Small-cap fraud gets more scrutiny SEC chief weighing greater safeguards, he tells senators


WASHINGTON -- Securities and Exchange Commission Chairman Arthur Levitt told Congress yesterday that he is exploring rule changes aimed at cracking down further on the persistent problem of small-company stock fraud.

"We have particularly seen an increase in abuses in the market for micro-cap securities, which provides opportunity for small businesses to raise capital, but also provides opportunity for fraudsters to prey on innocent investors," Levitt said during hearings of the Senate permanent subcommittee on investigations.

Levitt said the SEC may seek to extend safeguards over penny stocks to troublesome larger securities; require dealers to review additional financial information about tiny companies before publishing stock quotations; and tighten rules that ease small companies' ability to raise capital.

Small businesses can raise as much as $1 million a year in seed capital without complying with federal registration requirements, and as much $5 million a year without submitting audited financial statements.

"We do not plan to turn back these efforts; however, we are concerned about any abuse of these measures and the harm that may cause not only investors, but also those businesses the rules were designed to help," Levitt said.

Levitt said his concerns are directed at micro-cap stocks, which zTC are more numerous than penny stocks. Penny stocks, or securities priced at less than $5 a share, are not traded on the Nasdaq stock market or listed on a stock exchange. Micro-cap stocks, which also have low market capitalization and include penny stocks, can be traded on Nasdaq's small cap market.

While Congress and the SEC tightened safeguards against penny-stock fraud in the early 1990s, dealers and stock promoters are eluding these measures by concentrating on micro-cap stocks, Levitt said.

Stock promoters also are increasingly using Internet chat rooms and bulletin boards to advance micro-cap fraud schemes, Levitt said.

The SEC has brought enforcement cases against promoters of a coconut chip enterprise, an eel farm, an ethanol plant and gold- and diamond-mining enterprises, he said.

Separately, an SEC study released yesterday shows that the fastest-growing category of investor complaints is about brokers' cold calls," or unsolicited telephone calls to potential customers.

The number of cold-call complaints to the SEC rose 23 percent to 440 during the first six months of the year from about 358 during the same period in 1996.

This increase "is staggering when you consider most other complaints are down," said SEC investor-education director Nancy Smith.

Levitt and state and National Association of Securities Dealers' regulators who testified yesterday did not estimate the extent to which small-company stock fraud has increased.

Alabama Securities Commissioner Joseph Borg told lawmakers that regulators' traditional tools often are ineffectual.

"As regulators pursue and shut down one firm, another or even several emerge to take its place," said Borg, who represented the North American Securities Administrators Association. "The lying, cheating and stealing continues unabated."

Borg said employees at the infamous brokerages of First Jersey Securities Inc. and Investors Center went on to form Stratton Oakmont Inc., which was ousted from the securities industry in December, and 13 other firms.

Borg called for the SEC to consider denying or revoking dealers' registration based on enforce- ment actions by state regulators. The commission and NASD now file charges on the basis of their own investigative findings. He also urged the SEC to adopt a rule it proposed a year ago that would toughen record- keeping requirements imposed on brokerages.

Sen. Susan Collins, the Maine Republican who chairs the Senate panel, said fraud trends are linked to the increasing popularity of U.S. stocks.

"While we have the safest and most successful capital markets in the world, the irony is that public confidence in our markets actually creates opportunities for con artists to exploit the unwary," Collins said.

Pub Date: 9/23/97

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