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April 30, 1998

NASD's OTC Shootout

By Stephen Lacey

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The National Association of Securities Dealers is planning more crack downs on trading scams in non-Nasdaq, over-the-counter securities.

But the NASD's attempts to drive the sleaze artists out of the non-Nasdaq, OTC market could end in disappointment. About 8,000 stocks qualify as non-Nasdaq, OTC securities, trading on the NASD-owned, electronic OTC Bulletin Board, and the manually-traded, independently-run pink sheets.

While the vast majority of OTC stocks are issued by legitimate entities supported by honorable market makers, a small minority give traders a black eye and rouse the NASD's enforcement machine.

The OTC Bulletin Board, in particular, seems to attract much of the criticism.

"The biggest problem in the area of small-cap fraud has been with the OTC Bulletin Board," said Phil Feigin, securities commissioner for the state of Colorado. "There's not very good enforcement of the bulletin-board market."

The OTC Bulletin Board, a somewhat secretive world where the bid and asked spreads can be gargantuan, is perceived as a breeding ground for some of the market's most unscrupulous personalities.

With stock markets scaling new heights, Feigin and others believe that investors' temptations to parlay their capital gains to even greater heights could motivate sinister traders to find avenues to perpetrate their fraud, in the face of new enforcement regulations.

"You can make enforcement harder, but it's not going to decrease the level of fraudulent activity," Feigin said. "These are people with sky-high egos that honestly believe that they won't get caught."

NASD regulators have proposed three initiatives designed to protect investors from being ripped-off by fraudulent broker dealers.

In a release, the NASD said the initiatives proposed:

* Allow only those companies that report their current financial information to the Securities and Exchange Commission, and banking or insurance regulators, to be quoted on the OTC Bulletin Board. (About 50 percent of the OTC companies currently report their financial results to the SEC.)

*Require brokers, before they recommend a transaction in an OTC security, to review current financial statements on the company they are recommending.

*Require that investors receive a standard disclosure statement emphasizing the differences between OTC securities and other market-listed securities prior to the initial purchase of an OTC security.

"There has been a dramatic increase in the number of micro-cap securities in the public market place," said Frank Zarb, NASD chief executive, in a prepared statement. "These measures are designed to ensure that the level of integrity that exists in other parts of the market is achieved in the smaller-capitalized section as well."

At the same time, the SEC has its own proposals on non-Nasdaq, OTC securities that would put more responsibility for investor protection on market makers. At press time, the NASD's proposals are expected to be submitted to the SEC for final approval and public comment.

Investor scams have been around for as long as Wall Street has existed. But today's scams may be more menancing, as evident by well-publicized reports of organized crime infiltrating the OTC market.

Mob tactics on the market-making side allegedly have included the intimidation of legitimate market makers who have refused to artificially inflate the value of stocks. Naked short-selling is reportedly another favorite tactic.