamblers don’t have a reason to care about that.  This suggests to me that the website is a useful tool for OTC Market’s client base: publicly-traded companies.  OTC Markets knows how their industry works and what their clients care about.

The NASDAQ and NYSE websites aren’t nearly as useful.

*Full disclosure:  I do not own stock in OTC Markets, which is publicly traded through the ticker symbol OTCM.  The CEO, Cromwell Coulson (@cromwellc), follows me on Twitter.
I don’t own stock in NDAQ or NYSE.

Figuring out the transfer agent for an existing company

If you have a document search tool like Sentieo, you can search company filings for the phrase “transfer agent”.  Usually the company’s SEC filings will say who the transfer agent is.  if you don’t have a document search tool, you can open the DEF 14A filing and do a Crtl + F search for transfer agent.

Otherwise, you can use Google to search for the company’s name + transfer agent.  If you still can’t find it, perhaps try emailing investor relations.

Further reading

If you want to know more about becoming publicly-listed, there are lawyers who post good information online as part of their “content marketing” strategy.  Content marketing is when a freelance professional puts useful information online to attract new clients.  Content marketing is how I learned about shady securities law and money laundering.

SecuritiesLawyer101.com has excellent information on listing through IPO versus reverse merger.  The website explains why legitimate companies should avoid the reverse merger route favoured by illegitimate pump and dump schemes.

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