DON'T CALL MARK BELOYAN A “PENNY STOCK TOUT.”

Sure, Beloyan speculates in low-priced securities. And, yes, his book is built around trading and finding retail investors who want to make a bet on the shares of companies that are more or less still in the “story” phase of their existence. These companies, Beloyan says, are microcaps, thank you very much, and he views himself as one of the many muscles that drives the capital raising process, the sweat that lubes the economy of the United States.

“I'm a deal guy,” says Beloyan, the 43-year-old owner of Beloyan Investment Securities, a one-man brokerage in Davie, Fla., 30 miles south of Boca Raton.

Many might find his own definition inadequate, and prefer to describe him as a speculator rather than an investor. After all, the stocks he sells to retail clients usually trade for pennies on the OTC Bulletin Board, have just a few thousand shares outstanding and have few market makers. In short, he has built his business around the most easily manipulated shares on the market. But not all penny stocks are a scam, Beloyan says. Besides, he doesn't advocate investing in such companies — companies with more promise than current business — for everyone. These issues are just for those retail investors who have some money to allocate to the speculative, growth-y part of their portfolios, he says. The idea is to hit homeruns, the “ten-baggers” for which Peter Lynch used to search. Not all of them turn into homeruns, but when one does, it more than pays for the duds.

But regulators seem to have a different point of view: Indeed, for the past 18 months, Beloyan has been under investigation by FINRA, as the newly combined NASD and NYSE regulatory bodies are now known. For exactly which infractions, Beloyan says he doesn't know, since the investigation is ongoing. FINRA declined to acknowledge an investigation was under way, and says it doesn't comment on specific cases anyway. Nevertheless, Beloyan says that he's being investigated, and that his business is crumbling under the weight of legal bills. Why should you care? Because, according to Beloyan, his case represents a regulatory trend that is not only is unfair to him, but is threatening capital formation in the U.S. for the smallest entrepreneurs.

ONE MAN'S SAGA

Is Beloyan just a penny stock promoter who uses questionable sales tactics to entice retail investors into inappropriately risky shares? A penny stock promoter? Beloyan bristles. “Letting anyone call you that is like walking into Washington, D.C., with a sign around your neck that reads ‘I'm a terrorist.’”

A little over the top? FINRA thinks so. “We don't view penny stocks as good or bad,” says Cam Funkhauser, senior vice president of market regulation at FINRA. “Because they're highly speculative, and therefore carry high risk, they're unsuitable for most investors. But that doesn't mean those who trade them or raise capital for them are bad — absolutely not.” It's just that as recent SEC cases and speeches have pointed out, penny stocks are still a big problem, and in new ways.

Beloyan says he has never had so much as a customer complaint in his 22 years as a broker, let alone a regulatory run-in. (His U4 is in fact clean.) He says he's done nothing wrong other than operate in a corner of the industry that FINRA doesn't like. There's plenty to dislike: Over the years, such small issues have been rife with pump-and-dump schemes too numerous to mention by audaciously unscrupulous brokers.

Is this just the last gasp of a desperate man? Or is the penny stock world unfairly under attack?

LOW PRICE, HIGH RISK

According to the SEC, “penny stocks” are low priced (below $5), typically speculative securities of very small companies. Sometimes these securities don't even represent “going concerns,” but are rather capital-consuming story stocks whose very existence depends on new rounds of financing. The SEC includes this warning in the definition on its Website: “Investors in penny stocks should be prepared for the possibility that they may lose their whole investment [SEC's emphasis].” And the problems associated with them persist. Only now, instead of infamous brick-and-mortar brokerage houses like Stratton Oakmont and Blinder Robinson doing the pumping and dumping, the culprits are spammers, reaching out to their prey via breathless email come-ons. What a racket, too. No one — not the SEC, NASD or Department of Justice — keeps a running total of investor losses that result from penny stock fraud, but it surely runs into the tens of millions a year. The SEC does offer this tally: It estimates that 100 million spam emails hyping stocks are sent each week, or 5.2 billion emails per year. On investors' time alone — not actual losses — at $10/hour. (The SEC estimates the cost to the U.S. economy at $50 million each year.)

Funkhauser says FINRA uses a variety of tools to detect and find penny stock scams, including market surveillance; FINRA has the ability to sift through any and every trade to look for suspicious trends. But if the fraud involves a spammer, and not a registered rep, then it falls under the jurisdiction of the Department of Justice or the Securities Exchange Commission. (FINRA can only nail the company that brokers the sale of the stock for some other related crime — say, inadequate anti-money laundering controls.) A FINRA spokesman says the NASD refers between 100 and 150 penny stock fraud cases to the SEC every year as a result of market surveillance. It also uses investor complaints and routine exams. One example of a red flag, says Funkhauser, would be spiking trading volume levels on the OTC Bulletin Board. “It may just be active, or a large portion of the activity could be sub-penny stocks kicking up,” he says, at which juncture FINRA endeavors to find out why.

