Section 3(a)(10) and Regulation A

Most of the scams and schemes from the lower end of the public markets eventually make it over to the Reg A market, and this one is no exception. It’s essentially a variation on the “funder acting as undisclosed underwriter” caper.

Section 3(a)(10) of the Securities Act provides that the issuance of securities pursuant to a court-approved settlement is exempt from registration. The general idea is that the oversight by the court provides the investor protection that would otherwise be provided by SEC registration. It’s intended to protect the lender whose debt is being converted into equity.

Except in this case, it’s not the lender that needs protection.

In general terms, what is happening is that a funding entity (“Funder”) offers to take over a chunk of an issuer’s debt to a lender or creditor. The Funder is probably a better credit risk than the issuer and it will likely offer to repay the lender faster than the issuer could. The debt is assigned by lender to Funder. Funder and issuer put together a settlement agreement and trot off to court to get it rubber-stamped. Sorry, I meant “hold a fairness hearing under 3(a)(10).” Funder is issued shares at a discount to the current market price and repays the original lender in accordance with a schedule that matches Funder’s ability to dump the shares into the market. Promotional or “pumping” activities may occur around the same time.

Funder’s view is that it can resell its shares immediately upon receipt, because unless the issuer is a “shell company” the shares are not restricted. However, it would seem that there is a fine case to be made that Funder in these circumstances is a “statutory underwriter,” and that regardless of the exempt status of the transaction in which is acquired the shares, it took the shares with the intent of selling in a “distribution.”

How to recognize these arrangements? These are OTC-quoted companies. There should be a reference to 3(a)(10) in the financial statements and possibly in the body of the Offering Statement, although as with the other undisclosed underwriter deals, these filings tend to be inconsistently drafted. And bless OTC Markets for their Prohibited Service Providers list, because those same old names keep turning up.

Join CrowdCheck

More Blogs