0001
 1            U.S. SECURITIES AND EXCHANGE COMMISSION
 2   
 3   
 4   
 5   
 6          ROUNDTABLE ON THE EXECUTION, CLEARANCE AND
 7               SETTLEMENT OF MICROCAP SECURITIES
 8   
 9   
10   
11   
12   
13   
14                   Monday, October 17, 2011
15                           1:00 p.m.
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21   
22   
23            U.S. Securities and Exchange Commission
24             100 F Street, N.E., Washington, D.C.
25               Station Place 1 Multipurpose Room
0002
 1   PARTICIPANTS:
 2   
 3   Mary Schapiro, Chairman
 4   Robert Khuzami, Director, Division of Enforcement
 5   R. Cromwell Coulson
 6   Harold Crawford
 7   Peter Curley
 8   Susan DeSantis
 9   Chris Ehrman
10   David Feldman
11   Aaron Fox
12   Susan Grafton
13   Sarah Green
14   Jeff Horowitz
15   Lynne Johnston
16   Brian Lebrecht
17   Susan Merrill
18   Thomas Merritt
19   Mihal Nahari
20   Steven Nelson
21   Bill Park
22   Marvin Pickholz
23   Betty Santangelo
24   Claire Santaniello
25   
0003
 1   PARTICIPANTS (CONT'D):
 2   Chris Stone
 3   Walter Van Dorn
 4   Steve Vitulano
 5   W.T. Ryan Wilson
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0004
 1                        C O N T E N T S
 2                                                        PAGE
 3   Call to Order and Opening Remarks                      5 
 4   Panel 1:  Compliance Challenges Associated            11 
 5             with Microcap Securities
 6   
 7   Panel 2:  Anti-Money Laundering Monitoring            64 
 8   
 9   Panel 3:  Potential Changes to the Regulatory        111 
10             Framework Concerning Microcap Securities
11   
12   Concluding Remarks                                   160 
13   
14   
15   
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23   
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0005
 1                     P R O C E E D I N G S
 2             MR. EHRMAN:  Good afternoon, everyone, and
 3   thank you all for coming to the microcap fraud working
 4   groups.  
 5             First roundtable on the execution, clearance,
 6   and settlement of microcap securities, I know this is an
 7   important issue to everyone.  And I would like to thank
 8   Chairman Schapiro and the director of the division of
 9   enforcement, Robert Khuzami, for coming out to support
10   this initiative.  
11             And now I would like to turn it over to the
12   chairman.
13             CHAIRMAN SCHAPIRO:  Thank you very much.  Good
14   afternoon, everyone.  I am very pleased to open today's
15   roundtable discussion on the execution, clearance, and
16   settlement of microcap securities.  We are really
17   grateful that so many respected and experienced market
18   professionals have agreed to participate as panelists in
19   today's discussion.  
20             For those of you who are sitting out there,
21   your ideas and opinions will be very important to us, in
22   helping to illuminate the path that the agency may choose
23   to follow in this area.  And I thank all of you for
24   taking the time to attend.
25             We at the Commission are interested in the
0006
 1   unique regulatory issues that surround the microcap
 2   market.  Microcap securities and the over-the-counter
 3   market where they typically trade do offer small and
 4   growing companies access to our capital markets to allow
 5   them to raise money to fund their operations.
 6             At the same time, however, microcaps and the
 7   OTC market present increased risks to investors that the
 8   SEC has a deep interest in monitoring.  Indeed, the
 9   microcap market has been prone to fraud and manipulation,
10   most often in the form of pump-and-dump schemes.  These
11   continuing incidents of fraud are detrimental to the
12   market and investors, and are a serious concern which is,
13   of course, why the SEC created the microcap fraud working
14   group, to try to focus our efforts on combating microcap
15   fraud and strengthening this marketplace.
16             The volume of activity in the microcap market,
17   however, makes it difficult for the SEC to monitor
18   trading as closely as investors and other market
19   participants deserve.  And so, the market participants
20   who are tasked with clearing and settling trading
21   activity on the over-the-counter market play a very
22   important role in protecting the integrity of the
23   microcap marketplace, and they face unique
24   compliance-related challenges in processing microcap
25   transactions.
0007
 1             Today we will focus on those challenges, and
 2   explore ways in which the SEC can work with market
 3   participants to minimize the risk of fraud and other
 4   abuses, and bolster investor confidence in the market.  
 5             Our panelists represent a range of
 6   constituencies from financial services industry,
 7   including clearing firms, custodial banks,
 8   broker-dealers, FINRA, DTCC, AARP, and the securities
 9   bar.  We are privileged to have them here today and
10   grateful for the effort they have made to take part in
11   the roundtable.  And I look forward to a spirited and a
12   thought-provoking discussion.  
13             And with that, I will turn the roundtable over
14   to Robert Khuzami, director of the SEC's division of
15   enforcement, who will provide some additional opening
16   remarks.
17             MR. KHUZAMI:  Thank you, Chairman.  And
18   welcome, everyone.  I too would like to welcome you all
19   to the roundtable.  
20             I think one thing that we could probably all
21   agree on when it comes to the over-the-counter market: 
22   people have very strong opinions about it.  And, maybe
23   more so, people are not at all shy about expressing them. 
24   Investors have extremely passionate views about, so
25   passionate that I think a large percentage of the
0008
 1   enforcement division alone can attest to receiving emails
 2   every hour of the day or night, weekends, holidays,
 3   during major disasters, births, deaths, whatever it is. 
 4   The flow in our Blackberries on commentary about activity
 5   in the over-the-counter market is unceasing.
 6             And like the chairman says, we recognize the
 7   potential for that market to assist in capital-raising
 8   and providing liquidity and other advantages.  But in
 9   enforcement, unfortunately, we know the market as a
10   subject and source of a large amount of fraud.  The
11   30,000 or so, roughly, tips, complaints, and referrals
12   that we get each year, a large percentage of them deal
13   with activity in the microcap markets.  And we are all
14   familiar with the pump-and-dump schemes; that is the most
15   common form of fraud and misconduct in those markets.  
16             And I think we took a fresh look, at the
17   chairman's urging, to decide how to look at this problem
18   that has been around for a long, long time.  It was a
19   major source of the work I did as a prosecutor in New
20   York in the 1990s, and it is unchanged even now. 
21             And so, we set up the microcap fraud working
22   group as, really, a way of attacking the problem with new
23   strategies and new focus, primarily focused on trying to
24   be proactive and use data and intelligence and
25   coordination within the agency and with our regulatory
0009
 1   partners and others outside the agency to try and figure
 2   out a better way to deal with the problem.
 3             And so, we are looking at better ways of
 4   gathering information, using that information to develop
 5   strategies, primarily -- or at least in part -- focusing
 6   on gatekeepers, those participants in the markets who we
 7   think are not living up to their regulatory obligations,
 8   or with whom we can combine forces in order to get rid of
 9   the bad apples in the market and make it a vibrant and
10   effective market that achieves its purposes.
11             We are also, in the working group, looking at
12   improved rule-making and legislative affixes to give us
13   the tools we need to achieve that goal.  I think what it
14   has taught us, primarily, is kind of an issuer-by-issuer
15   approach in the enforcement division -- which has been
16   the historical model, historical enforcement model, get a
17   tip about one issuer, investigate it, figure out which of
18   the thousands that you get are most worthy of further
19   investigation in a world of limited resources, and 18
20   months later perhaps bring in a case against individuals
21   after which investor money is lost and the perpetrators
22   may be on to the next fraud already -- that is a model
23   that we didn't think was particularly effective.
24             And so, this working group is really trying to
25   change that through the use of analytics and intelligence
0010
 1   and better information.  So we hope, with today's
 2   roundtable, that we will learn a lot from all of the
 3   speakers here today.  Like Mary said, a really great
 4   line-up of panelists and experts from the securities bar,
 5   from the industry, from FINRA, from DTC.  
 6             We also have, from the agency, Sarah Green,
 7   from the office of market intelligence; Peter Curley,
 8   from trading and markets; and Chris Ehrman and Steve
 9   Vitulano from the microcap fraud working group, who are
10   going to be monitoring the panels.
11             We really value your opinion.  This is not just
12   checking the box, but the information, the opinions you
13   have, the insight you provide really will go a long way
14   toward helping to inform how this working group does its
15   work, going forward.  And so, I know we host every year
16   in February a two-day event called SEC Speaks.  Well, you
17   can say that today is SEC Listens.  And we are here to do
18   that, and we urge you to speak as frankly and openly and
19   as with much candor as you can, because that is the best
20   way that you will provide value to the Commission.
21             So, thank you, Mary.  And thanks to all the
22   commissioners, also, who have supported this with
23   resources.  And I wish you luck.  And I turn it back over
24   to Chris.
25             MR. EHRMAN:  Okay.  Thank you very much,
0011
 1   Chairman Schapiro.  Thank you very much, Rob, for coming
 2   out.  And again, we appreciate your unwavering support
 3   with this initiative.  And thank you so much.
 4             And now I would like to invite our panelists
 5   for the first panel, panel one, compliance challenges
 6   associated with microcap securities, to be moderated by
 7   Peter Curley.  If you could, please come forward.  Thank
 8   you.
 9               COMPLIANCE CHALLENGES ASSOCIATED
10                   WITH MICROCAP SECURITIES
11             MR. CURLEY:  Good afternoon, everyone.  I am
12   Peter Curley, and I am associate director in the division
13   of trading and markets.  My particular focus is on
14   clearance and settlement matters, so I am particularly
15   pleased to see so many people here today to discuss this
16   important subject matter.
17             As the chairman and Robert have indicated,
18   there are a number of themes that interact in connection
19   with the issuance and trading of microcap securities, and
20   they include:  facilitating capital formation; protecting
21   investors; ensuring compliance with securities laws and
22   regulations, and maintaining the efficiency and integrity
23   of our national market and clearance systems.
24             These matters are not just aspirational.  They
25   are fundamentally defined by the actions and interactions
0012
 1   of individuals in the securities industry with their
 2   customers and each other every day.  
 3             The ultimate objective in improving business
 4   practices in an area like this is to maintain the quality
 5   of the marketplace, and thereby ensure investors from
 6   this country and around the world who continue to entrust
 7   their hard-earned savings to privately-owned and operated
 8   businesses in our economy.
 9             This is necessarily a collective effort.  And
10   for our first panel today we are very fortunate to be
11   joined by a number of accomplished professionals from
12   different areas of the securities industry.  They will
13   help us to discuss compliance challenges associated with
14   the microcap sector, in particular, and help to set the
15   scene for the discussions on the other two panels.
16             All their biographies are on the SEC website,
17   so I won't take time out from the discussion to introduce
18   them individually.  But we will ask them each to
19   reference their background as part of their remarks, when
20   appropriate.  
21             So, to start off with, I would like to ask
22   Brian if you could please provide some perspective from
23   the point of view of microcap issuers, in particular.
24             MR. LEBRECHT:  Thank you.  Thank you, Chairman
25   Schapiro for being here today.  And I want to start by
0013
 1   thanking my fellow panelists.  We have already spent a
 2   fair amount of time discussing these issues.  And I want
 3   to assure the audience here and elsewhere that I feel
 4   confident that there is going to be some solutions
 5   reached here, and it is going to take place outside of
 6   this panel.  But the relationships have been established,
 7   and I am excited for what is going to happen over the
 8   next weeks and months in this area.
 9             I am a private practice attorney, and so I
10   represent primarily issuers.  I do represent some
11   broker-dealers in this space, as well.  And so I am on
12   the street, I guess, between the companies where
13   investors purchase securities, or make an investment, and
14   then the broker-dealers, the retail accounts where they
15   attempt to trade those securities.  And that is an area
16   where there has been a tremendous amount of friction
17   lately.
18             I sent out a reminder, an inquiry, to clients
19   and other contacts of mine when I was chosen for this
20   panel, asking for feedback.  And I was, you know,
21   bombarded with information from people.  But three themes
22   really emerged in this area, and so I want to put those
23   on the table today, right at the beginning.  And I won't
24   speak a whole lot more after I put them on the table,
25   because I know that a lot of the solutions and the
0014
 1   commentary comes from that end of the panel down there,
 2   not from me.
 3             But one was communication and transparency. 
 4   You know, issuers and transactional lawyers and issuers'
 5   counsel, we like rules and guidelines and checklists. 
 6   You know, give us a checklist and deadlines and dates,
 7   and we will jump through hoops to comply with that.  I
 8   think one of the frustrations that I hear is that as
 9   different organizations are attempting to tackle the
10   fraud and the risks in this marketplace, from the
11   issuer's perspective, it is not uniformly communicated
12   back to us what we are supposed to do.  
13             So I think that is number one, is here is the
14   ways that, for example, your security might be subject to
15   a chill from DTC.  And if that happens, here is how to
16   get that removed.  Here is the people to contact.  Here
17   is the documentation that you need to provide.  From a
18   broker-dealer perspective, you know, 0905, the FINRA
19   release, was -- you know, uses the word "reasonable"
20   again and again and again.  And I think, initially,
21   people felt like that was a regurgitation of rules that
22   people already understood.  But over time, I think -- and
23   people have gotten themselves worked up to where they
24   don't understand what that really means.
25             So, again, here is the information you should
0015
 1   have in your file, here is the questions that you should
 2   ask.  If this -- if you find this, and if you find this,
 3   then you need to go to level two and you need to ask
 4   this.  So that is number one, communication and
 5   transparency.
 6             Number two is surrounding the deposit of
 7   certificates.  From an issuer's perspective, you know,
 8   the fundamental simple concept of an investor goes to a
 9   company and makes an investment and gives his money to
10   the company and receives back a stock certificate, and
11   somewhere down the road, after a holding period or a
12   registration or whatever, that investor's intention is to
13   liquidate that security, and there is a breakdown in
14   that.
15             And so, investors can't do that.  The deposit
16   of certificates is getting more and more difficult.  The
17   paperwork behind that is increasing, and that is creating
18   frustration between those -- between the parties, the
19   investor community and the issuer community.  That is
20   raising the cost of capital, and making capital less
21   available to smaller issuers.
22             And then lastly, I think the third theme in
23   this came more from broker-dealer and transfer community,
24   is the attempts to shift liability in this area.  I think
25   a lot of people feel like they are the ones that are now
0016
 1   being made responsible for this and this and this.  
 2             It didn't use to be that way, they don't want
 3   to be the gatekeeper.  But if they do, they feel like
 4   there is an assault on them, in terms of shifting
 5   liability.  And I will put it out there that some of the
 6   organizations on this panel, you know, are the ones that
 7   are being accused of doing that.  So -- but different
 8   people in the chain of command feel like liability is
 9   being put back on them when they don't feel like they
10   have the resources to properly address that.  
11             Those are the three issues that surfaced in my
12   communications over the prior couple weeks.
13             MR. CURLEY:  Thanks, Brian.  Marvin, do you
14   want to weigh in next, and give us a little perspective
15   from your point of view?
16             MR. PICKHOLZ:  Sure.  But I would just like to
17   start by echoing something that most people from the
18   Commission start with, which is any views I express are
19   not my firm's, they are not necessarily partners' views. 
20   They are not necessarily any clients' views.  And, in
21   fact, they might not necessarily be my views.  Don't hold
22   them against me if I take a different position at some
23   point.
24             I guess -- and I wanted to make that
25   disclaimer, because I view this as an opportunity to
0017
 1   share some knowledge which may require us to tell you
 2   things that we have seen, and kind of take off the
 3   advocate's hat that you may be charged with wearing
 4   sometimes, and communicate with the staff the activities.
 5             And I heard some of what was just said about
 6   reasonableness, and I have seen the writings about red
 7   flags, and I am going to stay away from that, because I
 8   suspect that that is an issue that is far from being
 9   done, certainly given some Supreme Court cases that go
10   back a while.
11             I also understand that people don't want to be
12   gatekeepers.  But somebody has got to be responsible here
13   somewhere.  And maybe it is a combination of everybody
14   being responsible.  Because if you -- my view is if you
15   chop it up into little pieces, then everybody is looking
16   through a pin dot in a piece of paper, and nobody sees
17   what the real picture is, and nobody has responsibility
18   for it.  
19             And you overlay that with the words like "due
20   diligence," even when I was on the staff I always thought
21   that was such a nonsense phrase because, in my mind, an
22   accountant or a lawyer cannot do due diligence if you
23   don't have a client that you trust, or you don't know
24   what the client is doing.  And the people that Rob is
25   dealing with in some of these issues, the troublesome
0018
 1   issues, are not exactly telling their lawyers or their
 2   accountants or anybody else what is really happening and
 3   what the real game plan is here.
 4             So, I think you kind of have to put everybody
 5   together in a way that creates a total picture without
 6   creating additional liability.  I mean right now you get
 7   letters coming in to transfer agents and law firms
 8   saying, "You have told me the following facts.  And if
 9   these facts are true, then my opinion is X.  But if, of
10   course, if it's not true, then my opinion may be
11   something else."  And to my mind that is worthless,
12   because, you know, if you have the honest client, the
13   client is going to tell you what the truth is.  
14             If you don't have the honest client who is
15   sitting offshore someplace, whether that is China or the
16   Caymans or the straits off of Africa, they're going to be
17   telling you what you want to hear and what they think you
18   need to hear.  And only if we all work together to put
19   the picture together will it work.
20             In terms of shifting responsibility and nobody
21   has the ability to look at the whole picture, that's
22   probably true.  I don't know of any private lawyer that
23   has the power and the ability of the government to look
24   at something.  I certainly can't issue subpoenas or call
25   a prosecutor, or have an FBI agent or somebody go out and
0019
 1   talk to somebody.
 2             But one of the ways that we may deal with this,
 3   and perhaps get a better feed of information --
 4   certainly, I think, from transfer agents -- is to kind of
 5   adopt the concept that I guess Betty and her panel will
 6   talk about, which is the concept of the suspicious
 7   activity report.  If they see something, perhaps they
 8   ought to be able to file a report with the Commission or
 9   somebody else that says, "We are seeing this transaction. 
10   We are reporting it to you.  Clearly, we don't have the
11   ability to go and investigate it."  
12             And if it turns out that they have caught
13   something or reported something to you and it was a bad
14   situation, then that should be a pass for them, because
15   they did what they were supposed to do.  If they don't do
16   that, well, I guess they are taking a risk.  But I think
17   you almost need to open it up to -- from my point of
18   view -- to a group of people, each of whom is adding
19   something to the pie, so that somebody gets to look at
20   the entire pie.
21             MR. CURLEY:  Thank you.  And, Steve, I am just
22   going to skip past you for now, but promise to come back
23   and give you plenty of time in due course.  But I wanted
24   to ask Tom and Claire to come in at this point, and maybe
25   starting with you, Tom, from your perspective.  Can you
0020
 1   share a little bit about what you see in the transaction
 2   chain, and how you take those things into account as
 3   you're handling transactions of different kinds?
 4             MR. MERRITT:  Sure, Peter.  And first I would
 5   like to thank Chairman Schapiro for having me here today,
 6   and giving the group an opportunity to hear from a
 7   market-maker in the course of the issue that we are
 8   discussing.
 9             I think what's important to know is the
10   position that the market-maker plays in the marketplace. 
11   We do not -- specifically, Knight does not -- have the
12   customer information that an order entry firm would have. 
13   And, therefore, we have limited sort of resources to look
14   into sort of the background behind the customer, what the
15   customer's history has been with respect to the
16   particular security, and other factors that may be
17   important in the scope of reviewing a transaction.
18             So, the way that we approach this is we do look
19   at the order.  We look at the order size.  We look at the
20   order, as compared to the trading volume in the security
21   on that particular day, or during a course of time.  And
22   we evaluate it in that regard.  And that is really the
23   best that we can do, for the most part.
24             I think what Marvin has raised is an excellent
25   point, and I think the effective way to handle this issue
0021
 1   is on a collective fashion, which each participant, in
 2   their role in the marketplace sharing that information,
 3   and maybe at the end of the day sharing that with a
 4   regulator, specifically the Commission, where the
 5   Commission has the resources and ability to look into the
 6   particular facts and do a cross-evaluation that others in
 7   the marketplace would not have, I think that is certainly
 8   a way to approach this situation.
 9             I don't know, Claire, if you agree with that.
10             MS. SANTANIELLO:  I absolutely agree.  So I am
11   presenting this from the perspective of a clearing firm,
12   and we are in a little bit of a unique situation, as a
13   clearing firm, because we also are working with
14   introducing brokers who are interacting with our clients
15   and requesting that we process transactions on their
16   behalf.  And we more or less are providing them with
17   technologies, and providing execution at their option,
18   clearance and settlement of their transactions.
19             And it is a little bit unique, because every
20   time we see a red flag or something happening with
21   respect to a particular transaction, we need to work
22   very, very closely with the introducing firm to learn
23   more, because they are the ones with the responsibility
24   for knowing their client, and they are the only ones that
25   can provide information, relative to what that client is
0022
 1   and, in the case of microcap securities on the sell side,
 2   where it is that the client received the securities from,
 3   how did they obtain the shares, when did they obtain the
 4   shares, what do they intend to do with the shares.
 5             And from that information that we glean, we
 6   perform various analyses to try to see if there is any
 7   combination of information about the people involved in
 8   the transaction, because that is usually where the
 9   pattern starts.  We find that our experience tells us
10   there is usually typically only between 10 to 12 people
11   that are behind most of the problematic situations that
12   we see, though sometimes that is not always true.
13             But you know, it does lead to a bit of data,
14   and it is hard sometimes to get that information because,
15   as several people have pointed out already, not all of
16   the issuers are as transparent about what is going on, or
17   around who is really behind the securities, and we have
18   to spend a lot of time working with our introducing
19   brokers to try to ferret that information out.
20             So, we also see issues, though, conversely too,
21   on the pump side, where we are providing, obviously,
22   technology for our introducing firms to process
23   transactions.  We were seeing issues around people being
24   able to take over accounts and be able to, through very
25   organized and sophisticated cyber fraud schemes, be able
0023
 1   to place transactions without a client's authorization or
 2   knowledge in order to pump up the security, in presumably
 3   for somebody on the other side to be dumping it.  And you
 4   know, put in a lot of extra enhanced security controls
 5   and other edits for introducing brokers to use to
 6   mitigate risk.  
 7             But, you know, it doesn't -- it is not 100
 8   percent guaranteed, and you always have to try to step
 9   one step ahead of these issues and challenges to try to,
10   you know, protect the marketplace. 
