id4rox: I see YOU get the picture!
I've said many times: "All I want for Christmas is my own pink shell"!
Here's a good read on the scumbacs of the 'dark' side:
Our dirty secret
The Vancouver Stock Exchange may be gone, but shady promoters have found safe havens -- off the radar of regulators -- to prey on naive investors
Ray Dabney, president and CEO of Xraymedia Inc., sports all the vestiges of the VSE. He wears a gold necklace, gold bracelet, gold watch and three gold rings. He is vague about his academic credentials, saying only that he was educated at the "school of hard knocks." He operates out of the Harbour Centre in downtown Vancouver, just a couple of blocks from infamous Howe Street. And like his Howe Street neighbours, he is prone to corporate hyperbole.
On Aug. 2, Dabney had a blockbuster announcement for his shareholders: Xraymedia, which operates an Internet auction house for media advertising time, had established a partnership that would generate US$250 million in revenue. "With $100's of million's [sic] in media sales revenues under their belt, Xraymedia's newest [unnamed] partner should have no problem reaching its goal of generating over $250,000,000.00 in cash revenues for Xraymedia," he trumpeted in a press release. But we have heard this sort of thing before. In previous releases, Dabney has promised hundreds of millions of dollars in media transactions, but financial statements show that during the company's 10-year life, it has managed only US$69,807 in revenue while racking up US$19.3 million in losses.
The chasm between what Xraymedia is promising and what it is actually delivering is reminiscent of the Vancouver Stock Exchange--but there is a slight twist. Instead of being listed on the VSE, or its successor market, the TSX Venture Exchange, Xraymedia's shares are quoted on the OTC Bulletin Board in the United States, the rathole of North American equity markets.
The OTCBB is a trading forum for about 3,300 issuers, most of them nascent companies with no established business-- and many with no purpose other than to rip off investors. During the late '90s, when British Columbia regulators embarked on a concerted campaign to clean up the Vancouver junior market, many scoundrel promoters sought refuge in the OTCBB. The B.C. Securities Commission reckons there are now several hundred OTCBB companies with Vancouver connections. Theoretically, OTCBB issuers that are based in Canada must run a double gauntlet of American and Canadian regulators. But the reality is that Canadian regulators tend to ignore OTC issuers because they don't trade on Canadian exchanges. And American regulators, to the extent that they bother with OTC companies, are less inclined to pursue foreign issuers, especially with Canada's abysmal record of extraditing Canadian residents who breach U.S. securities rules. As a result, companies such as Xraymedia can behave outrageously with little fear of regulatory repercussions.
"This is part of the market that we think deserves more attention," says commission chairman Doug Hyndman. "We spent a long time and lot of effort dealing with problems, real and perceived, at the VSE to clean up our market, and we do not want to lose all of the progress we have made." He says the commission is working on some initiatives to deal with the problem, but isn't quite ready to talk about them.
Insp. Bill Majcher, in charge of the new RCMP Integrated Market Enforcement Team in Vancouver, describes the over-the-counter stock business as a "tremendous problem in Vancouver." Explains Majcher: "Not that Vancouverites are becoming victims, but we have become the jurisdiction of choice for criminals who are targeting the 300 million potential investors in America. The result is that the investing community, over time, will look with suspicion on any venture coming out of Vancouver, whether it's legitimate or not, just like we saw with the old VSE."
The problem is not unique to Vancouver. There are also dozens of Bulletin Board stocks operating out of Toronto, for the most part unimpeded by provincial regulators. Michael Watson, the Ontario Securities Commission enforcement director whose principal constituent is the more senior Toronto Stock Exchange, admits that errant OTCBB companies are at the bottom of his priority list. "We give highest priority to securities that trade on TSX and second-highest priority to securities that trade on Venture Exchange, and, below that, the OTC Bulletin Board."
The OTCBB is not an exchange in the traditional sense; it is strictly a quotation service. It was created by Nasdaq in 1990 to provide more transparency to securities that were traded over the counter (that is, from broker to broker) without any electronic record. Trades are now made by telephone between market makers (brokers who are willing to post bids and asks), and those trades must be electronically posted within 90 seconds of execution.
While this improved transparency has raised the quality of trade execution, there is still very little regulatory oversight. Nasdaq has no business relationship with OTCBB issuers. There are no listing agreements and there are no fees. By comparison, companies listed on the TSX or the TSX Venture Exchange must sign listing agreements, pay fees and follow stock exchange rules. Also, trading is supervised by the industry watchdog, Market Regulation Services Inc.
