U.S Fuel Corp. (fka USFF)

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DTC Eligibility for Smaller Reporting Companies
By Mina Oh, Autarky Consulting Inc.

A. Becoming an SEC Reporting Company
Companies seeking to obtain a quote in the National Association of Securities Dealers (“NASD”) OTC Bulletin Board (“OTCBB”) are required to file reports with the SEC under Section 15D of the Securities Exchange Act of 1933, as amended, or Section 12G of the Securities Exchange Act of 1934.

The OTC Bulletin Board (“OTCBB”) is a U.S. quotation medium for subscribing members used for many over-the-counter equity securities that are not listed on a national exchange. Broker-dealers can use the OTCBB or Pink OTC Markets, a competitor of the OTCBB to enter orders for OTC securities. Stocks traded in OTC markets such as the OTCBB or Pink Sheets are usually thinly traded microcap or penny stocks and both retail and institutional investors generally avoid them, because of fears that share prices are easily manipulated thus creating potential for fraud. As such, most companies choose to list on more established exchanges such as AMEX, NYSE or NASDAQ once they become eligible.

A common misconception is that once a company becomes fully reporting with the SEC, it is automatically listed. However, becoming SEC reporting is just the first step when a company’s securities are not exchange eligible, a Financial Industry Regulatory Authority (“FINRA “) member broker-dealer/market maker must file a Form 211 with FINRA in order to request approval to quote the security on either the Pink Sheets or OTCBB marketplaces. Companies may choose to become dually quoted on both the OTCBB and the Pink Sheets.

In order to qualify for the OTCBB listing, a company must be a fully reporting entity with the SEC as the Securities Exchange Acts of 1933 and 1934 govern the registration of pubic company securities. A company can become an SEC reporting entity by 1) filing a Form 10 to register the company under the Securities Act, which causes the entity to become a mandatory fully reporting company, or 2) filing a registration statement on Form S-1, which registers for sale (or re-sale) a number of shares of a company’s stock with the SEC. A company who has filed a registration statement with the SEC becomes a reporting company when the SEC declares the registration statement effective. The SEC must declare the registration statement effective prior to FINRA providing approval for the OTCBB quotation.
The OTCBB listing provides a better chance of finding acceptable financing partners and potentially better liquidity for the company’s stock than with a Pink Sheets listing. Because the OTCBB listing requires you to be fully reporting (whereas a Pink Sheets listing does not), an OTCBB listing subjects a company to SEC oversight. Thus, the investing public, institutional investors and broker-dealers will have a higher level of confidence in the accuracy and completeness of the information available on the company.

B. Form 211 - Obtaining FINRA Approval
To get a company’s stock trading, no matter how it became public, a company must get its stock quoted on the Pink Sheets, OTCBB markets or on a national stock exchange, such as the NYSE or Nasdaq. Smaller companies generally first get their stock quoted on the OTCBB and then uplist to a national stock exchange once they qualify.

In order to have a trading market, there must be one or more market makers. The market maker must be a broker-dealer who is a member of FINRA and registered with the SEC. To start trading, one market maker must file a Form 211 with FINRA.

After a company’s registration statement has been declared effective by the SEC, the company must meet the necessary conditions to enable a market maker to request shares to be quoted on either the Pink Sheets or the OTCBB. A market maker is the only entity allowed to make filings with FINRA to trade, quote and “make a market” in a company’s stock.

The market maker is required to perform a certain amount of due diligence in determining that the information presented to the public is accurate. Therefore, the market maker will require additional information from the company in addition to what is required on Form 211. The following information must be provided to the market maker:


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a list of all FINRA (NASD) member firms that participated in the offering;
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identity of the issuer’s officers, directors and principal shareholders. In addition, confirm that no officer or director of the Issuer is also an officer, director, or principal shareholder of any corporation on the Issuer’s shareholder list, except as disclosed;
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confirm that all shares held directly or indirectly by any officer or director of the Issuer are considered restricted;
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a detailed explanation of how the Issuer acquired its free trading shareholder base;
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a detailed chronology of how the Issuer arrived at its current state of existence;
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documentation relating to any discussions or negotiations entered into by the company concerning potential merger or acquisition candidates;
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documentation relating to compensation, dates of service, services provided and future expected services of any consultants or public relations firms
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a list of all companies that have been submitted for quotation on the OTCBB or Pink Sheets for which current or past management acted as an officer, director or major shareholder, including any companies for which they are currently an officer, director or major shareholder ;
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copies of all subscription agreements and canceled checks;
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a spreadsheet with shareholder names, solicitor, relationship between solicitor and investor and the appropriate securities law under which the shares were sold (i.e. Section 504, 506, etc.).
In the case of a pink sheet company, the issuer must complete a disclosure statement which is typically 15 to 20 pages long. The disclosure statement contains substantial information regarding the company, including management and capital structure, financials and business operations. The market maker must submit the Disclosure Statement along with Form 211 when filing the application with FINRA. There are no SEC filings and sworn certifications related to this filing, thus the broker-dealer is charged with conducting sufficient due diligence to be reasonably assured that the information presented is accurate.