11             But I do agree with all the sentiments so far
12   here, that we all play a role together.  I do really
13   welcome what I heard before about -- from Robert -- about
14   a more holistic approach in technology, because I think
15   there is different pieces that all of us can add.  And if
16   we had the ability to report it up and give either the
17   Commission, an SRO, or some other party the ability to
18   look more holistically at shifts and patterns and trends
19   and scoring of persons associated with transactions and
20   other things, it would probably be the right solution to
21   try to hone in on issues, and perhaps even halt trading
22   before the problem starts.
23             MR. CURLEY:  And, Claire, just to ask you to be
24   a little bit more specific on two things, which is, what
25   exactly will you do when you find problematic activities,
0024
 1   or things like that come to your attention?  What are
 2   your options, and how do you put them into action?
 3             And then, second, who do you communicate the
 4   concerns to?  Are there people in the transaction chain
 5   that you tend not to communicate with very much, and
 6   those you communicate with more?
 7             MS. SANTANIELLO:  Well, first, what we
 8   typically do is, A, we provide reports and tools to the
 9   introducing broker, to help them help themselves.  And we
10   also have some real-time interdiction tools that help add
11   certain parameters around transactions and things, to
12   help them get in front of large transactions and other
13   things that can be problematic.  But we also respond to
14   red flags and look for certain things in our
15   surveillance.  
16             In any case, we reach out to the introducing
17   firm, especially around large deposits, of course, and
18   certain things around percentages of ADV and turnovers of
19   shares.  But when we do so, you know, we have to ask a
20   lot of questions about the customer, and what they know
21   about that customer, and their comfort level with the
22   activity.  And often times we have to peel the onion back
23   and ask a lot more information to try to elicit whether
24   there is anything wrong with a particular transaction or
25   not.
0025
 1             And, you know, at that time we can decide that
 2   perhaps we're just not comfortable.  Often times the
 3   introducing broker will also not be comfortable.  But the
 4   conversation is always with them, as they maintain the
 5   primary relationship with the client, who is usually the
 6   one trying to affect the transaction.
 7             And, of course, we also work closely with our
 8   partners at DTCC, because, you know, a lot of the
 9   operational processes that they put in place we have to
10   respond to, as well, in terms of our technology and
11   procedures.
12             MR. CURLEY:  So, Mihal, that sounds like a
13   natural introduction to your space.  So why don't you
14   take it away, if you would?
15             MS. NAHARI:  Well, thank you.  And I would like
16   to echo what my fellow panelists have said, and want to
17   thank the Commission for taking the time and sponsoring
18   this roundtable on what is a very important topic.  And I
19   am here today to bring the perspective of a clearing
20   agency and the central securities depository.
21             And something resonated with me that both
22   Chairman Schapiro and Robert Khuzami said, and that is
23   the safe and sound operation of the marketplace.  And as
24   a regulated clearing agency, our statutory obligation is
25   to do just that, to ensure, not just for microcaps, but
0026
 1   for all securities that are cleared and settled through
 2   DTCC and our clearing agencies, that we bring enhanced
 3   risk mitigation and operational efficiencies.  And it is
 4   through that lens that we respond to our obligations and
 5   the transactions that we see when we process microcap
 6   securities.
 7             I did want to provide some insight to some of
 8   Brian's questions and the themes and concerns that he
 9   raised that are coming from various constituents,
10   relative to communication and transparency.  
11             And I think -- I would hope that everybody on
12   this panel would agree with me, that there isn't really a
13   cookbook that one can write when you are dealing with
14   suspicious activity.  And it comes up in different ways
15   and in different fact patterns.  And certainly we would
16   like to think that we take a very thoughtful and
17   reasonable approach in reviewing all of the transactions,
18   and making a determination that is based on the facts and
19   circumstances of a particular situation.
20             That said, there are certain baseline things
21   that we, as a clearing agency, will look like -- will
22   look at with respect to certain activity.  As a
23   foundational matter, all securities that are cleared
24   through us, in essence, either have to be registered or
25   have to be exempt, pursuant to a legitimate exemption
0027
 1   from registration.  
 2             And I think that part of the difficulty and
 3   struggle in the microcap arena comes in the space of
 4   exemptions and the ability for the clearing agency, once
 5   it detects unusual activity, whether it's a surge in
 6   deposits coupled with increased market activity and price
 7   volatility that we're seeing that causes us to look at a
 8   particular issue, and then be able to determine whether
 9   or not it is properly exempt from registration.
10             That becomes challenging, again, because in the
11   value chain, in the process, the clearing agency is
12   really at the end of the process.  We are doing the
13   clearance and settlement.  And to the extent that there
14   are others who need to be performing the due diligence
15   prior to the transactions even getting cleared and
16   settled, that is where we would like to see some
17   additional partnership and transparency, both with
18   attorneys who are issuing opinion letters, as well as the
19   issuers who are going out and making their securities
20   exempt, to the firms, the broker-dealers, whether it be
21   the introducing firms or the clearing firms who are
22   taking in these orders from customers, who equally have
23   an obligation of due diligence to determine not only
24   whether or not there is a reasonable exemption in place,
25   but whether or not there is compliance with section five
0028
 1   of the anti-fraud provisions.
 2             As somebody once said, it takes a village.  And
 3   no one individual player in this space is going to be
 4   able to root out the problem.  And I think, again, the
 5   collective goal is not to stymie those that are
 6   legitimate businesses that are looking for access to the
 7   capital markets, but, rather, to keep out those that are
 8   creating harm for the rest of us.
 9             I think that there are a number of things that
10   DTCC has done recently in response to some of the
11   dialogue that we have had with various parties.  
12             In terms of our ability to communicate, our
13   primary form of communication is through our participant
14   members, and those who come to us and sponsor securities
15   for eligibility in the depository.  And I would look at
16   that as a primary channel for other players in the chain
17   to establish relationships with, to enable a faster and
18   better process around resolving questions and issues.
19             And I would also echo some of the comments
20   relative to trading.  DTCC does not control in any way,
21   shape, or form, trading.  However, when trading occurs,
22   and isn't stopped at the outset, there is a clearance and
23   settlement responsibility and obligation, and a
24   downstream impact.  And I think that that requires,
25   again, the other constituency in the room to participate,
0029
 1   together with us, in looking at resolving this problem. 
 2   And that is the regulators.  And I am extremely pleased
 3   that we are all here together to try and look at these
 4   challenging issues.
 5             MR. EHRMAN:  Hey, Peter, can I chime in, just
 6   for a second?
 7             Mihal, I was wondering whether you all have any
 8   initiatives in place, or are considering them for the
 9   purposes of educating investors as to what you do. 
10   Because certainly, all of us here at the table can talk
11   about safety and soundness and risks to the marketplace,
12   and things of that nature.  
13             But, unfortunately, we receive a lot of
14   communication -- as do you, I'm certain -- where people
15   sort of view you as this monolith that sort of just shuts
16   them out of the marketplace.  And I don't know whether
17   either there is a failure to communicate that, or a
18   failure on their part to understand it, or sort of what
19   the issue is.
20             Because certainly, we receive a lot of
21   information from investors who are very confused and,
22   quite frankly, rather irate when some of their securities
23   get pulled out of the normal clearance and settlement
24   process.
25             MS. NAHARI:  Yeah.  So I think, again, there is
0030
 1   an opportunity for partnership there, to the extent that
 2   the investors are customers of the broker-dealers and the
 3   firms.  We really need to work together and partner with
 4   them, and we have a number of initiatives underway
 5   through SIFMA an through, quite frankly, a constituency
 6   within DTCC of a number of different firms that have come
 7   to us looking for ways for us to communicate better.
 8             As a result of some of those, for instance, we
 9   have added additional information to our public websites,
10   where folks can go to get additional information on
11   eligibility criteria, the rules and the requirements, so
12   that hopefully it becomes more and more transparent. 
13             So, I don't think we have declared victory. 
14   However, I think we are making strides towards that, and
15   certainly would welcome post-this roundtable, the ability
16   to continue those working groups, both with industry and
17   trade associations, as well as with our members.
18             MR. CURLEY:  Steve, do you want to weigh in now
19   and give us a little bit of your take on the dynamics of
20   the marketplace currently, and areas for improvement?
21             MR. NELSON:  Sure.  Again, I wanted to thank
22   you, Peter, and Chairman Schapiro, for having us all at
23   this roundtable.  I represent the Securities Transfer
24   Association on whose board I sit.  In line with previous
25   comments, I am not sure that my comments will necessarily
0031
 1   represent the views of each and every member of the
 2   Securities Transfer Association, but they do, in fact,
 3   represent the views of my company.
 4             I am interested in the general tenor of the
 5   comments, which are focused on the enforcement side and
 6   that, of course, is important to all of us, each member
 7   in the chain.  But I do want to hearken back to what I
 8   see as problems in the clearance and settlement system,
 9   which we first raised with Chairman Schapiro back last
10   year, and that is, basically, a complete break-down in
11   the clearance and settlement system for small cap
12   issuers, which has been reported to me.  
13             My company represents, give or take, 1,000
14   issuers, Securities Transfer Association members,
15   represent 15,000 issuers, and there are hundreds, if not
16   more, issuers who are not effectively having their
17   securities traded, accepted for deposit, and their
18   shareholders are left without a sufficient trading
19   alternative.
20             So, this situation, in essence, blunts the
21   SEC's express goals of promoting an efficient clearance
22   and settlement system, promoting small issuer formation
23   and capital raising, and promoting investor protection. 
24   So I guess the question is:  How do we interface what we
25   are seeing in the marketplace for microcap and small
0032
 1   issuers who are non-exchange-traded and can't get into
 2   the DTC system, and can't be accepted for deposit by
 3   clearing brokers -- almost all clearing brokers at this
 4   point?  
 5             How do we juxtapose what we are seeing in that
 6   marketplace with the other express goals of the
 7   Commission which are, of course, to protect investors and
 8   to protect the public against fraud and other abuse?
 9             And I think that is really the conundrum that
10   you face, because some could argue that we are, in
11   essence, throwing out the baby with the bathwater in the
12   current state of affairs.  So I do think that Mihal is
13   right, I think each entity in the chain has to come
14   forward and accept responsibility in their own portion of
15   the chain.  
16             And hopefully we can work better to get a more
17   efficient system, but you now have hundreds of issuers
18   who are effectively chilled -- to use DTC parlance -- and
19   the question is whether they are all unworthy, or whether
20   some of them are unworthy and the others are kept out of
21   the system.
22             So, that may be the opposite of what you are
23   trying to explore here today, but it is something that is
24   consistent with oft-expressed goals of the Commission to
25   promote small issuers who are supposed to be, I guess,
0033
 1   the engine driving the train for our economy.
 2             MR. CURLEY:  So, Brian, maybe to bring you back
 3   in here at this point, so we've heard from people that
 4   have described how they are exercising their judgement at
 5   different points in the transaction chain, and, to a
 6   certain extent, eliminating problematic practices on the
 7   ground, as they are happening.
 8             But for an issuer with clean hands who may
 9   experience this -- red flags have come up and they get
10   chilled, in fact, at DTC -- how easy is it, or
11   challenging is it, to work through the system and kind of
12   get trading started again?  And how cooperative, in
13   particular, are broker-dealers, FINRA members, in getting
14   you back on track?
15             MR. LEBRECHT:  Well, I will say that it is
16   improving.  And I will go against my constituency a
17   little bit -- and I am sure I will hear this tomorrow,
18   but -- and defend DTC a little bit.  And, as a result of
19   my communications with Mihal, I think that it is -- they
20   are getting it.  They are getting it, that it's having an
21   effect, and that most issuers want to do the right thing,
22   and most issuers are looking for guidance.
23             I think that there is a little bit of baby with
24   the bathwater in this effect.  But I think that -- you
25   know, DTC, I think, has been put in a position.  And I am
0034
 1   not sure that they were chartered to be in that position. 
 2   I don't know the answer to that question.  
 3             I think it's a little like taking, you know,
 4   the neighborhood music store and saying, "Okay, tomorrow
 5   you're in charge of iTunes," and, you know we presented
 6   them with a big burden that I think they're doing their
 7   best to respond to, but maybe initially weren't prepared
 8   for.  You know, they deal directly with their customers
 9   and a number of organizations, you know, use that
10   parlance, and that they deal with their customers, and
11   that may mean introducing organizations or, you know,
12   FINRA member organizations, or whoever.
13             But I guess I will remind everybody that the
14   ultimate customer are the issuers and their investors,
15   and none of us would be here if it wasn't for those two
16   organizations.  And so, regardless of who our specific
17   customers are, at the end of the day that is -- those are
18   the people that we need to provide service to.
19             MR. CURLEY:  And, Marvin, you had mentioned the
20   legal opinions in your remarks.  So, from time to time,
21   parties may be asked to give challenging opinions with
22   respect to the status of securities after certain events
23   have occurred.  Can you maybe give us a little
24   perspective on how difficult or easy that is to do, in
25   fact, when presented with that request?
0035
 1             MR. PICKHOLZ:  I missed the first part.  When
 2   you're presented with the opinion after the fact?
 3             MR. CURLEY:  Right, when an existing issuers in
 4   the DTC system -- if someone comes to you and asks for an
 5   opinion regarding the status of their securities when a
 6   red flag has gone up, how challenging can that be to kind
 7   of unpack and provide an opinion of that kind?
 8             MR. PICKHOLZ:  Well, let me say that I don't do
 9   that, but I think that it would be extremely challenging,
10   and I think it is also challenging to the lawyer, not
11   just as a lawyer, but as an economic entity.  I mean we
12   all have mortgages to pay, rents to pay, kids to get
13   through school.  So, to some degree it's a business.  
14             But I think that it's challenging, and I think
15   part of what has to happen is you need to take a look at
16   the client and need to say to yourself, "Am I comfortable
17   with this client?"  
18             I mean if that client can't pass the comfort
19   test -- I mentioned this channel island off of Africa  --
20   and somebody came to me and they want to set up a bank,
21   and it's all -- and the requirement is you can never be
22   on the island, you can never have your computers there,
23   you can't keep records there.  And if you remember back
24   to school, binary fission, you get a charter and you can
25   keep splitting that charter up and creating new banks. 
0036
 1   That didn't take me very long -- and they didn't want to
 2   meet with me, they were going to have their agent meet
 3   with me.
 4             So, you know, it didn't take me too long to
 5   think I think I'll pass on this one.  And I think part of
 6   what we as lawyers need to look at is what are we being
 7   asked to do, can we get the information of people
 8   reticent to give it to us.  Are they telling you, "Don't
 9   worry about it?"  Kinds of things that should be setting
10   off a little buzz in the back of your ear.  And if it
11   does, my view is life is too short.  Let them go get an
12   opinion from someone else.
13             MR. LEBRECHT:  Peter, if I can comment on that,
14   we do engage in that practice.  And I think you're
15   exactly right.  There is a gut feeling to it.  But -- and
16   lawyers do need to take responsibility for what it is
17   they're willing to opine on.  
18             And issuers, as well.  You know, issuer
19   transparency of information is something -- is a theme
20   that I think has been up and down this panel, and I agree
21   with that.  And an issuer that is lawyer-shopping or
22   doesn't have a relationship with his lawyer, or isn't
23   interested in that kind of transparent relationship with
24   his attorney is a red flag.  And that issuer may not have
25   as easy of a time through the system as other issuers.  
0037
 1             And that is something that issuers need to
 2   think about, reputation and relationships, and how they
 3   manage those relationships are important.  There are
 4   economic factors, you know, for certain.  And the price
 5   that, you know, a lawyer wants to charge for an opinion
 6   and what an issuer or a shareholder might be willing to
 7   pay are certainly a factor of that.  But I think a lot of
 8   that rests on the issuers, and that is an area where they
 9   need to step up in this discussion, for sure.
10             MS. NAHARI:  Peter, if I could just comment a
11   little bit, because there was some discussion on what DTC
12   accepts, what it doesn't accept, and sort of this concept
13   of us placing chills or restrictions on the processing
14   that DTCC will do for these types of issues, and the
15   comment of baby with the bathwater.  And I just want to
16   give some statistics, so that it's -- we put that baby
17   and bathwater into context.
18             So, year-to-date in 2011, DTC has made 2,400
19   equity securities eligible.  Five of those have been
20   denied for compliance-related reasons.  And just to even
21   hone that in a little bit more, 180 of those would be
22   considered as we consider microcap -- and we define
23   those, I think, quite narrowly as under a penny; I have
24   actually heard everybody go to everything from under
25   $5 -- and so that is, you know, about 3 percent.  So if
0038
 1   you turn that around, that is 97 of those that have come
 2   to us for requests of older eligibility actually have
 3   been accepted, in terms of review.
 4             And just so that the audience appreciates,
 5   there is two processes for eligibility at DTC.  There is,
 6   obviously, an IPO issuance, and then there is what we
 7   call an older eligibility process, where the securities
 8   are already in the marketplace, and now they're coming in
 9   to DTC, a participant is sponsoring them to come into the
10   depository and to the clearing agencies to avail
11   themselves of the efficiencies of processing through DTC. 
12   And that's called our older eligibility process.
13             Again, just to get out context, there are 3.6
14   million DTC-eligible securities today.  And we have
15   placed compliance restrictions on approximately 500 of
16   those.  And that actually represents -- and obviously,
17   given fluctuation of pricing -- but less than one percent
18   of all securities trading under a dollar.
19             Now, that's not to say that there aren't
20   problems, issues, and questions, and a need for to all
21   get together to make sure that even without those few
22   that we might be rejecting, we're looking at all the
23   facts and circumstances, and we are facilitating the best
24   kind of communication and transparency.  But I do think
25   that we're doing a very good job at making sure we're not
0039
 1   throwing baby out with the bathwater.
 2             MR. CURLEY:  Claire, you'd mentioned the role
 3   of technology, and maybe the unexpanded role of
 4   technology having a role to play here.  Can you tell us a
 5   little bit about your processes?  I mean we've heard also
 6   some comments about the application of judgement.  And
 7   what I'd be interested in hearing is how you combine
 8   statistical data, other information that you're
 9   collecting, with the more judgement-oriented aspects of
10   your review.
11             MS. SANTANIELLO:  Sure.  Typically we look at
12   things that are over a certain size and that represent a
13   certain part of the marketplace.  But then, when we drill
14   down and look at further information, specifically around
15   deposits, we do notice certain trends, whether it's where
16   the source of the shares were coming from, whether they
17   were exploiting, perhaps, some exemptions in reg D or
18   other places, whether perhaps there are certain people --
19   and it's usually the people that are the biggest red
20   flag.  
21             And they're not going to say that they're that
22   person.  They typically use the name of a close
23   associate, a spouse, they create an elaborate corporate
24   structure behind the ownership that, you know, is very
25   hard to penetrate, but when you do get certain
0040
 1   information you will find out there is an address in
 2   common or other things.  
 3             And trust me when I tell you it's not rocket
 4   science.  We do have to apply a bit of judgement to, you
 5   know, analyze our files and determine certain patterns,
 6   you know, around the particular issue to know that
 7   perhaps it was associated with either another security
 8   that we've had challenges with in the past, another
 9   client that we've had challenges with in the past, or
10   indeed, perhaps the people behind the issuer  -- a
11   promoter, someone like that, perhaps it was counsel for a
12   particular issue that we had challenges with before -- to
13   try to ascertain if there are certain patterns and
14   trends.
15             And, unfortunately, we all have pieces of that. 
16   And I may know certain issues that we've had challenges
17   with.  And, as I mentioned before, it could be the same
18   10 or 12 people, but that could be very different across
19   the whole space.  And if there was a way that, you know,
20   there was more transparency at the issuer level, and that
21   all of us could play a role in providing more information
22   up, that could be analyzed to try to ascertain these
23   problems and issues, you know, before they happen, it
24   would be great.
25             MR. CURLEY:  And, Tom, what about from your
0041
 1   perspective, just on the same theme?  How burdensome or
 2   challenging is it for you to review that type of
 3   information, and how have your processes maybe changed
 4   over time in response to the things that you have seen?
 5             MR. MERRITT:  Well, Peter, I think we do have a
 6   group that analyzes the data, puts it into a system.  And
 7   there is a procedure that we utilize at the firm that
 8   will look at the volume, the size of the trade, or the
 9   shares that may be coming from one order entry firm, and
10   there is analysis that's done.
11             I think one of the things that you should keep
12   in mind is a frustration that we see, is that if we're in
13   the position to prevent a trade from being executed, we
14   will decide that won't accept that order.  That may solve
15   the situation at that moment.  But one of the problems
16   that you see is then the order makes its way to you
17   through another avenue, and you're back to where you are. 
18   So you would go through the same analysis.
19             So, I think it's a constant -- I don't want to
20   say battle, but it's a constant analysis that you need to
21   employ, and you can't just stop at the one order that you
22   may not have accepted, because again, it may come -- you
23   may see it coming through another space.  So, we need to
24   be constantly on our toes in making sure that we're doing
25   an ongoing evaluation of orders in this space.
0042
 1             MS. SANTANIELLO:  I would like to echo that,
 2   because we do see quite a trend where they get smarter
 3   and smarter, and you've really only mitigated the risk at
 4   any one point in time, but it just shifts the risk
 5   elsewhere.  And I know what you mentioned before, that,
 6   you know, clearing firms are coming up with policies that
 7   make it harder and harder to deposit things.  
 8             But, you know, that bar is going to also
 9   continually probably raise, because as soon as they find
10   out what the policy is -- and again, this is only a few
11   bad actors, I am not trying to refer to the marketplace
12   in general -- but as soon as they figure out what the
13   pattern is and what you look for and what you do, they
14   very quickly evolve and try to do the next thing.  And we
15   also see more and more of them going offshore, too, and
16   then trying to come back onshore through different
17   mechanisms.
18             So, it's not that simple, and it's usually the
19   same people.  A lot of them have been barred from the
20   industry already, but they still find ways to get
21   themselves affiliated with our business.
22             MR. CURLEY:  So, Steve, if I can ask you to
23   come back in here at this point maybe and -- how does it
24   feel, or what's your experience, in terms of the way the
25   issuers and your clients experience those types of
0043
 1   reviews and, in particular, the changing standards that
 2   were just described for legitimate reasons that need to
 3   be employed to deal with the dynamics that they're
 4   looking at.  But what are some of the perspectives from
 5   your clients on that type of dynamic?
 6             MR. NELSON:  Well, let me say, Peter, that, you
 7   know, my clients run the spectrum.  If you're talking
 8   about 1,000 issuers or 15,000 for the Securities Transfer
 9   Association, if you're talking about exchange-traded
10   issues, those generally are not going to be in the
11   discussion, because they are mandatorily in DRS and the
12   DTC FAS system.
13             But insofar as we're talking about the microcap
14   space, there are many, many issuers who are, for want of
15   a better term, on the firing line on these issues, either
16   because they have been chilled or they're in the process
17   of review and don't get answers.  And Mihal and I have
18   spoken about this, and I think we actually can make some
19   headway on trying to make that process more transparent.
