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The Securities and Exchange Commission (SEC) recently announced charges in a nearly $200 million global stock fraud perpetrating one of the most complex schemes to ever target U.S. markets and investors. It is an unfortunate fact, that as investing becomes more inclusive and share values increase, our stock markets become richer targets for criminals.  

This type of fraud highlights the important day-to-day work of policing market integrity and prosecuting fraudsters and highlights regulatory gaps that need to be addressed as markets digitalize.  OTC Markets Group supports investor protection priorities that create better informed and more efficient financial markets. Our own success has come from leveraging data and technology to bring greater transparency to market participants and shine light on opaque corners of the financial ecosystem. 

OTC Markets Group has a history of providing key information that empowers regulators to protect investors and help broker-dealers make informed trading decisions. Our “information first” market model allows companies to improve the quality of market data and pricing information, thus allowing investors to better decide on the merits of an investment.

For example, we use the Caveat Emptor risk flag to alert the public when a potential public interest concern emerges. Like all regulated market operators, we regularly make referrals to the SEC and other regulators to note instances that may warrant further scrutiny. The more risk data markets make public, the better the SEC can serve its role to protect investors while not standing in the way of capital formation.

Global fraudsters are working tirelessly to find the next opportunity to take advantage of U.S. investors and we need our regulators and regulations to keep up with technology.  The SEC can better crack down on these criminals by implementing five key recommendations for regulatory modernizations:

First, the SEC can focus on enhancing investor protection by more quickly suspending current stock promotions and market manipulation schemes.  Stopping a manipulative activity and egregious promotion campaigns as they occur can reduce the potential harm to investors long before bad actors can be prosecuted. A small team of analysts monitoring the market volumes in real-time is a more efficient use of staff resources than an army of prosecutors deployed after the fact. Markets move faster today, and regulatory processes need to catch up. 

Faster suspensions will hit fraudsters in their wallets before they realize profits, much like credit card companies freezing accounts when they suspect wrongdoing. Engaging in complex frauds require initial outlays of capital, and more timely suspensions will make fraudsters think twice before they even try.  For example, the SEC’s prompt response to suspend trading in the stock of Blue Eagle Lithium Inc. (BEAG) eighteen days after it was identified as an active promotional campaign highlights the investor protection benefits of taking swift action ahead of the pump-and-dump scheme. Despite its success, the Commission has not used this tactic since last November, when they stopped a promotion in its tracks just fifteen days after it was identified .

Second, under the backdrop of investor protection, the SEC can name certain non-defendant individuals and corporate entities mentioned in enforcement actions to prevent fraudsters from repeatedly misleading reputable brokers, transfer agents, companies, and investors. Individuals willing to act at the behest of bad actors should be publicly identified so that the industry and investing public can make more sound investment decisions. This greater transparency will better inform the public, enhance industry accountability, and incentivize reputable professionals to avoid the risk of regularly making such associations.

Third, the SEC can modernize regulations while promoting capital formation by enhancing promotion regulation for the digital age. The meme stock era has left more Americans inundated with influencer marketing, online advertisements and spam emails, promising easy profits and “guaranteed” returns to any purchaser of some obscure stock or new crypto coin. Section 17(b) of the Securities Act only requires that the issuer identify the nature and amount of consideration paid to the promoter for disseminating such information. This framework allows the third parties behind the promoter and, in some cases, the original source providing compensation for these communications to hide. The current disclosure requirements are inadequate for the protection of today’s investors. Amendments to 17(b) could provide greater transparency for investors and better insight into the actors and motivations behind promotional activity.

Fourth, modernizing the SEC transfer agent rules will make the share issuance process more transparent and reliable. Transfer Agents can look to Blockchain technology as a use case to help provide real-time public notifications when new issuance takes place, restrictions are added or removed, and better identify shares held by affiliates with verifiable records of each transaction. We also need to give investors and public companies insight into affiliate and control shares once they are held at DTC in street name.  SEC Commissioners from both political parties have supported fixing the plumbing of share issuance to make it harder for fraudsters to evade securities laws.

Fifth, cracking down on fraud can also help the SEC and Congress’ growing desire to better facilitate and jumpstart small business capital formation. To accomplish this, the SEC can take a closer look at crowdfunding and Regulation A to as viable capital raising alternatives for small public companies and ultimately reduce the reliance on private transactions to unregulated entities as the primary means of raising funds. Financings taking place at a significant discount to prices in the public markets is a signal capital raising rules needs to be reformed. For that to work, smaller public companies need the same access to sell registered shares directly into the market through a regulated broker-dealer as large companies. It is no surprise that Bill Hwang’s attempted market manipulation was stopped by reputable issuers quickly selling shares using shelf offerings.

Cybercriminals and fraudsters will undoubtedly continue to target U.S. capital markets and investors. There is no silver bullet to stopping bad actors once and for all, but the SEC can better crack down on fraud by implementing these tailored regulatory reforms while still accomplishing its mission to protect investors and promote capital formation. Failure to modernize will harm U.S. markets and leave more investors holding the bag.

Cromwell Coulson is the President and Chief Executive Officer of OTC Markets Group Inc. and is a former Chair of the FINRA Market Regulation Advisory Committee. 

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