The financial services industry veteran talks with the Opportunist’s Managing Editor Leslie Stone about recent regulations affecting the industry, his thoughts on the state of the U.S. economy and what he would tell the incoming president of the United States.
Carl Dilley is president of Island Stock Transfer, a full-service stock transfer agency. Founded in 2003, the company is a division of Island Capital Management, LLC, based in St. Petersburg, Fla., and provides services to more than 500 clients and their shareholders. Dilley has three decades of experience in the financial services industry.
Opportunist: How have new regulations from the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) affected the transfer agency business?
Dilley: Well, to be honest I don’t know if there are any new regulations that directly affect transfer agencies. The SEC’s 1934 Act Rule 17A that governs transfer agents was a rewrite project that governs transfer agencies, but they have never finished that and that project is still pending. In terms of regulations, not much else has changed; however, there are a number of compliance related issues that have taken effect that have certainly affected transfer agents. For example: I previously wrote an article about how SEC Rule 144(i), which governs the ability for a shell company to be publicly traded and how shareholders of what would be known as a shell company would be able to use Rule 144 as a valid exemption from SEC registration, has added enormously to the regulatory burden.
Opportunist: Please tell us more.
Dilley: The interpretation of Rule 144(i) is some 98 pages long, but it essentially says that if a company was a shell when shares were issued in a private placement then shares cannot be sold using the Rule 144 exemption to another investor unless the company is fully SEC reporting and is no longer reporting as a shell. Prior to Rule 144 (i) the general interpretation was that stockholders who held shares for the period applicable under Rule 144 (k), whether or not it was a shell, were eligible to have a legend removed so they could go and publicly trade those shares. Brokers, clearing firms and transfer agents were clear that when shell shares go to an investor that investor has the right to have the legend removed. This is no longer the case. We as transfer agents are not attorneys and, therefore, not in the business of deciphering, legally, what the SEC regulations mean and so we had to rely on an SEC practicing attorney’s opinion. Previously the rule was straightforward and everyone was of the opinion that there was a safe harbor in knowing it was OK for this guy to remove the legend so the shares could be traded, if in fact they were paid for and held for the applicable period. Now with Rule 144(i) a huge burden has been placed on the entire industry. We have to look at the opinion letter—even if a company has been around for 20 years—to determine if and when it was ever a shell. Of course there is a lot of ambiguity in the new rule, and so everyone involved will not process these legend removals without an opinion letter from a competent securities attorney. This has added millions of dollars in annual costs that are borne by the shareholders or the companies they invested in. As part of the recent heightened regulatory influence by the SEC/FINRA—in an effort to control the distribution of unregistered shares—there is a lot more emphasis on the clearing and brokerage firms to perform due diligence and collect information regarding the pedigree of shares issued for private placement. This is now part of day-to-day due diligence when making transfers or deposits of shares for trading.
Opportunist: What is the result of that?
Dilley: It created a situation where it is now not uncommon for clearing firms to charge $1,000 when receiving shares for deposit and trading because they have to do a legal review of the pedigree of the shares to find out when the shares were issued, the status of the company at the time, the subscription agreements, prior transfers, etc. This has made trading in OTC securities very difficult and costly. Many firms will no long accept these certificates at all. In looking at our volume and revenues during the last 12 months, our revenue is down about 25 percent in the incidence of transfers in the small and micro cap sector. This segment has been adversely affected because it is now a time-consuming and expensive process to deal with penny stocks—anything below $2.50—for deposit or trading at all.
Opportunist: Has this caused many stock transfer agents to go out of business?
Dilley: I am not sure. You cannot point to one specific regulation and say it has caused transfer agents to go out of business; however, certainly some companies that were smaller in nature have ceased operation, resulting in a number of acquisitions and mergers in the last couple of years.
There is another significant regulatory burden I want to mention. The IRS has implemented the process of demanding that a transfer agent now be responsible for 1099 reporting related to the government’s perception that it is missing out on a huge amount of capital gains taxes on unreported transfers or sales of shares. Transfer agents weren’t required to report transfers between shareholders via 1099 until about 2011.
