SEC Action on False Press Releases

  SEC Action Regarding False Press Releases

I recently came across an older litigation release where the SEC charged a company and its CEO with making false press releases.  I wanted to take a closer look at this regulatory action as it provided a clear example of what the SEC considers when deciding if press releases are false and misleading.  Back in September of 2014, the SEC filed a civil action in the US District Court for the Southern District of New York against Michael Pagnano and Heathrow Natural Food & Beverage, Inc.  The SEC accused Pagnano of conducting a Pump-and-Dump scheme while at the same time causing the firm to issue misleading and false press releases concerning the company’s operations and business prospects.

Here are some of the facts that the SEC looked at in reaching its conclusions:

  1. Line of Business:  The company claimed to be a manufacturer and distributor of health foods.
  2. Press Release Claims: The press releases  announced the following:  A).  Sales of Products that the company did not manufacture;  B).  Baseless revenue projection; and C).  non-existent distribution agreements with national retail chains.
  3. Actual Business Operations:  The company lacked the funding to carry out its business operations.  This was not disclosed within the press releases.

The SEC alleges in its complaint against Pagnano that the company then issued a series of false press releases in order to increase the price of Heathrow Natural Foods and increase the trading volume so that he could engage in a pump-and-dump scheme.  The complaint then goes into a great amount of detail on how these press releases where false.  For his troubles, Mr. Pagnano has been charged with violating sections 17, 5 and 10b of the Securities Act.  The SEC is seeking monetary penalties and bars against Mr. Pagnano.

We are of the opinion that violations concerning false press releases is an area that needs dramatically more attention from the SEC. It is also our opinion that it is an area of securities fraud that is relatively easy to pursue.  Either a company is doing what it claims and has the resources to carry out its operations,  or it does not.  It is fairly black and white.

This enforcement action should also serve as a lesson for the investing public.  A review of the Heathrow Natural’s filings with the SEC shows that company de-registered, and stopped filing reports with the SEC in mid 2007.  While we understand why many companies legitimately chose to save on the expenses of being a publicly reporting company, it should also serve notice as to the limited financial resources of the company.  It should also be noted that Heathrow Natural began providing financial disclosure through OTC Markets in early 2009, thus providing disclosure that investors could review.  We looked at the financial statements and their notes for varying periods in 2009 and 2010.  They clearly raised doubts about the company’s ability to perform on any of the claims in its press releases.  The lesson here is very clear,  all investors should view all press releases from public companies they are considering investing into with a certain level of skepticism.  The issuance of a press release should never be the trigger event to buy stock in the open market; what should be is a reason to start further due diligence research on a company.  The best places to start this research are the SEC’s Edgar database and OTC Markets.

A copy of the SEC’s Litigation Release can be found at:  https://www.sec.gov/news/press-release/2014-212

A copy of the SEC’s complaint in this action can be viewed at: http://www.sec.gov/litigation/complaints/2014/comp-pr2014-212.pdf

We do applaud the SEC’s efforts to police this type of activity.

www.coralcapital.com

If you have any questions about the above blog post, please feel free to visit our web site, www.coralcapital.com and check out we have to offer.  Feel free to contact us if you have any questions.  We can be reached at 404-816-9220 and are always willing to speak with you.

About Coral Capital Partners

Coral Capital Partners is an independent consulting and advisory firm focused on companies and participants in the lower and middle markets. We partner with our clients to provide cost effective solutions to real world issues and situations. Our experienced team brings a diverse set of skills that allows us to service a wide variety of needs.  Our area of services and expertise focuses on bringing services and solutions to our clients that are normally only available to much larger firms.  Coral Capital Partners, Inc.  provides services to Investment Banks,  Private Equity Funds, investors, and both privately held and publicly traded companies, as well as various stakeholders in those organizations.  This has included international public companies with operations on three (3) continents to smaller privately held domestic companies.  Our experience in the areas of corporate advisory, due diligence reviews, and regulatory compliance allows for a cost effective and efficient solution to the issues at hand.  Please feel free to contact our offices to see how we may be of assistance.

