Do you feel as though your stock portfolio is losing value by the minute? Have corporate scandals and plummeting markets reduced your holdings to a fraction of their former value? Do you feel as if there is no end in sight – that the stock you own will continue to be worth less and less?
Shareholders of American Diversified Group, Inc. (OTCBB: ADGI) can go you one better. The shares they think they own probably don’t even exist, and they probably have never been registered with the Securities and Exchange Commission.
American Diversified Group has issued over 480 million shares. As it turns out, however, the Company is only authorized to issue 25,000 shares.
Now that’s a problem.
Come Blow Your Horn
American Diversified first came to our attention as a sidebar to an item on Hornblower & Weeks, the investment banking firm that keeps running afoul of the National Association of Securities Dealers (NASD). (See Hornblower & Weeks – In Trouble Again). On May 7, 2002, Hornblower & Weeks was barred from issuing research reports for six months, after the NASD found that the brokerage firm’s report on MyTurn.com (Pink Sheets: MYNTQ) contained misleading, exaggerated, and baseless representations.Apparently the message didn’t get through. On July 9, 2002, the NASD levied charges against the investment bankers for the second time in less than three months. This time, the NASD charged that Hornblower & Weeks had violated the bar by issuing a research report on American Diversified in late May, less than one month after settling the earlier regulatory claims. Here again, the NASD said, the Hornblower & Weeks report contained “exaggerated and misleading statements and failed to disclose material facts.”
A lawyer for Hornblower & Weeks says that the latest NASD charges are without merit. Could the investment bankers be planning to claim that their “in-depth Marketing Letter and Report” on American Diversified was not a research report at all? That would seem to contradict a May 30th press release from American Diversified, which predicted that the report would give “investors, brokers and the public an overview of the telecom industry and how our present positioning and planning fits into the future of telecom…”
Then there were these comments by Hornblower & Weeks’ Director of Corporate Finance, Paul E. Taboada, which certainly reflect the investment banker’s recommendation:
We are acutely aware of ADGI's short and long term business plans and strategies, their potential involvements, ventures, and local partner relationships in many countries which we believe will yield even more impressive performances and financial rewards in the world-wide telecom arena.
We continue to believe that the Company's fundamentals as illustrated in their sales, earnings and growth rate will be the driving force for the valuation of the Company's stock. We also believe the Company is on target to meet its financial goals for the year as set forth in previous releases.
It would appear, however, that the Company could be trying to distance itself from Hornblower & Weeks and Mr. Taboada. We found that two versions of the report have been posted on the Internet – with some significant differences. The copy that appears on American Diversified’s website does not identify the author and contains no reference to Hornblower & Weeks. Since it also does not indicate whether anyone has been compensated for preparing the report, it does not warn investors about the author’s possible conflict of interest.
An earlier version of the report was posted on the site of “the stockbroker.com,” an investor relations firm that represents a handful of penny stock companies, including American Diversified. On May 23rd, American Diversified announced that it had retained thestockbroker.com “to develop investor relations.” When we last checked, the stockbroker.com site contained no reference to American Diversified, except for an acknowledgement that American Diversified had paid $3500 in June 2002 for 30 days of “investor relations service.” Those 30 days (much like Andy Warhol’s “fifteen minutes of fame”) must be up. There was no sign of the Hornblower & Weeks report – at least not on the active web pages. It could still be found, however, in cyberspace, at http://thestockbroker.com/ADGI_RESEARCH2002.html
This version of the report, called a “Marketing Letter,” boldly identified Paul E. Taboada as the author. It also contained this key disclosure (in tiny print) – which is absent from the version currently posted by American Diversified:
…Hornblower & Weeks, Inc. has been compensated ten million shares of 144 restricted ADGI stock and ten million shares of ADGI free-trading stock by the company. Be aware of any inherent conflict of interest resulting from such compensation due to our intent to profit from the liquidation of these shares. Part or all of this position may be sold at any time, even after positive statements have been made regarding the above company. Hornblower & Weeks, Inc. currently makes a market in this security. Hornblower & Weeks, Inc., or their officers, directors and their clients may have very substantial positions in the securities referred to herein, and may as principal or agent, buy and sell such securities. Neither the information, nor any opinion expressed, shall be construed to be, or constitute an offer to sell or a solicitation of an offer to buy the securities mentioned herein. However, there can be no guarantee of the accuracy of the published information on a day-to-day basis, specifically applying to any securities position held by Hornblower & Weeks, Inc. and its affiliates.
That disclaimer revealed that Hornblower & Weeks had been handed 20 million shares of American Diversified common stock – but even that was not the full story. The research report did not disclose that its author – Taboada – had received at least 6 million of those shares.
That information can be found in American Diversified’s Amended Form 10-Q for the quarter ended March 31, 2002 (filed on May 16, 2002), which acknowledged that 10 million restricted shares of American Diversified stock had been issued to three Hornblower & Weeks employees; Taboada (6 million shares); John Rooney (the Hornblower & Weeks President, who was suspended by the NASD as part of the May 7th settlement) (2 million shares); and Eric Ellenhorn (2 million shares).
The Form 10-Q also noted that one of the Company’s affiliates had paid Hornblower & Weeks $30,000, and given the investment bankers an additional 10 million shares of American Diversified stock.