The SEC's John Stark, chief of the office of Internet enforcement, works closely with NASD's Funkhauser, and says it too utilizes market surveillance, and that technology has made it nearly impossible for fraudulent traders to hide. “Unless they're trading shares by hand, tracking down the trader isn't rocket science,” he says. A recent case in which teamwork between the NASD and SEC bore fruit was when they nabbed Michael Paloma in September. Paloma approached small business owners with big promises to take them public, and make them rich. Then, through stock promoters and spam email campaigns, he pumped the shares and dumped them for big gains, hammering both the business owners, and naïve investors for roughly $3 million in illegal profits, according to the SEC. The NASD picked up on the scam, and referred it to the SEC.

A Google search of “penny stocks” in early September yielded 2.1 million hits, but more enlightening is who is searching: According to Google Trends, the term “penny stocks” is most searched in Orlando, Dallas, Tampa, Miami and Houston — retirement country.

As for Beloyan, he's no spammer, he says, and his business is far from being some kind of schlock shop. “I speculate in lower-priced stocks, yes, but I've had the same clients for the last 15 to 20 years,” he says. “I know them, and most of them have accounts at other firms,” he says, meaning his clients expect speculative plays from him, not advice on their core investments. As for abusive sales tactics, Beloyan says he doesn't advertise, and can't even be found in the yellow pages.

Beloyan further says the stocks he trades have between six and 15 market makers, a fairly high number as far as penny stocks go, according to one trader in the know. Beloyan adds that contrary to popular belief, these are generally 1- to 3-year investments for himself and his clients. “I'm not here to short-term trade a bunch of penny stocks, I'm here to fund deals,” he says. He gets a 5 to 10 percent commission on every purchase his clients make in one of his “504” private placements. A 504 private placement is one in which unregistered securities — worth up to $1 million, as per SEC rules — can be sold to retail clients. After finding buyers, he registers the securities with the SEC through what's called an SB2, a 30- to 40-page document that includes a prospectus of the deal. The SEC asks questions, and if it approves the deal, the issuer gives it to the market makers who file a 15c211 with the NASD in order to get a ticker symbol and begin trading. The whole process, from idea to IPO, he says, generally takes six to 12 months.

Beloyan says he carefully researches each idea's market potential before investing. Nevertheless, “I tell every client this is a speculative investment, and that every dime invested could be lost,” he says.

GRIND HOUSE

Today, Beloyan's income is in the $5,000 to $6,000 per month range, down from $15,000 to $20,000 per month in years prior to 2006, and he says the $35,000 check NASD sent to all members earlier this year (to pass on the savings resulting from the NASD/NYSE merger) is helping him keep the lights on. His trouble began in February of last year, when investigators from the Washington enforcement division of the NASD (it wasn't yet FINRA) showed up at his office with a list of files they wanted. Since that time he says he's endured more than 15 “8210 requests,” 3 “OTRs” (on-the-record depositions), and nearly $60,000 in legal bills. They have not told him what they're looking for, or if they've found anything, but they don't have to either, according to Beloyan's lawyer, Brian Corliss of Stark & Stark. Corliss did not comment on Beloyan's case since it is still pending.

Beloyan understands that investigations aren't meant to be cozy undertakings, but he says the self-regulator's dealings with him seem intended to put him out of business — either that or FINRA is merely incompetent. For example, he says he's received “8210 requests” just days before going on vacation with his wife, even though NASD investigators were familiar with his schedule well in advance. (“I have to answer them, or I'll lose my license,” he says.) And he also complains that some conversations between the lead NASD investigator and his attorney (at a cost of hundreds of dollars per hour) strike him as redundant. (Again, FINRA didn't acknowledge the existence of an investigation, and doesn't comment on specific cases anyway.) In any case, it has been a drag on business. Usually, it takes a year to raise money for an idea and get the stock trading, by which time he likes to be working on the next deal. But the NASD's investigation has hurt his deal flow. “By now I'd be raising money for the next deal so that by March 2008 it would be trading,” he says. “For me to do that, I've got to get out there” to talk to people and discuss ideas. “I've lost a year, essentially, because of this investigation.”

Of course, Beloyan's cause, and his credibility, aren't helped by his association with a company that was busted (among 34 others) in March, in an SEC sting known as “Operation Spamalot.” To varying degrees, the SEC's case documented email blasts promoting the stocks of the 35 companies that were sent to hundreds, even thousands of investors — including one spam that arrived in the inbox of the SEC's director of public affairs. The estimated cost to investors from the activities of the 35 firms is in the “tens of millions,” according to the SEC press release on the matter.

Beloyan won't say which of the companies he was linked to, only that he raised $1 million for the company in a convertible debenture in 2003, and that he and his clients own several million shares of the company's stock. Incidentally, he believes this is why the NASD is investigating him. His reason for not disclosing the company's name is that he's confident that the company, and the technology it is developing, are both legitimate and will one day make him a rich man.

