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Tim Quast
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May 31, 1999

Fraud Campaign Unsettles Market Makers Risks Driving Some Desks Out of Small-Cap Stocks, Traders

By William Hoffman

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  • Fraud Campaign Unsettles Market Makers Risks Driving Some Desks Out of Small-Cap Stocks, Traders

The Securities and Exchange Commission's plan to make market makers more responsible for the credibility of issuers' financial data has provoked a storm of criticism from Wall Street traders.

"I hate it," said National Quotation Bureau (NQB) Chairman Cromwell Coulson, of the proposal. He calculated it would cost traders $300 million a year. (NQB publishes stock quote data for pink sheet securities.)

Having spoken with traders and firms throughout the Midwest, Independent Broker-Dealer Association president Alan Davidson said, "There are no other supporters of this proposal that I can find besides the SEC officials who wrote it."

The SEC "is looking for us, almost as a scapegoat here, to eliminate a responsibility they have to identify, punish and root out, securities fraud," complained Jon Blauner, a director at Hill Thompson Magid & Co.in Jersey City.

Comment Letters

The commission's "Proposed Amendments to Rule 15c2-11; File No. S7-5-99" have elicited some 300 comment letters, and at least one request for extension on the comment period.

Almost a week later, "we're probably still opening envelopes," estimated SEC spokes-

man John Heine. Other than that, Heine said the commission had no comment on feedback it had so far received.

Traders and other interested parties weren't so shy.

Blauner said the SEC's latest anti-fraud campaign is misdirected: "I suspect that the bulk of the fraud I have seen in recent years has come from Nasdaq, and not from the bulletin board [and pink sheet stocks]." The SEC's effort, aimed at market makers in small over-the-counter stocks, would target shares traded on the Bulletin Board and the pink sheets, but not on the Nasdaq's National Market System or its Small-Capitalization Market.

Fred Leslie, general counsel at Hill Thompson, said the current SEC anti-fraud campaign's underlying assumption - that quotations facilitate micro-cap stock fraud - is unsubstantiated. "You could just as easily say that telephones and fax machines cause fraud," he said.

In fact, Blauner said, experience argues contrary to the SEC assumption: If quotations aren't made and spread widely and accurately, unscrupulous traders can more easily exploit the lack of transparency and competition for their nefarious purposes. "Competition breeds legitimacy," Blauner said. Leslie added: "We believe the [rule change] is going to facilitate fraud."

Reduce Competition

IBDA's Davidson, who is also president of Zeus Securities, Inc., in Jericho, N.Y., said the SEC amendments will reduce competition by pushing compliance costs up and driving smaller broker-dealers out of the markets. "I consider this to be an anti-small business proposal," Davidson said.

With fewer small broker-dealers, Davidson added, small-cap issuers will have a harder time finding capital for their companies. Davidson also challenged the scale of alleged fraud the SEC seeks to curtail. He said he asked SEC officials if 10 percent of issues were tainted. They responded that the number was fewer, Davidson said. He asked if the number of tainted issues was more like one percent of the total. That's more like it, Davidson said the SEC told him.