Another important difference is that OTCBB companies do not have any minimum financial requirements. An issuer can have no assets or revenues--in fact, it can be hopelessly insolvent--and still trade. Until 1999, OTCBB issuers did not even have to file financial statements. Now, they must file quarterly and annual reports, proxies and insider trading information to the U.S. Securities and Exchange Commission, but the SEC does not scrutinize them very closely, if at all. "They now have disclosure rules, but there is no enforcement," says John Kaiser, a San Francisco-based analyst who closely follows Canadian junior stocks. "You may get financial statements eventually, if you are lucky, but there's no insider-trading filing anywhere, and there's no regulation of trading activity. It's just a free-for-all."
Given such an inexpensive and laissez-faire environment, it is not surprising that OTCBB business has been booming. In 2002, an average of 656 million shares, worth US$60 million, traded through the OTCBB every day. Last year, the daily average swelled to more than one billion shares, worth nearly US$160 million. That's many times busier than the TSX Venture Exchange, which last year traded a daily average of only 53 million shares, worth $25.3 million.
The proliferation of OTCBB companies, without the direct oversight of a traditional exchange, makes the Bulletin Board a regulatory challenge for the SEC and its state counterparts. "It's not like Vancouver where the business was concentrated and regulators could shine the light on one spot," notes Kaiser. "Bulletin Board companies are dispersed all over the country, and they are so small and insignificant in the whole scheme of things that the mainstream media has no reason to pay attention to them." Majcher says the SEC doesn't seem much interested in over-the-counter scams, either. "We've referred very specific cases to the SEC, but we haven't been able to generate a lot of interest," he says. "The SEC only has so many resources, and they would rather deal with a $50-million fraud than a half-million-dollar fraud. Problem is, those half-million-dollar frauds quickly add up to $50 million."
OTCBB companies usually trade at pennies. Xraymedia, for example, has traded from a high of 87¢US last year to a recent low of 8¢US. But this can be very deceptive. When it comes to making trading profits, volume can more than compensate. Since the beginning of 2003, Xraymedia has traded an average of more than 500,000 shares per day. Insiders, who hold tens of millions of shares, can potentially make millions of dollars. No wonder business is booming.
But for investors, it is perilous ground. Kaiser says that, among other problems, there is a ton of unregistered stock in the OTCBB system. "Promoters can create any paper they want," he says. "The SEC doesn't require disclosure of how many options or warrants are outstanding. A company may have 50 million shares issued, but there could be 200 million for all we know. That makes valuation impossible."
Can/Am Auto Sales Inc., a Vancouver car dealer with no revenue and negligible assets, provides a good illustration of why investors, when dealing with Bulletin Board issues, can toss efficient-market pricing theories out the window. The company (recently renamed LFG International Inc.) was trading on the OTCBB in July at pennies. Then, in August, it announced it would acquire a grab bag of European financial assets, including a German brokerage firm that is just emerging from bankruptcy and an unlicensed Swiss bank. No financial statements were provided, and there was no indication how many shares Can/Am would issue to acquire the new assets. As a result, there was absolutely no basis upon which an investor could value the deal. Still, Can/Am shares, on the thinnest of volume, soared to a high of US$7 in late August. With 300 million shares outstanding, that gave the company a total market capitalization of US$2.1 billion, compared to a book value of less than US$40,000.
What accounts for such a huge discrepancy? "The only answer is that the shares are tightly held," says John Woods, editor of Canada Stockwatch, a Vancouver-based market information service. "There is almost no supply stock into the market, which means the price can spiral upward miraculously, without necessarily any relationship to the company's real value." The message for investors is as clear as it is ominous: OTCBB promoters can often put the share price wherever they want.
Although Canada is the base for hundreds of OTCBB issues, the cause and effect is all American. The OTCBB is a creation of the U.S. securities industry, and most of its victims reside in the United States. This, probably more than any other factor, explains why Canadian regulators rarely intervene in OTCBB-related activity.
Sungold International Holdings Corp. is a good example of the regulatory attitude toward OTCBB companies. In 1996 and 1997, when it was listed on the VSE, Sungold ran into all sorts of regulatory problems, and rightly so. The company, headed by former Amway salesman Kim Hart, had announced it would build a casino in Korea at a cost to Sungold of US$150 million, a preposterous proposal for a firm with virtually no revenues and assets of just over $1 million. The stock levitated to $17.50 in February 1997, but there were signs that an invisible hand, which had nothing to do with Adam Smith, was at work. In October of 1997, the VSE fined Hart's stockbroker $15,000 for accepting orders from the promoter that artificially boosted the share price. For reasons that are not clear, Hart was never cited.
