What should investors know before they invest in unlisted securities?

1.Definition :-

Unlisted securities are shares in public or private companies not listed on an exchange licensed by the Financial Services Board (“FSB”) or not included in the list of securities to be kept by an exchange in terms of section 12(6) of the Securities Services Act, No.36 of 2004 (“SSA”) Trading in these securities takes place over-the-counter (“OTC”).
It is also known as an Unlisted Securities Market.

2.Legislative Background

2.1 The Companies Act, No. 61 of 1973 (“Companies Act”)

The trading of unlisted securities is regulated in terms of the Companies Act which is administered by the Department of Trade and Industry. All companies in South Africa must be registered with the Registrar of Companies and must comply with all the relevant provisions of the Companies Act. The Registrar of Companies has the power to investigate any contraventions of the Companies Act.

2.2 The Securities Services Act, No. 36 of 2004

a) The objects of the SSA are the following:

  • (i) increase confidence in South African financial markets by -
    •     • requiring that securities services be provided in a fair,efficient and transparent manner;
    •     • contributing to the maintenance of a stable financial market environment;
  • (ii) promote the protection of regulated persons and clients;
  • (iii) reduce systemic risk; and
  • (iv) promote the international competitiveness of securities services in the Republic.

b) The SSA regulates “securities services”, being services provided in respect of the buying and selling of securities, the custody and administration of securities, the management of securities by a member of an exchange, and the clearing and settlement of transactions in listed securities.

c) The term ‘securities’ is widely defined in the SSA to include, inter alia, shares, stocks and depository receipts in public companies and other equivalent equities, notes, derivatives instruments, bonds, debentures, participatory interests in a collective investment scheme and instruments based on an index, but specifically excludes money market instruments (except with regards to the custody and administration of securities).

d) The SSA does to some extent regulate the trading of unlisted securities. Section 20 of the SSA states that the Registrar of the FSB (the Executive Officer of the FSB) may prohibit a person from carrying on the business of buying or selling unlisted securities if that person carries on such business in a manner which defeats one or more of the objects of the SSA. The Registrar may also impose conditions for the carrying on of such business or may prescribe conditions in terms of which specified types of unlisted securities may be bought or sold. This is therefore a more reactive approach compared to the regulation of listed securities, i.e. the FSB does not licence such business up front.

e) Unlisted companies are entitled to make a market in its own securities, i.e. to facilitate the buying and selling of their own securities to investors. However, companies are not allowed to operate an exchange without being licensed by the FSB as such. An exchange is defined in the SSA to mean a person who constitutes, maintains and provides an infrastructure – (i) For bringing together buyers and sellers of securities; (ii) For matching the orders for securities of multiple buyers and sellers; and (iii) Whereby a matched order for securities constitutes a transaction.

3.Guidelines for investing in unlisted securities

The following guidelines will assist investors to make an informed investment decision:

  • a) Investors should ensure that the company is reputable and is registered with the Office of the Registrar of Companies.

  • b) Establish in which assets the company invests (underlying investment portfolio).

  • c) Be aware of being offered spectacular returns. Remember if it is too good to be true, it usually is.

  • d) Never purchase any securities without first evaluating the fundamentals of the company and investors should carefully review the financial statements, management background and other data before making an investment decision.

  • e) Obtain a copy of the company’s prospectus.

  • f) Obtain information on the directors of the company and make sure that they are reputable persons who are fit and proper.

  • g) Study the products and services being rendered by the company and make sure the company is not an empty shell.

  • h) Make sure that the company exists by calling the company secretary and establishing whether it has a website.

  • i) Obtain information on the auditors of the company and discuss the future prospects of the company with them.

  • j) Study the media releases issued by the company.

  • k) Beware of promises that the unlisted company will soon be listed on an exchange and that investors will make big profits. Contact the exchange concerned and establish whether an application for a listing has been received.