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Thursday, 10/28/2004 10:47:54 PM

Thursday, October 28, 2004 10:47:54 PM

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PHANTOM FINANCIALS

By CHRISTOPHER BYRON
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October 25, 2004 -- The notion that the investing public is well served by Reg D is preposterous.A new multi-billion- dollar penny stock ploy is spreading through Wall Street, and the Securities and Exchange Commission seems for the most part to be sleeping right through it.
While the regulators doze, lawyers and stock promoters are stampeding through a loophole in federal securities law known as Regulation D to mount a massive end-run around the jurisdiction of the SEC itself. The prize: billions of dollars of publicly-tradable stock in essentially worthless shell companies, which are being created in record numbers and at virtually no cost to the incorporators in business-friendly states like Delaware and Nevada.

The Reg. D loophole, created to allow mom-and-pop sized businesses access to the capital markets of Wall Street, permits the federally unregistered shares of these private companies to be sold to the public anyway, with their prices displayed on Nasdaq quotation terminals as if they were shares of Microsoft or IBM.

The assembly-line exploitation of this loophole has ballooned almost overnight into the penny stock market's newest get-rich ploy.

Between Memorial Day and Labor Day of 2004, while the stock market drifted lower, more than 100 such companies appeared out of nowhere and began trading in the market, versus barely half a dozen such companies during the same period in 2003.

"This has become a real epidemic," warns R. Cromwell Coulson, who heads Pinksheets.com, which provides Wall Street's most comprehensive quotation service for non-SEC-reporting companies.

One of the most active groups in this booming new business revolves around Reg. D companies formed by a Phoenix, Ariz. securities lawyer named David B. Stocker. An official at the Holladay Stock Transfer Inc. agency, which is based in nearby Scottsdale, last week told The Post that Stocker alone has created "15 to 16" such companies since the summer. When reached for a response, Stocker offered only a terse "no comment," then muttered "why are you trying to drag me into it," and hung up the phone.

HOLLADAY Stock Transfer has handled the back office re cord-keeping for at least two of the Stocker companies. And a Bonita Springs, Fla., stock promotion firm called ATN Enterprises has also figured in the action.

Paid stock touts such as ATN are required by law to identify themselves and to specify the types and amounts of their compensation on any stock-hyping press releases they distribute to the public.

The amounts of money ATN has thus been paid make plain enough just how big the stakes in this game really are: a startling $311,000, in cash, for writing up a mere handful of press releases for Auction Mills and two other Texas-based Reg. D. companies. Exactly who paid ATN for this work is not clear from the releases.



The most generous payments of all — $150,000 and 2.5 million "free trading" shares - went to ATN for its press release artistry on behalf of just one company in the group: a New Mexico industrial equipment company called CDC Systems, Inc. — the subject of much recent coverage in this space.

Both CDC Systems and Auction Mills have also employed the services of a one-time Texas bartender-turned-stockbroker named Patrick Arnett, who now works in Houston as a stock promoter.

FOLLOWING several critical stories about CDC Systems that ap peared in The Post beginning Oct. 13, the company issued a press release late last week, listing Arnett as the contact man, in which it acknowledged certain claims it had made in an earlier release were "inaccurate" and that the SEC has begun an investigation into its activities.

Nor are Arnett and ATN the only paid touts in the group. In Grand Island, Neb., a fax spamming operation that goes by several business names including "Market Advisors, Inc." was paid $5,000 to draft a glowing report on CDC Systems, Inc.

In Weston, Fla. a separate group of touts that likewise employ a variety of business monikers, including Capital Research Group Inc., Wall Street Capital Funding, and Wall Street News Alert, has been paid $100,000 for press releases on behalf Auction Mills as well as CDC Systems.

And in Lake Harmony, Penn., yet another paid stock tout named Charles P. Barry, who operates behind a variety of corporate names, routinely gets paid several hundred dollars each time he redistributes reports such as those prepared for CDC Systems by Market Advisors, Inc. and the group in Florida.

NETWORKS such as these exist solely to exploit the profits lurking in the fine print in Sec. 504 of Reg. D, which allows small businesses to raise up to $1 million of capital through the private sale of unregistered stock.

Yet it is not a mere $1 million in capital that the Reg D palyers are after, it's the ability to obtain limitless amounts of shares that can be sold on the open market.

And Sec. 504 of the rules provides it, by allowing the issuing company to register its shares with any of the 50 states, thereby rendering the stock freely tradable nationwide.

The only stipulation: the state where the shares are registered must make "substantive financial information" from the registration statement available to any investor who asks for it, whether the person lives in the state or not.

The net effect of all this has been to push the regulatory oversight of Reg. D offerings off the backs of the SEC and onto those of the individual states. And once the packagers and promoters of Reg. D offerings saw the opportunity that this presented, they began streaming through the Reg. D loophole in search of the most compliant and least demanding states in which to set up their deals and register their Reg. D shares.

THE notion that the in vesting public is well served by any of this is preposterous, for instead of making audited financial statements more easily accessible to would-be investors, the reform has paved the way for Reg. D promoters to build a booming new business out of hiding their companies' financial statements like itty-bitty needles in 50 different haystacks.

The North American Securities Administrators Association in Washington maintains no comprehensive database of state registrations of Reg. D offerings, and neither do any of the states. And most states don't even make their own data available to the public online.

Patrick Arnett of CDC Systems said last week that he wasn't certain but that he believed CDC's lawyers might have filed a Reg. D registration in New Mexico, where the company maintains its corporate headquarters in a postal mail drop.

After three full days of telephoning, a New Mexico state official was reached who searched through eighty boxes of archived documents in order to confirm that CDC Systems had filed no Reg. D. stock registration with the state.

No other state regulator queried for this story had any better luck. At deadline last week, CDC lawyers had failed to produce a copy of even a single Reg. D registration for this story, in spite of repeated promises from Arnett that they would do so.

The only document located anywhere that contained any financial information at all about the company came from the SEC's public reference room in Washington, though it was available only in hardcopy, and a representative from the Post's Washington bureau had to present himself personally to a clerk to get a copy. The document was a so-called Form D filing, showing only that CDC's total assets consisted of just $82,000 in cash, and that the company planned to sell shares only to a single Texas investor, who under the law could not resell them unless they were first registered somewhere.

The Form was dated Sept. 20th, and four days later the penny stock market was awash in CDC stock, with nearly 7.3 million shares changing hands on its first day of trading.

Where did the shares come from? Who was selling them? Was any of it legal? "Good question," says Texas Securities Commissioner Denise Voigt Crawford. "I have no idea — and you can quote me on that."


*Please send e-mail to: Cbyron@nypost.com

http://www.nypost.com/business/32610.htm


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