VSE officials, fed up with these shenanigans, ultimately drop-kicked the company from the exchange. This was a rare occurrence on the VSE, where raucous behaviour was tolerated, if not encouraged. (Years earlier, Forbes magazine, in its infamous "Scam capital of the world" article on the VSE, compared any company being kicked off the exchange to being booted out of the Khmer Rouge for being too bloodthirsty.) Despite this seal of disapproval, Hart was able to find safe haven on the OTCBB, where he pumped Sungold stock on the basis of an electronic horse-racing game offering a big "jackpot pool." Nothing had really changed except the trading forum, and the fact that Hart and his company were no longer on the regulatory radar.
Hart eventually found himself in more trouble, but not on account of securities regulators. Canada Revenue Agency stewards checked his purchase and sale of Sungold stock and found he had altered cheques to increase his cost base, thereby reducing his tax liability. One of the cheques appeared to have been made out to "Wally Cashman," but had actually been made out to "Cash." Hart had simply pocketed the money, then added the prefix "Wally" and the suffix "man" to make it look like the money had been paid to somebody else. During a raid on Hart's home, auditors found a receipt book with practice signatures matching the signature on one of the fraudulent receipts. That spawned many jokes, including a suggestion that Hart should write a book titled Calligraphy for Fun and Profit under the pen name Wally Cashman.
Hart admitted to the forgeries, pleaded guilty to understating taxable income by more than $200,000 and agreed to pay a fine of $43,500. Under the B.C. Company Act, anybody convicted of a fraudulent act cannot serve as a director unless the court orders otherwise. But Hart and his cronies, who control Sungold, found a way around this: they voted to re-register the company under the Canada Business Corporations Act, which has no such prohibition. Safely ensconced on the OTCBB, Sungold remains a B.C. reporting issuer in good standing, and Hart continues to work out of the company's Vancouver office, just a stone's throw from the office of B.C. Securities Commission chairman Hyndman.
To be fair, the commission's previous attempts to deal with errant OTCBB companies have not met with much success, mainly because it does not control OTCBB trading. Thermo Tech Technologies Inc., based in Langley, B.C., provides a good example. For years, the company--which has a process for turning organic waste into animal feed and fertilizer--had misrepresented its affairs, exaggerated its business prospects, associated with disreputable people and companies, engaged in questionable accounting practices and lost millions of dollars of shareholders' money. Like Sungold, it had also suffered the ignominy of being kicked off the VSE and managed to find refuge on the OTCBB. In July 1999, the commission began delving into the company's business dealings and issued a cease-trade order, but it applied only in British Columbia; shareholders in any other jurisdiction were free to dump their shares. So although the order protected prospective investors, it prejudiced existing B.C. shareholders. The commission was forced to relax the order to permit B.C. residents (except insiders) to sell any shares they acquired before the cease-trade order.
Canadian regulators occasionally take action that interferes with OTCBB activity, but that is usually a collateral result. In 2002, for example, B.C. Securities Commission investigators raided a Vancouver OTCBB stock boiler room supervised by notorious financial hustler Frank Biller. Biller and his former partner, Brian Slobogian, were well-known to local police and regulators. Between 1993 and 1997, as the top executives of Eron Mortgage Corp., they raised $227 million from more than 3,000 B.C. investors. They offered handsome returns, solid mortgage security and an unblemished record of meeting their obligations. But it was all a ruse.
In fact, few of the projects were commercially viable, and investors who were promised, for example, second position on mortgage titles found themselves in fourth or fifth position or in no position at all. Biller and Slobogian took exorbitant fees and diverted large amounts of investors' money for personal use. Like most scoundrels, they went on hedonistic binges, indulging themselves with luxury cars, Las Vegas junkets and Whistler condos. Biller, a former junior hockey star who dreamed of owning an NHL franchise, even used investors' money to buy his old team, the Merritt Centennials.
It all came to a crashing halt in October 1997, when B.C. regulators revoked Eron's licence. The receiver estimates that, when the dust settles, investors will have lost as much as $186 million. The B.C. Securities Commission deemed that Eron's offerings were securities and hauled Biller and Slobogian before a hearing. The hearing panel found they had defrauded investors, fined them $100,000 each (the maximum allowable at the time) and banned them from the B.C. securities market.
