A Conversation with Jason Paltrowitz

This month, we spoke with Jason Paltrowitz, Executive Vice President of Corporate Services at OTC Markets Group. In his role, Jason manages the international and domestic Corporate Services business, drawing on his significant experience in cross-border trading. A staunch advocate for Regulation A+ and small company capital raising, he is dedicated to helping small cap issuers, start-ups, and entrepreneurial innovators. Jason's focus is on reducing the hurdles these entities face in becoming and remaining public companies, especially in terms of cost, time, and complexity. We asked Jason five questions about his blog post: Lawful but Awful: The Small Cap IPO Cycle. What he said might surprise you.

What motivated the study as it clearly wasn't self-interest?

Our motivation for conducting this study stemmed from years of observing companies on our market uplist. We noticed a pattern where companies advised by bankers needed to uplist in order to raise funds, with promises of significant benefits following the uplist. Over time, we observed what actually happened to these companies post-fundraising and post-uplist. As the market began to shift, many of these companies failed to comply with exchange regulations and were forced to return to our market.

This pattern led us to delve deeper into the dynamics at play [and] provide small and micro-cap companies with a clearer understanding of the realities of uplisting. Our investigation revealed intriguing details about the size of the fundraising, the types of companies involved, and the measures they took to meet listing requirements. These measures often included reverse splits, and we noted how bankers were compensated, who was purchasing the stock in these fundraises, and the specifics of the fundraises, such as the inclusion of warrants.

What became apparent was that this capital market ecosystem was often structured more for the benefit of bankers and lawyers than for the issuing companies. A small group of bankers and lawyers were involved in over half of these deals. Sadly, a majority of these companies experienced significant negative returns, sometimes as drastic as 60-90%.

Our study aimed to clarify these issues. It's important to note that this isn't a critique of exchanges themselves, but rather a call for companies to be more discerning about why and how they list on a national exchange. We wanted to highlight these issues to shed light on what we believe are significant problems in the small and micro-cap ecosystem.

What has been the feedback on your blog piece?

The feedback on my blog piece has been quite mixed, as you might expect. Interestingly, a significant number of issuers and companies have reached out to me through calls, emails, or LinkedIn. They often express regret, saying things like, 'I wish I had read this three, four, five years ago.' Many have shared their negative experiences, such as being promised successful fundraises and great outcomes by bankers, only to end up doing multiple reverse splits and falling into a downward spiral due to convertible notes. Now they find themselves on non-compliance lists and facing removal from exchanges. They wish someone had informed them earlier. A lot of these founders and CEOs, who didn’t fully understand capital markets at the time, were approached by bankers promising to raise substantial funds, without considering the significant drawbacks.

This feedback from issuers has been gratifying as it shows these companies that there are alternative paths and solutions available. However, the other half of the feedback, quite frankly, comes from many bankers and lawyers. As you might expect, this group, who have financially benefited significantly from these practices, have been quite aggressive and harsh in their responses. It seems that shining a light on their actions, which I describe as preying on unknowing issuers, is not well-received by those who are profiting immensely from these situations.

How can a small-cap company discern when it's truly ready to list or uplist?

There's no one-size-fits-all answer for any company when it comes to deciding whether to list or uplist. Companies should first consider their reasons for uplisting and understand what they're undertaking. For instance, if you don’t have a sufficient capitalization table for being public, such as not enough shares outstanding, or if you need a significant reverse split just to become eligible, these are important factors. If you're already public on one of our markets and lack substantial liquidity, uplisting to an exchange might not be beneficial.

Also, it's crucial to scrutinize the transaction itself. If a banker proposes raising money for you but insists on an exchange listing, ask critical questions. Inquire about who will receive the securities – are they long-term investors or merely stock flippers? Understand who these individuals are, and what the banker's compensation will involve. Be wary of requests for warrants as part of their compensation, as this can be a red flag.

Companies need to assess whether they are truly suited for attracting institutional investors. Consider if you are large enough for attention from major investment firms like Fidelity, Janus, or Capital [Group Companies]. Determine if your natural shareholder base is more aligned with high net worth and retail investors. Reflect on what you gain in exchange for the cost of listing on an exchange.

Remember, as a CEO or CFO of a public company, you have a fiduciary responsibility to your shareholders. Listing on an exchange involves significant costs, and you must consider whether undertaking these costs aligns with your fiduciary duty. Think about whether this move would dilute your existing shareholders and the broader implications beyond just gaining visibility in places like Times Square. It’s not just about the initial glamour; it's about all the responsibilities and consequences that follow.

How do you envision the small-cap IPO cycle changing in the future, and what reforms are needed to improve the process for all stakeholders?

First, I believe the perception of what constitutes a penny stock needs to be reevaluated. There's a misconception that being listed on an exchange inherently makes a security more investable compared to off-exchange, or OTC, trading. Currently, there are around 700 stocks out of compliance on Nasdaq and the NYSE [New York Stock Exchange], many of which would qualify as penny stocks, if not for the exemption granted to exchange listed companies.

What needs to change is a wider recognition that the markets we operate in have implemented significant investor protection measures, while exchanges seem to have been given more leeway. Regulators should reexamine the criteria for penny stocks and consider which small and micro-cap companies should be on an exchange. They need to address how long an exchange should allow companies to remain out of compliance while still being listed. As it stands, a company can trade below a penny for almost a year and still remain on an exchange.

Furthermore, there should be more transparency in how companies disclose their diluted financings. Transfer agent reform is another area needing attention. We've introduced the transfer agent verified share program in our markets, requiring companies to regularly disclose their outstanding shares. This transparency helps to immediately reveal any dilutive convertibles. Such disclosure requirements are not as stringent for companies listed on exchanges.

Overall, there are several areas where companies listed on an exchange have an easier path to engage in practices not in the best interest of investors, compared to what we enforce in our markets.

How is OTC Markets supporting the likes of AIM and LSE and the UK with the 12g3-2b exemption that provides cost effective access to the US market?

We support issuers on exchanges like AIM and LSE by enabling them to access the US market without the need to comply with SEC regulations, Sarbanes-Oxley, or reconcile to US GAAP. This approach offers companies a cost-effective and regulatory efficient way to tap into the broadest and most diverse pool of capital, saving money and time.

There are several benefits to this approach. First, US markets tend to value securities higher than other markets. By attracting US investors, companies can bridge the valuation gap, effectively raising their overall valuation. Additionally, having a presence in the US market creates extended trading hours, which enhances liquidity through the arbitrage opportunities across different time zones.

This setup also makes these companies more visible and appealing to US investors, who often show a keen interest in early-stage growth companies. For example, a company listed on AIM is likely to be more attractive to a US self-directed investor than to a UK pension fund or endowment. The foreign private issuer exemption, known as 12g3-2b, plays a crucial role here. It allows these companies to comply with US state securities laws and trade in a manner that appeals to American investors – in US dollars and within US time zones. Importantly, it enables this without requiring the companies to alter their regulatory and disclosure practices in their home market.