In the case of an OTCBB-listed issuer, the market maker will generally be able to rely on the representations management has made in its filings and the certifications of the issuer’s financial statements. This lessens the burden on the market maker to substantiate the information presented to the public. The same issues apply to demonstrating how the issuer obtained its free trading shareholder base, unless it has filed and already has an effective registration statement on Form S-1 registering the free trading shares.

Non-affiliated Shareholders with Free Trading Stock

When FINRA processes the Form 211, there must be enough non-affiliated shareholders with free trading stock to make trading in the stock possible. FINRA will want to know how the company obtained its free trading shareholder base and require a regression diagram from the date of incorporation that details every share issuance, the applicable exemption available, the nature of the issuer’s business from the date of incorporation to present (including copies of subscription agreements and cancelled checks and any Form D filings). The company will have to document in detail how the stock was offered and sold and prove that it acted in full compliance with all securities laws and rules and regulations of the SEC and the states.

Timeline

While there is no set timeline in obtaining Form 211 approval, the process is similar to the registration process with the SEC although typically shorter in duration. The market maker must submit the Form 211 application to which FINRA will respond with comments typically in seven to 10 business days. The market maker works with the issuer to craft responses until the market maker and FINRA are satisfied that all requirements have been met. Once satisfied, FINRA will fax a letter to the market maker indicating the market maker is approved to submit the quotation for the securities. On average, if the application is prepared well and the market maker receives all of the required documentation, the company can expect to go through two to three more rounds of comments from FINRA in the case of an OTCBB listing (four to five rounds for Pink Sheets listings). This equates to roughly 45 to 60 days to obtain FINRA approval.

Costs

SEC rules prohibit the market maker from receiving compensation for either making a market or any related activity, including filing a Form 211 to have the company’s stock listed. What the market maker hopes to gain is trading activity in the stock and is granted 30 days exclusivity for trading the stock after obtaining FINRA approval. The challenge for the company and/or its shareholders desiring the listing is to convince the market maker that there is going to be sufficient trading volume in the company’s stock to make the listing process worth the effort. Oftentimes, the issuer’s shareholders will open accounts with the market maker as well, which provides revenue to the market maker in the form of commissions.


C. DTC Eligibility
What is DTC Eligibility?

After receiving FINRA’s approval of the Form 211 application, the next step is to become eligible with the Depository Trust Company (“DTC”), better known as “DTC eligibility.” Attaining DTC eligibility means that a company’s stock is eligible for deposit with the DTC, also known as Cede and Co., DTC’s partnership nominee. The DTC is a depository for all of an issuer’s physical stock certificates, and providing an efficient and safe way for buyers and sellers of securities to make their exchange. When a stock is bought or sold, DTC is responsible for making an electronic book entry noting the buyer and seller. By using electronic book entry, no stock certificates ever have to physically change hands when it is bought or sold. Especially in today’s market where stocks are bought and sold in fractions of a second, physical delivery is impractical and nearly impossible. Thus, in order to commence trading, a company must obtain DTC eligibility then deposit shares with DTC.

The DTC Eligibility Application Process

The application process for DTC eligibility is controlled by DTC eligible broker-dealers and their associated firms, known as “Participants.” Only Participants are allowed under DTC rules to file on behalf of issuers desiring DTC eligibility. Participants charge a fee for their services that vary between $9,500 and $15,000 per application. The time that it takes to have an issuer’s application approved by DTC depends on the skill and reputation of the Participant. On average, a reputable Participant can obtain approval within three to six weeks.