20             What our issuers have seen over the past two
21   years is they apply, they get an answer back after a
22   protracted period of time which says, "You've been denied
23   fast eligibility."  "What's the reason?"  "We can't give
24   you the reason.  Our risk assessment says you're out."
25             There is no right of review and there is no
0044
 1   right of appeal, and they don't have a reason.  So,
 2   sometimes the transfer agent will get involved in that
 3   process, because the issuer kind of throws up their hands
 4   and says, "Well, what do we do now," and we say, "Well,
 5   go back to your participant," and that's where Claire and
 6   the clearing brokers are on the firing line.  And, in
 7   essence, what happens is you're in a ping pong game where
 8   there is no information flowing back and forth.  
 9             So I think, in both directions, there can be an
10   improvement.  In the one direction, I do think that DTC
11   should be more transparent in trying to provide us -- us
12   meaning the universe of transfer agents, their issuers,
13   perhaps the participant who, after all, is really the
14   primary sponsor of that issue -- with some indication
15   which will not compromise DTC's risk metrics and open
16   them up so that the bad actors can see where the holes
17   are in their system, but give some indication back to the
18   issuer side of the transaction, so that they can provide
19   more information if, in fact, they're a legitimate
20   issuer, if there are opinions that are at issue, if there
21   are transactions, specific transactions, which constitute
22   red flags for DTC.  
23             Maybe there can be an effective and transparent
24   interchange of information.  Right now there is no
25   effective interchange of information once the participant
0045
 1   makes the application, and it is denied.  So I think we
 2   can improve that.  From our side, I think the Securities
 3   Transfer Association -- and I believe the DTC -- is
 4   genuine that we can come up with a better mousetrap
 5   without compromising their risk metrics internally in a
 6   deleterious way.
 7             And the other side of the coin is, you know,
 8   transfer agents come in different flavors, as well. 
 9   There are the large transfer agents, of which there are
10   five or eight in the country which handle 98 percent of
11   all shareholder records on the registered side -- DTC
12   holding the street side.  And then there are 100 smaller
13   transfer agents.  So all of them are regulated by --
14   assuming they've registered, they're regulated by the
15   SEC.  But not all of them, for instance, are banks. 
16             So, there are those who are banks who are
17   regulated by banking authorities and fall under AML, BSA,
18   and other acronyms in the alphabet soup of regulation,
19   which require them to do all kinds of due diligence and
20   regulatory oversight.  But for those transfer agents who
21   are not banking institutions or financial institutions,
22   as that term is used for those regulations, then the bars
23   are a little bit different.  And I think the interchange
24   of information and the responsibilities on those sides
25   are a little bit more ambiguous.
0046
 1             MR. EHRMAN:  I'm sorry to interrupt.  If I
 2   could -- Ryan, how's it going?  This is Ryan from the
 3   AARP.  Again, we're all industry folks, and I think
 4   sometimes we get into our own industry-speak when we're
 5   talking about communication.  
 6             But I think, to echo the chairman and Rob
 7   talking earlier about protecting investors and
 8   communicating with investors, Ryan, I was hoping maybe
 9   you could weigh in a little bit, give us your assessment
10   as to how well we are communicating with investors, and
11   maybe what we could do better to make sure that we are
12   communicating with them more effectively.
13             MR. WILSON:  Thank you.  And I'd like to thank
14   Chairman Schapiro, as well, for having us here today --
15   we were kind of a late invite, to make sure that we also
16   were here -- and my fellow members of the panel, for
17   being here as well.
18             I represent a small membership organization of
19   the 50-plus population.  So we have approximately 38
20   million people.  I'm sure there is at least one person
21   with whom -- who might disagree out of our membership
22   with some of the things that I might say, but I will
23   speak on behalf of the retail investor.
24             And I think one of the themes that I heard
25   throughout many people's comments today have been about
0047
 1   communication and transparency.  And for the retail
 2   investor, remembering that that person is actually saving
 3   or investing toward an end, and not just because he or
 4   she is investing because, you know, investing is fun or
 5   investing is cool, but because he or she has children who
 6   are going to college, or wants to retire, and may want to
 7   retire, you know, somewhat comfortably, et cetera,
 8   transparency in the system is paramount.
 9             And I think one of the things -- it is a
10   challenge for the retail investor to sift out whether,
11   you know, a small cap stock is right for them, or a
12   particular stock is right for them, or a particular
13   company, or a security, or whatever, however, is right
14   for that person.  And finding the channel for doing so is
15   difficult.
16             I did a little bit of research online over the
17   last several days, just to kind of bring myself up on the
18   issues and to find out, you know, who is responsible for
19   these things, and found it kind of hard to do through the
20   requisite channels.  You know, going through the SEC
21   website I found some information.  I found some other
22   information at other websites.  But I found it very hard
23   to do.
24             And I think this is my business, I do this for
25   a living. I am a lawyer, trained as a lawyer, I work in
0048
 1   securities industry and other investment industries, and
 2   it's my business to understand these things.  People
 3   whose business it isn't to understand these things may
 4   have a very difficult time getting the right information
 5   and understanding.  
 6             And putting a perspective again on the baby in
 7   the bathwater, if you're the individual who buys the
 8   baby, it doesn't matter how small the baby is, relative
 9   to the bathwater.  If you've been the person defrauded,
10   that was your life savings, that was the thing that you
11   were going to retire on, or the thing you were going to
12   send your children to college on.  
13             And as I have said many times when I have
14   talked about the idea of getting the right investment, if
15   Mom doesn't get the right investment, Mom moves in with
16   you.  To make it very personal -- and I love my mother
17   very much, but I don't want her moving in with me.
18             (Laughter.)
19             MR. CURLEY:  Well, thank you for that.  And I
20   think we appreciate having that perspective on the panel
21   today.
22             And, Brian, maybe I will come back to you,
23   since you're right here, and ask you to also maybe
24   comment a little bit on the interaction between the
25   company and their investors when it's -- or other event
0049
 1   that -- like we've been discussing happens.  What are the
 2   frustrations that the -- their shareholders, and how they
 3   experience that type of thing directly?
 4             MR. LEBRECHT:  I think one of the -- that's a
 5   communication issue in the beginning.  And often times
 6   issuers hear about it because an investor has been denied
 7   his request to do something to engage in a transaction,
 8   or do a deposit, or something like that.
 9             While DTC does publish, you know, daily updates
10   of information, I think historically that is not
11   something that a lot of us practitioners have been in the
12   practice of going to and checking.  We certainly are now. 
13   But -- and issuers, as well.  
14             So I think what happens is there is a
15   transaction of some sort that happens, it's denied.  A
16   few days go by while, you know, the clearing firm
17   communicates with DTC -- you know, everybody wants to
18   communicate with the person kind of right above them in
19   the chain.  And so the investor has his retail broker,
20   and they have a clearing firm, and there is DTC, and each
21   wants to communicate only with the person above, directly
22   above or below them.  So, sometimes the communication
23   takes days, if not longer, to get back to the shareholder
24   or the issuer that something is in effect here.  
25             And so -- and then, of course, the issuer calls
0050
 1   its counsel, and we try to find out the information and
 2   provide information, and it works back up that chain of
 3   command.  And then there is a response that kind of comes
 4   back down the chain of command.  So it's just not
 5   efficient, I guess, is what I'm trying to say.
 6             I think that everybody now recognizes that.  I
 7   am not sure that everybody understood that a couple weeks
 8   ago, before this panel got together, and I think
 9   everybody understands that, and everybody has an
10   objective to try to make that process more efficient.
11             But it is very frustrating, because issuers or
12   investors, you know, have put themselves out there, you
13   know.  They are -- the AARP's constituency, I mean, if
14   that investor made a decision and gave his money to a
15   company, and no fault of the company and no fault of the
16   investor -- usually, not always -- but no fault of either
17   one of those parties that were engaged in that
18   contractual contraction, that investor cannot liquidate
19   his securities and get his money back, and so he is very
20   frustrated by that.
21             MR. CURLEY:  And Tom, I think as part of our
22   earlier discussions you had mentioned the dynamic of --
23   between clearing and the trading markets, and when we may
24   have some greater ability to impose chills and other
25   restrictions on the clearing process, but maybe not as
0051
 1   much effective tools on the trading.  Does that also kind
 2   of contribute to things you have seen in your experience?
 3             MR. MERRITT:  Absolutely, Peter.  I think one
 4   of the issues created -- and I can understand DTC's
 5   taking the position there should be a chill or a lock  --
 6   but the security is still going to trade.  And, as a
 7   result of that, as a market maker, we are going to be
 8   involved in that business.  And now we're going to be
 9   involved with physical certificates, which is a very
10   difficult process, very costly, and prevents a lot of
11   hurdles, I believe, to the ultimate investor.
12             I think that one of the ideas or potential
13   solutions is -- again, one of the things we've been
14   talking about so far this afternoon is communication, and
15   maybe greater communication between DTC and the SEC, and
16   participants such as us, in making a decision whether the
17   stock should be halted, instead of a chill or a lock. 
18   That would give everyone the opportunity to understand
19   there is a problem with the issuer, and people need to
20   react to that problem.
21             So, for our -- in our sort of viewpoint, it
22   creates -- it does create a risk transference down
23   through the chain to us, and we need to deal with it, and
24   there may be more effective ways to do that.
25             MS. SANTANIELLO:  If I could jump in, Peter, I
0052
 1   completely agree.  I mean I think if at the end of the
 2   day the goal is to protect the investor, and to prevent
 3   the investor from being defrauded, it seems as if there
 4   is a concern or an issue that's raised with a particular
 5   issue, why allow the trading to occur at all?
 6             It is allowing, as the trading is happening,
 7   potentially more and more investors to be possibly
 8   defrauded and to lose their hard-earned money and
 9   savings.  And so I think that there is definitely -- and
10   hopefully -- room for discussion around what can be done,
11   in terms of stopping the transaction at the trading
12   point.
13             The second thing that I would say is there is a
14   great difficulty in trying to deal with all of this on a
15   one-off basis.  And you know, an issue-by-issue basis, as
16   I think was mentioned by Mr. Khuzami in his opening
17   remarks.  And so, I know it will be for the third panel,
18   but I do think that there is a need to consider
19   additional reforms around how to potentially prevent the
20   bad actors from coming back in and reinventing themselves
21   in different companies.
22             One of my colleagues has referred to it almost
23   as a game of whack-a-mole.  You stop it in one place, and
24   they crop up somewhere else.  And I think that there is
25   benefit in looking at stricter requirements around
0053
 1   exemptions.  I know the Commission has a proposed rule
 2   out there looking at whether or not they should be adding
 3   the same language in the reg D exemption on bad actors as
 4   it has for reg A, and I would highly encourage the
 5   Commission to look at that as an additional means of
 6   getting at the source of the problem, as opposed to
 7   trying to deal with it one at a time.
 8             CHAIRMAN SCHAPIRO:  That is actually a great
 9   segue into what I wanted to ask, because we have been
10   focused fairly technically on clearance and settlement
11   issues.  And we have heard a little bit about
12   communication, a little bit about halting stocks, and
13   then your very good points that you just made.
14             But if I could take us back up a level, I would
15   love to ask each member of the panel if there is -- you
16   know, what's the single most meaningful thing the SEC
17   could do to protect investors in this marketplace?
18             MS. SANTANIELLO:  Make the marketplace more
19   transparent, require data, no delinquent filings, make
20   sure that -- it doesn't have to be an ultra-expensive
21   process, but you have to require a certain minimum amount
22   of information about the issuer, and the people behind
23   the issue.  And, as well, you know, any of the red flags
24   that are out there around it I think need to be more
25   transparent.  
0054
 1             And it's very hard to get information.  We have
 2   to ask lots of questions to get that information.  It is
 3   not readily available sometimes in the marketplace in
 4   EDGAR or anywhere else, or often times the information in
 5   EDGAR is stale, because they're not readily filing.
 6             CHAIRMAN SCHAPIRO:  Of course the challenge for
 7   us in that is issue by issue, and that is what is
 8   required for our analysis in order to do anything like
 9   that, and has all the burdens that Rob was speaking of.
10             MS. NAHARI:  I actually would just reiterate
11   what I had said earlier.  Because again, I think we do
12   see the problematic situations in the exemptions, in the
13   exempt securities.  And to the extent that the Commission
14   can take a relook at what is required in order to have an
15   appropriate exemption, and the specific proofs and
16   evidences that would have to be established in order to
17   obtain an exemption, I think that that might be a more
18   holistic way of looking at this problem.
19             MR. MERRITT:  I would concur with Mihal on that
20   point.  I am not a person who is in favor of more rules. 
21   We certainly have a lot to deal with, as it exists now.
22             But potentially by viewing this in a more
23   global fashion, maybe increasing the bar somewhat, that
24   will deal with the issue more from a holistic standpoint.
25             MR. NELSON:  I think, as an aggregator and
0055
 1   provider of information, additional information than
 2   what's out there right now, what's out there through the
 3   EDGAR system and what not, is information about issuers. 
 4   I think there is a tremendous amount of information about
 5   trading, trading patterns, trading parties that could be
 6   made available where interested people could go and make
 7   their own decision about whether to enter into a
 8   transaction, including the people on the -- in this chain
 9   of command and issuers, all the way down to retail
10   brokers.
11             MS. SANTANIELLO:  I would echo that, saying
12   it's similar to the insight reporting that we do to FINRA
13   now, where you provide certain information from the
14   bottom up.  We are already gathering a lot of that
15   information anyway.  And if we could provide that to a
16   central place that, you know, overseas that -- I think
17   that would be helpful.
18             MR. WILSON:  From the perspective of the retail
19   investor, I think if there were one thing -- you know,
20   again, communication was something we heard several times
21   along here, and that each party has its part in making
22   the market work better.
23             One of the things that somebody mentioned
24   recently was that catching bad actors is like
25   whack-a-mole.  And as one of my former positions, I was a
0056
 1   legislative attorney with the Maryland legislature,
 2   working in financial services area.  And I am familiar
 3   with that whack-a-mole because, you know, if somebody was
 4   a bad insurance agent, then they just get a securities
 5   license.  If they got their license yanked as an
 6   insurance agent, but then if that license got yanked,
 7   then they'd go be a mortgage broker.  And if that license
 8   got yanked, then they'd try something else, or they would
 9   move to a different state.
10             And the moral of the story is that regulators
11   of different stripes and sorts need to speak to each
12   other in a fashion that they can help ferret out these
13   bad actors, because sometimes that same actor might be
14   giving the entire industry a black eye.  And the industry
15   needs to work together in helping -- in communication
16   with regulators in finding a way to comply in such a
17   fashion that they can keep their own industry from having
18   a black eye.  Because not everybody who represents small
19   microcaps or others is trying to -- as we heard in the
20   statistics, not everybody is trying to rip people off.  
21             In fact, many of these things are small
22   businesses trying to -- start-ups trying to get capital
23   into their businesses.  And they're not really out there
24   to create jobs, they're out there to make money and to
25   provide services to people.  That's what businesses do. 
0057
 1   I was in business before, and my business was to make
 2   money for the people -- for the shareholders.  And that's
 3   what they do, but they do so legitimately.
 4             So I think those are the two things that I see,
 5   is communication between regulators and communication
 6   between parties, on an ongoing basis, between those in
 7   the compliance field and those at the regulatory level.
 8             MR. CURLEY:  Steve or Marvin, you want to weigh
 9   in on this one, too?
10             MR. NELSON:  Yeah, I'll take a shot.  I would
11   say there are two areas which I think the Commission
12   could focus on with some salutary results.  We have -- a
13   number of us have spoken about the lack of transparency,
14   and we see it as between transfer agents and DTC on the
15   eligibility side.  But it's really a whole stream of
16   commerce from the primary broker, the clearing broker,
17   and the investor, all the way through the transfer agent
18   in DTC.  And that process is bogged down right now.
19             Now, I do think that we can come up with some
20   better fixes.  But in my conversations with Mihal before
21   the panel started, one of the things that I think
22   prevents the interchange of information and the
23   transparency is DTC has their own risk metrics
24   internally.  So they are concerned that if they reveal
25   too much, they are setting out a road map for the evil
0058
 1   doers in, you know, trying to flaunt and get around their
 2   system.
 3             So, I don't know the answer to this.  But to
 4   the extent that DTC can be encouraged to be more
 5   forthcoming to worthy industry participants, maybe the
 6   sponsor participant, and perhaps the transfer agent, as
 7   well as whatever other professionals you thought worthy,
 8   we can then exchange information.
 9             So, for instance, if issuer XYZ is applying for
10   eligibility, right now we hear they're denied
11   eligibility, we're given no reason.  DTC says, "Risk
12   compliance, we can't give you any reasons."  If they were
13   able to give us a reason saying, "Well, have you looked
14   at their opinion file," or, "Have you looked at their
15   regulatory filings," maybe that would enlighten the
16   process, and maybe the transfer agent would say, "Well,
17   you know, now I'll go look, and maybe I don't want to be
18   associated with that," or the participant would.
19             But right now there is no interchange of
20   information.  So the question is whether we can be more
21   efficient, and whether perhaps DTC needs some regulatory
22   cover to be able to exchange information with whatever
23   entities you think are worthy.
24             The second area -- and I think that is going to
25   be hard, because it is hard to give them legal cover, and
0059
 1   to define who the covered entities would be.  But
 2   otherwise, we are at a bit of a stalemate in the exchange
 3   of information which will allow us to identify those that
 4   we really want to keep out of the process. 
 5             And the second thing is we started with the
 6   notion of, you know, what should be required in opinions,
 7   and how difficult it is, et cetera.  On the transfer
 8   agent side I can say -- and I have spoken with trading in
 9   markets for years about this -- we get our customers
10   coming back and saying, "Why are you requesting opinions
11   on restricted transfers?  There is no regulation which
12   says issuers have to give transfer agents an opinion on
13   restricted transfers."  
14             Indeed, there is not even a regulation that
15   says that we are entitled to request opinions for
16   original issuances, although with recent enforcement
17   actions, et cetera, it has been pretty clear, even to the
18   most resistant issuer, that we should get opinions on
19   those kinds of transactions.
20             So, the question is whether it would be
21   appropriate for the Commission to codify the opinion
22   requirements and set forth what you're really looking for
23   and what's mandatory, rather than making transfer agents
24   and other industry participants, the attorneys, kind of
25   gatekeepers without giving exact guidance as to whether
0060
 1   there is a requirement, and, if so, what it should be.
 2             MR. CURLEY:  Want to have the last word here,
 3   Marvin?
 4             MR. PICKHOLZ:  Well, looking at it from a
 5   slightly different perspective, mainly the litigation or
 6   the investigative side, I think I would probably have
 7   signs printed and put in everybody's office that has one
 8   word.  "Huh?"  I think if you just say huh when somebody
 9   says something to you, you're going to get to a lot of
10   the right answers.
11             And, you know, for every Steve Jobs or Bill
12   Gates or Thomas Edison who fails and tries again, you
13   kind of know when you see something.  Somebody suddenly
14   picks up a charter out of Las Vegas or someplace, two
15   weeks later they have a public relations firm and have
16   suddenly announced that they're working on a drug to cure
17   people of encephalitis because that's the hot new thing
18   out there.  And I think one of the things that we need to
19   do -- and I tell this to people in our firm -- is get out
20   from behind your desk and go visit the site. 
21             I don't know anybody who is a good trial lawyer
22   that doesn't go out and look at the scene where something
23   has happened, so it falls into perspective for you. 
24   Because if you walked into that kind of company I
25   described in a room this size, and it had three Formica
0061
 1   desks and a microscope that looked like something that I
 2   had back in high school, there is no way you can come out
 3   of there and say to yourself this company is legitimate. 
 4   And you don't need to run computer models and anything
 5   else.  You just look at it and say, "Huh?  Doesn't make
 6   any sense."
 7             We know we need to focus on this one.  So I
 8   think I would bring more of a skepticism, but I would do
 9   it by going and actually seeing what it is that they're
10   doing at this place that -- telling me what's going on.
11             And particularly, if you go -- and I'd stop in
12   a parking lot first, because if this new start-up company
13   has three parking spots and it says, "Big, Bigger, and
14   Biggest," I know I'm in trouble right there.
15             MR. CURLEY:  Well, thank you, everyone.  I hope
16   that was interesting for all of you.  It was certainly
17   useful, from my perspective, and hopefully from others',
18   as well.  And we are just about out of time, so I want to
19   just include the panel, and thank you again for your time
20   and participating in the panel today.
21             (Applause.)
22             PARTICIPANT:  Thank you, everyone.  We will
23   take a 15-minute break, and then we will start our second
24   panel.  Thank you.
25             (A brief recess was taken.)
0062
 1             MS. GREEN:  I am Sarah Green, I am the Bank
 2   Secrecy Act specialist in the office of market
 3   intelligence, here at the SEC's division of enforcement. 
 4   And thank you all so much for coming today.  This is the
 5   anti-money laundering panel here at the microcap
 6   roundtable.  And before we get started, I just want to go
 7   down the line and let you know who our distinguished
 8   panelists are here for the microcap panel.
 9             So first, we've got Hal Crawford from Brown
10   Brothers Harriman.  Next is Susan DeSantis from DTCC. 
11   And you can read full bios of all these people in your
12   program, so I'm not going to go through all of that. 
13   Aaron Fox of IPSA International, Jeff Horowitz of
14   Pershing, Lynne Johnston of RBC, Bill Park from FINRA,
15   Betty Santangelo from Schulte Roth, and Ryan Wilson from
16   AARP.  So, thank you so much, all of you, for joining the
17   panel.  
18             And by way of introduction I wanted to -- I
19   think all of us that do AML could talk for a day alone
20   about the AML challenges associated with microcap
21   securities.  But we are really just going to focus on
22   three main questions today.  
23             And the first is some of the major challenges
24   that some of our panelists face with respect to microcap
25   fraud, from an AML perspective, and microcap securities,
0063
 1   just in general.
 2             The second will be the types of internal
 3   controls and policies that they implement to limit and
 4   deter some of these challenges that they face.
 5             And the third are recommendations that they
 6   think might help in the regulatory framework, might help
 7   with some of these challenges.
 8             But before we move into those three questions,
 9   I wanted to start out by giving you some numbers. 
10   Actually, separate and apart from this roundtable, those
11   of us at the SEC who review SARs, or suspicious activity
12   reports, have been noticing that, boy, we had seen just a
13   real increase in the number of SARs filed with respect to
14   microcap activity.  