The other two deals that Beloyan has done recently are listed on the OTC Bulletin Board — Global Music International (GMUS.OB) and Waterpure International (WPUR.OB). Global Music is a content aggregator that delivers music videos and music tones to mobile phones and other wireless devices. Recently, the company issued a press release announcing a partnership with China Unicom Newspace, a subsidiary of China Unicom, the third largest cell phone carrier in the world, to offer its content to China Unicom customers. The other venture, Waterpure, sells portable dehumidifier machines that take the moisture out of the air, filter and clean it, creating up to five gallons of drinkable water per day, says Beloyan. The Waterpure idea, Beloyan recalls, was hatched with a client while they were on a boat in the Florida Keys shortly after Katrina hit. “We were talking about what the world could use right now,” he says. But both GMUS.OB and WPUR.OB typify how speculative his companies can be. Global Music grossed just $126,526 in revenues from its inception in July 2004 through March 2007, and Beloyan acknowledges the Waterpure concept hasn't taken off yet — revenues since its inception in June 2005 are zero. But he remains confident: “None of the ideas are mine, but I have vision. I can see possibilities where others can't.”

THE REGULATORY BURDEN

He also sees something else: an increased regulatory burden that just may be stifling ingenuity and entrepreneurship. “The regulators have totally destroyed any VC prospects in the U.S.,” he says. “Unless you can get $5 to $20 million from a PE [private equity] firm or angel investors, you really can't do deals anymore if you're a little guy,” he says. “How did Hewlett Packard start? Two guys in a garage.”

But others say such analogies are a big stretch. Ben Holmes, founder of Morningnotes, a firm that catalogues IPOs, took a look at the SEC filings of both Global Music and Waterpure. Holmes says there's a reason that deals like the ones Beloyan is talking about don't get funded, and it's not because the regulators are stamping out American ingenuity and entrepreneurship. “Yes, the cost of SOX [Sarbanes-Oxley] — legal and accounting — is too great for a company that small,” Holmes says. “But if you have a legitimate company, business plan, and technology and the potential market for what you're selling is perceived to be big enough, you will get funding. These are small businesses, they don't warrant venture capital.” As for penny-stock IPOs, Holmes steers clear. “They don't go into our database — nothing SB2 or anything else that is either less than $5 or less than 1 million shares.” Why? Because Holmes doesn't trust such issues.

Jacob Frenkel, an attorney with Shulman, Rogers, Gandal, Pordy & Ecker, spent 10 years in the SEC enforcement division, much of it investigating penny stock fraud. Frenkel says he has no sympathy for those who play fast and loose in the capital markets. He represents small issuers today, and says the principal challenge they have is access to capital, a problem made much harder by Sarbanes Oxley. “Private equity firms will look at them but the demands they make can sometimes be injurious,” he says, such as asking for 35 percent of the equity of the issuer.

As for Beloyan, whether he's guilty or innocent of something is yet to be determined, but his case stirs up an interesting debate. Meanwhile, he rates his chances of getting off without some kind of punishment as slim. “They're going to find something, whatever it is — they've been at it for a year and a half you know. At that point I'll have to decide whether to fight it and pay thousands in legal bills, or pay up whatever they want and accept punishment without admitting or denying guilt,” he says. For now he's not giving in, and says he'd accept a letter of caution but would fight anything else, though possibly without his attorney — who at $300 to $500-per-hour — is breaking his bank. “I'll represent myself if I have to,” he says.

TOP 10 MICROCAP FUNDS
(under $500 million market-cap)

Most advisors should steer clear of penny stocks. Here are respected microcap funds ranked by total 5-year annualized returns.

Fund Total Returns, 5-yr Annualized Avg. Market Cap (mln) Standard Dev., 5-year Net Assets (mln) Net Expense ratio
1. Bridgeway Ultra - Small Company 25.39% 303 18.19 126.9 1.09
2. Nationwide Micro Cap Equity A 24.66 208 17.00 73.1 185
3. Oberweiss Micro-Cap 23.52 256 22.65 52.2 1.62
4. Perritt Micro Cap Opportunities 23.22 315 13.08 530.6 1.29
5. Perkins Discovery 23.07 134 16.01 35.2 2.50
6. Satuit Capital Micro Cap A 21.63 360 15.40 146.5 1.95
7. Bridgeway Ultra-Small Company Market 21.23 362 15.37 1000.7 0.65
8. Royce Micro-Cap Inv 20.25 341 15.26 941.1 1.43
9. Fifth Third Microcap Value Instl 19.68 247 18.19 75.9 1.37
10. Wasatch Micro Cap 19.48 448 15.83 607.5 2.14
Russell Micro Cap TR Index 17.21 n/a n/a n/a n/a
Source: Morningstar, results through 8/31/07