Opportunist: Is that a headache to deal with?
Dilley: Yes, and it—CBRS (Cost Basis Reporting System)—demands that the transfer agent account for stock splits, forward and reverse mergers and stock dividends. Tracing and reporting of all that is very difficult. In order to do a good job from a regulatory standpoint, you also need to transmit that information when shares are transferred from one agent to another or to and from a broker or bank. It’s a very expensive thing for a lot of transfer agents. If we didn’t have a robust service provider, in terms of software etc., we would find it very difficult to meet that requirement. That CBRS alone would be responsible for some people hanging up their hat.
The bottom line is that the IRS estimates there are millions of unreported capital gains out there, which sort of implies that there were literally hundreds of thousands of individuals falsifying their tax returns. The downside is that another layer of regulatory burden costing millions of dollars annually has been laid at the feet of the public company and its shareholders.
Opportunist: Is that possible?
Dilley: I have no idea if that’s true or not, but what is clear is that millions of dollars that otherwise could have created jobs or used for research and other corporate development is now spent on reporting systems for the IRS. Does the added cost of this regulation get offset by the tax revenue? Personally, I highly doubt it.
Opportunist: How did you get into the field?
Dilley: In 2003, our sister company Spartan was beginning to do work with small cap and micro cap issuers. They were having trouble with some transfer agents, which were basically mom and pop operations that worked from home. The quality of service they offered issuers and shareholders was certainly not something one would brag about. So we thought, Why don’t we take a look at getting into this business? And that’s what we did. The Transfer Agency was incorporated in 2003; I joined the company shortly after that and we have grown pretty successfully ever since.
Opportunist: What is your background?
Dilley: I guess you could say I am a serial entrepreneur —as it relates to the financial services industry. I started out in the brokerage business in Canada in 1981, where I worked for the predecessor company to RBC [Royal Bank of Canada]. They were bought out, and from 1986 coming forward I have been involved in the brokerage side of the financial services industry. I joined my partner Micah Eldred in 2003 at Spartan Securities and we have been partners in this business ever since.
Opportunist: Tell us about Island Stock Transfer and what makes it different from the competition.
Dilley: The pure operational functionality of the transfer agent is not really distinct from one transfer agent to another. We comply with SEC regulations and the DTC-FAST system that imposes strict requirements, including a $10 million bond, on transfer agents. In compliance with OFAC [Office of Foreign Assets Control] and the U.S. Patriot Act requirements, all the shareholders in our database are run against the system every day to determine if they have ever done business with or assisted any terrorist organization—even unknowingly.
Opportunist: That sounds serious.
Dilley: Multimillion-dollar fines are imposed for Patriot Act violations. Any entity or person our clients have had contact with in any of the countries that have sanctions imposed against them—Cuba, Syria, Iran, etc.—is on that list. It’s a monstrous thing that grows every day. If someone has sold or transferred shares to one of those parties, knowingly or unknowingly, they are flagged.
Aside from that, we have been in the financial services business for a long time—on the brokerage side and in various other activities—so we understand a lot about other parts of this business. We built this company on providing outstanding service. Many times we get referrals to other investment bankers and shareholders, to assist them in accomplishing what they are trying to do.
Opportunist: What are your thoughts on the future of the industry? Do you see changes on the horizon?
Dilley: I have no doubt there will be consolidation in this industry because of the regulatory burden now in the United States. The number of new listings is running at historically low levels and the number of publicly traded companies has been declining for several years. Other countries are seeing increases. So, with regard to the regulatory burdens affecting the transfer agent’s business, I would say it is going to be very difficult for those with just a few clients to stay in business. Aside from ourselves and maybe two or three others, we are continuing to add clients, but generally the declining universe of public companies is going to make the whole business much more difficult to manage. Having said that, I believe we are on the cusp of getting new regulations that relate to the JOBS Act and that may be one area where we can get some new business.
Opportunist: How will that affect transfer agents?
