Clearing stock certificates has become one of the complicated processes in stock trading. While the process is one that very few traders will ever have to experience it is one that is becoming increasingly more difficult as the SEC (Securities Exchange Commission) attempts to combat fraud throughout the stock market and especially in microcap stocks. With the large majority of fraud being committed by individuals involved in the promotion and sale of shares in micro caps the SEC believes it can control fraud through closer monitoring of stock certificates.
Part I: What is a stock certificate
A stock certificate is basically a piece of paper that states that an individual owns a certain number of shares in a company. That certificate has a theoretical value based on the quantity of shares named on the certificate multiplied by the current market value. However, with it becoming so difficult to get shares turned from paper from into actual free trading shares that paper is almost worthless until it converted if conversion is even possible in the first place.
Normally the certificate is obtained in a few different ways.
1. The investor contacts the company and attempts to buy shares off the market. This is done so that the investor is able to obtain a large block of shares without chasing the price up. This is done so an investor is able to get a better price for shares. Many times large investors are able to obtain discounts on their shares in this manner which gives them an advantage when trading the stock as they are instantly profitable upon the clearance of the shares.
2. A company that is owed money has their debt converted into shares of the company owing them money in hopes that they can sell those shares on the open market to recover their debt. Normally during a debt conversion there is a significant discount given to shares as the company wanting the debt paid doesn’t want to be an investor, they just want their money.
3. A company or individual that is given shares in order to promote or make investors aware of the company. This is often done so that the company is able to sell shares into the market in order to raise money for new operations. It can also be done if a company is looking to uplist to a higher market, such as going from pink sheets to Nasdaq. While it is more likely that a company is looking to sell shares there are reasons other than that to hire a company to bring about awareness to their products.
Part II: The Process
The normal process for clearing shares can be a complicated one. Those that attempting to clear shares that they have purchased through debt conversion or a private placement are going to have a much easier time getting their shares cleared than someone that was given the shares for free as compensation.
To get the shares cleared there are going to be several requirements that the clearing agency and broker are going to require before they will even start the process. The first and most important item is of course the stock certificate. Without the certificate nothing else matters. Once the subscription agreement is held, either a subscription agreement or a promissory note are going to be required. The subscription agreement is needed if shares were given away and a promissory note is required if the shares were purchased. The promissory note simply states where the shares came from and why. The subscription agreement does the same thing however it can have other terms attached to it. It will also be important to have a corporate resolution which simply states that the officers of the company understand that shares are being given out.
Once either the promissory note or subscription agreement are in hand along with the corporate resolution those documents should be submitted to an SEC attorney. The attorney will then verify all of the documents and put together what is known as an attorney opinion letter. This letter is basically one that will take everyone else off the hook if the shares turn out to be attached to any fraud. It simply says that the attorney talked to all parties involved and verified that the shares are indeed valid and that all documents match up. The attorney will most likely have all parties sign an agreement of representation before they will perform work and will obviously require an up front fee to be paid.
Now along with the attorney opinion letter all documents should be submitted to a broker that is willing to accept certificates. Some of the biggest will not accept microcap certificates so it is a good idea to shop around to make certain that you have a broker that is willing to take the certificate.
The broker will now send the documents over to a clearing agent often times that agent is going to be Penson Financial Services as they control the majority of the market. Penson will now compare the documents and make certain that they can accept the certificate. Since they have a policy of only accepting a percentage of any company at a given time they could reject the certificate without any real reason. This unfortunately makes clearing the shares far more difficult as a new broker that uses a different clearing firm would have to be obtained. This can add substantial time to the process and isn’t a guarantee. Expect to pay a fee to Penson or any other clearing firm whether they accept the shares or not. This fee is upwards of $500 normally and is often taken directly from your brokerage account or paid by check directly to Penson or any other agent.
Assuming everything goes through just fine it is a matter of waiting. This process can normally take anywhere from 5 days to 3-4 weeks. It just depends on the shares that are being cleared, the company the shares came from, and the documentation that was submitted along with the certificate.
Part III: Final Thoughts
Purchasing certificates can be a great way of making money in the stock market as they often come at a discounted price, but they come with significant risk. If any part of the process fails then that certificate is worthless and the money spent will be wasted. Those that receive free shares have an even greater problem as they are often going to be required to hold the shares for at least a year before they are able to sell them. This is typically a requirement of shares that can’t be shown as purchased. This is done in order to protect shareholders from promoters that simply push a stock up and drop it down quickly when they dump all of their shares at once. The dumping of shares during promotion is considered scalping and illegal but it hasn’t stopped many promoters from doing it regardless.
By understanding the requirements necessary for clearing shares the speed of which they are cleared can be much faster although it should still be assumed that it will take nearly a month or two before shares will be available for free trading.