Section 3(a)(10) l The Paper Crime Exemption
Section 3(a)(10) of the Securities Act of 1933 (the “Securities Act”) provides an exemption from registration that permits a company to issue common stock to public investors “in exchange for one or more bona fide outstanding securities, claims or property interests” without having to file a registration statement with the Securities and Exchange Commission (the “SEC”), “where the terms and conditions of such issuance and exchange are approved after a hearing upon the fairness of such terms and conditions” by any court or any governmental authority “expressly authorized by law to grant such approval.”
Section 3(a)(10) has become a common tool used by the unscrupulous to create or transfer manufactured “claims” for the sole purpose of receiving large blocks of unregistered securities.
Under most circumstances, the conditions of the exemption are not met because the relevant transactions do not involve “one or more bona fide outstanding securities, claims or property interests” as required by 3(a)(10). In these proceedings, the participants violate not only the SEC’s registration provisions but also the anti-fraud provisions, because they misrepresent various facts to the court. The Plaintiff, for example, may maintain that he holds a “claim” against the Issuer to obtain approval of the issuance of unregistered securities in exchange for settlement of that claim at the fairness hearing. In reality, the parties to the action are working in collusion, and at the time of the filing of the action have entered into an undisclosed agreement that will permit a financier to receive “free trading” securities in exchange for settlement of the fabricated claim.
Section 3(a)(10) schemes may appear complex but they are not. They are very simple. They have the same objective as most illicit schemes involving penny stocks: to issue unregistered shares of stock that will quickly be dumped into the public markets.
Section 3(a)(10) transactions involve at least three complicit participants (the “Participants”). Often times at least one of the Participants, the purported claimholder, is an investor relations firm, lawyer or auditor who purports to be owed money by an Issuer.
The primary Participants are:
♦ a public company (the “Issuer”);
♦ a person or entity (the “Claimholder”) that purportedly is owed a sum of money (the “Claim”) by the Issuer; and
♦ a person or entity (the “Funder”) who claims to have purchased the Claim from the Claimholder.
Section 3(a)(10) schemes entail the creation of a great many documents; the mass of paper makes detection difficult and at times cumbersome. Only four of these documents are actually important. A review of them reveals the nature of the scheme and the complicit parties with clarity. In fact, it would be relatively simple for a regulator to bring a civil or criminal action against the Participants based solely upon the four documents described below:
♦ an assignment of a receivable (the “Receivable Purchase Agreement”) of the Claim requiring (i) the Claimholder to transfer the Claim to the Funder; (ii) the Funder to pay the Claimholder the amount of the Claim; and (iii) the Issuer to issue free trading shares to the Funder in settlement of the amount of the Claim;
♦ a state court complaint (the “Complaint”) filed by the Funder stating that the Issuer is (i) obligated to pay the Funder; and (ii) is in breach of its obligation to pay the Funder;
♦ a Stipulation of Settlement between the Funder and the Issuer seeking approval at a fairness hearing of a settlement of the Claim that the Issuer owes to the Funder in exchange for free trading shares; and
♦ an order by the state court approving the Stipulation of Settlement.
In reality, the Funder does not hold a Claim against the Issuer as stated in the Complaint and represented to the state court because:
♦ the Issuer never becomes obligated to pay the Funder for the Claim and is only obligated to issue free trading shares if court approval is obtained;
♦ the Funder has not paid the Claimholder for the Claim;
♦ the Funder is only obligated to pay the Claim if the court approves the issuance of shares to the Funder – in other words, the Funder is only obligated to deliver payment in the amount of the Claim in exchange for free trading shares; and
♦ the Participants fabricated the entire action set forth in the Complaint solely to evade the registration requirements of the securities laws.
Upon receipt of the order or shortly thereafter:
♦ the Funder receives free trading shares valued at a price much lower than the market price;
♦ the Issuer is relieved of its obligation to pay the Funder the amount of the Claim;
♦ the Claimholder is paid by the Funder for the assignment of the Claim; and
♦ the Funder pays for promotional activity using the free trading shares or proceeds therefrom so that it can maximize the profit it receives from the public resale.
Rarely does an issuer disclosed all material information to the public in its SEC or OTCMarkets filings when engaging in a 3(a)(10) transaction. Even when the 3(a)(10) transaction has been disclosed, disclosure failures are present. Material facts are omitted that would, for instance, reveal the identity of the Claimholder, who is often an insider being paid by the Funder upon assignment of their receivable. Most importantly, most issuers fail to file the relevant assignment documents as exhibits to their public filings as required by SEC rules. The reason being that often these documents reveal undisclosed enrichment to insiders and the Funder has not paid for the claim it purports to hold at the time it files the Complaint.
Section 3(a)(10) schemes often fly below the radar precisely because the Receivable Purchase Agreements are not filed with the SEC or with OTCMarkets. Without them, investors and even the regulators lack the information necessary to determine whether the transaction was legitimate.
Any disclosure of a Section 3(a)(10) transaction should be considered a red flag, and should prompt further investigation by investors, who could then make inquiries of the company, and by the regulatory agencies. Perhaps the SEC will soon take a greater interest, given that now the issuance and illegal sale of unregistered securities appear to have become an enforcement priority. Issuers being misguided as to 3(a)(10) transactions should consult with independent auditors and legal counsel not being compensated through the assignment of their invoices to the Funder to determine what remedial measures should be taken.
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 and compliance 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
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855