15             And we asked FinCEN, the financial crimes
16   enforcement network -- I see Eileen O'Neill there in the
17   audience -- to run some numbers for us.  And they were
18   nice enough to run some numbers on SAR SFs -- so SARs
19   filed by the securities and futures activity -- relating
20   to microcap activity.  And it was really quite
21   astounding, and -- the numbers that they gave back to us.
22             In 2003, which was the first year that the
23   securities industry was filing SARs, there were 32 SARs
24   filed relating to microcap activity.  And this is based
25   on a key word, so it's nothing too scientific.  But by
0064
 1   last year that number had risen to about 1,600.  And for
 2   this year, it's projected to be -- based on what's been
 3   filed so far, and projections based on growth in the past
 4   couple of years, it's projected to be about 1,800, which
 5   is about 10 percent of all SARs.  So I think that was
 6   really astounding to me.
 7             We read all of them here at the SEC.  We read
 8   all of the SAR SFs.  And so, you know, we hear very
 9   closely what the industry is saying here, and it was just
10   really incredible to us to kind of underscore the -- you
11   know, what a bigger issue this has become for us in the
12   AML industry.
13             And I wanted to turn to Bill Park to give us
14   some more color on, actually, some of those SAR numbers
15   before we move to our questions.
16               ANTI-MONEY LAUNDERING MONITORING
17             MR. PARK:  Sure.  Thanks, Sarah.  And just by
18   way of background, I'm in FINRA enforcement.  I spend a
19   lot of time looking at and investigating suspicious
20   trading cases, whether it be in section 5, manipulation,
21   and obviously AML, that goes along with that.
22             So, from my seat I have seen procedures that
23   are, quite frankly, non-existent AML procedures to very
24   fulsome and robust ones.  And I get really excited when I
25   see, you know, very good ones and the right attitude with
0065
 1   the procedure.  So I'm glad to see that.
 2             So -- but when we're talking about microcap and
 3   AML, I always think of, okay, you're talking about
 4   suspicious trading, right?  You're talking about
 5   potential manipulation, suspicious liquidations, it could
 6   be a combination thereof.  And, you know, there should be
 7   no doubt that there is an application of AML to
 8   suspicious trading.  I mean it's right there on the SAR
 9   form, right?  It says, "Market Manipulation."  It says,
10   "Securities Fraud."  Pre-arranged trading, wash trading,
11   fictitious trading, I mean it's all right there, and
12   certainly should be filed in a SAR form.
13             So, you know, FinCEN has their SAR by the
14   numbers that they publicize, I think, quarterly.  And so
15   I looked at it the other day to get a handle of how many
16   market manipulation file -- you know, SAR filings there
17   have been, and this is consistent with what Sarah pulled
18   on the overall SAR number.  She was saying that 2003
19   around 32 or so total SARs were filed with the microcap
20   fraud.  Well, I looked at 2006 for market manipulation as
21   the category.  There is 578.
22             And then, through 2007 through 2010, there were
23   not less than 1,400 per year.  So that's a dramatic
24   increase.  In 2010 there was 1,516 for SARs.  So at least
25   from those statistics and kind of just the fact that
0066
 1   we're here talking about this, I think there has been a
 2   real big increase in this type of act of monitoring for
 3   suspicious trading.  So let's keep it up.
 4             MS. GREEN:  Yes.  Okay.  Well, with that kind
 5   of introduction, I wanted to turn to our -- the first
 6   question that we were going to address, which is some of
 7   the major challenges that panelists face with respect to
 8   microcap securities.
 9             And I think, Lynne, if you want to, start us
10   off from the retail perspective, and then we will kind of
11   move on down the chain.
12             MS. JOHNSTON:  Sure.  So I think if I could sum
13   it up in one word, it really is the cost to firms for
14   really having clients who trade in microcap securities. 
15   And I really look at it from both the perspective of
16   bringing in a new client that wants to deposit microcap
17   securities, particularly physical securities, into an
18   account, the sort of other due diligence you need to do
19   on that client to understand who they are, how they got
20   the securities, what their planned activity is with those
21   securities really is much more enhanced in some ways than
22   it is for just another retail client that walks in and
23   wants to establish an account with you.
24             Through the enhanced monitoring that you have
25   to do, through the investigations that you have to do
0067
 1   whenever you're investigating fraudulent activity or
 2   potentially unusual activity in connection with a
 3   microcap security, all of which are very challenging, and
 4   in our very resource-constrained environment which I know
 5   all of us are dealing with, it really creates additional
 6   challenges on firms.
 7             MS. GREEN:  Jeff, do you want to --
 8             MR. HOROWITZ:  Sure.
 9             MS. GREEN:  -- talk about the clearing
10   perspective?
11             MR. HOROWITZ:  Sure, and I will go back to the
12   number of SARs being filed.  You know, post-0905, if you
13   look at the date and you look at the spike, there is
14   probably a direct correlation because, you know, that put
15   an onus on us to do due diligence on large deposits of
16   low-priced securities.
17             From a clearing firm perspective, you know, a
18   small poll, about 30 to 50 percent of clearing firm SARs
19   are filed on low-price security activity, and half of
20   those are filed on those that trade sub-penny.  So it's a
21   big undertaking for us.  Given the regulatory and the
22   reputational risk, many of the clearing firms have taken
23   a different stance of what are we going to allow for
24   deposit, what are we going to allow for liquidation.
25             So, the gamut that we heard from before starts
0068
 1   from sub-penny to $5.  Most are focusing on the sub-penny
 2   level.  Some are charging a due diligence review before
 3   they will accept the deposit, and charge their
 4   introducing firms.  
 5             But the real challenge is, you know, as Marvin
 6   said, you know, drive out and visit this medical plant in
 7   Vegas.  I don't meet my introducing firm's customers.  I
 8   don't go out and meet the securities that they want to
 9   deposit.  It's a large challenge for clearing firms, but
10   we have a SAR obligation.  We know we can't stick our
11   head in the sand.  So we're spending a lot of resources
12   focusing on how do we alert law enforcement and how do we
13   alert the SEC of those stocks that we see in play, those
14   customers that are repeat offenders, or possibly even the
15   issuers.
16             MS. GREEN:  Sure.
17             MS. FOX:  To build on what Lynne was saying,
18   one of the things that you take into account when you're
19   dealing with a client who wants to deal in these
20   securities, you -- the normal CIP, KYC, EDD, you can send
21   something to Equifax, you can find out if their Social
22   Security number matches.  You can get litigation about
23   them.  But you can't necessarily efficiently find in one
24   place all of those clues and those red flags about the
25   behaviors that they may be executing.  Are they a stock
0069
 1   promoter?  Are they -- if it's a non-reporting company,
 2   you may not see that they're an officer.
 3             So, there is a huge human element, and I think
 4   Jeff would concur with that, that we can monitor
 5   electronically for a lot of things.  But it's that human
 6   element that has to be added, and then you've got to
 7   develop a base of knowledge there.  And that's extremely
 8   challenging, especially since they evolve.  Every time we
 9   start to figure something out, they're on to the next.
10             MS. JOHNSTON:  And I think just -- one of the
11   challenging things is that they often use somebody who
12   can act really as a nominee, who doesn't have any sort of
13   negative news about them or any negative regulatory
14   history, it's -- and who is saying, "I invested in this
15   company, I am who I am, I'm not in the securities
16   industry."  
17             And those things, it's very difficult to
18   distinguish between the legitimate person who has made an
19   investment in a microcap company versus the person who is
20   being paid to do it, and is part of a larger scheme that
21   really is ultimately a fraudulent scheme.
22             MS. GREEN:  Hal, do you want to talk about it
23   from the BBH perspective?
24             MR. CRAWFORD:  Sure.  Well, as global
25   custodian, I'm one step away further than, actually,
0070
 1   Jeff, in that, you know, I'm at the back end of receiving
 2   securities.  They are typically in bulk delivery.  And in
 3   some cases we're seeing securities come in
 4   internationally.  Who are our clients?  Foreign financial
 5   institutions or domestic institutions and funds.  
 6             And, as an AML compliance professional, we are
 7   spending more and more of our time looking through to try
 8   to understand who is our client's client, who is our
 9   client's client's client.  And let me tell you, that's
10   not an easy thing.  And we find that we have dedicated,
11   this year alone, 30 percent more resources in our
12   staffing to these investigations, to help us understand
13   who is behind these.
14             You know, I kind of was thinking about what DTC
15   was saying earlier on the first panel, as well, when we
16   talk about challenges.  You know, the Patriot Act, the
17   Bank Secrecy Act, give us the ability to communicate with
18   other regulated financial institutions under a tool which
19   we call 314(b).  And that's great when institutions want
20   to talk to each other about money laundering concerns.  
21             It is very hard -- and actually, the law almost
22   prohibits, if not almost -- it does prohibit us from
23   being able to reach out to others to say, "Hey, who is
24   this?  What are you doing, and why are you doing it?"
25             So, I think the SAR number has gone up.  I
0071
 1   think it's going to go up a lot more by the end of this
 2   year.
 3             MS. GREEN:  Susan, do you want to talk about it
 4   a little bit from the clearing agency perspective?
 5             MR. DESANTIS:  Sure.  One fact that isn't very
 6   well known about the Depository Trust Company is we are
 7   actually a bank.  And, therefore, we have the same SAR
 8   filing obligations as other banks and broker-dealers.  
 9             What makes the microcap space a little
10   challenging for us is, as we've heard, the sheer volume
11   of what is going on, and the large share deposit activity
12   that we see.  But, as a central depository, everything
13   gets aggregated at the DTC.  So we have a different
14   perspective than individual broker-dealers or custodians
15   have.
16             And, as Jeff and Hal have mentioned, you know,
17   we have -- we are even further away from the customer. 
18   Our customers are our participants, not the individuals
19   who are making these deposits, not the issuers whose
20   issues we are serving as DTC-eligible issues.  So that
21   makes the compliance factor very challenging for us.  
22             And the ongoing continued activity, if one of
23   our broker-dealers doesn't like a particular customer,
24   has an issue with that customer, they have the ability to
25   sever the relationship with that customer.  The following
0072
 1   month we will just see that activity at another
 2   participant.  So that continues to be a challenge for
 3   DTC.
 4             MS. GREEN:  Okay, great.  Anybody else on the
 5   panel have anything they want to add on challenges? 
 6   Betty?
 7             MS. SANTANGELO:  I just thought -- and I
 8   thought of this as we were listening to the first panel,
 9   and this probably goes to Susan's reference to DTC -- one
10   of the questions on the first panel -- or comments -- was
11   about transparency.  And when you have SAR reporting,
12   there is a lot of concerns about tipping.  And that
13   really wasn't referenced at all in the first panel.  
14             But I think, Susan, that is a concern, isn't
15   it, when you're dealing with this, and also with the --
16   and all of the members of the panel have to deal with
17   that.
18             MR. DESANTIS:  Absolutely.  In fact, talking
19   about red flags and talking about what you are
20   monitoring, we have to be very careful not to relay too
21   much information because these are, in fact, the SARs
22   that we're filing.
23             So we do leverage 314(b) extensively, and we
24   have a very good rapport with our participants related to
25   314(b) requests for information.  But outside of that,
0073
 1   outside of law enforcement and regulators, we really
 2   aren't in a position to share a lot of that information.
 3             MS. SANTANGELO:  I mean you can still share
 4   that information, but you don't get the safe harbor of
 5   314(b), and you can't talk about SARs to anybody outside
 6   of your institution.  So I think that is an important
 7   fact to consider.
 8             MR. CRAWFORD:  I was just going to add how
 9   invaluable those 314(b) discussions are for compliance,
10   as well as for our regulators and law enforcement,
11   because that's really the triangle of success for us.
12             I mean our job is to identify potential
13   suspicious activity and report it.  And on the back side,
14   we're also trying to stop it.  And you know, without
15   tools like 314(b) within the regulated industry, I'm not
16   sure we'd be as successful as we are.  And I actually
17   believe that may be attributing to the increase in SARs.
18             MS. SANTANGELO:  If I could just add one more
19   thing, Sarah, Jeff mentioned the FINRA notice to members
20   0905.  I think that's been critical, not only in terms of
21   the timing of the SARs, but I think one of the challenges
22   is that the examiners have been really holding firms to
23   account as to what their procedures are in this area. 
24   It's not just that the firms are just doing their SAR
25   reporting.  People are being examined, questioned, and I
0074
 1   think this is an area where, because of 0905, that firms
 2   are really required to ask a lot of the questions that
 3   are being asked.
 4             MR. PARK:  Sarah, just real quick on 0905,
 5   that's obviously dealing with the large deposit transfer
 6   and liquidation of various microcap securities.
 7             Just an observation from -- again, from my seat
 8   is, you know, because of 0905, you're also seeing "bad
 9   guys" are getting smarter, and they're looking -- you
10   know, they're looking for firms that don't ask a lot of
11   questions.  They're looking for -- you know, if there
12   is -- putting in various layers.  And we can talk about
13   this in maybe another panel someday, master and sub
14   accounts, and so on and so forth.
15             So, I think that adds a complexity.  But
16   obviously, if we're on top of our game, we can stay on
17   top of it.  But that's an observation that we're seeing,
18   that they're trying to move and go around the
19   restrictions because of 0905 and other cases that are out
20   there.
21             I would also add that I think all of us up here
22   have the same concern and problem -- and we're trying to
23   stay on top of it, if not maybe a step behind it -- is
24   technology, right?  With all of the speed in trading, and
25   I think you're going to have more and more direct market
0075
 1   access, more online capabilities.  
 2             With that, I think there is -- certainly CIP is
 3   incredibly important, but that only goes so far, and you
 4   will have that kind of -- when you have like an online
 5   type of system, there is a lot of pressure that's being
 6   put on the surveillance of the transactions.  And that is
 7   difficult to do, when you can't see the person, you don't
 8   even know where they're putting the trades in.
 9             PARTICIPANT:  Bill, if I could jump in there,
10   in terms of notice to members 0905, the -- we've seen
11   during our examinations of the broker-dealer community a
12   reluctance to conduct that reasonable inquiry, or the AML
13   monitoring based on electronic delivery of securities,
14   because the notice to members specifically talks about
15   physical delivery of certificates. 
16             And I'm wondering, from your point of view,
17   have you seen some reluctance upon your membership of,
18   you know, having to do that, that reasonable inquiry, or
19   any AML surveillance based on that electronic delivery,
20   because they're looking to others?
21             MR. PARK:  Yes, absolutely.  Yes.  You know,
22   from our perspective -- at least from my perspective,
23   I'll put it that way -- a DWAC, electronic transfer of
24   shares, and a physical transfer of shares, -- it's more
25   or less the same thing, because all you're doing is just
0076
 1   depositing and liquidating the shares.  
 2             And you still have the same questions that were
 3   raised earlier, I think maybe on the earlier panel as
 4   well, is who is the customer, how did they get these
 5   shares, when did they get these shares, and is there any
 6   possible connection whatsoever between that customer, as
 7   a nominee, as Lynne talks about, or some other way to the
 8   promoter of the issuer or the issuer itself.
 9             So, we've received that kind of, I guess,
10   resistance, so to speak.  But, you know, the way we put
11   it is just, well, here is the list of -- I hear you, but
12   here is the list of red flags.  The only change is the
13   fact that it was electronic transfer versus a physical
14   deposit.  Someone still saw it, someone still put the
15   sell order in for that particular account.  So we still
16   approach it the same way, but we have heard that, yes.
17             MS. FOX:  To that point, one of the things that
18   makes it even more difficult is we heard the transfer
19   agent folks talk about transparency and communication. 
20   When you're going out to gather that information,
21   transfer agents refusing to confirm the volume of shares
22   in the market, and we know that multiple sources have
23   inconsistent data.
24             Additionally, there are at least two transfer
25   agents out there right now that will execute a DWAC in
0077
 1   the absence of a broker-dealer relationship.  So now
 2   you've got an entity that doesn't have an obligation to
 3   identify who their customer is or anything about it, and
 4   allowing that transfer to occur with no documentation of
 5   who is really behind -- and that is impossible to get
 6   past.
 7             MS. GREEN:  Well, now that we've heard a lot
 8   about the challenges -- and I know we could go on about
 9   those -- but let's talk a little bit about some of the
10   internal controls and policies that some of you implement
11   to control these and address these challenges.
12             Betty, do you want to start out by some of the
13   things that maybe some of your clients --
14             MS. SANTANGELO:  So I guess there is two things
15   we need to talk about.  One is internal controls, which
16   kind of limit the types of securities that come in,
17   because I think firms have just sort of, in order to deal
18   with the resource issues, because these are very
19   resource-intensive, and to deter people from making
20   deposits of certain securities, have limited deposit of
21   securities, particularly like, for example, sub-penny
22   stocks.  Those are -- many firms have just decided that
23   they're not taking those.  Others put a real focus on the
24   securities, and it ranges from under $5 to under $1.  It
25   depends upon the risk assessment the firm has made in
0078
 1   their own securities.
 2             So, a number of firms have just basically
 3   limited those securities.  I don't know if anyone here
 4   wants to talk about their limitations of it, but --
 5             MR. HOROWITZ:  Sure.  You know, in addition to
 6   the price of the stock, it's also looking at where
 7   they're trading.  Are they on the bottom three levels of
 8   the OTC markets?  And many firms have just stopped taking
 9   those deposits, because they're not as transparent, some
10   of them don't have financial audit responsibilities.  And
11   I think that's kind of a starting place.
12             We talked in the last panel about throwing out
13   the baby with the bathwater.  Some of that may happen. 
14   But from the activity that we see in the SARs that are
15   filed, they are a pattern.  They're the reverse merger
16   companies.  They're the ones that were making coffee,
17   they're high-tech, and tomorrow they're going to be
18   cancer research.  They're not that hard to find out, from
19   the surveillance perspective, but they may be very hard
20   from the end customer, who is the consumer who sees this,
21   and he's getting the hyped email from investing in it.
22             And, you know, it took us about 35 minutes on
23   the last panel before we focused on -- you know, we
24   talked about the challenges if the issuers, challenges in
25   DTC, but we didn't talk about the end consumer.  And I
0079
 1   think that's -- from a clearing firm perspective, an
 2   introducing broker, I think that's our biggest -- or, you
 3   know, what we're looking to do first.  And then we'll
 4   figure out some of the efficiencies in the marketplace. 
 5   Because the regulatory scrutiny, some of the enforcement
 6   actions they're talking to, how come you didn't know that
 7   this customer was a stock promoter?
 8             You know, it's very hard, you know, when you're
 9   in the clearing firm seat, or you're all the way down as
10   the custodian, to know that, you know, custodian number
11   seven was the stock promoter.
12             MS. SANTANGELO:  And the caveat emptor
13   securities, too, which are labeled caveat emptor, most
14   firms will not take caveat emptor securities.  I mean, so
15   people are just trying to stop that, on the one hand. 
16   And on the other hand, they are monitoring, because they
17   have to monitor for anti-money laundering procedures,
18   they have to file on suspicious activity.  
19             And so there is monitoring, by virtue of the
20   physical securities as they come, in the DWACs, to the
21   extent that you can actually identify the DWACs, and then
22   I guess setting certain parameters as to what volume of
23   deposits you're going to look at.
24             But again, in large part because of 0905, I
25   think, firms are really looking at that.  They're using
0080
 1   questionnaires.  I know clearing firms are working with
 2   introducing brokers to kind of get the answers because,
 3   as Jeff said, they're not their clients, so they have to
 4   come back, they have to get them to explain what are
 5   these securities.
 6             But the questions that come up in this area are
 7   very difficult.  There is many investigations of every
 8   one of these.  That's what the resource issue is.  You
 9   are looking to see who is the issuer, as Jeff said, the
10   history of the issuer.  What were they selling last week? 
11   What are they selling this week?  You know, what were
12   they selling last year?  You know, they go from gold to
13   widgets in one year.  You're looking at the promoter. 
14   Who is the promoter?  They have a history of disciplinary
15   issues.  You're looking at the lawyer.  Is the lawyer --
16   you don't always have the high-caliber lawyers that you
17   saw in the first panel that are giving the opinions here.
18             So, I think there is a number of things you
19   have to deal with.  It is very, very resource-intensive.
20             MS. GREEN:  Aaron, do you have anything you
21   wanted to add on internal controls or policies?
22             MS. FOX:  Thank you, Jeff.  Yeah.  A lot of
23   firms have put in place good programs, good -- a good
24   effort towards monitoring, or at least trapping and then
25   investigating.  So you've got a trigger that you see
0081
 1   something, and then you investigate.  
 2             But the problem is, once you develop
 3   competency, they've moved on to something else.  We
 4   started with physical certificates and journaling.  Then
 5   it started to become DWACing.  DWACing started to get
 6   difficult -- there are a number of firms out there that
 7   are monitoring -- so they moved beyond just DWACing
 8   between broker-dealers.  Now it's from an unrelated
 9   entity in the industry.
10             And we have also heard that they are going
11   offshore.  So blocks of shares go offshore, they come in
12   through a foreign financial institution that has an
13   omnibus relationship.
14             So, staying ahead of these folks, part of the
15   problem in getting this up to speed is you can't build an
16   internal system.  But you've got to get the resources
17   trained to keep following the trends.  So, really, those
18   education -- every time -- it's not simply an AML
19   function.  It's pushing it out to the front of the house,
20   and going after your written supervisory procedures and
21   saying, "Okay, for every single one of these, is there a
22   way that something gets to AML?  Is there an AML hook
23   here?
24             So, distributing that responsibility, and
25   making it a firm goal more broadly than simply focusing
0082
 1   on what's going on in AML -- AML is after the fact.  A
 2   lot of this emanates at the front of the house.
 3             MS. GREEN:  Hal, did you want to say something? 
 4   I see your finger perched on the button.
 5             (Laughter.)
 6             MR. CRAWFORD:  I love to chat, so that's the
 7    -- you know, I think we -- a lot of people have hinted
 8   upon, you know, this concept of internal controls.  What
 9   we have found at BBH is training has been critical.  And
10   if you go back and you look at the FinCEN's SAR advisory
11   guidance over the years, right, there is always a section
12   about training, training your employees.  
13             And most importantly, there is always a section
14   about the number one source of suspicious activity
15   reporting for financial institutions is the human being. 
16   We spend a lot of time and effort in other areas of the
17   institution -- electronic surveillance, stopping, looking
18   at trades, understanding who is behind it.  
19             But we find also spending more time -- a lot
20   more time -- with our people in our restricted shares
21   group, training them, having them show us what looks
22   good, what doesn't look good, documenting it, creating
23   examples, cross-training our staff -- and we're finding
24   that, you know, the physicals are a lot easier, because
25   eyes are going on it.  I hate to use the expression,
0083
 1   because I wear glasses, but four eyes is actually very
 2   effective here.  We are looking at it not once, but
 3   twice.  So when something is out of the ordinary, we have
 4   the leisure, and that's a great control.  People are your
 5   best control.
