John T. Potratz
3625 SW Warsaw Street
Seattle, WA 98126-3047
May 6, 1998
Jonathan G. Katz, Secretary
Securities and Exchange Commission
459 Fifth Avenue NW, Mal Stop 6-9
Washington, D.C. 20549
Subject: SEC 17 CFR part 240: Release No. 34-41110; File No. S7-5-99
RIN 3235-AH40. Comments on Rule 15c2-11
Overview: Proposed rules should not be implemented: While laudable goal:
I believe that the SEC has undertaken a laudable goal "Ö in response to concerns about increased incidents of fraud and manipulation in over-the-counter (OTC) securities." as stated in the Summary for the proposed rules. After having reviewed the filing in the Federal Register, I can understand that translating a goal into effective and efficient rules is difficult given the government rules and regulations.
After review and deliberate consideration, it is my personal belief that implementation of this proposed rule would:
1. Unlikely deter people who are committing fraud and abuse in the OTC market.
2. a. Seriously reduce the liquidity for a portion of the microcap stocks (hereinafter called the unknown and unloved, or U&Uís), and nay, may threaten many of the U&Uís very existence and survival.
b. Furthermore, if anyone is committing fraud, it is the SEC itself on these microcap stocks by denying them access to liquidity by making onerous requirements for market-makers to trade U&U stocks.
My Background and Perspective
I believe you will understand my perspective once I provide information on my background and avocation investment interests.
I have been interested in the larger world since my first thoughts. When I was seven, I made my first investment through my father in stocks from funds raised selling tomatoes door-to-door. I have continued my interest over the years. Finally, in 1983 I became an equity analyst for a Seattle brokerage firm for about a year before becoming a stockbroker. Since 1987, I have been an Investment Advisor both at another firm and for my own firm since early 1996. Thus, I have been involved in investing for some 44 years, both personally and professionally.
My avocation interest has been investing in the very smallest of firms, which have significant leverage to change. Often, these firms are the remnants of our industrial society, as the economic fortunes of industry ebbs and flows. These firms are often rich with history of our nation or how not to run a business. For instance, I was on the Board of the Northern Railroad on New Hampshire, a company that opened up a significant portion of New Hampshire when built in the 1830ís. When I first became involved in this company in the early 1970ís, there were 30,684 shares outstanding which traded about $7 per share, or a market capitalization of $214,788. With the resolution of the bankruptcy of the Boston & Maine, etc, over $150 per share in cash was subsequently paid to stockholders. Or how about Concord Natural Gas (now part of Energy North) which provided gas distribution utility services to Concord, the capital of New Hampshire? When I first started buying the stock, it traded about $40 per share with only 22,000 shares outstanding. I could add more stories of my experiences over the years involving stocks that have a very small market capitalization that have formed the core of my portfolio.
I have also been involved in companies, the financial statements of which are unavailable. The first instance is when companies have fallen on hard times. Barely able to survive, financial statements are a luxury. What matters: is there cash in the bank? I am today trying to get stock in two companies that have struggled for several years to survive. If they make it, I think their future is bright. I have been trying to get the stock for several years, and continue to be frustrated by the lack of market makers and liquidity in these stocks.
The second instance is that some companies donít want new stockholders and refuse to provide financial statements, even to stockholders. Why financial statements arenít provided is often conjectural, but I have talked with some companies who want to limit the number of stockholders to avoid the costs of filing with the SEC. Two companies have told me it costs them over $100,000 per year to file with the SEC.
My experience is thus over 40 years of exciting fun-filled research of the world around me. To be able to own these securities, I have to work with the market makers (MMís).
I have worked with many MM over the years in my efforts to acquire the U&U stocks. For several securities, I found that there were no MM making a market in the securities. I have had to personally beg MMís to make a market for me, and not always successfully. And why? I am told it is because of rules and regulations, and the potential for liability if one of the stocks is subsequently involved in fraud. Thus, I have been excluded from even trying to buy the U&U securities.
