A steady stream of “shell” companies with little cash, assets or business plans marched onto public markets in 2014 and early this past year. Now, pressurized from regulators, the Canadian Securities Exchange takes significant steps to tighten that access.
An overhaul of the CSE’s listing requirements is in progress, the result of negotiations with regulators, primarily at the Ontario Securities Commission, sources say. The marketplace watchdogs are understood to have been alarmed by the proliferation of these shells and also the danger they might pose to investors.
The CSE, an upstart rival to the Toronto Stock market, plans to introduce strict working capital requirements for newly listed companies, effectively pushing empty shells from the picture. The proposals, published late last month and today open to public review and input, would also require firms to achieve “appropriate business milestones” before gaining an inventory.
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“There continues to be strong feedback that however such as the approach we take to regulation, they would feel well informed when the bar was higher in route in and if there were continuing listing requirements as well,” Richard Carleton, the CSE’s chief executive said in an interview.
The exchange took steps last year to staunch the flow of questionable firms to the public market, but that failed to placate all of the concerns of regulators.
Shells were going public on the CSE via a court-controlled legal manoeuvre referred to as a plan of arrangement. By taking this route, these were capable of getting listed without having to file a prospectus or being susceptible to any significant vetting by regulators.
Clean shell companies with public listings can be sold for a profit, ostensibly to entrepreneurs looking to build them into viable companies. But the OSC was uneasy since it had little understanding of these lenders before they obtained public listings and have become available for trade by retail investors.
Regulators this past year halted exchanging at least two firms that went public through plans of arrangement coupled with unexplained run-ups within their share prices.
“I can easily see why they’re cracking down on it in the sense that you have listed companies without real businesses,” said Krisztin Tth, a partner in the securities practice at law practice Fasken Martineau DuMoulin LLP in Toronto. “Once there’s real mischief, it’s not the CSE that will stop it. It’s the OSC that has to part of.”
A Financial Post investigation in March 2015 found that a large number of companies went public utilizing a plan of arrangement despite having minimal cash and scant evidence of your own business plan.
Regulatory filings showed a few of the companies were capitalized with as little as $1,000. And the spinoffs were happening so rapidly that even those at the helm from the root companies claimed they weren’t keeping track.
One root company, Winston Resources Inc., was discovered to have spawned a lot more than 50 spinoffs, many of which secured a listing on the CSE by simply becoming “reporting issuers” through the plan-of-arrangement loophole.
The CSE’s first make an effort to rein in this novel method of creating shells was in January 2015, when the exchange stated that could turn down listings if a company did not demonstrate “sufficient capital to invest in an acceptable business plan.”
Carleton said the exchange successfully “quashed” the troubling trend last year. Regardless of the exchange’s added guidance, however, legal and regulatory practitioners noticed micro-cap companies formed through plans of arrangement and spinoffs were continuing to create their way to the public market.
For example, True Leaf Medicine Ltd., Data Deposit Box Inc., and JG Wealth Management Corp. were all created through the legal manoeuvre and began trading on the CSE in February and March last year.
The proposed listings requirements would codify last year’s guidance into official rules for the CSE. In an additional step, the Ontario Securities Commission has modified the CSE’s recognition order that sets the terms to which the exchange is able to operate.
Specifically, the commission will now require the CSE to consider “the public interest and risks linked to the listing and continued report on issuers” if this carries out its function of determining which companies can list their shares for trading around the exchange.
“The proposed [listing] amendments, along with the variation to CSE’s recognition order recently produced by the Commission, are essential steps to address risks associated with the increasing quantity of issuers listing around the CSE through avenues apart from initial public offerings,” Huston Loke, the OSC’s director of corporate finance, said in an email.
For-profit exchanges such as the CSE must balance sometimes-conflicting objectives, said Fasken lawyer Tth. The exchanges exercise a “gatekeeping” function to ensure the quality of the companies they list, and also at the same time frame collect fees from listing companies in a competitive marketplace.
“I’m sure it was either partially not diligent enough, and, also, you’re getting fees … it should be a mix of those that led to this situation,” Tth said.
Once a few firms got through, he said it isn’t surprising others piled in and made a “pig inside a python” situation that caught the interest of regulators, who then pushed the CSE to boost the bar.
“They always had this discretion. It’s just they got called on it by their parent, the regulator, having some concern,” Tth said.
Some of the companies created through plans of arrangement and listed on the CSE have already drawn attention from regulators.
Shortly following the Financial Post’s story on the proliferation of shells was published this past year, regulators in Alberta temporarily halted trading in ChitrChatr Communications Inc., a shell company spinoff brought to market utilizing a plan of arrangement. As justification for imposing the halt, Alberta Stock market officials said: “Circumstances exist or are about to occur that may lead to other than orderly trading.”
Over the prior 6 months, shares of ChitrChatr had soared to $2.17 from 20 cents, giving the organization a market capitalization of $75.4 million when the shares were halted last March. At that time, ChitrChatr had just $45,243 of current assets (including cash) against $167,259 in current liabilities.
Today, the shares are worth just 9.5 cents and the company includes a market price of approximately $3 million.
Regulators in Canada and Germany also flagged concerns with Orca Touchscreen Technologies Ltd., another former shell which was delivered to market using a plan of arrangement.
Orca’s shares were halted on the Frankfurt Stock Exchange in reaction to allegations of “improper investor solicitation.” A German regulator issued an alert to investors about unsolicited phone calls, or phone calls, recommending the purchase of the shares. Orca shares had jumped to 59 cents from 5.5 cents around the CSE in 2014, and then to $1.08 in February 2015 before trading was halted.
Orca’s share price began to nosedive once the halt was lifted. It’s now worth 4.5 cents.
In future, the CSE uses a company going public to be either generating revenue, or to have at least $200,000 of capital to carry out a work plan within the next 12 months.
“By hard-coding that requirement into the rules, it can make it clear to the people who are applying for listings what they need to possess by means of capital resources on the way in,” Carleton said.
Another requirement is the fact that initial public offerings cost at least of 10 cents per share. That ensures companies have healthy capital structures and are doing more than the minimum to get listed. Firms that issue countless shares at fractions of pennies are also prone to “pump-and-dump” schemes completed by unscrupulous promoters.
“There’s more room to promote – at this level,” says Ed Waitzer, someone at law firm Stikeman Elliott LLP in Toronto. It’s “easy to maneuver the marketplace small amounts which, on bulk, can skim off lots of money.”
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