Native American Energy Group (NAGP), an oil and gas exploration company has been granted full eligibility for clearing and settlement services through the Depository Trust Co., in the latest in a series of victories by microcap companies involving the DTC. According to several sources, the effort was a four-year battle for Native American Energy that cost the company $175,000 in legal fees, left it $2 million in debt and caused it to lose more than 30 funding opportunities.
The DTC Dilemma
Over the past couple of years, DTC eligibility has become a concern for many OTC Issuers as clearance and eligibility has become a daily obstacle for penny stock and over the counter Issuers. Obtaining and maintaining eligibility is of utmost importance for the smooth trading of an Issuer’s float in the secondary market. Moreover, DTC eligibility is a prerequisite for OTC Issuers’ shareholders to deposit securities with their brokers and have such securities be placed in street name.
For penny stocks, DTC provides two hurdles. First is initial eligibility. In a three part blog, I previously set out detailed eligibility standards. In summary, a DTC member participant must submit an application on behalf of an Issuer (much like a 211 process with FINRA). In order to be DTC eligible, an Issuer’s securities must:
(i) be issued in a transaction registered with the SEC under the Securities Act of 1933, as amended (“Securities Act”);
(ii) be issued in a transaction exempt from registration under the Securities Act and that at the time of seeking DTC eligibility, are no longer restricted; or
(iii) be eligible for resale pursuant to Rule 144A or Regulation S under the Securities Act.
Although eligibility can be an issue, for many Companies’ it is maintaining the full range of DTC services that has become the real problem. In technical terms, a DTC chill is the suspension of book-entry clearing and settlement services with respect to an Issuer’s securities. In layman’s terms it means your stock can’t clear or trade electronically. Since all trading in today’s world is electronic, it really means your stock doesn’t trade.
In the real world, a DTC chill, or even the looming potential of a DTC chill, has resulted in an investing chill into small cap companies. Investors are understandably concerned that their stock will not be able to clear and trade, even after effectiveness of an S-1 registration statement. You see, a DTC chill prevents the clearance of ALL electronic securities of an Issuer. That is, if DTC has a problem with 100 shares of stock worth $10.00 issued 5 years ago by previous management; it will chill clearance on all stock of that Issuer, including the $10 million dollar investment from a PIPE investor which was registered in an S-1 this year. No joke, keep reading.
The SEC offers some assistance
Moreover, the active imposition of chills by DTC is a relatively new phenomena, which appears to have begun in earnest late 2009/early 2010 but which has taken center stage for the small cap industry in the past year. As a result of increasing frustration by small cap issuers and requests for SEC intervention, on March 15, 2012 the Securities and Exchange Commission (SEC) issued an administrative opinion (In the Matter of the Application of International Power Group, Ltd. Admin. Proc. File No. 3-13687) requiring that DTC provide Issuers facing a chill, with a fairness hearing and due process. Up until that opinion, DTC had refused to do so. In fact, up until that opinion, DTC had refused to even inform Issuers as to the reason for a chill. The SEC did not tell DTC what the criteria for determining whether the chill was appropriate or not should be, only that the Issuer is entitled to “fair procedures”. See my blog from March of this year discussing the SEC opinion.
As of today, DTC has not amended its rules or adopted new rules in response to the SEC mandate, but it has, in practice, been providing Issuers with reasons for a chill and an opportunity to provide responses and opinion letters in an effort to remove the chill. In fact, this firm has already written several such opinion letters and assisted Company’s with the removal of several chills since March of this year.
The Native American Story
The process however is still loose to say the least. After a four year battle, Native American Energy won the battle by receipt of a simple e-mail from Susan Desantis, a DTC official stating, “Operations confirmed the chill is lifted. I believe a letter is also going to your attorney. Take Care, Susan.”
Native American’s dispute with the DTC began with the formation of its predecessor Halstead Energy Corp. on Jan. 18, 2005 followed almost immediately by a name change to Native American Energy (NVMG). At the same time, however, another company also named Halstead Energy Corp., which had declared bankruptcy in 1999 and is now defunct, was the victim of corporate hijacking by an unrelated third party.
In February 2005, when Native American undertook a 1-for-200 reverse stock split, the DTC held 1,037,714 shares of the defunct Halstead and inadvertently submitted them to Native American’s transfer agent for 5,195 shares of stock as part of the reverse split. As a result, the “hijacked shares” were commingled with Native American’s public float. Through various additional splits designed to remove the taint of the highjacking, Native American reduced the number of highjacked shares to just 10 shares (no joke), or 0.00003% of the company’s 36 million shares outstanding. Yes, you read correctly, it was DTC’s error that caused the problem and they were ultimately dealing with 10 shares of stock!
In a sweeping action addressing the corporate hijacking issues, the SEC suspended trading in Native American for 10 days in 2008, along with 25 other companies. However, the SEC did not pursue any enforcement action against Native American and their stock was cleared for trading. Nevertheless, as result of all of this DTC issued a global chill on their stock.
Since the global lock, Native American has pursued the reinstatement of full clearance and settlement privileges for their stock. Until now, the DTC has refused. Accordingly to Native American, they tried to do everything they could to resolve the matter with both the SEC and the DTC. They couldn’t get anyone at the DTC to even answer their or their numerous attorneys’ calls or return their letters or emails. Following the March 2012 SEC administrative opinion, DTC finally became responsive and things started moving in the right direction for Native American, culminating in the simple, yet vastly important e-mail, that the chill had been lifted.
This is an important step in the right direction. DTC has a monopoly on the services it provides. It clears the stocks for all United States public companies, big and small. If DTC doesn’t process and settle trading in your securities, it just doesn’t happen. I stress that even though DTC has yet to issue rules and procedures relating to an Issuer’s rights and due process resulting from a chill and clearly the process still needs a great deal of improvement, since March 2012, this firm at least, has found DTC to be much more responsive in providing reasons for a chill and assistance in what they will accept from the Issuer to resolve the matters.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the over the counter market including the OTCBB and OTCQB. For almost two decades Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to crowdfunding, registration statements, PIPE transactions, private placements, reverse mergers, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SRO’s such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
© Legal & Compliance, LLC 2012