 

Toxic Financing Explained

Toxic Financing Explained

Toxic Financing

Danger – Toxic Financing

We have reviewed countless financing proposal and documents on behalf of our clients over the years.  It seems lately that we have had a surge in calls recently asking us to review documents that were for toxic fundings.  I have even gotten a few calls my office offering toxic financing to some of the companies that I am an officer and director of.  To the inexperienced eye, these financing proposals may even seem legitimate.  Unfortunately, they are not.  Back in January of 2013, shortly after the SEC initiated action a

gainst Edward Bronson for illegal fund raising for penny stock companies, I published an article detailing are meeting with him in the summer of 2006 , and how we identified the financing he was offering as a toxic funding.    Given the current fund raising environment for small cap and micro cap companies, I decided it was time to start writing again on this subject, and start getting some information out there so the companies that are receiving these fund raising offers can understand what is being presented to them.

In this article, I would like to take a look at what a toxic funding is, and what happens to a stock in a toxic funding.

What is a Toxic Funding

A toxic financing is convertible debt or preferred stock that allows the financier, the holder of the debt or preferred shares, to essentially receive an unlimited number of free trading common shares when they convert their debt or preferred shares to common stock.  The debt or preferred shares carry an interest or dividend rate that the company is usually unable to pay; and as a result the financier converts the shares into common shares that they then sell into the market in order to be repaid and earn a profit on the investment. The formula for the conversion into common shares is structured so that there is no downside limit on the price received for the converted shares.  This is what is known as a “floorless convertible” and this is what makes the financing or funding toxic.

These convertible preferred and convertible debts usually convert into common shares based upon a formula (“floating conversion rate“) that is effectively a discount to the market price of the shares at the time of the conversion.  For example in the early days of these types of convertible instruments, the formula might call for the conversion of the debt or preferred shares into common shares at a 20% discount to the market price on the day of conversion. Therefore the language in the contract might say something “has the right to convert into common shares at a price equal to 80% of the closing price.”  Now as the participants in the market have gotten more sophisticated, and the language in the contracts has gotten a lot more sophisticated as well.  Now there are a whole host of clauses and provisions that take into account the price weighted volume, the average price over a several day period of time, lowest price over a period of time.  The conversion clauses have become far more complicated, and far more difficult for the average person to understand.  It is easy to see how these clauses can get past people who really do not understand what they are reading.

It should be noted that a conversion clause with a floor would read something like “the greater of $2.00 per share, or 80% of the market price…”  With this language in a conversion clause, the lowest price at which the convertible debt or convertible preferred can be converted into common shares is $2.00 per share.  This conversion clause actually has two (2) types of provisions in it.  The 1st being the hard conversion price of $2.00 per share.  The 2nd being the floating conversion rate of a 20% discount (80% of the market price) from the market price.  The “greater of” language establishes the hard conversion price of $2.00 per share as the floor price of any conversions.

What Happens in a Toxic Funding

The vast majority of small and micro cap company Presidents and Chief Financial Officers (CFO) are not familiar with the term toxic financing, and even less understand what happens if they undertake a toxic financing.  As a result it is important to understand what happens once a company engages in a toxic financing.

The form of the contract or funding agreement can vary greatly from one toxic funder to the next. However, once the agreement has been signed, usually some money is provided to the company.  There is now a debt or convertible preferred that can be converted into free trading common shares one of three ways.  The methods of obtaining free trading shares are either through the registration statement filed with the SEC, a court order, or Rule 144 exemption.  We will take a greater look at these methods of obtaining free trading shares in a later article. However, what is important is that within a short period of time, the company now has a convertible instrument on its balance sheet that can be converted into free trading shares.

In the vast majority of instances, the companies that enter into these toxic funding agreements have a very limited amount of market liquidity for their shares.  As a result, when the conversion notice arrives, and the debt or preferred is converted into common shares, the owner of the toxic debt receives free trading shares that are deposited into a brokerage account and sold into the market. This selling almost always drives the price of the stock lower.

One might be tempted to think at this point that it over and done with; that they have converted their debt or preferred and moved on.  However, it does not work that they.  The toxic financiers are smart.  They are only going to convert a fraction of their debt or preferred into common shares.  They are only going to look convert a portion of their holdings into shares. Their goal is to convert and sell as many shares as they can above the conversion price, before their selling drives the stock price below the conversion price.  As a result, the conversion notices trickle in, and the stock price continues to move lower, and lower.  Think of it as a death by a thousand cuts.

Each subsequent conversion, will be for a greater number of shares, even as the dollar amount being converted remains the same or declines.  When this starts to happen, two other important things begin to happen.  The 1st being the number of shares issued and outstanding begins to sky rocket.  The 2nd being the existing shareholders are massively diluted in their existing holdings. It is not uncommon for some companies that have engaged in a toxic financing to see the number of shares they have issued and outstanding go from less than 50 million to over 5 billion.

