For years economists and others have complained that the U.S. suffers from a lack of dynamic young businesses. In 2012, a solution called The JOBS Act promised to cure this malaise by easing the rules for small stock offerings. We were supposed to get new jobs and new industries. Instead, we’ve gotten GoFundMe-style websites hawking penny stocks and professional wrestlers shilling shares on TV.
Five years on, have these mini-offerings delivered on their promise to create jobs or the next SpaceX? Have they made money for investors?
We studied the hundreds of mini-IPOs made under the Jumpstart Our Business Startups Act (JOBS) rule called Regulation A+. There are earnest entrepreneurs with real products. But sad to say, most Reg A+ businesses haven’t gotten beyond the startup phase known as the pipedream. Cannabis paraphernalia. Flying cars and guns. The founder of rock band Blink-182 Tom DeLonge seeks your money to study UFOs, telepathy, and light-speed travel, but declined to talk to Barron’s about it.
Investors so far have little to show for the hundreds of millions of dollars that the U.S. Securities and Exchange Commission says have gone into these IPOs since Reg A+ took effect in 2015. Investment returns are hard to find, mainly because only a few dozen of the 300-odd Reg A+ stocks have gotten so far as to list on the NYSE, NASDAQ, or OTC markets, where you can trade or at least get a price quote. Those include a handful of community banks and one outfit carried high on the recent blockchain froth. Excepting those, the average Reg A+ stock fell 40% in the six months after its mini-IPO and has underperformed the raging bull market surrounding them by nearly 50 percentage points.
Whether that means Reg A+ was a bad idea-or just needs improvement-depends on your perspective.
“Many of us were concerned as RegA+ was being developed that it would be a disaster for investors,” says Tyler Gellasch, a former SEC staffer who now runs the Healthy Markets Association. “A few years into this experiment, and these results are about as bad for investors as anyone could have predicted.”
“A market—an entire market—losing half its value when the rest of the stock market was going through the roof is a massive problem,” Gellasch says.
“Crowdfunding in the U.S. is off to a relatively slow start,” says Ryan Feit, chief executive of a crowdfunding platform called SeedInvest (seedinvest.com). By contrast, crowdfunding now contributes about 17% of all early-stage capital in the U.K., where investors rally behind favorite businesses like the Scotland-based pub chain, BrewDog. The chain has dozens of brewpubs around Europe and is using Reg A+ to fund its first U.S. brewery, in Columbus, Ohio. Proven ideas like this are rare among microcaps.
“There are some really crappy offerings,” warns Jamie Mcintyre, a financial industry veteran who’s backed SeedInvest and some Reg A+ offerings. “But that’s like any marketplace. I’d rather have the openness, so that we can figure out what’s going on and let the cream rise to the top.”
The JOBS Act came together in a more bipartisan time. Congressmen from both parties gathered around President Obama in the White House Rose Garden as he signed the law in 2012. Among them was David Schweikert (R-Ariz.), who contributed the piece that led to the new Reg A+. While he wrote us that he’s “thrilled” to have championed the legislation, he thinks it could have had far more success if the Obama Administration hadn’t “slow walked” the implementing regulations until 2015.
Also at Obama’s signing was investment banker David Weild IV, a vigorous proponent of the law. Since then, however, Weild’s little New York firm has worked on only one Reg A+ offering. The small stock IPO market hasn’t revived, he says, because the law didn’t fix the aftermarket for small-capitalization stocks. Today’s narrow trading spreads and shrunken commissions won’t support the sales effort needed to distribute microcap stocks, says Weild.
Another reason for the dearth of penny stock brokers, of course, is that a bunch were bounced from the business or jailed in 1990s enforcement actions against boiler rooms like Stratton Oakmont-the firm depicted in the movie “The Wolf of Wall Street.” Investors need protection, says Weild, but issuers and bankers need incentives to sell stock. “For any market to work, you need balance,” he says.