Those details were absent from the “Marketing Letter.” As we discovered, they were hardly the most important omission.
Out of Stock
When it came time to review American Diversified’s prospects, the Hornblower & Weeks “Marketing Letter” presented all of the roses and none of the thorns. The reportfocused on the Company’s plan to establish a niche in South America, by selling prepaid telephone calling cards and marketing Voice over Internet Protocol (VoIP). It did not, however, detail the business risks, outline the obstacles to be surmounted, or describe the level of competition. Nor did it mention the fact that the Company has depended on two affiliates for over 96% of its sales.
And then there are those shares. The Company was originally formed in Nevada in 1979 as Terra West Homes, Inc. and changed its name to American Diversified Group in March 1995. As American Diversified now acknowledges, the original Articles of Incorporation authorized the Company to issue 25,000 shares of common stock. In order to increase the number of authorized shares, the Company would first have to amend its Certificate of Corporation. That was no simple task. The original Articles of Incorporation provided the following procedure for any such amendment:
The corporation reserves the right to amend, alter, change or repeal any of the provisions contained in these Articles of Incorporation provided that unanimous consent is first given by both the full Board of Directors then seated and the holders of shares (in good standing) issued and outstanding of the corporation.
There’s nothing equivocal about that. The Company could not increase its authorized shares unless all of the Directors and all of the existing shareholders agreed.
Somebody wasn’t paying attention. Between December 1991 and August 2001 the Company filed at least seven defective amendments to its Articles of Incorporation, purportedly increasing the authorized shares over that time from 25,000 to 700 million. In all but one case, the Company claimed that the Amendment had been approved by a majority of the outstanding shareholders – but never by unanimous consent.
In the final instance, on August 15, 2001 American Diversified said that the Amendment had been approved by its Board of Directors because Nevada corporate law did not require shareholder consent. But the Nevada statute does not give that power to the Directors if the Articles of Incorporation provide otherwise – as they certainly do here. Consequently, that attempted Amendment was also invalid.
Even the Company’s name is in question. The Amendments changing that name never received unanimous approval either.
It would be comical, but the consequences for investors could be potentially disastrous. The Company says it is now trying to rectify the situation, but is that even possible?
Phantom Votes
The Company says that it wants to cure the share problem by moving from Nevada to Delaware. American Diversified – or whatever its name is – is asking its shareholders to approve a plan that would swap all of the outstanding shares of American Diversified common stock for an equal number of duly authorized shares of a newly-formed Delaware subsidiary, GlobeTel Communications Corp.There would seem to be one basic problem with that scenario. How can the existing American Diversified “shareholders” agree to any plan since they don’t own validly issued shares (other than the first 25,000 shares that were issued) in the first place? In other words, how do you vote your shares, when your shares technically do not exist?
The Company claims that its Nevada attorneys, Kummer, Kaempfer, Bonner & Renshaw, have offered their opinion that the plan to exchange shares will be valid and binding if it is approved by a majority of the American Diversified shareholders. Still, it is difficult to understand how those votes can possibly be counted if the shares were never authorized. Wouldn’t they need a majority of the original 25,000 shares to approve the move, and how would the Company ever determine who holds that stock?
Shareholders may remain skeptical. After all, the Company has received legal opinions before – albeit from another attorney. Between December 1996 and November 2001, the Company filed no fewer than fifteen Registration Statements on Form S-8, purportedly registering more than 100 million shares. Each of those Registration Statements was accompanied by an opinion letter, issued by the Company’s attorney, Thomas J. Craft, Jr., that included language along the following lines:
In connection with this opinion, I have…determined that the shares have been legally issued, and are fully paid and non-assessable shares of the Registrant. Further, the Registrant has duly authorized the issuance of the shares and the filing of this registration statement.
Mr. Craft, who also has served as the Company’s corporate secretary and on its Board of Directors, has received more than 10 million shares from American Diversified, millions of which have been included on the Form S-8 registrations.
As we now know (and as the Company acknowledges) the shares covered by those registration statements – including those issued to Mr. Craft - had not been properly authorized, and therefore were not available to be issued. Does that render the attorney’s opinions invalid? If it does, what happens to the shares that were registered? The purchasers of the S-8 stock may be protected from the registration glitch, but that is not their only concern. In the end, what recourse is available to shareholders – assuming they really are shareholders at all?
There’s more. There have been twenty-five Form 144 filings since June 2001, covering the contemplated sale of over 26 million shares of American Diversified stock. What is the status of those unauthorized shares?
What are brokerage firms supposed to do now that they have been alerted to the fact that virtually all of the American Diversified shares are unauthorized – and that many of those shares may not have been properly registered? Will they now be subjecting themselves to liability if they recommend, or permit investors to purchase, American Diversified shares? Once they have become aware that the shares were not authorized, or not registered, can they continue to make a market in the stock?
And what are those same brokers supposed to do with the proxies relating to the share exchange? Can they submit votes on behalf of shareholders – knowing that those shareholders probably do not hold authorized stock (unless they own a portion of the 25,000 authorized shares)?
Do you suppose Hornblower & Weeks has a recommendation?
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