 6             So, I don't want people to fall short that
 7   training is not important.  It's more important today
 8   than it ever was.
 9             MR. EHRMAN:  I had a follow-up question, just
10   on -- from an enforcement standpoint.  The concept of the
11   SAR, it's all well and good when you all stand up and
12   say, "Hey, there is some suspicious activity going on
13   here" -- thank you, I'll take that commission.
14             I mean at what point do you draw the line
15   between filing something with your respective regulator
16   and just not doing it?  Is there a way you can
17   effectively draw that bright line?  I throw that out to
18   anybody.
19             MR. HOROWITZ:  Sure.  I think it's risk-based. 
20   We heard about reasonable.  But we don't just file the
21   SARs and then move on and let the activity continue.  You
22   know, most of the time we shut down the account. 
23   Sometimes we register and ship the shares back to the
24   issuer.
25             You know, we're trying to do our part.  I don't
0084
 1   know if there is a bright line, you know, three times and
 2   you're out, but it's really egregious when you see the
 3   500 million shares come in, and it's really
 4   distinguishing between that and someone who really does
 5   want access to the capital markets.
 6             MS. FOX:  I agree.  I think it's very
 7   challenging to have a bright line and say, you know, "You
 8   file a SAR and you're out."  I think it really is a
 9   judgement test.  I do think for a lot of firms, though,
10   once you've had a couple of SARs or maybe even three
11   SARs, it's very difficult to justify continuing to do
12   business with somebody.  
13             But the first time it comes up, I think it
14   really comes down to a bit of a judgement call as to how
15   clear the activity was that's giving you concern, what
16   the scope of it is, how well you know the client, and
17   what they're telling you that they are doing.  And I
18   think all those things have to come together for you to
19   make a decision.  But I certainly think that there is no
20   firm represented here that wants to be seen as or known
21   for being facilitating illegal activity.
22             MR. CRAWFORD:  I think it also adds -- you have
23   to understand what our roles are, too.  Each one of us
24   has a different role in the chain.  In our case, we may
25   go so far as interdict parties associated with those
0085
 1   transactions, be it the promoter firm or disregard a
 2   legal opinion coming from a particular lawyer over and
 3   over and over.  
 4             Those are all part of what we do.  It's not
 5   just filing, it's taking it and making it part of who we
 6   are in our institution.  We want to protect our
 7   reputations.  We want to do what's right for the law, as
 8   well.
 9             MR. PARK:  Just, you know, from my perspective,
10   you know, a lot of the cases that I bring, for the most
11   part, they involve firms that did not file any SARs.  In
12   fact, they didn't even question the activity in the first
13   place.
14             But I guess going back to the earlier question
15   in internal controls and that type of thing, and also to
16   pick up on, like, whether it's a bright line test, and
17   reasonable -- it really is, at the heart of it, it's
18   sensitivity to red flags, reasonableness and being, you
19   know, flexible, adaptable.  
20             Like I said earlier, I think Jeff mentioned
21   that the training fits in -- Jeff and Hal mentioned that
22   the training fits in that you're going to, you know --
23   there is going to be a new scheme developed.  Okay,
24   what's this -- you saw something happen here, on this
25   account.  
0086
 1             Perhaps there is -- maybe you just learned
 2   something right there.  Well, maybe look across the
 3   board.  If you're seeing something developed in-house,
 4   perhaps use your 314(b) to share that information, which
 5   I'm sure is happening.
 6             But I guess to back up -- and this is a point
 7   to the earlier panel, where I saw, you know, we had a
 8   market-maker on the earlier panel, we had -- Knight was
 9   there.  They don't have customers.  They completely are
10   trading institutional or with other broker-dealers.  They
11   have AML procedures, and so -- to monitor for activity,
12   as he described.  So they're looking mainly on the
13   transactions themselves.
14             And so, from an enforcement case standpoint,
15   when we're bringing cases, we're certainly looking at
16   what is the business mix of this broker-dealer, and what
17   is it -- you know, where is the risk for -- I'll use
18   the -- to overuse the word, the "bad guys" to take
19   advantage of that system.  
20             Okay?  Is it an online firm, where you can't
21   see anything?  Is it a -- are they a -- perhaps there is
22   a prime broker or an introducing broker, a clearing
23   broker, an introducing firm, and maybe the account is
24   offshore somewhere.  I'm just -- these are thrown up into
25   various complexities that can happen, I'm sure do happen. 
0087
 1   So, you know, what is it, what kind of business are we --
 2   is this broker-dealer in?  And then, what kind of
 3   internal controls and procedures do they have in place?  
 4             And where we have found firms fall short is
 5   they didn't do that first assessment:  Where is the risk? 
 6   What's that risk of the broker dealer, where someone can
 7   really come in here and do some bad things?  To protect
 8   the markets, keeping in mind that, you know, we're all
 9   gatekeepers of the marketplace, especially
10   broker-dealers, where they are, like, the last ones
11   standing to push the button to sell, a button, all of a
12   sudden the shares are out there.  And it's to the
13   investor who is buying shares that may have been, you
14   know, the control person of the issuer.  No one even knew
15   it.
16             And so, that is something we look at.  So as I
17   mentioned earlier, on the suspicious trading categories,
18   I really -- you know, in my head I lump them this way. 
19   You have the suspicious liquidations that we've been
20   talking about, kind of the 0905-described of the
21   physical, the deposit or the DWAC deposit, and then
22   liquidation, and those can be part of various -- into
23   various pumped-up markets, promoted markets.
24             But then you also have the situations where the
25   broker-dealer can be actively engaging in a manipulation,
0088
 1   whether it's going to be brokers at the firm, or
 2   something along those lines, where you can have matched
 3   trading, pre-arranged trading going on within the walls
 4   of the broker-dealer itself.  And that same broker-dealer
 5   has an AML obligation to actually look for suspicious
 6   activity, in addition to supervisory issues and not
 7   engage in fraud.
 8             So, those are two very big areas that we
 9   certainly look at.  And going back again to the
10   complexities that we see, or the difficult -- the
11   challenges, especially with the technology, you know, the
12   hijacking of accounts -- I think that was mentioned in
13   the earlier panel, where someone could, you know, take
14   over an account, liquidate the shares, and the proceeds
15   used to buy stock that's being manipulated -- that
16   definitely needs to be monitored.  
17             But also, what about the willing participants
18   that are right there within the broker-dealer that -- you
19   know, the stock promoter who may be involved doing that?
20             So it's a risk base, but you know, certainly
21   looking for -- being taken advantage of and willing
22   participants --
23             MS. GREEN:  right.  And I wonder if maybe Lynne
24   or Jeff, if you want to comment on -- you know, we've
25   heard a lot about kind of the bad actors here, but there
0089
 1   is legitimate microcap activity, and I don't know if you
 2   have any thoughts on kind of how you distinguish that
 3   legitimate activity from some of this activity that is
 4   not as legitimate.
 5             MS. JOHNSTON:  Well, I think the first point, I
 6   always think about AML as being the first thing is
 7   preventing customers from coming into your firm that are
 8   going to do illegal things.  
 9             So, the first part, from my perspective, is
10   knowing their customer, what they're coming in to do, why
11   they have the microcap securities, what their trading
12   background is.  And I think that goes a very long way to
13   deciding whether you want to have this customer, whether
14   you're going to be comfortable with their transaction
15   activity, and whether they're legitimately at your firm. 
16   I think that is just -- to me, that's one of the most key
17   sort of controls we have.
18             MR. HOROWITZ:  In the last panel we talked
19   about knowing your customer.  And, for the clearing firm,
20   it's knowing our introducing broker-dealers, and it's
21   really developing the relationship with them, giving them
22   the tools so they can best monitor their activity.
23             But, you know, we track our introducing
24   broker-dealer activity.  Who are the ones that are
25   bringing us the most large -- low-priced securities?  Is
0090
 1   there a certain branch?  Did their business model change? 
 2   And they didn't always use to do institutional business,
 3   and now we're seeing a flood of that.  
 4             Did they bring on a new rep office?  It's hard
 5   to monitor the, you know, 5 million, 10 million end
 6   customer activity we have, but we do focus on what are
 7   those spikes in our introducing brokers', you know, key
 8   risk indicators.
 9             MR. EHRMAN:  Do you see any particular problems
10   in -- from an AML perspective in omnibus accounts
11   specifically having -- when your firm or a firm would
12   have another financial institution, a broker-dealer, or a
13   foreign financial institution as a client, and ultimately
14   the risk of not knowing the identity of the person who is
15   ultimately selling the securities through that other
16   entity?
17             MR. HOROWITZ:  Just by the word "omnibus," it's
18   a challenge.  But it really comes down to the onboarding
19   KYC we do of all of our introducing firms, whether
20   they're fully disclosed or omnibus.  You know, what AML
21   program do they have in place?  Some of our foreign
22   broker-dealers, we actually collect them and read them,
23   to see if they meet the spirit of the Patriot Act and the
24   requirements we would have here, in the States.
25             But when you're dealing in an omnibus, the best
0091
 1   you could do is look at the controls of the introducing
 2   broker.  Who are the people running the shops?
 3             MS. SANTANGELO:  That's an -- you're talking
 4   about omnibus clearing relationship, as opposed to an
 5   omnibus account.  Chris, is your question directed to the
 6   account, or the --
 7             MR. EHRMAN:  The account, yeah.  So your
 8   typical -- you will have a broker-deal account somewhere
 9   else, and there is another individual who may or may not
10   want to remain anonymous and take advantage of that
11   omnibus relationship to potentially thwart at least
12   initial inquiry from regulators, or even you. 
13             So, I'm just wondering, you know, whether you
14   have to do certain things when dealing with that
15   relationship.
16             MS. SANTANGELO:  Well, I think on that one, I
17   mean, I think we already have requirements for when you
18   have an omnibus account and you have subaccounts, when
19   you can treat the omnibus accounts solely as your client,
20   or whether you have to look through the omnibus account
21   to the underlying subaccounts.
22             And certainly I think any time you have -- if
23   you are custodying the assets for the client, and you
24   have any kind of notice that there may be somebody acting
25   underneath the master level and directing trading in
0092
 1   those accounts, I do think you have to go to that
 2   underlying level, figure out who is directing trades.
 3             And maybe, you know, it may get down to getting
 4   CIP on them, and treating each underlying subaccount as a
 5   client.
 6             MR. EHRMAN:  How about if they're offshore?
 7             MS. SANTANGELO:  I think you may have to do the
 8   same thing.  And it depends on offshore.  I think if you
 9   think of a hedge fund, for example, a lot of hedge funds
10   are offshore, but that doesn't necessarily make them
11   higher risk.  
12             But I think you have to look at them on a
13   case-by-case basis, what jurisdiction they're operating
14   in, who their underlying clients are, what would be the
15   typical activity for them, who can be directing trading
16   in those accounts, you know, the sort of full spectrum of
17   questions you would ask for any client coming on.
18             MR. CRAWFORD:  I guess I would just add that,
19   you know, the foreign financial institutions, as clients,
20   typically now have very high standards for AML and KYC. 
21   The international standard, for example, and the EU have
22   risen at such a fast pace in the past three years that
23   they are not only on par with the U.S., and in some
24   places exceed par.  The concept of reliance and the
25   ability to rely on one another within the EU was clearly
0093
 1   defined within the EU directive.  And the regulation and
 2   examination over those institutions is very high.
 3             Therefore, as a U.S. firm looking to do
 4   business with a foreign financial institution, we do look
 5   to understand what are their obligations, what are their
 6   programs.  We typically meet with our counterparties in
 7   the AML world, and understand what their tolerance of
 8   risk is.  That's all part of our onboarding process.
 9             And I like to always say that we're onboarding
10   them, but they're also onboarding us.  And they
11   understand the challenges of doing business with
12   financial institutions in the U.S.
13             MS. GREEN:  Susan, I didn't know if you had
14   anything you wanted to add from the kind of internal
15   controls, policies, and procedures perspective.
16             MR. DESANTIS:  Well, one point that I wanted to
17   make is, you know, we talk about know your customer. 
18   Another telling mark on these types of cases is also
19   looking at the issuer itself.  And there are certain
20   characteristics that you see with the issuer that are red
21   flags that you would want to look at.
22             And I know Jeff mentioned the pink sheet tiers. 
23   I think a lot of issuers have wised up to those controls,
24   and most of the issues that we see are providing some
25   form of disclosure.  But you need to look at what that
0094
 1   disclosure actually is.  Do the numbers -- literally, do
 2   they add up?  Their unaudited financials, what are they
 3   actually telling you about the issue?  So, that's another
 4   angle that we like to explore.
 5             MS. GREEN:  Okay.  Anything else, in terms of
 6   internal controls, policies, before we move on to our
 7   last issue?
 8             (No response.)
 9             MS. GREEN:  Okay.  Our last issue is really
10   kind of teeing up the next panel, in some respects, but
11   we want to talk about -- I think in planning for this we
12   all had ideas, and you all had many kind of good ideas
13   about what would help in this area, in terms of improving
14   regulatory framework in this area.
15             So, I am going to open it up to anybody who
16   would like to chime in.  Jeff?
17             MR. HOROWITZ:  Sure.  You know, one of the
18   things we see are the reverse mergers.  And, you know,
19   one of the thoughts we had were:  Why do we allow those
20   companies that become inoperative to stay listed?  When
21   you are on the New York Stock Exchange or American Stock
22   Exchange, and you file Chapter XI or XIII, you're
23   required to delist.
24             It may make it less transparent for us, as the
25   investigators, as we can see the history, but it may make
0095
 1   it more transparent for the end customer, who is
 2   investing in these securities.
 3             MS. SANTANGELO:  The other area that is -- that
 4   probably people who represent the transfer agents won't
 5   really like, but you know, the transfer agents are really
 6   the first ones to see the issuers, and to kind of -- and
 7   to have the ability to kind of know them and ask
 8   questions.
 9             And for those of the firms who are actually
10   subject to anti-money laundering program requirements, it
11   doesn't really make sense to us that they are sort of out
12   of the loop of the AML program requirements.  That's not
13   an SEC rule, it's a FinCEN rule, but it's obviously --
14   it's very important, because you can't -- it's very hard
15   to share information with them.  They're not looking for
16   suspicious activity the same way.  And there should be a
17   lot of obligation on them to identify who it is that's
18   coming into them, and have information that they can
19   document.  And that would be, I think, extremely helpful.
20             MR. HOROWITZ:  And going back to, you know,
21   314(b) that Hal said, you know, that would be another
22   avenue where we can get to the same place and do it with
23   a safe harbor.
24             CHAIRMAN SCHAPIRO:  314(b), for any of you in
25   the audience who are wondering what that is, is a rule
0096
 1   under the Patriot Act which allows financial institutions
 2   who have filed certain forms with FinCEN to share
 3   information with each other on customer activity related
 4   to money laundering and terrorist financing, and to have
 5   a safe harbor from violations of the privacy rules. 
 6   So --
 7             MS. FOX:  Where they are headed is obviously
 8   AML programs for transfer agents.  But I think it's even
 9   broader than that.  I think it is possibly a tiered
10   licensing requirement.
11             We know that the major transfer agents, the
12   transfer agents that are already under the Patriot Act in
13   another space, or the BSA, don't have the same kinds of
14   issues as the smaller transfer agents.  So, looking at
15   changing the licensing requirements a bit, requiring an
16   AML program, requiring some of that data to simply  -- if
17   an issuer is not reporting a smaller issuer, it doesn't
18   mean we need to make the reporting onerous.  Simple bits
19   of data, requiring a transfer agent to make some type of
20   filing every time there is more shares issued in the
21   market.  
22             Because then -- and getting information into a
23   common repository such as EDGAR, that systems can then be
24   built around so you can automate some of these
25   comparisons, instead of forcing the entire brokerage
0097
 1   industry to chase this data in various public sources
 2   that are not consistent.
 3             MR. DESANTIS:  To kind of build on that point,
 4   another area that personally we would like to see is more
 5   requirements for disclosure from the issuers.  And some
 6   level of SEC reporting for all issues that are traded, as
 7   well as some controls put around the exempt share
 8   issuances, particularly under the reg D exemptions.
 9             MR. HOROWITZ:  OTC -- FINRA doesn't require
10   financial statements for OTC issuers to be audited, just
11   prepared with GAAP principles.  Is that an avenue we
12   could explore to make it more transparent, and either
13   have them have a PCAOB auditor or audited financials to
14   be submitted?
15             MR. PARK:  That I'm not sure, because I'm not
16   in that area.  But I do know, because I work closely with
17   the clearing for OTC BB, Form 211, office of fraud
18   detection and market intelligence, and I know, just based
19   on the questions and the scrutiny that they put on the
20   actual issuers themselves, and the relationship between
21   the initial shareholders and what kind of market they
22   anticipate, as in the sponsoring broker-dealer, that
23   they're -- you know, speaking on my behalf, how I work
24   with them, I know that there would be a -- at the staff
25   level, investigative level, would be something that makes
0098
 1   sense on that.
 2             So I'm not sure about the requirement for it. 
 3   I am -- I fall towards the, yeah, I think more
 4   information is better, obviously, with that.  
 5             But I will -- you know, separate from, I guess,
 6   new regulations, new rules, I guess if there are new
 7   regulations, new rules that kind of enhance the existing
 8   AML obligations, I would just want to echo some things
 9   that have been said throughout this panel by everyone
10   here today, is that there really should be a buy-in at
11   the top and at the front.  And what I mean by the front
12   is the sales, the brokers, the people actually getting
13   the business in the door.  There has to be a buy-in to
14   the importance of it, an appreciation of the gatekeeper
15   responsibilities of the brokerage firm looking at -- I
16   think you could point to the horror stories of investors
17   basically left holding the bag at the end of the day. 
18   And this is one of many tools, AML, to help prevent
19   something from happening like that.
20             I also think that with existing AML systems and
21   any enhancements, that there should definitely be a
22   closer tie-in -- because I've seen it bifurcated -- a
23   closer tie-in with anti-fraud efforts.  You know, it
24   really is hand-in-hand, good communication across the AML
25   guys and the fraud guys.  You know, corporate security,
0099
 1   all of that, I think, really should be one -- if it's
 2   not -- each business has their own model, but obviously
 3   there should be just a streamline of communication going
 4   on there.
 5             And then I mentioned earlier -- which we have
 6   talked about -- kind of the flexibility and adaptability. 
 7   That is crucial, so crucial.  And, you know, there are
 8   new rules, they are there, but again, you put a rule out
 9   there -- this is from my experience -- bad guys will try
10   to find a way to go around it.  It's just always going to
11   be that way.
12             And so, it really kind of -- you're looking at
13   the boots on the ground, the people who are actually
14   looking at these things, and really training them to do
15   what I call this what-are-the-odds analysis, right?  What
16   are the odds that this is actually legitimate.  You know? 
17   Two different customers come in for a stock nobody has
18   ever heard of to sell and buy four or five times a week,
19   the same stock.  
20             I mean are there things that just don't make
21   sense, that you're -- to use the earlier panel, "Huh?" 
22   That type of -- I really believe in that.  And I think,
23   at the end of the day, you really do have to rely on
24   that.
25             PARTICIPANT:  Sarah, if I can just jump in a
0100
 1   second -- oh, sorry, Ray.
 2             MR. WILSON:  Yeah, actually, I do want to jump
 3   in.  And a couple of things, one of which is that
 4   somebody mentioned the human element earlier.  And it's
 5   been -- we have referred back to it several times in
 6   several different ways, which is, you know, if you make a
 7   rule that says you can't do this, then somebody will go
 8   around it and find a way around the rule.  
 9             I think part of that is you have to have
10   broad-based rules that take account of things that change
11   over time as -- you know, we find different means of
12   transaction business, we do things differently.  Very few
13   people, you know, listen to LPs any more.  You can get
14   them.  I was at Best Buy recently, they had some on the
15   shelf.  But very few people do that.  You know, iPods. 
16   Who thought 20 years ago -- who heard of an iPod?  Ten
17   years ago, who heard of an iPod?
18             So, I think, you know, having that type of
19   understanding about things, that things are going to
20   change, and the business models are going to change, the
21   crooks are going to change, because, you know, as soon as
22   they figure out that they're going to get caught one way,
23   they're going to try something different.  So the human
24   element is one thing.  Remembering the end user is
25   something that the investor, the retail investor, is
0101
 1   something that is important.
 2             Something that -- you know, getting company
 3   buy-in is that when so-and-so did something and something
 4   bad happened, it's usually a company reputational risk
 5   problem, actually, that they want to -- that helps to get
 6   that buy-in.  It's not like Rogue Trader appears on the
 7   front page of the, you know, national newspaper.  It's
 8   so-and-so brokerage firm ripped off Grandma.  And I don't
 9   think many of us want to be associated with the brokerage
10   firm that ripped off Grandma.
11             MS. JOHNSTON:  I will say, though, just to
12   speak in terms of the issuers, I do think there are a few
13   things that can be done -- and I think Jeff alluded to
14   them, or spoke directly to them -- that wouldn't have a
15   significant chilling effect on sort of the
16   capital-raising that we look to providing with microcap
17   stocks.
18             I mean audited financial statements, it is not
19   difficult to get audited financial statements if you're a
20   legitimate company.  And lots and lots of very small
21   companies, including private companies, get audited
22   financial statements, just so that they have the ability
23   to get sort of corporate loans.  So, certainly imposing
24   that on companies does not seem to me to be tremendously
25   unreasonable.  
0102
 1             And certainly having additional disclosure for
 2   companies that -- they have to keep up to date also, it
 3   doesn't have to be -- particularly if you're a fairly
 4   small company, I just don't believe it's that burdensome
 5   or onerous on them, and that would create a lot more
 6   transparency, and I think much more challenging for
 7   somebody to misuse these companies.
 8             MS. FOX:  To build on both Lynne and Jeff, I
 9   think there is some context necessary.  Because when we
10   talk about the change in SARs, I have been watching
11   what's going on in daily trading in the pink sheets
12   since -- pretty closely since 2007.  Anecdotally looking
13   at the numbers.  It used to be $200 million to $300
14   million a day in trading activity.  Now it ranges between
15   $400 million and $700 million a day.  Do the math. 
16   You're talking about 125 to 180 million, depending on the
17   way it -- or billion -- depending on the way it plays
18   out.
19             Apply your own percentage of fraud to that. 
20   You could be looking at fraud every year.  That is money
21   that is diverted from the markets, that is not available
22   for small firms.  That is money that is not staying in
23   the market, so it's really important that we rebalance
24   expectations.  How do we create commerce without creating
25   chaos?  How do we make these rules functional, and put in
0103
 1   place reporting to a common repository?