Weild’s Reg A+ deal was an August 2017 offering by Chicken Soup for the Soul Entertainment , which raised $30 million at $12 a share. It became the first Reg A+ company to list on the Nasdaq’s global market. Spun off by the publisher of popular inspirational books, Chicken Soup for the Soul Entertainment produces inspirational videos.
Chief executive Bill Rouhana says he thought Reg A+ would be “a great way to combine Wall Street and Main Street.”
In retrospect, he thinks that a traditional IPO might’ve been easier. Rouhana’s bankers did a good job of placing shares with their customers, but when novice investors came directly to the company, the Chicken Soup team had to teach them how to open a trading account.
Since their $12 debut, shares of Chicken Soup for the Soul Entertainment (ticker: CSSE) dipped below 7 bucks and climbed back up above $9. Operating cash flow has been negative. Programming sponsors tend to pay in the December quarter, says Rouhana, so investors must wait for that quarter’s report to see if it turns around the company’s losses for 2017’s first nine months. A recent acquisition of a library of old films and TV shows should also add revenue.
To date, the only investment success among Reg A+ stocks is the international fintech company, Longfin. Since its December 2017 offering at $5, the stock (LFIN) is up 640% to $38, after initially soaring as high as $142 when investors thought it had something to do with Bitcoin.
“It’s insane, it’s really insane,” admits founder, CEO, and controlling stockholder Venkat Meenavalli. Longfin includes a blockchain venture called Ziddu.com, but it has nothing to do with cryptocurrencies like Bitcoin, Meenavalli says. Longfin also owns Meenavalli’s business Stampede Capital , a profitable company that’s listed in India and provides market-making technology for financial exchanges.
At current prices Longfin’s equity is valued at a hefty $2.8 billion. Even at recently lower prices, this is not a cheap stock.
But Longfin is an outlier. While backers touted the new law as some kind of win for the little investor, the performance of most Reg A+ shares suggests the opposite.
To see if the little guy has made money, Barron’s checked the returns of every Reg A+ stock that has a price history. Out of more than 300 stocks, there have been only 31 with reported trading prices. The eight community banks of that bunch are clearly their own category, with steady share prices tied to their book values. So we measured the banks separately from other Reg A+ stocks.
Starting from the date that each company got its “qualification” notice from the SEC (that’s the Reg A+ analog to the agency’s declaring a conventional offering “effective”), we measured each stock’s return over its first six months of trading. So, historically, these were mini-IPOs that came out between 2015 and six months ago. On average, the banks gained 9% in their first six months. There are 14 other Reg A+ stocks with six months of trading prices. On average, they fell 16% (as we show in the chart below).
But even that’s too generous a measure. Many Reg A+ stocks trade for fractions of a penny, so their percentage changes influence an average unduly. Weighting the average returns by each stock’s price-better approximating an investor’s portfolio-the 14 Reg A+ stocks dropped an average of 40% in just six months of trading.
Those returns were all the more embarrassing for taking place in the teeth of a roaring market updraft. Relative to two small-cap benchmarks-the Russell 2000 Index and the S&P SmallCap 600-the Reg A+ shares underperformed by about 23 percentage points in their first six months. Price-weighting the Reg A+ average, they lagged the benchmarks by nearly 50 percentage points.
Investment banker Weild believes the sorry returns of Reg A+ shares show the absence of brokers who could support the stocks with research and sales calls. He’d like to see a “JOBS Act 2” that would support brokers with wider trading spreads and bigger commissions. “We’re in the third inning of a nine-inning game to fix capital markets,” he says.
Working at Weild’s firm for a while last year was Andy Altahawi, a Reg A+ pioneer who has consulted on more than 20 deals since 2015. He also sports a finance PhD from an online diploma mill called Chelsea University, which he concedes is “honorary.” Chelsea’s London address and its president John D. Ozwell are both fictitious, while Britain’s university authentication organization H.E.D.D. singles out Chelsea’s website as an example of a fake university.
