How a Push for More IPOs Fueled a Wave of Scams — Heard on the Street — WSJ

By Jonathan Weil

The U.S. government has tried to address the long decline in stock-exchange listings by relaxing the rules for small public companies. But this approach creates a persistent risk: more stock scams.

The quandary is on display now at the Securities and Exchange Commission. Its chairman, Paul Atkins, is pushing to further ease the reporting obligations for many smaller companies under a 2012 statute called the JOBS Act. The law gives special treatment to "emerging growth companies," or EGCs, including exemptions from many accounting, auditing and disclosure requirements.

At the same time, Atkins is leading a fresh attack on stock frauds targeting individual investors. Since late September, the SEC has suspended trading in 12 companies' stocks. That is more suspensions than in the previous four years combined. The SEC cited potential manipulation that appeared to be aimed at inflating the stocks' prices and volume.

The critical link: All 12 are emerging growth companies under the JOBS Act. Though the acronym stands for "Jumpstart Our Business Startups," these aren't American companies. It is highly doubtful any of them could have gone public on U.S. exchanges without the JOBS Act and the regulatory relief afforded by their EGC status.

All 12 are based in Asia, including four in Hong Kong and one in China. Ten went public this year, and two last year, on the Nasdaq Stock Market. All 12 initially went public as "penny stocks," pricing their IPOs at less than $5 per share. Yet most didn't stay that way.

QMMM Holdings, which is incorporated in the Cayman Islands and based in Hong Kong, had a $6.8 billion market value when the SEC suspended trading in September. Just a few weeks earlier, its shares zipped past $300 after it announced a cryptocurrency strategy.

Three of the 12 suspensions occurred within three weeks of the companies' IPOs. Hong Kong-based Charming Medical, a beauty-care company incorporated in the British Virgin Islands, went public at $4 on Oct. 21 and was suspended on Nov. 11 after its share price had topped $29.

By design, EGCs have fewer regulatory obligations, enjoying exemptions for up to five fiscal years after going public. However, companies can lose this status sooner if they exceed certain thresholds for revenue, public float or debt issuances. The limit on annual revenue, for example, is $1.235 billion.

Proponents of the exemptions say they save companies money and encourage more IPOs. Noting that EGC status can be lost in as little as one year, Atkins suggested in a Dec. 2 speech that companies should be allowed to remain EGCs for a minimum number of years , even if they exceed the JOBS Act's size thresholds. He said this "could provide companies with greater certainty and incentivize more IPOs, especially among smaller companies." While the SEC has general authority to exempt companies from many securities-law requirements, it isn't clear if it could use that authority to override a specific statutory limit set by Congress.

Critics say the JOBS Act reduced transparency and created new opportunities for fraud. For example, EGCs are exempt from outside audits of their internal controls, which are the checks and guardrails crucial to ensuring financial reports are reliable.

Whatever one's views on regulation, the stock market is now awash with struggling EGCs. On Nasdaq, there were 304 listed companies trading below $1 a share as of Dec. 12, according to FactSet. A review of their filings showed that 205, or 67%, self-identified as EGCs. Of that group, 130 were foreign companies, just over half of which were from China or Hong Kong.

By comparison, Nasdaq had 3,359 listed companies as of Sept. 30, excluding exchange-traded products, according to its disclosures.

The SEC says there are more than 1,000 EGCs, and that most are domestic companies. The bulk of the EGCs with sub-dollar stock prices are concentrated on Nasdaq.

The New York Stock Exchange had just six listed companies trading for less than $1 at the end of last week. All were U.S.-based, and none was an EGC. The NYSE American, formerly known as the American Stock Exchange, had 46 listed companies trading below $1. Most were U.S.-based, and most weren't EGCs.

Atkins declined to be interviewed. In a statement, SEC spokesman Ben Watson said "it is unreasonable to conclude" that EGCs in general "are at a higher risk of violating securities laws" just because the 12 recent stock suspensions were all at EGCs.

But investors have good reason to treat the EGC designation as a warning flag. Today when a company's stock has fallen below $1 on a major U.S. exchange, it is more likely than not an EGC, especially if it is listed on the Nasdaq. Expanding the number of companies entitled to special treatment under the JOBS Act could make the stigma worse. A better question may be whether it makes sense to let so many questionable overseas companies take advantage of the legislation.

Write to Jonathan Weil at jonathan.weil@wsj.com