 2             OTC markets pink sheets has done us a
 3   tremendous service by proving that these issuers are
 4   willing to give information.  Now it's time to step up,
 5   ask for additional nominal regulation that gets bits of
 6   information into common central repositories -- again, so
 7   that systems can be built, so that it's easier to
 8   monitor, easier to identify the bad actors.
 9             MS. SANTANGELO:  Right, because -- to add on
10   that, I mean, and to build on what the first panel said,
11   I mean, there is just too much redundancy of what
12   everyone is doing here.  People are all re-analyzing the
13   same issuer.
14             And, you know, first of all, you can use 314(b)
15   if you know that another firm is having the same issue. 
16   But that doesn't really happen in the micro-fraud (sic)
17   area, you know?  So we need to figure out a way to
18   have -- approach this issue efficiently and without
19   redundancy.  And I think the more disclosure we have, the
20   better we can -- you eliminate some of the redundancy. 
21   But there is a lot of individual investigations that go
22   into the deposit of every issuer.  And that is one of the
23   problems, I think.
24             MR. HOROWITZ:  One of the things we've done
25   here is, you know, we have retail brokers that are taking
0104
 1   a stance and looking at those certificates as they're
 2   coming in clearing firms, DTC, and their global lock and
 3   chilling and the custodians, but we haven't solved the
 4   problem.  They're just going to find a path, the path of
 5   least resistance, whether that's a different clearing
 6   firm or a different introducing broker-dealer.
 7             One of the things we need is stiffer penalties
 8   for the repeat offenders, and that is -- whether that is
 9   civil or criminal from the SEC, you know, I think the
10   deterrence hasn't been enough to really stop the bad
11   actors, because they will go from one broker-dealer to
12   the next broker-dealer.
13             MS. FOX:  For years and years and years.
14             MR. WILSON:  And I'm not sure always that those
15   things are always a deterrence, because there is going to
16   be somebody for whom even the death penalty is not enough
17   of a deterrent to keep them from trying to take, you
18   know, trying to take somebody else's life or money, or
19   whatever.
20             But again, I go back to smarter regulation. 
21   Some of the things that you all mentioned recently, you
22   know, the accounting, having something like that, where
23   you can go in and read and an accountant has actually
24   looked at, you know, a board statement or something like
25   that.  That's a disinterested third party, usually,
0105
 1   unless, you know, that person is also involved in the
 2   fraud.
 3             MR. HOROWITZ:  I think mom moving back in was a
 4   deterrence enough that we need to do something.
 5             (Laughter.)
 6             PARTICIPANT:  I just want to address Lynne and
 7   Jeff.  I see -- in our experience, we have seen that your
 8   two firms do a particularly great job at AML monitoring. 
 9   And I reference the -- there is a low-price security
10   questionnaire that gets sent out.
11             So we've heard some dissenting views on, you
12   know, what's required at the clearing firm level, and how
13   much to do.  And you guys do a major part of it.  Is
14   there any agreement among the clearing firm community on
15   those?  I mean since you guys are doing a particularly
16   good job at that, by sending out those questionnaires, is
17   that just something that you do on your own?  Is -- I
18   mean it's -- because we have seen others in the clearing
19   firm community that don't necessarily meet that bar.
20             MR. HOROWITZ:  I think there is a lot of
21   information sharing of what are the best practices.  And
22   we share -- because I think we're all in this together --
23   but I think clearing firms have come to a different
24   stance on how far do you dig, as well as what are you
25   going to stop bringing in.
0106
 1             I mean the gamut was from $5 to sub-penny. 
 2   There is a number in the middle there that's probably the
 3   right amount to stop.  But from the questions, I think,
 4   you know, FINRA has given us a lot of red flags to focus
 5   on at some of our committees and conferences.  We talk
 6   about what are those best practices.  But happy to share,
 7   you know, some of those questions with the larger group,
 8   if they're not readily available.
 9             MS. SANTANGELO:  I think 0905 really suggests
10   the questionnaire.  So most of the clearing firms that I
11   work with use questionnaires for that reason.  But as I
12   said, the questionnaire is usually filled out by the IB.
13             MS. JOHNSTON:  I will say that one of the
14   challenges -- not every firm has the privilege of
15   clearing with a firm as large as Pershing.  And so if
16   you're a smaller, you know, clearing firm, the firms that
17   you're going to clear for are going to be probably
18   smaller broker-dealers, and you're probably going to be
19   spending a lot more of your time with microcap
20   securities.
21             And so, you don't want to -- and this is a
22   very, you know, revenue-generating, challenging
23   environment for everyone.  So part of the balance you
24   have is how do I continue to make business, and make
25   money, have clients coming in without having too much
0107
 1   being applied to them, if most of the stocks they're
 2   bringing in really are microcap.
 3             MS. GREEN:  Okay.  Well, I was going to -- I
 4   think you guys have been saved by the bell, because I
 5   think we're about out of time.  I was going to ask you
 6   about beneficial ownership, but --
 7             (Laughter.)
 8             MS. GREEN:  But I think we're about up.  We're
 9   at the 3:30 mark.  So thank you all so much for your
10   participation.
11             (Applause.)
12             MR. EHRMAN:  Thank you.  We will take a
13   15-minute break, and then we will have our third and
14   final panel.
15             (A brief recess was taken.)
16             MR. EHRMAN:  We will get started with our third
17   panel, which is called "Potential Changes to the
18   Regulatory Framework Concerning Microcap Securities." 
19   Our original-scheduled moderator, John Polise, was unable
20   to attend today.  So his understudy is me and Steve
21   Vitulani, who will be performing for you.  
22             So, again, John sends his regrets.  He has been
23   intimately involved with dealing with the OTC space from
24   enforcement, regulatory, and self-regulatory organization
25   perspectives throughout his career, and I am sorry to say
0108
 1   he won't be here to add his unique perspective and
 2   intelligent insight.  But certainly Steve and I, as his
 3   proxies, will do the best that we can.
 4             And I think to start things out, I would like
 5   to ask each of the panelists.  I will start here with
 6   Chris, to kind of go down the list and give us sort of
 7   the five to seven-minute view on your role in the
 8   microcap space.  And then, after that, we will start a
 9   cheerful banter with the Q&A.
10             MR. STONE:  Great.  Thanks, Chris, and
11   appreciate the invite for having me to speak today.
12             As many of you probably know, in October of
13   2005 the NASDAQ stock market became a registered national
14   securities exchange.  And at that time there were a
15   variety of functions that the NASDAQ exchange had
16   historically processed that the Commission determined was
17   no longer consistent with exchange operations.  So, FINRA
18   at that point in time took over full operation and
19   ownership of a variety of these over-the-counter-like
20   roles.
21             So, at that point in time we took over full
22   ownership and operation of the bulletin board, quote
23   system, the OTC equity trade reporting facility, which is
24   the trade reporting platform for FINRA member
25   broker-dealers to execute and trade report trades in the
0109
 1   over-the-counter market.  
 2             And then finally we took over a wide range of
 3   what we'll call uniform practice code, UPC functions,
 4   from NASDAQ.  It includes a wide range of corporate
 5   actions, processing functions.  And I think before we go
 6   too much deeper into that, it's worth saying what is this
 7   universe of securities, because a lot of people don't
 8   necessarily deal with the scope of it on an everyday
 9   basis.
10             The universe of OTC equity securities is over
11   19,000 symbols, which is actually a lot larger than most
12   people think when they first look at this space.  It's --
13   obviously, that dwarfs the exchange listed market, in
14   terms of the number of symbols in the space.
15             A subsector of that universe is OTC BB quoted
16   securities.  Another subpart of that is OTC market quoted
17   securities, and then the last tranche is gray market
18   securities.  So, publicly traded, unlisted equity
19   securities that aren't quoted on any inter-dealer quote
20   system in the OTC equity market.
21             So, I guess one thing that's important to note
22   in terms of our role in this space is we manage this
23   universe of securities, both in terms of setting dates
24   and managing symbol changes.  Thus far this year, year to
25   date, we have affected over 13,000 corporate actions,
0110
 1   symbol changes, additions, deletions.
 2             And I guess about two years ago, we first
 3   started talking with the enforcement division about, you
 4   know, are there things FINRA can do in this space to
 5   combat microcap fraud, specifically around corporate
 6   actions changes.  And one thing we found in conjunction
 7   with the enforcement staff and with the DTC staff was
 8   that this really -- this function sits in a key spot,
 9   with respect to corporate actions changes that, down the
10   road, ultimately can lead to microcap fraud and turn into
11   microcap fraud down the road.
12             So, one thing we did was we took a step back
13   and said, "What additional due diligence and work can we
14   do up front on corporate actions changes before they're
15   processed, to determine if potentially it's something
16   that should be declared deficient and not processed, if
17   we think it might be related to potential downstream
18   microcap fraud?"
19             So, in September of last year we had our new
20   rule 6490 put in place, which lays out specific criteria,
21   a set of five criteria that allow us to declare a
22   corporate action that's requested by a microcap issuer as
23   being deficient.  Again, we have processed 13,000
24   corporate actions and symbol changes, additions, and
25   deletions this year, year-to-date.  That includes
0111
 1   bankruptcies, symbol changes, updates, deletions.  We
 2   have ultimately declared six deficient so far.
 3             So, we see this as an iterative process.  We
 4   are working with the Commission and DTC to further
 5   develop our processing in this space and OTC markets.  We
 6   don't have contractual privity with issuers, the way
 7   exchanges do, in connection with a listing agreement on
 8   the exchanges, so we don't necessarily have a direct line
 9   of communication with issuers in this space.
10             So, it can be challenging.  It requires us to
11   use all the data points we can get our hands on, and to
12   interact with issuers as proactively as we can, in
13   conjunction with the request for corporate actions
14   changes.  And that is really, I think, the key part of
15   what I would like to hit on today, in terms of what our
16   recent processing is around corporate action changes.
17             POTENTIAL CHANGES TO THE REGULATORY 
18           FRAMEWORK CONCERNING MICROCAP SECURITIES
19             MS. MERRILL:  Hi, I'm Susan Merrill.  I have
20   been asked by our absent moderator to speak a little bit
21   from my perspective as having been the head of
22   enforcement for FINRA for several years.  And I am going
23   to do that, but I should also say that now I represent
24   some of those same broker-dealers and exchanges that we
25   had been targeting.  So it will be a bit of a delicate
0112
 1   balancing act, but I think I'm up to it.
 2             Bill Park, with whom I had the privilege of
 3   working when I was in enforcement at FINRA, who was on
 4   the last panel, spoke quite a bit about the regulatory
 5   notice 0905.  And he and others who worked on his team
 6   were instrumental in putting that out, in addition to
 7   bringing some cases that were specifically targeting the
 8   broker-dealers who had repeatedly allowed the sale of
 9   unregistered securities without having any adequate
10   inquiry into whether the people who were selling them or
11   requesting the sale were related to the issuer, or
12   whether they were unwittingly or wittingly being involved
13   in an unregistered sale of securities.
14             And Bill and his team tried very hard to shut
15   down that avenue of fraud that some unscrupulous issuers
16   were using, or people related to issuers, to getting
17   their stock out.  In particular, as it relates to
18   pump-and-dump schemes.
19             And so, using the AML standards that were
20   applicable to broker-dealers for reporting of suspicious
21   trading as not just money movement but suspicious
22   trading, and also FINRA's supervision rules generally,
23   Bill and his team brought a number of cases and worked on
24   what is now 0905.  And I am glad to hear that it has had
25   an effect on the way broker-dealers are conducing their
0113
 1   business.
 2             But I can tell you that when we were working on
 3   drafting this release, we were searching for the proper
 4   support to put in here for the SEC -- from the SEC to
 5   show that broker-dealers really do have this duty of
 6   inquiry, to make sure that they're not participating in
 7   this kind of offering.
 8             And what we did find -- and what is quoted in
 9   here extensively -- is an SEC release, a Securities Act
10   release 4445, that was issued on February 2, 1962.  I
11   remember the date, because it's my birthday, but I was
12   five years old at the time.  And I think it really points
13   to what we're going to talk about on this panel today,
14   which is the need for more explicit guidance -- in
15   particular, not just from FINRA in the form of regulatory
16   notices, but in the form of rule-making by the SEC that
17   will address the issues of what the gatekeeper's
18   responsibilities are.  Because that is, I think, a very
19   important way that this market can be policed.
20             Enforcement actions alone are not going to do
21   it.  And while there is a very small number of
22   illegitimate companies, issuers, promoters out there in
23   this market, no matter how small that percentage is, they
24   have a very real impact on investors.  
25             So I do think -- and we will talk about it in
0114
 1   more detail as the panel goes on -- that there is a need
 2   for more legislation, more regulation in this area.
 3             MR. COULSON:  I am Cromwell Coulson.  I am CEO
 4   of OTC Markets Group.  We are where the majority of small
 5   company trading takes place, of quoting and trading by
 6   broker-dealers.  I used to say, well, there is the FINRA
 7   OTC BB.  But since 95 percent of the quotes have left the
 8   OTC BB to move to our more electronic platform, it is --
 9   we own it.
10             And I think, as we define this, we really have
11   to decide what is microcap.  Because if you look about
12   the traditional definition of microcap, it means under
13   $300 million market cap.  And that is smaller companies,
14   to me.  
15             And one of the fundamental things, as we look
16   at how do we make regulation work for good, for bad, is
17   you invest in a security as an outsider to buy something
18   that eventually you can sell -- hopefully for more value,
19   sometimes for less value -- and the OTC markets today are
20   an incredible marketplace for outside investors.  The
21   improvements have been fantastic.  It's more electronic,
22   it's more transparent, it's more efficient.  There is
23   better audit trail, and the best broker-dealers with the
24   best technologies are providing execution services,
25   liquidity providing -- it's turned into a great
0115
 1   marketplace.
 2             The problem is when insiders interact, and when
 3   insiders interact without a level playing field.  In the
 4   1960s we knew.  Insiders interact, they've got to be
 5   making disclosure.  There has got to be adequate current
 6   information.  If they're not, they shouldn't be
 7   interacting.  We saw that with Facebook.  Doesn't let
 8   employees trade on second markets.  Simple idea.  You're
 9   an insider, you have information, don't trade.
10             So, how do we make this work?  I mean I think
11   that's the biggest side, because the OTC markets -- a
12   fundamental property right of ownership under the
13   capitalist system is the right to sell, transfer, or
14   otherwise dispose of your interest.  And if you have it
15   for a holding period, you want the ability to sell that
16   stock, because that is ownership.
17             Now, on the flip side, if you're in control,
18   you should be producing information.  
19             So, microcap definition, if you say it's
20   sub-penny trading, well, sub-penny trading on our
21   platform is less than one percent of the dollar volume. 
22   It's interesting, 90 percent of that 1 percent is below
23   half-a-penny.  The majority of those companies are
24   SEC-registered of that sub-penny dollar volume.  That's
25   kind of interesting.
0116
 1             The growth of our trading.  A lot of it has
 2   been driven in international securities, ADRs, as U.S.
 3   investors want to globalize their investment opportunity. 
 4   We have created this great opportunity for them.  They
 5   can buy at a -- very efficiently, and hold through their
 6   U.S. broker-dealer an ADR in Roche, an ADR in Adidas.  
 7             And we have actually, as we have changed this
 8   market, you know, we've brought in categories.  Five
 9   years ago, you couldn't -- the OTC market was like
10   Craig's list.  You couldn't tell who was who.  We have
11   categorized the OTC market.  Now there is disclosure
12   levels.  And 95 percent of the dollar volume in quoted
13   securities, there is current information available.  That
14   is pretty interesting.
15             So, there is some securities that still trade
16   with no information.  We put a stop sign on those quotes. 
17   And then there is the caveat emptor, when we see spam. 
18   We invented that.  It's now become part of the term, and
19   it's great, helpful for clearing firms, for brokerage
20   firms, when they see the caveat emptor.  
21             But the private market is segmented.  And there
22   is actually -- I see companies with stop signs that are
23   real companies that a sophisticated investor should buy. 
24   And a good point was made by DTC.  Just because there is
25   disclosure that says there is current information,
0117
 1   investors need to read. 
 2             So, you know, I would go back to the idea that
 3   if Grandma is buying a sub-penny stock with a stop sign
 4   or that is late in SEC reporting, you know, you got to
 5   stop that, because she is going to end up moving in with
 6   you.  Well, the truth is, if she's not buying that, she's
 7   probably going to be moving in with her tango instructor,
 8   and he is going to get that money.
 9             So, you know, we can't build our markets around
10   dumb investors.  Disclosure needs to have a level of
11   investors reading things, and not saying, "Oh, I took
12   risk, and I lost."  Well, that's a problem.
13             So, let's talk about what we've done really
14   well in this space.  Boiler rooms are almost gone. 
15   That's pretty cool.  Also, SEC suspensions.  Last 5
16   years, they're up 200 percent.  The SEC is getting more
17   enforcement activity as there is disclosure.  That's a
18   great change.
19             You know, 0905 is great guidance for companies
20   about brokers having to look at what they have to do. 
21   That said, you know, as we build this better market,
22   there are things we need to do.  Because you make markets
23   clean the same way you make streets less dangerous: 
24   transparency through better lighting, security cameras so
25   there is an audit trail, you close an open door or two,
0118
 1   put a better lock on it, or -- and finally, you put in
 2   alarms and have lots of passerbys who are honest
 3   citizens, because they can alert the police.
 4             At the end of the day, more crime is stopped by
 5   passerbys or private alarm systems than police stopping
 6   individual crimes.  Now, what the police are very good at
 7   is systemic crime, where there is a ring that's robbing
 8   houses numerous times.  And that is a different side. 
 9   But this marketplace needs more transparency.
10             Number one is the issuer responsibility for
11   disclosure.  Limit companies and affiliates from buying
12   or selling in the public markets if there is no current
13   information available.  Pure and simple, let's decide
14   what the level of information needs to be.  Let's freeze
15   them out, if they can't.  That needs to be there.
16             We also need transparency.  When are insiders,
17   affiliates buying or selling?  Guess what?  If you get
18   reports -- and form 144 is just intent to sell -- with
19   non-reporting companies, there is no "I sold, I actually
20   did it."  And you put those in electronic format, it's
21   much easier to connect the dots.  Who is an insider?  Who
22   did they live with?  Where is this -- you get the
23   addresses, it goes into the system.  Much better.
24             Also, transfer agency standards.  Clearly, we
25   are asking DTC to do a job that transfer agents should be
0119
 1   doing.  And there is no level of standard.  Should
 2   transfer agents be -- have to check every piece of
 3   information?  No, but they should have a process to
 4   collect it.
 5             We started collecting attorney opinions.  And
 6   when we got bad opinions, we banned those attorneys.  And
 7   we actually did something interesting.  We posted that
 8   list on the Internet.  Most people, they don't post --
 9   when something bad happens, it's quiet.  Now the
10   community knows who we won't accept an opinion from. 
11   That's a big plus.  
12             All these back-room things that happen, where
13   good people are stopping bad people, that's not great for
14   anything.  You need transparency.  And those opinions
15   that we blocked, most of them have SEC actions against
16   them, and they are used a lot by the community.  And
17   actually, they're starting to set a standard.
18             Also, you know, there needs to be a way that
19   transfer agents share with broker-dealers the history of
20   the shares.  When they lift a restriction, why was it
21   lifted?  Who is this person?  Are they an affiliate? 
22   Where do they come from?
23             Thirdly, because there is no more boiler room
24   selling small stocks, there is actually no more
25   legitimate brokers selling small stocks, recommending
0120
 1   them.  That's moved to promotion.  Almost half the
 2   companies listed on NASDAQ have no research.  So there is
 3   promotion -- it's a real service for companies.  We can
 4   say it's a bad service, but it's actually -- small
 5   companies need someone to tell their story.  And -- but
 6   we have no transparency about promotion.  We have no
 7   locks on the doors about promotion.  It's just a limited
 8   "I was paid."  Well, who are you?  Who paid you?
 9             When you start a promotion, you should be
10   restricted for a year.  You shouldn't start a promotion
11   and start dumping.  And also, if that's automated, if
12   that's electronic, who it is, what their address is,
13   again, it goes into the electronic systems.  It's so much
14   better for the industry.
15             But we did a rule proposal, we -- public
16   request for rule-making to the SEC five years ago.  We
17   got almost 100 letters of support saying there needs to
18   be more disclosure and obligation on promotion.  Well, we
19   haven't heard anything.  I think it's a great idea.  I
20   don't know if our approach was right or wrong, but I
21   would have liked to have a candid conversation from the
22   SEC staff with this rule proposal well supported by a
23   diverse base.  Let's bring transparency, let's bring
24   obligation.  But it's been empty.
25             That's not to say -- enforcement has been
0121
 1   great.  They have been using our information, they have
 2   been cleaning out bad guys from our marketplace.
 3             PARTICIPANT:  Cromwell, can I ask you a
 4   question there?
 5             MR. COULSON:  Sure.
 6             PARTICIPANT:  Are you suggesting that a
 7   transfer agent should be sharing shareholder ownership
 8   history with the public, or --
 9             MR. COULSON:  No, I --
10             PARTICIPANT:  -- just with the broker-dealer
11   community, or --
12             MR. COULSON:  With -- I think part of the point
13   of making it all electronic is you can transfer more
14   fields. 
15             I do think transfer agents should be required
16   to post shares outstanding at the end of the month.  I do
17   think transfer agents should be required to post who the
18   officers and directors are, and keep that updated as they
19   see that.  Who are their authorized signatories, as they
20   go through those points?  Because -- you know, but it
21   should be publicly available.
22             Stuff that is kind of in the private, it gets
23   missed, it doesn't get viewed, you know, a good
24   marketplace needs everybody looking at the information,
25   because you're never too sure who is actually going to
0122
 1   say, "Hey, there is a chink there."  
 2             And you know, that is -- but those three rules,
 3   I think, could really create a better, more transparent
 4   marketplace out there, and make it a better place for all
 5   investors.  Because we have -- the numbers are very
 6   clear.  Small companies are not going public.  Small
 7   companies are not having their securities traded.  We
 8   have created all these barriers to entry.
 9             If I am a small company, I register with the
10   SEC, goes through that process, FINRA approves my 211
11   application, I am ready to quote.  And actually, FINRA
12   spends -- 70 percent of the applications they look at are
13   companies listed on non-U.S. exchanges.  What use of time
14   is that?  We've got a request in with the SEC on that,
15   too.  They don't want any loosening, even if it's because
16   BMW's -- their ADR-211 took 3 weeks to qualify.  That's a
17   waste of time.