Dilley: The JOBS Act talks about general solicitation being available for 506 Offerings and crowd funding but really hasn’t advanced from what is sort of the first step into developing the final rules, which are still with the SEC. It deals with solicitation and the raising of capital but does not take the next step in how to streamline the process for one of these development stage companies to access the public markets. It’s a little bit early to tell if that’s going to have any impact out there or not, but we are hopeful that there will be a requirement for these companies to engage a transfer agent as part of the process. If there is a bright spot in the future, that might be it. We have several initiatives to look at other opportunities, but nothing I can really disclose at this point.
Opportunist: What are your thoughts on the U.S. economy?
Dilley: The biggest issue is how do we, the U.S., stay in business if we spend $4 billion more than we take in—in tax dollars—a day if we don’t do anything to get back to a balanced budget? I’m not sure that, regardless of which government you elect, they have the ability to make substantive changes. We have created this enormous bureaucracy that now has become a machine unto itself. Dialing all that back so that we can see a situation where we are fiscally responsible again is going to be very difficult. Take Medicare and Social Security, for example. Nobody wants to be the one who stands up and says, ‘Here’s how to fix it,’ but the choices are not going to be popular and won’t help get you elected the next time. This guy Fareed Zakaria, on CNN, did a comparison recently of where the United States stands competitively relative to the rest of the industrialized world. We are way down the list now in a number of categories. That’s very depressing. We were always No. 1. I may not have the numbers exactly correct, but thanks to bloated, ineffective government, regulatory burdens and the tax code, we are now in 60th or 70th place in many categories. I believe we are about 80th in quality of education. When you look at the broad spectrum of those indices that rank us against other industrialized countries of the world, and the fact that we are piling on debt at an ungodly rate, it seems clear that the United States is going to continue to decline as a world power. The ability to grow our economy and compete globally is going to be hampered substantively unless something changes.
Opportunist: Given the chance, what would you like to tell the incoming president?
Dilley: I tell everybody who will listen this story: I spent 10 years in Latin America, in countries which had little to no securities regulations at the time. Canada was reasonably robust in terms of securities regulations, etc.—albeit normally bright line rules as opposed to some of the highly ambiguous rules subject to opinions and interpretations that we have here in the states. Anyway, the mindset in Latin America was that you don’t invest or give your money to somebody unless you bloody well know that person and know the deal is real. Nobody would or will get your money back for you if you screw up. You have to take responsibility for your own actions. Without this bureaucracy you have to rely on yourself. If you screw up, you screw up. Now I am not suggesting that we disband the SEC, but if you roll it back a little and look at all the regulations that have nothing to do with actually preventing somebody in the industry from defrauding someone, it’s ridiculous. There are all kinds of rules against fraud on the books but every time someone goes off the reservation there is a whole new set of rules to protect us from the last crook. For example, in the wake of Enron and other events, if you run a public company your accountant can no longer be your auditor because of conflict of interest. What is the benefit? Every single public company in the country has one more guy they have to pay, and that probably amounts to hundreds of millions of dollars annually. It is just another expense that does nothing to add value, nothing to create jobs—aside from the accountants—and I am not so sure it has helped with transparency. Coming on the heels of Madoff and Dodd-Frank, the SEC is still writing their regulations and is so far behind on rule making both from an internal project status, such as Rule 17a, and from what is dictated by Congress. In fact, they may never catch up.
We have become a society where people think the government is supposed to take care of everything. You can go to Las Vegas and gamble away the mortgage and yet we [the government] have to protect investors from themselves. Ask yourself, ‘Would gambling on investing in a high-risk, high-tech business be better for our economy and add more value than playing blackjack, slot machines or buying government sponsored lottery tickets even if you knew up front that 90 percent or more of those businesses would fail?
The concept of government sponsored investor protection at all costs has put a huge damper on the ability for small public companies to raise capital and create jobs. The bottom line is that instead of using capital to hire people or build their business people are forced to use that money to feed regulatory obligations, which in many cases is completely counterproductive.
Leslie Stone is an award-winning writer/editor with more than two decades of experience covering business, finance and lifestyle issues for newspapers, magazines and online publications. Originally from Virginia, she currently resides in the Orlando area.
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