Tag: Registration requirement

Accidental Securities Underwriter

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So you made almost $1 million on selling penny stocks through the pink sheets on $75,000. Nice pay day. Then the SEC makes you give it all back.

This is the sad tale of Rodney Schoemann, a professional stock market trader.

Schoemann had previous purchased some restricted shares in Stinger Systems, Inc. that were marked “RESTRICTED” on their face. He apparently thought the company was worth investing in, so he asked to purchase 100,000 unrestricted shares from one of the company’s insiders. Schoemann paid the insider at the company $0.75 per share, which were not marked with a restriction. He later deposited the shares with his broker and sold them to the public.

Unfortunately, those 100,000 were not registered and that insider was in control of the issuer.

An administrative law judge found that Schoemann violated Sections 5(a) and 5(c) of the Securities Act of 1933 in November 2004 by offering and selling the securities of Stinger Systems, Inc.when no registration statement was filed or in effect for those securities and no exemption from registration was available.

Securities Act Section 5(a) prohibits any person, directly or indirectly, from selling a security in interstate commerce unless a registration statement is in effect as to the offer and sale of that security or there is an applicable exemption from the registration requirements. Securities Act Section 5(c) prohibits the offer or sale of a security unless a registration statement as to such security has been filed with the Commission, or an exemption is available.

Schoenmann argued that he was not an underwriter. But individual investors may be deemed “underwriters” within the statutory meaning of that term if they act as links in a chain of securities transactions from issuers or control persons to the public.

Section 2 of the Securities Act has this definition:

The term “underwriter” means any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking; but such term shall not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors’ or sellers’ commission. As used in this paragraph the term “issuer” shall include, in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer.

From the testimony, both Shoemann and the insider thought the shares were freely transferable. The insider did not think he was a control person and Shoemann never inquired the insider to see if he was control person.

Shoemann did see a legal opinion that shares in Stinger Systems, Inc. were freely tradeable. This opinion was submitted to the transfer agent and the Pink Sheets. Advice of counsel is not a defense, since it merely goes to the question of scienter.

A showing of scienter is not required to establish a violation of Section 5. There is strict liability.

The last test was whether Shoemann had purchased the shares for distribution. This test involves intent. Since Shoemann sold all 100,000 shares in the two weeks after he purchased them, he would have a hard arguing that he did not intend to distribute them. So Schoemann served as a link in a chain of transactions where securities moved from the issuer to the public, and in doing so, served as an underwriter.

The deal made financial for Shoemann, but he failed to realize the legal background on the shares. The SEC made him disgorge his $967,901 ($1,042,901 in gross proceeds, minus Schoemann’s initial $75,000 purchase price) from his “violative sales” of Stinger stock. In addition to the disgorgement of profits, he has to pay prejudgment interest of $335,370.98.

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