Altahawi promoted Longfin’s offering, as well as more modest ventures like Viva Consulting Group, which plans to register landowners in the Buganda kingdom of Uganda, and Tahawi Aerospace, which was started by Altahawi’s 22-year old son and says it plans to build turboprop planes. The aerospace enterprise has been on hold, says the father, while his kid finished college. “He’s into aviation,” says Altahawi, who is the company’s other officer. “He did some flying when he was 15 years old.”
Meanwhile, there’s worry that the looser standards of Reg A+ deals allow Wall Street’s wolves another way in.
YayYo is a startup with a ride-sharing app that works poorly based on our recent experience with it. The SEC cleared YayYo’s Reg A+ deal in March 2017 after founder and chief executive Ramy El-Batrawi finished a five-year ban from publicly-held companies, to which he’d consented in settling SEC charges of stock manipulation (charges he neither admitted nor denied). By the end of June, El-Batrawi’s new venture raised $1.8 million through Reg A+-helped by TV ads in which “Seinfeld” actor John O’Hurley touted the IPO. Another Reg A+ issuer Adomani hired retired wrestler Bill Goldberg to tweet his fans. Such stunts prompted the SEC’s enforcement division to warn investors in November to beware of stocks that pay celebrities for endorsements.
And there’s Stealth Air, which says it is developing automated landing stations for unmanned drones. Cleared to sell stock in May 2017, the company has assembled “a stellar team of consultants and advisors,” including “former and current members from the NYPD, FDNY, Miami PD, NCPD, and SCPD,” as well as ex-military Special Ops and former state senator Michael Balboni-who served as New York’s head of homeland security for governors Eliot Spitzer and David Paterson.
At last report, Stealth had no revenue or stockholders’ equity. Its largest shareholders were an entity owned by Mark Pellettieri, a former penny stock broker who’d agreed to a fine and suspension by FINRA’s predecessor agency in 2003 (without admitting the regulator’s charges), and Stealth’s chief executive Craig Redding, who worked with Pellettieri at Stratton Oakmont. Unlike that boiler room’s notorious leader Jordan Belfort, the pair were not charged with wrongdoing for their work there. Our queries to Stealth and these gentlemen went unanswered.
Another Reg A+ company whose leaders could give investors pause is Level Brands (LEVB). The marketing company listed on the NYSE soon after an November 2017 offering at $6 a share that was the largest Reg A+ distribution yet. Level Brands’ “chairman emeritus” and chief brand strategist is Kathy Ireland-a former swimsuit model who the New York Times recently identified as having hundreds of thousands of fake Twitter followers.
Level Brands’ chairman and chief executive is Martin A. Sumichrast, whose career promoting underachieving stocks goes back to the 1990s, when a couple of his companies came public through Stratton Oakmont. After Sumichrast’s firms Czech Industries and Eastbrokers went bust, he teamed up in several publicly-held internet businesses with Bruce Bertman-- until Bertman was arrested and convicted in 2003 of conspiring to pump and dump a stock (see “Casualty Ward,” Aug. 26, 2002).
More recently, Sumichrast touted Chinese companies that reverse-merged into U.S.-listed shells (see “Beware This Chinese Export,” August 28, 2010), only to flounder. He then co-founded a merchant banking firm called Siskey Capital, which made headlines in Charlotte, N.C. papers when his partner Richard Siskey committed suicide in 2016 as the Federal Bureau of Investigation was closing in on a Ponzi scheme that Richard Siskey had allegedly been running. Neither Sumichrast nor Ireland responded to queries from Barron’s, but Sumichrast filed claims against his dead partner’s estate, claiming ignorance of Siskey’s scheme. Securities regulators have never charged Sumichrast with wrongdoing.
Reg A+ has clearly created jobs for stock promoters with checkered stock market histories, but no one has tallied how many real jobs we’ve gotten for the hundreds of millions that investors have sunk into these stocks. Before Congress serves up a JOBS Act 2, its proponents ought to show us real benefits for jobseekers and investors.