Despite his notoriety, or perhaps because of it, Biller managed to find work supervising 18 telephone salespeople who were pushing several OTCBB companies, including Brek Energy Corp., GlobeTrac Inc. and Communicate.com Inc., all big money-losers and largely unfit for human consumption. In November 2002, B.C. commission investigators, accompanied by police, raided the office and found copies of call scripts used by phoners (low-level "qualifiers" and senior "closers"). "Our last 2 deals went to 32, 44 respectively/our clients were all in under $3 p/share--just like Globetrac is now--that's the type of profit you want to make in less than six months," read one script.
Investigators also found call sheets used to summarize telephone conversations with prospective pigeons. One qualifier, enthused with the prospect of roping in an investor from Houston, reported: "Sounds like the real deal! Return to me after you are done closing this speech handi-capped fool!" Another qualifier said of his conversation with an Alberta prospect: "Nice girl, looking for an investment. Has to like what she sees...Also I pitched CMNN [Communicate.com] so beat that out of her too. Dumb bitch."
The B.C. commission focused on Biller, citing him for violating his earlier trading ban. Also, Crown prosecutors charged Biller and Slobogian each with 33 criminal counts--later consolidated to 14--relating to the Eron debacle. Their trial is scheduled to begin in January.
Feeling the heat, Biller skipped off to Ontario where, due to the balkanization of Canadian securities regulation, his B.C. ban had no force or effect. He assumed the alias Francis Derby and began promoting Extreme Poker Ltd., which trades through an even more lowly quotation service called the Pink Sheets. The 100-year-old Pink Sheets (named after the colour of stationary originally used to publish stock quotes) is a privately owned and completely unregulated market. Issuers--there are 4,551 securities quoted exclusively on the Pink Sheets--don't have to have a viable business or file yearly financial statements. Forbes magazine described the market as home to "abundant scams and legions of the walking dead--shares of bankrupt companies like Enron..."
Extreme Poker certainly fit that profile. It had no operating history and no financial statements. All it had was a story.
In mid-August, posing as a prospective shareholder with $15,000 to invest, I phoned "Derby" and asked about the company's commercial prospects. Biller said the company was planning an event called the Great Canadian Poker Tournament, which would be held at SkyDome in front of "30,000 to 50,000 people." He added, "The catch is that it's, like, reality-TV based. What makes the whole thing work is the fact that we should be days away from announcing we have a contract with TSN, all across Canada. It will show in January, Saturday nights at 7 or 8 o'clock, depending on whether or not there is hockey."
Asked whether TSN had formally agreed to televise the event, Biller replied, "At this point I can't tell you if they have or haven't. But what I do know is there should be a letter of intention in the next day or two, and from my sources, they're telling me it's not 90%, it's 100%." He encouraged me to invest: "I would go in, pick up $10,000 or $15,000 worth at 17¢. I mean, this is just getting ramped up. Guys really believe this is a two- to five-dollar deal. And when the TSN news release comes out, which I believe is going to [be] next week, ****, I think we're going to be really rock solid."
At that point, there had been no mention of SkyDome or TSN in any of the company's news releases, raising the spectre of disclosure breaches and illegal insider trading. Michael Watson, the OSC's enforcement director, was not overly impressed with Biller's conduct. "You have described activity that, obviously, based on the description, contravenes provisions of the Securities Act, at least on the face of it," Watson told me. "So it's definitely worth following up."
Extreme Poker chairman Lawrence Freedman admitted that he knew Biller was subject to criminal charges, had a regulatory record, had been banned from promoting securities in B.C. and was now promoting Extreme Poker in Ontario. But he claimed that Biller had undergone a religious transformation and was now a "devout Roman Catholic." He also said he knew Biller was operating under an alias, but he claimed that was not unusual: "I've had stockbrokers who have changed their names as they moved from one firm to another. An alias is not of concern, it's what [service] he provides. He must tell people to speak to a stockbroker, and he does that."
With regard to Biller's representation that the poker tournament would be held in SkyDome, Freedman said he had originally contemplated it would be held there but he had not approached the facility and had since decided to hold it elsewhere. With regard to TSN coverage, he claimed the company had a "letter of agreement" with the television network. But Stewart Johnston, TSN's senior director of programming, denied the network had made any formal commitment to televise the event. He said the network had simply issued a "letter of interest" that had many conditions attached to it. Extreme Poker stock, far from heading to Biller's $2 to $5 target price, is trading at mere pennies.
