December 26, 2019
December 26, 2019
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-1090
Re: Comments to the Publication or Submission of Quotations Without Specified Information (File Number S7-14-19) (the Proposal)
As an individual retail investor, I often look for inefficiencies in the market where I can obtain a knowledge advantage over other market participants. Competing against large financials institutions is nearly impossible with most large and small cap stocks that are saturated with analyst coverage however OTC stocks offer an enormous amount of opportunity as they are infrequently or light covered by these institutions. A savvy retail investor can research these stocks over the internet, and then take a position based on their own risk tolerance. In many instances, after taking a position, the investor can then obtain a copy of the companys financials. Proposal S7-14-19 as written would eliminate this important niche in the market, which is both friendly and rewarding space for retail investors to invest in.
As an example, J.G. Boswell is the United States largest producer of cotton, and one of its largest producers of Tomato paste. The company owns approximately 150,000 acres of valuable real estate in Californias central valley, along with valuable water rights. The companys stock price is about $600 a share with a market cap of approximately $600 million, and an enterprise value of around $900 million - the company has routinely paid a dividend of around 2-4% over the last two decades. The average volume of shares traded for J.G. Boswell over the last three months is around 400, meaning that approximately $250,000 of the stock is traded on any given day. Is this the type of company that the SEC should be blocking investors from investing in - does this company really pose a threat to a retail investor like myself? I think the answer is unequivocally, no. However, since J.G. Boswell only publishes annual financials (which are audited by Grant Thornton), brokerages would be forced to stop quoting this security, and if that happens where would that leave investors who currently own shares in J.G. Boswell?
As many investors have commented already, imposing this rule would likely result in the value of an OTC investment dropping to zero, as it would eliminate a mechanism for efficiently trading these securities. Investors like myself who have invested tens of thousands of dollars into these securities would see our investments wiped out overnight. Does the SEC really want to hurt thousands (if not tens of thousands) of retail investors - the same individuals that you purport to be helping? The very existence of this proposal has already begun to have an impact on many of these securities as investors are starting to sell these stocks, not based on fundamentals mind you, but based on the fear that this proposal will go through.
Additionally, as others have commented, this proposal could truly play into the hands of many companys that would want to take their company private. Should this proposal go through, as mentioned above the value of the OTC security would drop precipitously as investors would be forced to buy and sell shares without the assistance of a brokerage. In this instance the company whose stock has been immensely devalued could choose to offer a tender offer at the new low stock price (post proposal implementation), and investors would likely have no other option than to sell at an artificially reduced price. This would truly be a perverse outcome, no? In this instance the SEC would be rewarding companys that dont regularly report and punishing that companys shareholders - the exact opposite intention of the proposal
Furthermore, bad actors will always find a way to manipulate stock prices whether they have regular reporting or not. As an example, in August 2018 a small Ohio company called Avalon Holdings (NYSE: AWX), which is a NYSE registered company saw its stock price surge from $2.22 on July 24th, 2018 to over $20 a share on July 30th just four trading days later. On July 31st, a day after trading over $20, the stock had crashed back down to $3.30. Avalon, which had approximately 3.8 million shares outstanding, and around 3.2 million shares that werent owned by the company, had average volume for the company of around 10-20,000 shares per day. However, during the price spike, and resulting drop, volume was in the millions of shares per day - including an eye popping 13.6 million shares on July 27th, 2018 and 22.1 million shares on August 10th, 2018. The only news during that time period was the fact that a company named MintBroker International according to a form 4 filing on July 27th, 2018 reported owning 45% of the companys stock. Avalon Holdings for its part sued MintBroker International for price manipulation.
Additionally, it seems Pollyannaish to think that regular SEC filings of a companys financials will protect shareholders from fraud. Last time I checked, Worldcom, Enron, AIG, Bear Stearns, and Lehman Brothers all filed timely 10-Ks and 10-Qs. These filings didnt exactly protect shareholders from those companies going bankrupt (or near bankrupt) due to poor internal controls and an opacity surrounding certain valuation techniques and accounting practices. Despite an army of large institutions and ratings firms analyzing these companies, most sophisticated firms were unable to accurately value these companies and asses their true risk. The reason for this is that the fundamental valuation of many of these companies is nearly impossible for sophisticated investment firms, let alone retail investors.
As an example, if we look at Citigroup, in the month of December 2019 alone Citi had over 250 SEC filings. Their most recent 10-K was 305 pages, not including additional exhibits. Keep in mind that exhibit 21-4 on that same 10-K, indicates that the company has 81 subsidiaries across the globe incorporated in places like the Cayman Islands, Mauritius, and the Bahamas among other places. If we are going to force all OTC securities to file regular reports with the SEC, then why wouldnt we force all subsidiaries of publicly traded companies to file as well? Arent these reports just as material? Im not trying to pick on Citigroup, but I would argue that an investor on their own can never truly gauge the true risk profile of Citi (or any other large multi-national corporation) because they can never dig into the details on all of the subsidiaries that a company owns which could be hiding material information to shareholders.
Contrast Citi up against many of the firms on the OTC like J.G. Boswell. These OTC firms are generally only involved in a handful of business operations, have minimal if any subsidiaries, and have easy to read balance sheets, income statements, and statements of cash flow. If anything, I would argue smaller investors are better off investing in these types of firms, than investing in individual fortune 100 companies. At least they stand a chance of understanding the company.
All of the above is to say please dont paint all OTC securities with the same brush, they are not all shell companies being used for nefarious purposes. The same way not all Fortune 100 companies are destined for bankruptcy because they have a byzantine maze of complex financial reporting. Many OTC companies are wonderful and thriving business, which do offer audited financial statements to their shareholders.
Lastly, I echo two commonsense solutions that other commenters have made for this complicated matter. The first solution could be for investors to check a box prior to buying or selling any OTC security stating that they understand and agree to the risk involved with purchasing these assets. The second solution is to change the qualifications for the number of shareholders from "Shareholder of Record" to "Beneficial Shareholder". That would force many companies to report, but wouldn't force dealers to stop providing quotes, and would not harm existing shareholders in these companies.
Thank you for your time and consideration of my comment.
Best Regards,
James Duade