FINRA Uses Rule 6490 To Stop Wash, Rinse, Repeat Issuers
In late 2009, the Financial Industry Regulatory Authority (“FINRA”) proposed changes to its Rule 6490. Until that time, the Rule had provided merely that the agency review and process certain corporate actions taken by companies not listed on exchanges, companies known to most as OTC securities. The changes imposed by Rule 6490, which became effective in 2010, gave FINRA more clout: it can now deny corporate actions in certain specific circumstances including reverse mergers.
Rule 6490 codifies Rule 10b-17 of the Securities Exchange Act of 1934 (“Exchange Act”). The corporate actions in question include name changes, forward stock splits, reverse stock splits, distributions of cash or securities such as dividends, and rights and subscription offerings. Recently, FINRA has begun to use the Rule has as an enforcement tool to deny corporate actions by penny stock issuers accepting capital from known toxic funders. The blacklisted toxic funders have been the subject of recent SEC enforcement actions and Department of Justice Investigations; it is these legal actions that permit FINRA to deny the request from companies that have not themselves been targeted.
FINRA’s refusal to process certain corporate changes for issuers accepting toxic funding will likely cause a review by the Depository Trust Company (“DTC”) of stock issuances made by the companies whose requests are denied, resulting in a global lock or DTC chill. Lather, Rinse, Repeat issuers are not new to the penny stock markets. The behavior is most likely to occur when dormant issuers have been taken over in corporate hijackings. The 2010 amendments to Rule 6490 were in fact prompted by an SEC investigation of, and litigation against, Canadian Irwin Boock and his associates, who hijacked dozens of dormant public shells with the help of the fraudulent transfer agency they created. A common pattern in these issuers is to issue issue millions—sometimes billions—of shares of unregistered and illegally free trading stock until reaching their authorized capital. Once they hit the limit, they seek to enact aggressive reverse splits to reduce their outstanding shares so that they can repeat the scheme.
FINRA Review Of Corporate Actions
Rule 6490 requires issuers to complete and file a document with FINRA at least 10 business days prior to the record date of the intended corporate action. FINRA approval must be received prior to the corporate action becoming effective. In addition, FINRA may request additional documents, conduct detailed and selective reviews of the issuer’s submissions and cause the issuer to delay the announcement of its corporate action. This is particularly problematic for reverse merger companies that may not have all documents requested by FINRA.
A FINRA review will be triggered if any of the five factors set forth in Rule 6490 are thought to be present:
♦ FINRA believes the forms are incomplete, inaccurate or filed without the appropriate corporate authority;
♦ The issuer is not current in its reporting obligations with the Securities and Exchange Commission;
♦ Persons involved in or related to the corporate action are the subject of pending or settled regulatory action or are under investigation by a regulatory body or are the subject of a pending criminal action related to fraud or securities law violations;
♦ Persons related to the corporate action are likely involved in fraudulent activities involving securities or may pose a threat to investors;
♦ There is significant uncertainty in the settlement and clearance process for the issuer’s securities.
Issuers will be charged fines for failure to comply with the rules. Some of these fines include:
♦ Timely Rule 10b-17 Notification 10 business days before the Action – filing fee $200
♦ Late filing, but filing at least 5 calendar days before the Action – $1,000
♦ Late filing, but filing at least 1 business day before the Action – $2,000
♦ Filing on or after the Action date – $5,000.
After FINRA clearance of corporate actions under Rule 6490, issuers should expect a full review by Depository Trust Company (“DTC”) and will be required to provide an opinion from their SEC lawyer as to the tradability of shares held in CEDE & Co. As a result of this review, issuers may find themselves losing DTC eligibility and eventually being added to the DTC Chill list. It should come as no surprise to issuers accepting funding from toxic funders if their securities end up on the DTC Chill list after FINRA refuses to process the reverse splits they contemplate.
For more information about Reverse Mergers please visit our blog post at:
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post 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 advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
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Boca Raton, Florida 33432
Telephone: (561) 416-8956
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