OTCBB companies began to proliferate in Vancouver in the late 1990s, after a government inquiry into regulation of the VSE described the exchange as a forum for "shams, swindles and market manipulations." The B.C. Securities Commission and VSE tightened up regulation and bounced dozens of the sleazier companies and promoters. That purging, coupled with the Bre-X Minerals-induced slump in the exploration business, left a huge void in the Vancouver securities market. Many small dealers, concerned about their survival, turned to the OTCBB, which was booming.
In a January 1999 interview, Max Meier, then president and CEO of Pacific International Securities and a former vice-chairman of the VSE, complained that the exchange was becoming over-regulated and that many of his customers were defecting to the OTCBB and Nasdaq. "We go where out clients want to go," he said, noting that 40% of his Vancouver firm's commission revenues were being derived from U.S. equity markets, up from 10% a few years earlier. "We don't recommend stocks in those markets, but there seem to be a lot of people who want to be involved in them." Problem was, many of those people turned out to be mobsters.
In June 1999, a federal grand jury in New York handed down an indictment alleging that members of the Colombo family and the Bor Russian organized crime group had set up boiler rooms to promote stock to public investors on the basis of false and misleading statements. One of those stocks was said to be an OTCBB company called Orlando Supercard Inc. The grand jury named U.S. stock promoter David Houge as an unindicted co-conspirator and claimed he controlled two shell companies that had set up accounts at Pacific International. Another complaint alleged that--at the behest of Houge--two Pacific International brokers, Dirk Rachfall and Michael Patterson, conducted fraudulent trades and manipulated stock in Orlando Supercard through those accounts.
Houge, who had become a co-operating witness, lured the two brokers down to Washington state on the pretext of a golf game and they were swiftly arrested by FBI agents. The pair eventually pleaded guilty to one count of securities fraud and were imprisoned for five months and fined more than US$130,000 each.
Although it was not accused of any wrongdoing, B.C. Securities Commission enforcement staff were alarmed that Pacific International was being used for illicit activities. Feeling the pressure, the company announced "bold new compliance initiatives" to curb illegal activity. It refused to allow U.S. residents to open accounts, or share certificates of OTCBB companies to be deposited into client accounts. Other firms, most notably Canaccord Capital Corp., stepped up scrutiny of OTCBB business.
But for Pacific International, it was too late. In July 2001, B.C. enforcement staff cited nine of the firm's most senior officers and directors, including Meier, with turning a blind eye to Mob-related securities fraud and money laundering. The hearing, which has evolved into the longest in commission history, is still in progress.
The B.C. Security Commission's actions have curbed the buying and selling of OTCBB stock through B.C. brokers, but it has done nothing to curb the proliferation of OTCBB issues emanating from Vancouver. Among them are Shep Technologies Inc., which claims to be developing a device that hydraulically captures the energy generated by a vehicle when it brakes, then releases that energy when the vehicle accelerates, and HepaLife Technologies Inc., which claims to be working toward the development of an "artificial liver device." Although the SEC is currently investigating parties who were involved in trading Shep shares, and HepaLife's principal promoter is the subject of a prior SEC action, neither of these companies, judging by their share prices and volumes, are having any difficulty finding U.S. brokerage firms to trade their stock.
In 2000, Nasdaq, in an effort to curb the free-wheeling OTCBB, proposed replacing the quotation service with a traditional exchange, to be called the Bulletin Board Exchange. It would have formal listing agreements, charge fees and impose stringent listing and reporting requirements. The BBX would even have its own index. Any companies that chose not to join the exchange, or did not meet its standards, would be relegated to the Pink Sheets. To promote the exchange, Nasdaq officials went on a road show, making presentations in cities throughout the United States and Canada. TSX Venture Exchange officials claimed they were not worried about the prospective competition, but there is no doubt that a cleaned-up Bulletin Board, with its massive U.S. exposure, would have been viewed as an attractive forum by many Canadian juniors.
Alas, Nasdaq officials abandoned the initiative. It is not clear, though, that the proposed exchange would have solved anything. The lower-rung companies would have merely migrated to the Pink Sheets, like hookers who are pushed from one street corner to another. And like the hooker-client relationship, there is no innocent party: even to invest in these stocks requires a touch of larceny, and the trading statistics show there are plenty of larcenous investors out there. "The general public doesn't really want to go to the trouble of figuring out why they are betting on these things," says analyst Kaiser. "They all want to play this greater fool theory; they don't care if it's a legitimate deal. In fact, I think people who actually believe in these deals are quite rare."
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