WASHINGTON, D.C. – Apparently there is life for Internet start-ups unable to secure reputable venture capital financing. The only problem; however, is that the Securities & Exchange Commission is saying that it’s actually a life of crime.
In the past few months, the SEC has begun cracking down on Web site operators caught giving away free shares of unregistered stock to online visitors.
Most recently, the regulatory agency decided that Miami-based Universalscience.com tried to manipulate consumers into using its services by offering unregistered free shares to anyone who signed up for membership on the company’s Web site. Moreover, the company was found to have been selling additional stock in 1,000 share units at a price of $1,000 per unit.
While nobody seemed to bite at the dollar-per-share deal, more than 4,000 Web surfers signed up for Universalscience.com membership and the free shares offer.
The problem with such activity, of course, is that all offered securities – even ones offered freely – must be registered with the SEC, said David Levine, the SEC’s senior advisor to the director of enforcement.
“The question in this action was the legality of stock giveaways,” Levine said. “Securities laws require that when you conduct a securities offering you register it with the SEC, unless you’re subject to an exemption. The securities laws describe a sale as any exchange of stock for value.”
In other words, when a company engages in an Internet free stock giveaway, the SEC believes it is actually giving away the securities in exchange for expected revenue derived from increased traffic and, in turn, increased advertising activity.
In addition, some Web sites require users to sign up for long distance service or hyperlink to some other related site that has some sort of hidden revenue stream.
Despite disavowing the SEC’s allegations of intentional wrongdoing, Universalscience.com has agreed to discontinue its free stock giveaways. Company management claims it was initially unaware that shares had to be registered before being given away.
“Rene Perez, the president of Universalscience, was not represented by us at that time and didn’t know what they were doing was illegal,” said Jose Riguera, an attorney for Universalscience. “Once the SEC came in, he looked at what they had to say and then consulted with us. He wasn’t collecting money for the stock so he didn’t think there was a requirement that he register the stock.”
And, even though Perez was clearly mistaken, the free stock offer did have the desired effect as Universalscience chief financial officer Luz Lilchin reported that the offer increased visits to the company’s Web site.
Despite the SEC reprimand, Universalscience.com’s transgressions seem quite tame compared to the actions of some other Internet firms.
Indeed, some “businesses” accused by the SEC of illegally giving away free stock have subsequently been found to have no real offices, little or no revenue and were not even incorporated.
For four years, Joe Loofbourrow offered free stock in his company, American Space Corp. The company’s Web site touted the firm’s plan to build the largest aerospace manufacturing plant in the world, and stated it was in the midst of creating a subsidiary to research cures for a number of fatal diseases.
Loofbourrow claimed that his company’s stock had a value of $1 per share, despite the fact that American Space was never incorporated and had no offices or employees.
Another firm, WebWorksMarketing.com, informed investors on its Web site that the free shares they could receive had a value of more than $38 per share, and could eventually balloon to roughly $200 per share. The company, which was actually run out of the owner’s home, had only 35 customers and less than $30 in revenues.
Other examples of such deception include WowAuction.com Inc., which hyped a free stock offer by falsely promising an eventual initial public offering, and Kinesis International Inc., which offered free stock to those who registered or put a link on their Web site to the Kinesis site. “Investors” with Kinesis were promised additional shares if they referred other investors to the site, even though the company was actually unincorporated. Approximately 200 investors fell for that scam.
These companies may have been able to get away with the giveaways in the past, but the SEC recently decided to amend its rules covering securities offerings in response to growing “boiler room” and “penny stock” operations.
Historically, there was an exemption to Rule 504 (covering securities offerings), which said that a company needn’t have to register a securities offering if it was selling $1 million or less in securities.
“About a year ago, we amended that rule in response to micro-cap fraud. One of the limitations we put on Rule 504 is that you can’t advertise unless you register under state law in each state you’re conducting that offering in,” Levine said.
Offering free stock on the Internet is considered an offering in all 50 states. For each of these four cases there was no registration with all 50 states. In practice, this would have been a costly operation.
“These sales were occurring without registration of the stocks and without a valid exemption. However there has been a drop in free stock giveaways since the SEC took action against these companies,” Levine said.