SEC charges microcap companies with harming investors

The Securities and Exchange Commission has charged six microcap companies, four company officers, and several market professionals for their roles in a scheme to raise millions of dollars in capital through improperly registered stocks to fund the companies' struggling businesses.

In four separate enforcement actions, the SEC alleged that these public offerings dumped billions of shares on the market through so-called employee stock option programs. These share offerings were improperly registered on Form S-8, which is a simplified registration statement used for compensating employees and consultants. In fact, the programs functioned as public offerings in which the companies used their employees as conduits to the market so that they could raise capital without complying with the securities laws. They then received at least 85 percent of the proceeds from the shares' sales as payment for the options' exercise price. The SEC further alleged that one of the companies, Global Materials & Services, Inc., and its former officer, Stephen J. Owens, committed securities fraud when they issued shares to sham consultants who then kicked back over 60 percent of the shares' sales proceeds to Owens and his other businesses.

"In bringing these charges, the Commission is sending the clear message that it will not only aggressively pursue companies that violate the registration provisions, but also the gatekeepers who provide a roadmap for violating these provisions," said George Curtis, Deputy Director of the SEC's Division of Enforcement.

Merri Jo Gillette, regional director of the SEC's Chicago regional office, added, "Form S-8 offerings, when used legitimately, give companies a streamlined method of compensating employees with stock. The Commission's actions allege that the defendants abused this offering process to sell stock to the general public without providing necessary disclosures."

According to two SEC complaints filed on August 6 in federal district court in Orange County, CA, Global Materials and five other companies - Angel Acquisition Corp., Marshall Holdings International Inc., NW Tech Capital Inc., Winsted Holdings Inc., and Zann Corp. - improperly registered shares issued under their employee stock option programs on SEC Form S-8 registration statements. The Commission also charged Marshall Holdings’ officers Richard A. Bailey and Florian R. Ternes and Winsted Holdings’ former officer Mark T. Ellis with implementing and administering their companies’ employee stock option programs.

Form S-8 statements may be used to register shares issued to compensate employees and consultants, and the forms have abbreviated disclosure requirements as compared to statements registering shares used to raise capital. The SEC alleges, however, that the programs violated the registration requirements of the Securities Act of 1933 by functioning as public offerings that raised capital.

The SEC's complaints further alleged that the companies' programs had features that, taken together, virtually guaranteed that the options would be exercised and the underlying shares simultaneously sold to the public at or near the time the options were granted. First, the options' exercise price, which was typically set at 85 percent of the sale proceeds from the options' underlying shares, floated with the market value of a company's stock at the time of exercise. Second, the options vested immediately, meaning that no conditions needed to be met before the options could be exercised. Third, a cashless exercise method was used so that the exercise price was paid from the sale proceeds of the underlying shares rather than directly by the employees. Other than opening brokerage accounts and signing blank letters of authorization, the companies' employees made no decisions regarding the options' exercise or the sale of the underlying shares during the course of the programs.

The Commission today instituted cease-and-desist proceedings against Alexander & Wade, Inc. (AWI), a San Diego investment banking firm, and its agent James Lee for causing the registration violations. AWI and Lee allegedly introduced the programs to the companies and advised them on how to implement and administer the programs.

The Commission also instituted administrative and cease-and-desist proceedings against Finance 500, Inc., a brokerage firm located in Irvine, CA. The Commission found that Finance 500 provided the brokerage services for the employee stock option programs despite red flags indicating that the employees were being used as conduits. Finance 500, without admitting or denying the SEC's findings, consented to the issuance of an order censuring it, ordering it to cease and desist from committing or causing future registration violations, and requiring payment of $271,484 in disgorgement and $74,015 in prejudgment interest.

Five companies charged - Angel Acquisition Corp., Global Materials, NW Tech, Winsted Holdings, and Zann Corp. - settled the SEC's charges without admitting or denying the allegations. They all consented to being permanently enjoined from future registration violations, and Global Materials also consented to being permanently enjoined from future fraud violations based on the SEC's allegations that it fraudulently used Form S-8 to enrich Owens through the use of sham consultants.

The Commission's investigation is continuing.
 

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