These toxic fundings also shut off a company’s access to more legitimate fund raising sources.

In our upcoming blog articles on toxic financing a/k/a toxic funding or death spiral financing we explore the issues raised in this article in greater detail.

www.coralcapital.com

If you have any questions about the above blog post, please feel free to visit our web site, www.coralcapital.com and check out we have to offer.  Feel free to contact us if you have any questions.  We can be reached at 404-816-9220 and are always willing to speak with you.

About Coral Capital Partners

Coral Capital Partners is an independent consulting and advisory firm focused on companies and participants in the lower and middle markets. We partner with our clients to provide cost effective solutions to real world issues and situations. Our experienced team brings a diverse set of skills that allows us to service a wide variety of needs.  Our area of services and expertise focuses on bringing services and solutions to our clients that are normally only available to much larger firms.  Coral Capital Partners, Inc.  provides services to Investment Banks,  Private Equity Funds, investors, and both privately held and publicly traded companies, as well as various stakeholders in those organizations.  This has included international public companies with operations on three (3) continents to smaller privately held domestic companies.  Our experience in the areas of corporate advisory, due diligence reviews, and regulatory compliance allows for a cost effective and efficient solution to the issues at hand.  Please feel free to contact our offices to see how we may be of assistance.

Form D Report – July 2017

Form D Report – July 2017

Welcome to our introductory post of the Form D Report by Coral Capital Partners. Each month we look at the Form D filings with the Securities Exchange Commission (SEC) and analyze the data to see what is occurring in the private capital raise industry. We take a look at the industries that are raising capital, the types of offerings, and the involvement of investment banks in the capital raising process.  There are roughly 150 Form D’s filed every business day with the SEC. There is a tremendous amount of information contained within each and every Form D filing.  This information becomes even more informative when you start looking at all the filings within a month, a quarter, or a year.  We will be looking at this information and sharing our findings with you.  A printer friendly copy of this month’s report may be found (Form D Report (pdf copy) July 2017).

The month of July saw approximately 3,237 Form D filings with the Securities Exchange Commission (SEC).  Approximately 1,869 or just under 58% of those filing were new filings, with the remainder as amendments.  The three (3) top industries for filings were Pooled Investment Funds, Finance (banking, other banking & investment) and technology companies.

Equity offerings accounted for approximately 56% of the offerings, and Pooled Investment Funds accounted for approximately 34% of the filigs.

Investment banks were listed as receiving sales commissions on approximately 460 or approximately 14% of the offerings.  Of those 460 offerings, Pooled Investment Funds accounted for 287.

Form D Report – July 2017
# %
Total Filings 3,237
New Filings 1,869 57.7%
Amendments 1,368 42.3%
Industry Groups Type of Offering
# % # %
Agriculture 16 0.5% Debt 206 6.4%
Biotech 74 2.3% Equity 1,806 55.8%
Business Services 16 0.5% Equity & Debt 0 0.0%
Commercial 141 4.4% Pooled Inv. Fund 1,104 34.1%
Commercial Banks 13 0.4% Not Listed 97 3.0%
Computers 17 0.5%
Investing 35 1.1%
Oil & Gas 38 1.2%
Other Banking 318 9.8% Investment Bank Listed
Other Energy 24 0.7%
Other R/E 108 3.3% # %
Other Tech 322 9.9% Overall 460 14.2%
Pharmaceuticals 16 0.5% Pooled Inv. Fund 287 17.2%
Pooled Inv. Fund 1,668 51.5%
REITS 26 0.8%

About Coral Capital Partners and Erik Nelson

Erik Nelson is the President of Coral Capital Partners, an independent consulting and advisory firm focused on companies and participants in the lower and middle markets. Coral Capital Partners provides cost effective solutions to real world issues and situations. Coral Capital Partners, Inc. provides services to Investment Banks, Private Equity Funds, investors, and both privately held and publicly traded companies, as well as various stakeholders in those organizations. This has included international public companies with operations on three (3) continents to smaller privately held domestic companies. Our experience in the areas of corporate advisory, due diligence reviews, and regulatory compliance allows for a cost effective and efficient solution to the issues at hand. Please feel free to visit our web site at: www.coralcapital.com or call our offices via. telephone # (404)-816-9220 to see how we may be of assistance.