Depositing Shares of Issuer in a Brokerage Account

In order to maintain DTC eligibility, there must be a certain amount of stock certificates deposited with the DTC. The DTC allows the issuer up to 30 days after granting eligibility in which to deposit approximately 10,000 shares into Cede and Co. In the event the issuer does not deposit the necessary amount of shares within the 30 days, the issuer’s eligibility will be revoked. Typically, brokerage accounts are opened with the market maker to control and manage the process of transferring the 10,000 shares to Cede and Co.

This time frame is crucial since the 30 days in which to deposit shares runs concurrently with the 30 days in which the market maker is the exclusive trader in the issuer’s stock. If the company uses a broker-dealer other than the market maker to open the accounts and this is not done within the allotted time frame, the market maker would suffer and the company would run the risk of losing DTC eligibility. Therefore, the market maker typically begins the process of opening the brokerage accounts as soon as the DTC eligibility application is filed. Once DTC eligibility is granted, the market maker can begin making a market right away.

In order to open brokerage accounts as discussed above, the company must prepare stock certificates beforehand so that they can be obtained as soon as the DTC application is approved. Once the stock certificates are ready, an aggregate of 10,000 shares must be deposited with Cede and Co. Thus, shareholders holding an aggregate of at least 10,000 shares must open brokerage accounts with the market maker in order for the shares to be deposited with Cede and Co.

DTC FAST Processing

Fast Automated Securities Transfer (“FAST”) processing is a functionality that is available for issuers that are fully DTC eligible. Participation in FAST allows issuers, security holders and brokerage/clearing firms to move stock electronically between one another. Transfer agents must file for FAST participation. DTC approves each issuer on a merit review basis.

Through the DTC FAST program, shareholders are able to hold their certificated shares in book-entry electronic form directly with the transfer agent. These shares can be transferred via Deposit/Withdrawal At Custodian (“DWAC”) from the transfer agent to the broker and vice versa without going through DTC. DWAC is a method of electronically transferring shares from DTC, which acts as a clearinghouse for settling trades in securities.

This speeds up processing times and allows shareholders the option to be issued physical or book-entry certificates rather than in certificated form or in “street” name. The benefits of becoming DTC FAST include eliminating lost certificates and associated replacement fees, lengthy broker physical certificate deposits and processing fees, printing of stock certificates. The issuer may also benefit from instant transfer of shares to brokers and increase funding opportunities from institutional investors, lenders and investment bankers. There are two ways in which this process works:


1
shareholders can deposit their shares directly into the Direct Registry System (“DRS”) method held by DTC; or
2
shareholders may resend their physical certificates to be converted into book-entry and sent to a broker via DWAC.
The issuer must be approved and accepted by DTC to become a DTC FAST eligible issuer. Because DTC is regulated by the SEC, the U.S. Department of Treasury and the Federal Reserve, it must comply with various regulations pertaining to approving issuers. If an issuer ‘s application is rejected, DTC has the right to not provide explanation of why the issuer was rejected. In order to prepare for acceptance, the issuer can do the following:


1
if rejected, re-apply after 2 to 3 months after the rejection;
2
be fully reporting without missing or being late on any reports;
3
have few to no corporate actions (i.e. name changes, stock splits, etc.) and officer changes within the last 3 to 5 years;
4
ensure the company and officers are not involved in lawsuits or fraudulent activities that would raise Anti-Money Laundering (“AML”) or Office of Foreign Assets Control (“OFAC”) issues (i.e. pump and dump scheme);
5
avoid Reg 504D issuances or other unregistered sales;
6
clean up any Pink Sheet “halt” or “yield” statuses; and
7
grow your company as the company may be considered too small or the financials not large enough.
Steps in Obtaining DTC Eligibility


Step 1
File a registration statement on Form S-1 with the SEC.
Step 2
Once the registration statement has been declared effective, the broker-dealer/market maker must file Form 211 with FINRA.
Step 3
Provide due diligence information about the company to the market maker.
Step 4
Issuer works with the market maker to respond to several round of comments from FINRA.
Step 5
After FINRA approves Form 211, Participants (eligible broker-dealers) begin the DTC Eligibility application process. Approval can typically be obtained in three to six weeks.

Step 6
Issuer prepares stock certificates of an aggregate of 10,000 shares so that they can be deposited as soon as the DTC application is approved. Shareholders open brokerage accounts of an aggregate of 10,000 shares with the market maker for deposit with Cede and Co.
Step 7
Once the company receives DTC eligibility, the market maker has 30 days to deposit 10,000 shares with Cede and Co. and begin making a market in the shares.

http://www.autarkyconsulting.com/MarketMakingMemo.html