18             Finally is -- but then you go to DTC.  I'm not
19   sure that a real company has an easy process that they're
20   going through these three spots of something that should
21   kind of be connected.  So, you know, that's my side, is
22   how can we make this more efficient?  
23             We have smaller companies.  We are probably the
24   greatest capitalist economy in the world, but we have
25   stopped having small companies trade.  NASDAQ became a
0123
 1   copy of NYSE.  Let's have a marketplace for small
 2   companies, because it is good for capital formation.
 3             MS. GRAFTON:  Hi, I'm Susan Grafton, I'm at
 4   Gibson, Dunn & Crutcher, and I spend a lot of my time on
 5   broker-dealer compliance issues, but I also regularly
 6   advise on whether broker-dealer registration is required. 
 7             And so I would like to sort of build on a point
 8   that Cromwell made with respect to sales activities.  And
 9   that goes to the issue of questions that arise in the
10   context of an issuer who wants to pay somebody who has
11   referred potential investors to the issuer, and then
12   others who wish to monetize their contacts.  And we see
13   what we all refer to frequently as finders fees.
14             And so, generally we all know that the
15   economics of these arrangements really only make sense if
16   the compensation is transaction-based, because it really
17   only makes sense for the issuer to sort of extend itself
18   based on, you know, the number of successful investors
19   that it gets.  And then, it only really makes sense for
20   the potential finder to be paid based on how successful
21   their efforts are.
22             And, of course, then that means under the
23   definition of broker in section 384, that that finder is
24   likely going to be deemed to be a broker, and have to
25   register with the SEC.  
0124
 1             And so, while there are other factors that are
 2   out there that the staff, particularly in the past, has
 3   cited as potentially triggering broker-dealer
 4   registration, such as whether you're involved in
 5   negotiating the terms of a transaction, whether you
 6   handle funds or securities, it really is the receipt of
 7   transaction-based compensation that is going to put
 8   somebody into the bucket of having to register as a
 9   broker-dealer.
10             Now, of course, one of the issues with that is
11   that there is really only a one-size-fits-all model for
12   broker-dealer registration today.  So you can do some
13   sort of tailoring of the requirements based on your
14   particular business model, so that you can tailor
15   supervisor procedures.  Your net capital is going to be
16   lower if your business is more limited.  But you still
17   have all of the infrastructure, in terms of the -- you
18   know, your compliance and your operational procedures.
19             So, one of the, I guess, suggestions that I
20   want to put on the table would be going back to 2005,
21   when the ABA's task force on private placement
22   broker-dealers put forth a proposal that -- to recommend
23   to the SEC, working together with FINRA and the state
24   securities regulators, to come up with basically
25   broker-dealer registration light.  And so this would be a
0125
 1   model of registration for private placement
 2   broker-dealers that would, you know, be geared towards
 3   the type of activities that they have, and the risk that
 4   they pose to investors.
 5             Among the conditions that were proposed would
 6   be that these limited broker-dealers could participate
 7   only in best efforts private offerings, so no public
 8   offerings, that they could only make their sales efforts
 9   to accredited investors and qualified purchasers, even if
10   the issuer sold to other investors.  There could be no
11   secondary trading, no market making, they couldn't hold
12   or handle customer funds and securities.  None of the
13   principals or the registered persons could be subject to
14   a statutory disqualification.  They would have to provide
15   certain types of annual activity statements to the SEC. 
16   And then, of course, all of the federal licensing
17   requirements would apply to the principals and associated
18   persons.
19             So, you know, we know that the SEC staff and
20   the Commission itself has a very full plate these days
21   with all of the Dodd-Frank-related rule-makings, and they
22   should be commended for all of their efforts.  But this
23   might be one area where there could be some rule-making
24   that would both facilitate capital-raising as well as
25   protecting investors.
0126
 1             Because, you know, I think that it's fairly
 2   common knowledge that there are probably a lot of these
 3   finders that make that business risk decision, and decide
 4   that they're not going to register because maybe they're
 5   only doing this on -- they're contemplating doing this
 6   only for one transaction.  And so they would take the
 7   view of not being in the business of being a broker or
 8   dealer.  So thank you.
 9             MR. FELDMAN:  Okay, good afternoon.  I am David
10   Feldman.  I am a partner of Richardson & Patel in New
11   York.  We are an LA-based firm representing over 100
12   public companies, as well as broker-dealers in
13   underwriting transactions.  And the focus of my comments
14   initially are going to be about taking companies public
15   and the fact that the IPO has been the gold standard
16   forever, even though there were over $2 billion in fines
17   paid by underwriters of IPOs in the late 1990s. 
18             So the question is:  What's the legitimate way
19   to go public?  And we have worked with a lot of companies
20   in reverse mergers and other IPO alternatives, and the
21   most important thing I want to say is reverse mergers are
22   not evil.  But some people who do reverse mergers are
23   evil, but some people who do IPOs are, as well.
24             So, we have to look at, you know, managing the
25   process of looking at the people, and not the technique. 
0127
 1   And there are many companies that feel that it's easier
 2   to go speedier, quicker, cheaper, simpler, more efficient
 3   than an IPO.  In fact, many companies don't qualify for
 4   an IPO.  If they're below several hundred million in
 5   market value, an IPO is very unlikely in today's market,
 6   or in the market of the last five to seven years.  Yet,
 7   these are companies that could benefit from being
 8   publicly held to raise money and grow and do
 9   acquisitions, and they can bear the cost of doing so.
10             So, the question is:  How do we get them there? 
11   And the reverse merger has developed as a very efficient
12   way to do so.  And it's become in the last 10 years very
13   popular, not only because of the problems in the IPO
14   market, but because of improved regulation from the SEC
15   that has required greater transparency in these
16   transactions.  And you also, as a result, have other
17   investors who have come forward and said, "We are willing
18   to finance these transactions."
19             But we have had in the last couple of years,
20   unfortunately, a handful of alleged accounting issues in
21   some Chinese companies that went public in the U.S.  Now,
22   I didn't say "through reverse mergers," although that's
23   usually how it's written in the press.  The truth is, of
24   the many companies that are being accused of mostly
25   accounting irregularities from China, a number of them
0128
 1   did traditional IPOs, including one Longtop Financial,
 2   whose underwriter was Goldman Sachs and whose auditor was
 3   Deloitte.  Now, what should we do about that?
 4             A number of them also did complete reverse
 5   mergers.  However, the reverse merger was with a
 6   non-trading Form 10 shell, where there was a pipe that
 7   took place on the same day.  Not a single share of stock
 8   traded until a few months later, when a fully
 9   underwritten, SEC-approved, firm commitment underwriting
10   of a public offering took place.  And some of those
11   companies are facing allegations, even though they got
12   all the same protections as a traditional IPO.  Yet, for
13   good or bad, the regulators have kind of focused in and
14   honed in on reverse mergers, and said, "This is where we
15   need to attack."
16             The China problem is not about how the
17   companies went public.  It's about the companies
18   themselves.
19             So, with that said, a couple of -- there is
20   ways to deal with issues in these types of transactions,
21   and ways not to deal with it.  I think ideas like
22   restrictions on trading are worth exploring.  I think
23   restrictions on time limit of shells is worth exploring. 
24   I like the idea I heard earlier about stronger penalties
25   for things that went wrong.  And I think -- but the way
0129
 1   that it has been done, and is proposed to be done can be
 2   a problem. 
 3             For example, in 2008 rule 144(I) was passed. 
 4   That rule says if you ever were a shell company ever in
 5   the past, then if anyone wants to sell their shares under
 6   rule 144 without registration, the company has to have
 7   been current in its SEC filings for the last 12 months.
 8             Now, that doesn't sound so terrible, except it
 9   lasts forever.  It paints a scarlet letter on every one
10   of these former shell companies and says to Texas
11   Instruments, Blockbuster, Radio Shack, Berkshire Hathaway
12   and on and on, all these famous reverse merger companies,
13   "You're subject to this too, forever."  And what it does
14   is it hurts -- it makes registration rights harder to
15   fashion, you cannot remove a legend, typically, until an
16   actual sale, which is a problem.  
17             And in 2008, I worked with a group of 9 law
18   firms to submit a petition for rule-making to reverse
19   this.  It hasn't happened yet.  I haven't, frankly, heard
20   one member of the staff come forward and say, "This is
21   why we believe this made sense, from a policy
22   perspective."  I think to say that decades later you
23   still treat these companies differently doesn't make
24   sense.  So that is, in my view, not the right way to
25   address these issues.
0130
 1             More currently, we have the proposal from the
 2   major stock exchanges -- NASDAQ and AMEX and NYSE, to
 3   season reverse merger companies on the over-the-counter
 4   markets for a year prior to allowing uplisting.  Put
 5   aside the fact that that will effectively put an end to
 6   the practice I just described, where Form 10 -- clean,
 7   start it from scratch, not a beer company that becomes a
 8   technology company, they admit they're a shell, they sit
 9   without trading until a merger and a subsequent
10   registration with all the investor protections, that
11   would end.  Because you would have to go and trade on the
12   over-the-counter markets for a year, rather than the
13   immediate uplisting that that other technique would
14   allow.
15             So, the theory is that fraud and manipulative
16   trading is more likely to be discovered.  But the reality
17   is you're relegating these companies to trade  -- no
18   offense to those here who are in the OTC world, but some
19   companies say, "Look, I would just rather bypass that and
20   go right to a national securities exchange, where I am
21   going to have less of a challenge in terms of building
22   market support and getting analyst coverage, and really
23   helping my company grow." 
24             And this proposal is saying, "Well, no, we
25   don't want you to do that, we want you to go trade in a
0131
 1   place where it is going to be more challenging to get
 2   analyst coverage, where it is going to be difficult to
 3   get market support and trading going.  And then, "By the
 4   way, we need you to trade at the price that our initial
 5   listing requires for a period of time before you uplist."
 6             Well, you don't have all the benefits of the
 7   higher exchange to get that price going.  So you could
 8   lose the next great software or defense company getting
 9   their opportunity to raise capital and grow.
10             So the AMEX and NYSE proposals do have an
11   exception that says if you're coming to them with a 40
12   million or higher public offering, you don't have to do
13   the seasoning.  In all other listing requirements of NYSE
14   and AMEX -- AMEX's requirements are lower than NYSE, but
15   not here, for some reason, 40 million is the same for
16   both.  
17             So in the comment letter that I put in on this,
18   I said, well, there should be no minimum on a public
19   offering.  Or, if there is one, make it reasonable, like
20   10 million or 15 million, something like that.  To
21   suggest that investors in a $15 million public offering
22   don't get the same protections as those in a $40 million
23   public offering means maybe there is something wrong with
24   the regulatory environment.
25             What did I want to add?  One -- okay.  I was
0132
 1   going to talk about private placement brokers, but I
 2   won't, except to say I agree totally with everything you
 3   said.
 4             Last item.  It does seem exciting that Congress
 5   seems to really be moving forward with the reform of
 6   regulation A, which is something we have been talking
 7   about a lot here.  And I have always said we wouldn't
 8   need reverse mergers if IPOs were easier to do.  And reg
 9   A offers that opportunity if a larger amount could be
10   raised than is currently allowed, and if blue sky review
11   could be pre-empted.
12             So the bill that is working through Congress
13   now would raise the amount to be raised in a reg A
14   offering to 50 million, and it would exempt blue sky
15   review under certain circumstances.  So that could be
16   very exciting.  Could be a nice alternative, if reverse
17   mergers become more and more difficult.
18             And I guess that is where I will look forward
19   to the rest of the discussion.
20             MR. VAN DORN:  Okay, hello.  I am Walter Van
21   Dorn.  I am a partner in the law firm of SNR Denton. 
22   Thank you for having me.  My perspective on this, the
23   small cap, microcap securities industry may be a bit
24   different than a lot of the other panelists you have seen
25   today, except for, ironically, maybe David.  That is why
0133
 1   they had us sit together, I don't know.  
 2             And that is, first of all, I am not a -- no
 3   longer a regulator, and not in industry -- you know,
 4   private law firm.  But more specifically, I am a
 5   corporate finance lawyer, rather than a litigator or a
 6   market reg lawyer.  So I can just sort of try to
 7   highlight the areas where I brush into this and I see
 8   some issues that I think could be improved in my own
 9   practice -- or, I should say, for my own clients in my
10   own practice.
11             So, as I noted, where I would get involved in
12   this with my clients is typically in the capital-raising
13   process.  As I think David implied, you don't see too
14   many IPOs in the small cap or microcap area.  There can
15   be a few, but they are difficult.  
16             So where you typically run into this is in the
17   various types of private placements there are, and there
18   certainly are a number.  Reg A was just mentioned.  Reg D
19   is the other most common one that I'm sure most of you
20   are familiar with, and certainly there are issues there
21   that I think could be fixed and cleaned up or tightened
22   up, and there have been various proposals, including the
23   recent bad actors proposal that one of the earlier panels
24   mentioned today that probably merits looking at.
25             There is also the exemptions under rule 144,
0134
 1   Regulation S.  Regulation S is of great interest to me,
 2   because a lot of my practice involves non-U.S. companies. 
 3   And there has been a lot of work done here at the
 4   Commission over the last number of years with Reg S.  A
 5   lot of that has been an improvement.  But there is still
 6   a number of things that could be worked on there, to
 7   reconcile all these different exemptions with each other
 8   under the 1933 Act.  And I think if that was done, that
 9   would be a big help in the small cap area for all sorts
10   of different market participants up and down the chain.
11             So, once you get past your capital raising,
12   assuming you should get that far, whether it be private,
13   public, so the next road block a number of issuers and
14   other participants come into is the 34 Act registration
15   question.  There has been a lot of talk about the
16   requirement under section 12(g) of the 1934 Act to
17   register once you have 500 shareholders.  There is a
18   slight variation of that for foreign private issuers.  
19             And a lot -- it was quite helpful, actually --
20   that has been done there to facilitate foreign issuers
21   that qualify as foreign private issuers to navigate the
22   34 Act registration process.  As Cromwell knows, there
23   has been a big improvement in the administration of
24   so-called level 1 ADR programs and unsponsored ADR
25   programs.  But again, there are still issues there that
0135
 1   companies run into in the small cap area.
 2             Another area that my clients occasionally run
 3   into -- and I see -- which was mentioned earlier -- is
 4   the DTC eligibility system.  And obviously, that is an
 5   issue that is, you know, a number of people have
 6   mentioned is a concern.  Certainly, you know, it should
 7   be focused on.
 8             And finally, an area -- I think that's three of
 9   us, and I will also skip it, since Susan did a good job
10   of highlighting it, but that is the broker-dealer
11   registration issue.  This comes up a great deal -- even
12   as a corporate finance lawyer in all sorts of different
13   private placements where many people are under the
14   misconception that if you're a broker or some other
15   finder in a private placement, then you're off the hook
16   on broker-dealer registration, which we all know is not
17   true, but it's a not surprising area where people trip up
18   and are confused, and that's certain an area that I would
19   join the others in noting that it could use a little more
20   focus.
21             MR. WILSON:  Hi, I am Ryan Wilson with AARP. 
22   And I don't -- we represent the retail investors in this. 
23   And there were a couple of things that folks mentioned
24   that I just wanted to go back on.  
25             I think Cromwell was the first person who
0136
 1   mentioned disclosure and how that worked very well.  And
 2   I think there is -- one thing about disclosure is that in
 3   order for disclosure to work, it has to be able to
 4   influence whoever's actually getting the disclosure. 
 5             And there are several types of disclosure. 
 6   There are legal disclosures that we must -- that firms
 7   must give to their regulators.  But there are also
 8   disclosures that are given to the public, which are
 9   completely different animals.  And in order for a
10   disclosure to work, you know, for some other -- for a
11   regulator or somebody who is an attorney practicing in
12   the industry, it must have certain things that that
13   person can use.  
14             But to the retail investor who is trying to see
15   if maybe I want to invest in a small company or something
16   like that, it has to be understandable, in a form that
17   they can actually use and read.  And most retail
18   investors aren't always speaking in acronyms, and may not
19   understand everything else that those in the industry may
20   understand.  So that would be the first thing.
21             The other thing that I wanted to mention
22   that -- again, in order for a market to work efficiently,
23   there has to be some light on the market.  And both
24   parties have to be able to have some understanding of
25   information.  And when we talk about bad actors in this
0137
 1   area, the easiest way to do so is for retail investors
 2   and others to be able to look up and find, you know, who
 3   is a bad actor.  And I think one of those things that
 4   regulators could do -- I mentioned this on the first
 5   panel -- is start talking to each other from different
 6   perspectives.
 7             I heard discussion here about FINRA, the SEC,
 8   and state securities administrators talking to each
 9   other.  It's very rare that -- you know, sometimes turf
10   battles happen in these regulatory frameworks.  "Well,
11   that's my end of it, that's my end of it."  But
12   frequently, if we don't get together and talk and start
13   saying, "Well, you know, I know you're doing that, but
14   what are the holes, where are the areas that we missed,
15   because I'm only doing my end of it, and somebody else is
16   doing their end of it, where is the holes, what are we
17   missing," because the bad guy is looking for the holes.  
18             They are looking for the holes, and that hole
19   is where they're going to go through.  And, you know,
20   they may defraud their attorneys, they may defraud a
21   whole lot of people.  And, as I mentioned earlier, you
22   know, if we get this wrong, the people who are saving and
23   investing, it doesn't matter whether it's only one person
24   or a bunch of people.  They lose their shirts, and mom
25   moves in with you.  
0138
 1             So, it really -- I think it takes a lot of
 2   people to ferret out and make markets work.  And that's
 3   it.
 4             MR. EHRMAN:  All right, I thank you all for
 5   those opening statements and descriptions of what you do.
 6             I think this all sort of highlights the issue
 7   that people -- as Rob talked about earlier, before we
 8   started -- that people have very different views of the
 9   OTC market.  You have the theoretical this is the cradle
10   of capitalism, this is the greatest thing, this is the
11   place where small companies in America come to raise
12   capital and flourish, and then you have the other people
13   who view this as being a cesspool.
14             Now, we've got two divergent views.  And I
15   think the thing we have to discuss here is why do we have
16   so many of these companies that are creating so many
17   problems for people and these continued frauds that just
18   keep coming again and again and again?
19             I'd like to throw this out to the panelists. 
20   And, David, I would like you to lead it off.  Why do we
21   have this problem?
22             MR. FELDMAN:  Part of why we have the problem
23   is because there is very limited trading in these stocks. 
24   And so you do have a greater ease, if you will, of
25   manipulating trading.  So that's certainly issue number
0139
 1   one.
 2             And there are ways to deal with that.  It's
 3   hard.  You know, but one of the things about whack-a-mole
 4   is when you play whack-a-mole you do whack some moles. 
 5   And so you can be somewhat successful, trying your best
 6   to look from place to place.  Why we go after the poor
 7   mole, I don't really understand.  But maybe raccoons
 8   would be better.
 9             So I think that's a major part of the problem,
10   is that you have the ability for short-sellers and others
11   to really make a difference and make money, even where
12   there isn't necessarily something negative there they're,
13   you know, trying to send a message about.  I think that's
14   a part of it.
15             And I think you do have the issue in that small
16   corner of the OTC markets world where there is no
17   reporting, there is no information.  And, in those
18   situations, there is no question that there is greater
19   opportunity for mischief.  And I think there should be
20   looked at, the possibility of saying, "Well, if your
21   stock is going to be publicly traded, there should be
22   some minimal information that should be out there."  How
23   we decide what that is -- I think insider reporting is
24   really important, maybe even more important than audited
25   financial statements.  
0140
 1             And you know, so trading issues are -- and
 2   information flow are the two reasons that I think there
 3   is more of a sense of problems in this market.
 4             MR. EHRMAN:  Chris, you have any thoughts?
 5             MR. STONE:  Sure, thanks.  I think I would
 6   agree with everything that was said on that so far.  I
 7   think a big part of it is, frankly, there is a wide range
 8   of issues in this space, right?  I mean we said a minute
 9   ago there is over 19,000 issued symbols in the space.  
10             About two years ago, we took a step back and
11   looked at how many symbols were there, and there actually
12   were, I think, more than 40,000 we deleted, because they
13   were seen as -- they were fully inactive, or dead
14   symbols.  And, as Cromwell knows, those can be real
15   targets for microcap fraud, when a fraudster sees a
16   symbol that is not trading, it's potentially a dead shell
17   but can be used for microcap fraud.
18             So, at the same time, I think we looked at our
19   OTC equity symbol database, and roughly 50 percent of the
20   symbols in there are ADRs and F-shares.  So you've got a
21   wide variety of issues that are trading in the space,
22   many of them are section 12 financial filers timely.  You
23   know, I think that's what I'd say, is that there just
24   are -- there is a wide variety of issues in the space.
25             MS. MERRILL:  Well, I would just add that
0141
 1   these -- you're right, these issues are not new, by any
 2   stretch.  Thinking back to the 1980s, there are some of
 3   the same exact cases that enforcement is dealing with
 4   today that we were looking at 20 or 30 years ago. 
 5             And so, I think there is always going to be
 6   some level of unscrupulous behavior in these markets. 
 7   And for some of the reasons that David mentioned, maybe
 8   these markets are more vulnerable than others.
 9             I think what has changed is the technology that
10   is available now to spread these sorts of scams in a way
11   that is much more viral than it was 20 or 30 years ago. 
12   And that makes it all the more challenging.
13             It is one of the reasons that I do question
14   whether there should be some further restriction on the
15   types of purchasers that can participate in this market. 
16   And I hesitate to say that, because I do know that that
17   would cut off, for some investors -- for many
18   investors -- the availability to get in on the next big
19   thing, and particularly when the markets have not
20   performed as consistently as they had for the prior
21   30-year period, people who have seen the 401(k)'s go down
22   to the 201(k)'s are looking for that kind of pop.
23             So, completely restricting mom and pop
24   investors from that market may not be the right move. 
25   But I do think greater transparency of information has to
0142
 1   be out there for every company that's trading.
 2             MR. EHRMAN:  How do you feel about maybe a
 3   compromise there, where certain investors are prohibited
 4   from directly investing in the marketplace, but perhaps
 5   maybe the idea of creating investment companies or others
 6   that do trade in that space, and then they can invest
 7   in -- so they've got another gatekeeper --
 8             MS. MERRILL:  Through a fund, so to speak?
 9             MR. EHRMAN:  Right.
10             MS. MERRILL:  Yeah.  I think that might be a
11   viable option.
12             MR. COULSON:  Well, actually, I mean, probably
13   the most successful investors in this space are kind of
14   the private partnerships, hedge funds of -- you know,
15   Warren Buffett, he actually was in -- when you read
16   "Snowball," he was excited each that the printed version
17   of the book of prices came out, so he could look for
18   things.