It is my belief that the proposed regulations by the SEC will seriously hamper my investing efforts.
But it is not only my efforts that are thwarted, but I believe that the liquidity for the U&U stocks will be seriously and unjustly damaged by these SEC rules.
Comments on Specific Items in the Proposed Rules
The proposed rule-making requests comments on several items. My comments follow.
Comment #1: Overall Perspective
I have read the Wall Street Journal almost daily for the last twenty years. I continue to be entertained over the years by the ability of fraud artists to stay a step ahead of the regulators. While I disagree with what they do, I do admire their ability to adapt to their environment. I watch in awe as they hire legal counsel that finds ways around rules and regulations, or cut and twist the regulations to stay out of jail. Like the AIDS virus, fraud artistsí permutate and evolve in ways to survive. I fully anticipate that if these rules are implemented, that the same thing will occur.
I agree that something needs to be done. But should the small capitalization stocks be the victims of these efforts? I argue that they should not be.
What might work? I find interesting the educational program the SEC has recently been pushing Internet brokers to disclose to their customers. Fraud often exists wherein people are uneducated about investments or their greed gets in the way of prudent investing.
But can the world be safe for all people at all times? No, it canít be. We have to accept some imperfections in life. Unfortunately, this is one of them.
Comment #2: III. 5. Other Exceptions (Page 11130)
Recommendation: The unsolicited status of a customer order should NOT be called into question if a MM repeatedly publishes a quotation on the basis of the unsolicited customer order exception.
Basis for Recommendation: I have occasionally been successful in being able to get a MM to make a market in a security for me that becomes marked "unsolicited". Given the relative infrequency at which these trade, it may be years between trades. Really Ė not a typo and not an exaggeration Ė years, as I kept track of several securities as I was frustrated that I was unable to buy any stock. You really have to understand the relative infrequency with which some securities trade. This is the way life is. Whoever proposed this limitation on unsolicited customer orders really has no clue about how infrequently small capitalization stocks can trade.
Comment #3: VI. B. Costs (Page 11138)
Recommendation: MM should not be required to review information from non-reporting issuers because it is often not available from many legitimate companies.
Basis for Recommendation: I have had personal experience with two general situations wherein data is not available. First are those situations where the companies donít want to provide information. The reasons why are often not forthcoming, and often a form letter is received in response to a request for financial information. The second is those situations wherein the companies just donít have the money to do financials. Remember that when you are trying to survive, you cut whatever costs you can.
The comment by the SEC that "However, we are assuming that non-reporting issuers maintain their financial information in compliance with prevailing accounting standards and, in most instances, would have available updated financial information prepared in accordance with generally accepted accounting principals (GAAP)." is a patently false assumption. It assumes financial statements are available (not always the case) and that it will be provided (not always the case).
The SEC needs to understand the real world and then maybe it wonít make such obvious mistakes in assumptions.
Comment #4: VI. B. Costs (Page 11138)
Recommendation: The benefit to the market of improved liquidity from not having this proposed rule far outweighs the benefits from potential reduction in fraud and manipulation.
Basis for Recommendation:
My hands-on life experience over the past few years is that the SEC rules as herein proposed, and as originally proposed in 1998, has really made if difficult to almost impossible to be able to get a MM involved in a new stock listing. Without a MM making a market, there is no liquidity for a stock. Period.
Market liquidity has been a continuing problem for me and my investments. I still remember having completed for a broker - in 1977 - all the paperwork for filing for Southbridge Water Company, Southbridge, MA. While the company denied my request for financial reports, I got around this issue. I personally went to the Department of Public Utilities to get copies of the financial pages necessary for a filing.
These proposed rules almost certainly would drive liquidity from the stock market for the smaller companies. We will go from bad to worse.
Conceptually, I agree with the goal to eliminate the fraud in the OTC market. But I firmly believe that these regulation changes will not eliminate the problem, as the people doing it will only find a way around it. Furthermore, regulations will only further exacerbate the illiquidity for smaller capitalization stocks.
Very truly yours,
John T. Potratz