DTC Chills & Global Locks l Securities Lawyer 101
The Depository Trust Company (DTC) is the only stock depository in the United States. When DTC provides services as the depository for an issuer’s securities, its securities can trade electronically. Without DTC eligibility, it is almost impossible for an issuer to establish an active market in its stock. Issuers must satisfy specific criteria established by DTC to receive initial DTC eligibility, and to remain DTC eligible. Even after those securities become DTC eligible, DTC may limit or terminate its services. DTC can limit its services by placing a chill (“DTC Chill”) on a security and terminate them by placing a lock (“Global Lock”) on the security.
Is There A DTC Conspiracy?
When DTC eligibility is limited or terminated, issuers and their securities attorneys often express astonishment and scream foul play asserting various conspiracy theories, each more ludicrous than the last. We have all read about issuers who self-righteously proclaim that their loss of DTC was due to conniving short sellers, nefarious clearing firms and the purported “agenda” of the Securities and Exchange Commission (“SEC”) to eliminate small broker dealers and microcap issuers.
The reality is that microcap issuers lose DTC’s services for two primary reasons, illegal issuances of free trading securities based upon flawed tradabililty opinions and fraudulent investor relations activity. It should come as no surprise to microcap management that DTC reviews their issuances of free trading shares since these are the securities that DTC holds in its depository, under its name CEDE & Co. nominee .
DTC has several options when concerned about the eligibility status of a newly eligible security, or detects fraudulent activity. These include limiting or suspending its services for the security. DTC may also make referrals to the enforcement division of the SEC.
When DTC eligibility is lost, issuers will often tell their stockholders, they have no idea what happened. Since only the company can direct its transfer agent to issue free trading shares, most often it knows exactly why DTC limited or suspended its services. Many officers and directors of microcap companies are facing the harsh reality that reliance upon a legal opinion will not provide them with an effective defense to securities violations.
What Is Really Going On?
DTCC’s Office of Corporate and Regulatory Compliance monitors unusually large deposits of microcap securities that are deposited into DTC when there is a suspicion or indication that the issuer or persons associated with the issuer have violated the securities laws.Global Locks mean that DTC has terminated its services.
With Microcap stocks, this behavior typically involves the deposit of large blocks of unrestricted securities in reliance upon flawed legal opinions rendered in connection with convertible notes, reverse merger transactions or Rule 504 offerings.
Where any of the foregoing are present, the issuer should expect a review by DTC and should be prepared to provide a competent legal opinion from an independent securities attorney.
Does FINRA Rule 6490 Have Anything To Do With This?
DTC review is also prompted when issuers provide notice to the Financial Industry Regulatory Authority (“FINRA”) pursuant to Rule 6490, of name changes, stock splits, dividends, reverse mergers and spin-offs. While FINRA examines the corporate action prompting the notice under 6490, DTC reviews matters related to the issuer’s shares including the tradability of the securities it holds on deposit.
DTC staff may discover (previously undetected) illegal free trading share issuances or other fraudulent activity that will persuade them to limit or suspend its services. In these instances, DTC may make referrals to appropriate regulators including the SEC’s Division of Enforcement.
How Will A DTC Chill or Global Lock Impact Trading?
A DTC Chill restricts DTC’s services, including limiting a DTC participant’s ability to
deposit or withdraw chilled securities. A DTC Chill may last a few days or for an extended period of time depending upon the problems that caused the chill and the issuer’s willingness to address them. A “Global Lock” is a termination of all of DTC’s services to an issuer. Like a DTC Chill, a Global Lock may last a few days or for an extended period of time, depending on the reason for the action. If the fundamental issue cannot be corrected, then the security will be removed from DTC’s depository, and transactions in the security subject to the Global Lock will no longer be eligible for clearing at any registered clearing agency. When this happens, clearance and settlement of open market trades is significantly delayed because trades can only occur upon physical delivery of stock certificates between the buyer and seller’s brokerage firms. In such circumstances it could take weeks for trades to clear and settle.
