This Is a Good Idea if the Risks Can Be Controlled

Businesses are born when people who have new ideas meet people with money to risk on new ideas. The problem often is that the two groups can’t easily find each other.

The Pacific Stock Exchange is trying to build a wider bridge between the two: The exchange wants to begin trading stocks of very small companies that couldn’t otherwise qualify for exchange listings. It’s an interesting concept, though some experts are concerned that the idea could backfire by encouraging too many unsophisticated investors to leap into high-risk stocks.

The PSE’s plan, now before the Securities and Exchange Commission for approval, would in theory make it easier for young companies to raise capital by providing a highly visible market for their shares--as opposed to the obscure over-the-counter trading to which very small firms now are relegated.

Companies could qualify for listing on the PSE if they have just 250 shareholders, 200,000 shares outstanding and a stock market value of $1 million. A listing now on the PSE requires at least 750 shareholders, 750,000 shares outstanding and a market value of at least $2.25 million.

The plan is an outgrowth of a program developed by state securities regulators nationwide to streamline stock issuance by young firms. Known as Small Corporate Offering Registration (SCOR) or Uniform Limited Offering Registration, SCOR was authorized by Congress in 1980 but has only recently begun to blossom.

SCOR allows a qualifying small company to raise up to $1 million a year by selling stock directly to individual investors, avoiding the expense of a brokerage underwriter and the red tape of the federal Securities and Exchange Commission’s stock-approval process.

Basically, SCOR leaves it up to state regulators to screen their own companies and decide which ones can and can’t sell stock. SCOR also requires that a participating company must offer shares at a minimum of $5 a piece--to avoid some of the scam possibilities associated with penny-stock offerings (those 10-cent-and-under share offerings that proliferated out of Denver in the early-1980s).

As more banks and venture capital firms have pulled back from small-business financing in recent years, many state regulators have come to view SCOR as the answer for their cash-starved entrepreneurs. Eighteen states now participate in SCOR, and Washington and Arizona in particular have become big boosters of the program.

“We think there will be a real flood of these offerings,” says Sandra Forbes, assistant director for policy in Arizona’s securities-regulation office.

So far, only an estimated 15 to 20 SCOR stock offerings have been completed nationwide, says Drew Field, a San Francisco-based attorney and advocate for the program. He is helping to bring the first SCOR offering by a California company: a $1-million stock sale by Real Goods Trading, a Ukiah, Calif. firm that sells photovoltaic cells and other “alternative energy” goods by mail order.

For the PSE, listing such stocks would be a way to bring in more trading business in an era of soaring competition among various stock markets. For the companies, a PSE listing could lend an air of legitimacy, and attention, that they couldn’t get from a listing in the over-the-counter “pink sheets”--the lowest rung of OTC trading.

But given the high risk involved in any small business, some states aren’t convinced that SCOR financing guidelines provide enough protection for potential investors. California, for example, doesn’t accept SCOR’s streamlined stock-sale process. “We are concerned about the level of disclosure (by the issuing companies) and the lack of audited financial statements,” says William Kenefick, assistant commissioner in the state’s Department of Corporations in Sacramento.

California feels more comfortable with its own company-review process. And in fact, that process is porous enough to allow many small firms to issue stock--if not as many as SCOR’s guidelines might. (Real Goods, for example, made it through California’s process, while also using SCOR in other states in which its stock is being offered.)

Whether the SEC will go along with the PSE’s listing idea isn’t known. SCOR is meant to finance very small entrepreneurs--and for as many who strike it big, there are great numbers of failures.

If every investor who ever bought such stocks completely understood the risks, no one could raise an objection to SCOR. Problem is, as more investors grow excited about small stocks in general today, the smallest stocks may begin to look sexiest to uninformed investors.

SCOR and the PSE are in the right place at the right time, and we all know that our economy needs more entrepreneurs, and that they need financing. But the burden will be on the states to guarantee that SCOR doesn’t become the Waterloo of the 1990s’ small-stock bull market.

Root for the ‘Skins! A Super Bowl victory by the National conference team has most often coincided with a gain for the year in the Standard & Poor’s 500 stock index. But when the American conference team has won, the S&P; index has usually fallen. How the “Super Bowl indicator” has called the market for the past 25 years:

NFC victory predicted rising market: 17 years AFC victory predicted falling market: 5 years Indicator failed: 3 years Percentage Completion: 88% Source: Sutro & Co.