19             And, you know, this market exists.  There is
20   500 banks on the platform.  On average, about 75
21   companies a year upgrade to exchanges, which is
22   actually -- from the OTC markets -- which is actually a
23   pretty good number, in comparison to Toronto, from the
24   venture to their listed.  
25             And I actually disagree with David.  Small
0143
 1   companies should season.  And part of the problem is when
 2   companies -- companies build a record.  You don't
 3   suddenly become magical to real investors day one.  You
 4   build a track record of performance.  That's how small
 5   companies grow.  And small companies should be able to go
 6   access capital over time, tell their story, execute
 7   results.  
 8             And that, in a way, is missing because the
 9   advisory community on the regulated side has moved a bit
10   too much to the promotional community.  We have created
11   something called OTC QX, which is -- has been very
12   successful internationally, and is starting to see
13   traction from -- in the U.S., where -- and those
14   companies, they have to have certain financial standards,
15   they have to be -- the disclosure has got to be reviewed
16   by a professional.  
17             Internationally, you know, we have had four
18   companies come in and test the waters internationally,
19   and then upgrade to NYSE, which is pretty incredible for
20   international companies coming to NYSE.  We have also --
21   we have a U.S. company that is -- was on the AIM, came
22   back, built volume in the U.S., and they're moving to
23   NASDAQ.  
24             And that part of a feeder marketplace, people
25   forget.  NASDAQ had a different market structure.  It was
0144
 1   a dealer-driven liquidity provider.  These securities
 2   don't trade at the velocity of thousands of trades a
 3   second.  A good small company stock on NASDAQ trades 300
 4   times a day.
 5             MR. EHRMAN:  I think -- Cromwell, sorry to
 6   interrupt.
 7             MR. COULSON:  That's -- yes.
 8             MR. EHRMAN:  We were talking about comparing
 9   yourself to NASDAQ, and things like that.  Do you all
10   ever have any concerns -- I mean obviously you're a
11   broker-dealer quotation medium.  But on your site you
12   have these various things, tiers you were describing. 
13   Are you ever fearful that perhaps in doing so you're
14   creating the -- an exchange-traded environment really,
15   when it's entirely different on the OTC, due to the lack
16   of privity with the issuers quoted?
17             MR. COULSON:  I actually think we provide by
18   being OTC, by people understanding that OTC is not
19   listed, it's not second market.  It is -- OTC is very
20   blunt.  Our bottom layer is still pink.  We've got a stop
21   sign is -- you know, people understand.  I mean the
22   important part for us is actually getting our tiers out
23   with our price feed.  So a lot of online investors.  And
24   we're seeing more and more online brokers show with our
25   real-time quotes that it is different.
0145
 1             MR. EHRMAN:  Ryan, do you think that's true?
 2             MR. WILSON:  I don't think that's always true,
 3   that all retail investors do.  I mean I think there are
 4   certain retail investors that do understand the
 5   differences.  But I'm not sure that everybody who has
 6   access to a computer and, you know, goes out and does
 7   investing online or otherwise knows how to.
 8             And to answer Chris's question from earlier is,
 9   you know, why are -- do some people see these as cess
10   pools and others as good things.  Well, sometimes good
11   things come from cess pools.
12             MR. EHRMAN:  Can I use that?
13             (Laughter.)
14             MR. WILSON:  Yes, yes, you can.  Sometimes good
15   things come from cess pools.  But --
16             MR. EHRMAN:  Walter, you have any thoughts?
17             MR. VAN DORN:  About cess pools?
18             MR. EHRMAN:  Anything you'd like, about your
19   mother moving in or with her tango instructor.
20             MR. VAN DORN:  Or the opportunity to change the
21   subject.  
22             No, look, I could see how individual investors
23   logging on to a computer may not be able to, you know,
24   tell the difference between, you know, Cromwell's
25   organization or another one that is a stock exchange,
0146
 1   obviously.  But at the same time I agree with Cromwell. 
 2   It's been very useful, especially, you know, a large part
 3   of my practice, as I mentioned in the beginning, is
 4   dealing with non-U.S. issuers, especially in the ADR
 5   world. 
 6             You know, for some unfortunate reasons, the
 7   public trading markets have become unpopular in the last
 8   decade or so, especially with European companies.  And at
 9   least there has been some sort of haven to keep a number
10   of them here in the level 1 ADR format, for which they
11   have used the OTC system.  So I think that's been a good
12   thing.
13             MR. EHRMAN:  I guess the next question --
14   Chris, I will start with you, no pressure.  Is there any
15   particular rules you see, as an SRO, that the SEC has in
16   place that perhaps may need to be kind of tweaked,
17   changed, updated, removed, altered, you name it, to maybe
18   make your life a little bit easier, maybe do a little bit
19   better job of protecting investors?
20             MR. STONE:  Sure.  Thanks for the platform.  As
21   was mentioned earlier on the panel, we administer rule
22   15(c)211, which is the gatekeeper for authorizing quoting
23   activity on an inter-dealer quote system.  Our regulatory
24   group in Rockville, Maryland, administers that.  
25             And, as you know, Chris, 211 is kind of a
0147
 1   one-stop shop.  You do it when you come in --
 2   broker-dealers proffer the information they need to get
 3   clearance up front.  But I think, you know, there has
 4   been various proposals over the years around 15(c)211
 5   where there could be some kind of ongoing requirement, or
 6   revisiting of the 211 clearance on an annual or some
 7   other basis.  And I think we have thought for a while
 8   that that could really be a positive step, to ensure that
 9   the information is still there, with respect to issuers
10   that are being actively quoted.
11             Another area, as long as I've got the mic, it's
12   10(b)17 is the provision, again, that requires OTC equity
13   issuers to communicate with us in connection with
14   corporate actions.  And there is a 10-day requirement.  A
15   lot of issuers don't know the rule exists that we talk
16   to, and we're obviously actively, every chance we get,
17   communicating with them to tell them that there is a
18   federal rule in place that says, hey, you have to talk to
19   FINRA and tell us 10 days in advance of a corporate
20   action so we can administer it.
21             You know, there are certain parts of that rule
22   that I think could be improved.  For instance, in
23   connection with a bankruptcy of an issuer, we found that,
24   you know, we don't have privity with the issuers under a
25   listing agreement, so we can't force the level of
0148
 1   communication an exchange does.
 2             So, for instance, in bankruptcies with GM, GMQ,
 3   liquidation trusts -- obviously, it was a big problem,
 4   resulted in an OTC equity market halt -- we would like to
 5   see better communication there with the bankruptcy bar
 6   when an issuer is going into bankruptcy, becoming
 7   defunct, and needs their symbol deleted.  If we can't
 8   find out the requisite information about it from the data
 9   feeds we have, or from lawyers or OTC markets or
10   wherever, you know, that may not get put in place in
11   time, in part because we don't have this direct
12   relationship.
13             MR. EHRMAN:  Susan, you have any thoughts?
14             MS. MERRILL:  Sure.  You know we've talked
15   about broker-dealer registration, 15(c)211 probably could
16   stand revisiting a little bit.
17             Another area might be -- and this goes to the
18   prior question relating to sort of the information that
19   is disseminated about these companies -- it might be
20   helpful to have some guidance around 202(a)11 and the
21   definition of investment advisor.  Obviously, when
22   broker-dealers publish research, that research is very
23   highly regulated.  When you have a lot of sort of the
24   larger -- you know, to be a little bit pejorative, but
25   more legitimate companies who come out with their
0149
 1   databases and their research publications, they are very
 2   concerned about not triggering investment advisor
 3   registration, or complying if they do.
 4             But then you have a lot of the research that
 5   comes out through the websites and the Internet that
 6   is -- sort of falls between the cracks.  It doesn't have
 7   the disclosure regarding ownership and conflicts of
 8   interest.  And so that might be a hook to try to more
 9   greatly regulate that type of research.
10             MR. EHRMAN:  Cromwell, what do you think about
11   15(c)211, as an OTC -- from the OTC market perspective?
12             MR. COULSON:  It's been proposed three times to
13   twist it, I'll call it, to a continuing reporting
14   obligation.  The comments have been universally in
15   opposition.  It keeps -- it's kind of like every -- it
16   dies for 10 years and crawls back out.
17             It's fundamentally problematic, because you're
18   asking -- you know, today we've driven -- the
19   broker-dealers who do the majority of transactions do not
20   have a direct relationship with the issuer.  And they
21   have automated.  And this is good things for markets.  I
22   mean it is generally -- transparency is good, having good
23   institutions, trading securities is good. 
24             However, the idea that there should then be
25   this merit review -- and people say it's not a merit
0150
 1   review, but you're supposed to go look through for red
 2   flags of filings that have been through the SEC and all
 3   these various problems -- is going to add a layer that
 4   actually probably going to remove a chunk of transparency
 5   and liquidity to all securities in this space.
 6             And maybe -- I mean I think, instead of the
 7   15(c)211 debate, we just say, should there be public
 8   markets for smaller companies?  Because bad things
 9   happen.  And let's have a clear debate, because I have
10   heard personally that if we have 15(c)211, we're going to
11   throw some sand in the gears, this stuff will just go
12   away.  
13             And it's like, for market makers, you know, I
14   get 15(c)211, that the market maker has a relationship
15   with the issuer if the market maker is selling on behalf
16   of an affiliate, but has an investment banking
17   relationship.  Those are ways you can induce review, do
18   due diligence.  And if you look in England, where the AIM
19   works, the AIM works because the nomads are efficient at
20   going in and doing due diligence.  For an outside market
21   maker, Knight Securities, to have a team of compliance
22   officers going through, "Is this SEC reporting good?  Is
23   this SEC" -- I think the industry would rather actually
24   have the SEC hire more examiners.
25             MR. EHRMAN:  Yes, I was wondering about that. 
0151
 1   I mean I know some people don't see 15(c)211 as being
 2   particularly onerous, particularly because there is no
 3   real evergreen provision, and that there can be people
 4   quoting right now who are piggy-backing on the review
 5   that can be over 10 years old by a broker-dealer that no
 6   longer even exists.  Do you think that maybe that is the
 7   other extreme?
 8             MR. COULSON:  Well, once you have someone
 9   quote -- the bad guys would love it if they could do a
10   211 and nobody else can go in and quote.  That is a
11   license to -- I mean there were some -- when I started in
12   the -- this is how much we've gotten better -- there were
13   some stocks on NASDAQ nobody could trade because some
14   mafia firms controlled it.  When a market maker would
15   pick it up and start short-selling it, guys with baseball
16   bats showed up at the trading room.  
17             And that's not happening any more, but that
18   is -- you know, the general idea is once it's traded, you
19   actually want competition, and you want independent
20   market-makers who are driving price, based on order flow
21   and demand.
22             MR. EHRMAN:  Aren't we kind of conflating the
23   concepts of market liquidity and then effective
24   information as to who to invest in?  I think those are
25   distinct concepts.
0152
 1             MR. COULSON:  Well, are they -- I mean is a
 2   market maker telling people to invest in a security, or
 3   are they providing transactional liquidity?  If you're
 4   asking for the marketplace to do something different,
 5   which is say every security is an investable security in
 6   this marketplace, I mean, there is lots of legitimate
 7   securities.  
 8             We talk about how GM was this terrible event,
 9   because a short squeeze took place and lots of failure to
10   deliveries took place so the stock shot up.  Then we have
11   General Growth.  It was a company that was delisted from
12   NYSE, in bankruptcy.  Bill Ackman was buying the stock at
13   $.25, everybody thought he was crazy.  It was a liquidity
14   problem.  And that security actually -- Bill Ackman came
15   in, his support of the stock showed confidence.  They
16   were able to refinance to lenders.  It went back to NYSE
17   at $12 a share.  
18             And the marketplace functions -- when it
19   functions well is when one holder can say, "Hey, I don't
20   want to take the risk any more," and someone else says,
21   "Well, I'm going to buy, and I'm going to make it work,"
22   and that takes place in this marketplace is -- of
23   outsiders.  And that's a part of the market.  And maybe
24   we should say that should all just take place privately. 
25   This shouldn't be done through broker-dealers. 
0153
 1             But, you know, we should straightforward have
 2   that discussion and then say, hey, we're going to layer
 3   on something to have every market maker reviewing it, so
 4   we're going to take out a chunk of market makers from the
 5   space, and we're going to make these securities in First
 6   National Bank, of which TA is going to go from five
 7   market makers to three market makers.  
 8             And maybe that doesn't matter, but let's have
 9   that discussion instead of say let's do 15(c)211 because
10   if we have one more place on the hook of reviewing it,
11   it's going to be -- because the one thing I haven't seen
12   is fraud is easier to do in a non-reporting company than
13   a reporting company.  I think it's actually -- the guys
14   who are doing distributions, they like reporting
15   companies, because they get registration rights.  They
16   are still -- they like reporting companies, because they
17   can tell investors their SEC reporting.  
18             We have to decide how can we bring transparency
19   into this market of who are the guys doing these things. 
20   How can the industry track them?  Some guy who is selling
21   in 10 different micro-stocks, they should probably set
22   off some alerts.
23             MR. EHRMAN:  David, I want to ask.  What are
24   your thoughts on this?
25             MR. FELDMAN:  I mean I guess what's maybe being
0154
 1   lost in this discussion is also keeping in mind that we
 2   want to make sure that the U.S. securities markets remain
 3   competitive.  And we're talking about putting in a lot of
 4   roadblocks and making it a lot more difficult.
 5             I can see the idea of more disclosure, more
 6   penalties.  But when we're seeing the brokerage firms
 7   taking this sort of just-say-no approach to depositing
 8   these microcap stocks, we have the risk of the whole
 9   field being decimated.  And do we want a vibrant microcap
10   market with reasonable regulation or not?  
11             And if the answer from the regulators is,
12   "We're not so sure," then let's say that and have that
13   discussion.  But if the answer is no, we want a vibrant
14   microcap market for the next exciting companies, and for
15   people to make money trading those stocks, because it's
16   risk/reward and it's exciting, and done right it can be
17   very successful for an investor.
18             So I think that's the bigger question that
19   needs to keep being asked.
20             MR. EHRMAN:  Is anyone on the panel aware of
21   any studies out there that show -- I know we've done a
22   lot of anecdotal evidence -- that show that this
23   marketplace is functioning as a capital market, that's
24   allowing for legitimate capital-raising?  Or could it
25   potentially be acting as a tax on the capital-raising if
0155
 1   the marketplace were structured differently?
 2             MR. WILSON:  It is like that in the research
 3   world.
 4             MR. EHRMAN:  Okay, thank you.  I guess
 5   something we talked about briefly -- and I feel a little
 6   bad talking about it, because I don't have any transfer
 7   agent folks up here -- but we heard various discussions
 8   about working as a team, and we want to avoid looking
 9   through the pinhole, and people have greater perspective.
10             But if there is any gatekeeper duties that
11   could be beefed up in the regime that we have -- and
12   hopefully at some point we will all be able to hold
13   hands -- but where do you think that emphasis would go,
14   put those gatekeeper responsibilities, if not the
15   broker-dealer, where they tend to rest the most right
16   now?
17             MR. COULSON:  I mean we see transfer agents as
18   a completely mixed bag.  And there is a lot of ones who
19   have real processes.  And, you know, Steve Nelson spoke
20   about the problems of when they ask for an opinion letter
21   their competitors aren't.
22             And, you know, there is no standards in the
23   transfer agent world which -- for dealing with restricted
24   securities.  And I think that's -- the process is when
25   restrictions get lifted.  The person doing that stamp is
0156
 1   a transfer agent.  
 2             And, you know, there was an SEC case against a
 3   transfer agent in Dallas, where they deposited money in
 4   their personal account for a while.  And they were -- I
 5   mean the thing that wasn't said was the guy who owned
 6   that transfer agent was a shell promoter.  So you have
 7   transfer agents owned by shell promoters.  You have a
 8   non-level playing field of people with good processes,
 9   with strong technology, with good record-keeping, and
10   then you've got the rest.  
11             And that is -- you know, rule-making-wise, I
12   don't know what it needs to improve.  I know when I talk
13   to our broker-dealer customers, they say transfer agents
14   are a mixed bag, there are these scary things with some
15   transfer agents.  There are some where certificates
16   come -- and that is a real part of getting this
17   marketplace of -- because it's much harder for the
18   scammers to work if they can't print new certificates.
19             PARTICIPANT:  I mean is it enough, though, for
20   a transfer agent to obtain an opinion letter, and should
21   there be some other diligence required on the part of the
22   TA to go further -- what's beyond the opinion letter? 
23   Because, I mean frankly, you see the attorneys writing
24   opinion letters based on oral representations made by
25   shareholders, and then the TA is looking to the opinion
0157
 1   letter saying, "I am relying on the opinion letter in
 2   processing the restriction."  And so --
 3             MR. COULSON:  Well, let's --
 4             PARTICIPANT:  Is there any thoughts on that by
 5   you, Cromwell, or anyone on the panel?
 6             MR. COULSON:  So we've got a lot of experience
 7   with low-end attorneys and we have high-end attorneys. 
 8   So you know, we just -- I thought it was a great day, we
 9   had Schulte Roth to sponsor U.S. SEC reporting companies
10   to OTC QX and review disclosure.
11             But on the flip side -- and, you know, they're
12   going to be very picky about the companies they choose. 
13   Their brand is very important, and that's going to be
14   good, and companies are going to be able to tell they're
15   a Schulte client, which is great.  But on the low end,
16   you have to specify where they should be doing due
17   diligence into the shareholder records.
18             There are certain things that they can look at
19   which are pretty easily obtainable facts, such as the
20   shareholder records.  There is some stuff they are going
21   to have to rely on issuers.  But you want them to rely
22   with -- not like this.  And a lot of attorneys we saw in
23   the space were going in blind, closing their eyes. 
24   Because an opinion letter is really a description of the
25   work done by an attorney.  And the bad attorneys don't do
0158
 1   any work.
 2             There was a guy who we had banned, and he
 3   worked for 144 opinions, and he was getting paid $75 an
 4   opinion letter, and he had issued -- you know, we banned
 5   him for one opinion on our website, but he had issued
 6   something like 2,000 other opinions to the transfer agent
 7   world.  That's a problem, if you're seeing those things.
 8             And I think there is a reasonable change in the
 9   experience that can get us two-thirds of the way there. 
10   And when we're there, we're actually going to have a
11   better idea of how to get that other third -- knock out
12   another two-thirds of it.  
13             And, you know, that's where you build the
14   process, you review.  There is some things you think is a
15   good idea, and you're like, "That's a waste of time." 
16   There is some things you missed.  And, you know, it's a
17   dynamic process.  We have been working on it as we have
18   tried to build our disclosure standards, but we've dealt
19   with a lot of attorneys.  We have dealt with some great,
20   careful attorneys, and we have dealt with some who are
21   terrible and scream they want to sue us all the time.
22             PARTICIPANT:  Just, you know, one thought on
23   that.  I think earlier we heard from one of the panelists
24   on panel one that there seemed to be concern from the
25   registrant community those attempts by the Commission,
0159
 1   the SEC, to shift liability onto the BDs and the TAs.  Is
 2   that an unfair assessment?  I mean is that something that
 3   needs to continue to happen, or -- I mean any thoughts on
 4   that from any of you?
 5             MS. MERRILL:  You have to have gatekeepers in
 6   this market, because there aren't enough resources in the
 7   regulatory world at large to police the type of fraud
 8   that's out there.  But I think that -- so I am in favor
 9   of liability on gatekeepers, but I think there has to be
10   clearer guidance, and even in the form of rules, about
11   what exactly is expected from each of the gatekeepers.
12             And it was mentioned on a prior panel that
13   there is a lot of redundancy.  And I think that partially
14   comes from the fact that people are not clear as to who
15   has to do what.  And if there could be more explicit
16   guidance as to which of the various gatekeeper have to do
17   what, perhaps it could be a more efficient process.
18             At the moment, I think a great deal of the
19   burden does fall on the broker-dealer, and they are the
20   person entering the order.  And I think FINRA has done a
21   very good job of putting out regulatory notices, both
22   with respect to unregistered securities, but also in the
23   reg D space, with the information memo they came out with
24   last year, regulatory notice 1022.  
25             If there was more of that, and more of that
0160
 1   from the Commission, I think the gatekeepers would know
 2   what it is that's expected of them.
 3             MR. EHRMAN:  Well, thank you, Susan.  And,
 4   unfortunately, we are rapidly approaching 5:00.  We all
 5   got so excited about it, the time got away from us.
 6             So, first and foremost, I would like to thank
 7   all our panelists for participating today.  I know you
 8   took times out of your busy schedule, so thank you for
 9   coming.  For those of you who stuck around the entire
10   day, thank you so much.
11             And I would like to thank all the panelists who
12   participated today, as well as Chairman Schapiro, Rob
13   Khuzami, and the commissioners who sponsored this.  I
14   think this was an interesting dialogue, hopefully one we
15   can continue.  And I think it was better than I expected,
16   so thank you all for participating.
17             And have a great evening; take care.
18             (Whereupon, at 4:53 p.m., the meeting was
19   adjourned.)
20   
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0161
 1                   PROOFREADER'S CERTIFICATE
 2   
 3   In The Matter of:   ROUNDTABLE ON THE EXECUTION, 
 4             CLEARANCE AND SETTLEMENT OF 
 5                       MICROCAP SECURITIES
 6   File Number:        3-01117
 7   Date:               Monday, October 17, 2011
 8   Location:           Washington, D.C.
 9   
10             This is to certify that I, Donna S. Raya,
11   (the undersigned), do hereby swear and affirm that the
12   attached proceedings before the U.S. Securities and
13   Exchange Commission were held according to the record and
14   that this is the original, complete, true and accurate
15   transcript that has been compared to the reporting or
16   recording accomplished at the hearing.
17   
18   _______________________       _______________________
19   (Proofreader's Name)          (Date)
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0162
 1                    REPORTER'S CERTIFICATE
 2   
 3   I, Jon Hundley reporter, hereby certify that the
 4   foregoing transcript of 160 pages is a complete, true and
 5   accurate transcript of the testimony indicated, held on
 6   October 17, 2011, at Washington, D.C. in the matter of:
 7   ROUNDTABLE ON THE EXECUTION, CLEARANCE AND SETTLEMENT OF
 8   MICROCAP SECURITIES.
 9   
10   
11   I further certify that this proceeding was recorded by
12   me, and that the foregoing transcript has been prepared
13   under my direction.
14   
15                       Date:____________________________
16          Official Reporter:________________________________
17          Diversified Reporting Services, Inc.
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