DTC does not always disclose the reason for a chill or Global Lock, nor does it suggest how long it will be in effect. DTC Chills and Global Locks are publicly announced at:
Should Issuers Hire DTC Chill Removal Specialists From The Internet to Fix A Chill?
Recently, quite a few websites have popped up claiming their operators can remove DTC Chills and Global Locks. The irony is that most of these service providers participate in the activities that can cause the loss of DTC’s services. Some of these quick fixes are offered by the same lawyers who render flawed tradability opinions and the same transfer agents who knowingly or blindly accept the opinions that cause DTC difficulties in the first place. Similarly, stock promoters with pump and dump websites now tout that they can remove DTC Chills despite the fact that their own dubious services have resulted in DTC problems.
There are only two people who can help you remove a DTC Chill, a securities attorney acceptable to DTC, who can render a tradability opinion concerning the issuer’s unrestricted shares held by DTC and a DTC Market participant, who can ask that DTC provide its services with respect to a security. Anyone else claiming he can secure DTC eligibility or remove a DTC Chill is unqualified to do so.
September 24, 2009, the Securities and Exchange Commission (“SEC”) filed a complaint in the United States District Court for the Middle District of Florida alleging that International Power Group (“IPWG”) had issued shares of common stock in violation of the securities registration requirements . The SEC reviewed the actions taken by DTC, and determined that DTC must provide issuers with fairness procedures, adding further that DTC’s suspension of its services to an issuer is subject to DTC review upon request.
The SEC did not make a determination that DTC’s suspension of services to IPWG was unwarranted. It merely concluded that DTC did not follow required fairness procedures. Unfortunately, the agency failed to define adequate fairness procedures precisely. Even with a fairness hearing there can be no assurance that DTC will resume its services; it continues to have a broad discretion in these matters.
Will DTC Ever Remove a Chill or Global Lock?
In some circumstances, DTC obtains additional information from the issuer and its
securities counsel regarding the activity in question, and may decide not to limit its services or may remove a DTC Chill with respect to the security. Accomplishing this is not an easy task. Even with the SEC’s new requirement that DTC provide a fairness hearing from a practical perspective nothing has changed for most issuers. A fairness hearing is expensive, and may take years to obtain. In the few cases in which removal of a Chill is possible, the process requires among other things, an opinion from securities counsel concerning the (free trading) shares held on deposit by DTC and a DTC Participant- usually a market maker- for services to be resumed. DTC reserves the right to refuse to rely upon the opinion of any issuer’s securities counsel. In recent months, the SEC has brought multiple enforcement actions against attorneys in connection with tradability opinions rendered for microcap issuers. Often these actions are preceded by a loss of DTC eligibility.
Because DTC may choose to refer securities violations it discovers to the SEC’s Division of Enforcement, issuers need to consult with qualified legal counsel at all stages of the DTC process, particularly when information must be provided by the issuer. The selection of counsel to address DTC problems, and potential problems, should no longer be considered a routine legal matter. The most satisfactory solution for issuers seeking DTC eligibility is for the issuer to file a registration statement under the Securities Act of 1933, for either an Initial or Direct Public Offering.
Issuers expecting to obtain and maintain DTC eligibility need to recognize that they may be penalized if they go public in a reverse merger with a public shell company or use the services of securities professionals- including unregistered brokers, stock promoters, investor relations firms, transfer agents and even lawyers- who have been the subject of SEC investigations and enforcement actions.
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For further information about this article, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 201 S, Boca Raton, Florida, (561) 416-8958, by email at [email protected] or visit www.gopublic101.com. This memorandum is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. For more information concerning the rules and regulations affecting the use of Form 8K, FINRA Rule 6490, Rule 506 private placement offerings, Regulation A, Rule 504 offerings, SEC reporting requirements, SEC registration on Form S-1 and Form 10, Pink Sheet listing, OTCBB and OTCMarkets disclosure requirements, DTC Chills, Global Locks, reverse mergers, public shells, go public direct transactions and direct public offerings please contact Hamilton and Associates at (561) 416-8956 or by email at [email protected]. Please note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 201 South
Boca Raton, Florida 33432
Telephone: (561) 416-8956 Facsimile: (561) 416-2855