Overview
BMB
Munai, Inc. (“BMBM”) is a Nevada corporation that
originally incorporated in the State of Utah in 1981. From 2003 to
2011, BMBM’s business activities focused on oil and natural
gas exploration and production in the Republic of Kazakhstan. In
September 2011, BMBM sold all of its right, title, and interest in
and to its oil and gas licenses and licensed territory to an
independent third party for cash of about $170 million. The
proceeds of the sale were used to, among other things, repay
outstanding obligations, satisfy certain post-closing undertakings,
meet ongoing expenses, and make two separate cash distributions
totaling approximately $74,750,000 to its
stockholders.
On
November 23, 2015, BMBM entered into a Share Exchange and
Acquisition Agreement with Timur Turlov (the “Acquisition
Agreement”) with the intent to build an international,
broadly based brokerage and financial services firm to meet the
growing demand from an increasing number of investors in Russia and
Kazakhstan for access to the financial opportunities, relative
stability, and comprehensive regulatory reputation of the U.S.
securities markets.
Pursuant to the
Acquisition Agreement, BMBM acquired FFIN Securities, Inc., a
Nevada corporation, (“FFIN”) from Mr. Turlov in
exchange for 224,551,913 shares of BMBM common stock, which
constituted approximately 80.1% of BMBM’s outstanding common
stock after giving effect to the transaction. FFIN was established
to serve primarily foreign clients referred from LLC IC Freedom
Finance, a Russian limited company (“Freedom RU”) and
its wholly owned subsidiary JSC Freedom Finance, a Kazakhstan joint
stock company (“Freedom KZ”) as part of a strategy to
provide these clients with access to the U.S. securities markets
through a single integrated financial services firm.
In
December 2015, FFIN applied to become a member of FINRA and a
licensed securities broker-dealer with United States Securities and
Exchange Commission (“SEC”). This application was
subsequently withdrawn in 2016. Through the date of this report,
FFIN has not resubmitted its new membership application to FINRA.
We continue to believe licensure as a securities broker-dealer in
the U.S. may be a valuable component of our business strategy and
we continue to evaluate the cost benefit, likelihood of success and
appropriate timing of another application, or to otherwise become a
licensed securities broker-dealer in the U.S.
On June
29, 2017, BMBM closed the acquisition of Freedom RU. The
acquisition of Freedom RU included the securities brokerage and
financial services business conducted by it in Russia, along with
its wholly owned subsidiaries: Freedom KZ, and the securities
brokerage and financial services business conducted by it in
Kazakhstan; LLC FFIN Bank, a Russian limited company (“FFIN
Bank”), and the banking business conducted by it in Russia,
LLC First Stock Sale, a Russian limited company
(“FSS”), and the online securities marketplace it
provides to Russian investors, and Branch Office of IC LLC Freedom
Finance in Kazakhstan, a Kazakhstan limited liability company,
(“KZ Branch”) organized to serve as the representative
office of Freedom RU in Kazakhstan.
Pursuant to the
terms of the Acquisition Agreement, BMBM previously agreed to issue
to Mr. Turlov 13% of its issued and outstanding common stock for
his 100% interest in Freedom RU. As BMBM had insufficient
authorized but unissued common stock to deliver the full agreed
upon consideration to Mr. Turlov at the closing of the acquisition
of Freedom RU, as an accommodation to facilitate the closing, Mr.
Turlov agreed to accept a partial issuance of 209,660,533 shares of
BMBM’s common stock and to defer issuance of the balance of
the shares agreed to until such time as we complete a reverse stock
split and recapitalization, to provide sufficient additional shares
to issue him the percentage agreed in the Acquisition
Agreement.
We
continue to make progress in our efforts to close the acquisition
of FFINEU Investments Limited, a Cyprus limited company,
(“Freedom CY”), and the securities brokerage and
financial services business conducted by it in Cyprus. We continue
to work with the Cypress Securities and Exchange Commission
(“CySEC”) to obtain the necessary regulatory approvals
to transfer ownership of Freedom CY to BMBM. At this time we cannot
predict with certainty if and/or when the required regulatory
approvals will be granted.
Recapitalization
We are
authorized to issue 500,000,000 shares of common stock. Pursuant to
the Acquisition Agreement, BMBM agreed to issue sufficient shares
to Mr. Turlov such that following the acquisitions of FFIN,
Freedom RU and Freedom CY, Mr. Turlov will own
approximately 95% of the issued and outstanding common stock of
BMBM, which together with our currently outstanding stock, would
exceed our authorized common stock. As we had insufficient unissued
authorized common stock to deliver the full agreed upon
consideration to Mr. Turlov at the closing of the Freedom RU
acquisition, as an accommodation to facilitate the closing, Mr.
Turlov agreed to accept a partial issuance of 209,660,533 shares of
BMBM common stock, and to defer issuance of the balance of the
shares agreed to until such time as we can complete a reverse stock
split and recapitalization so we have sufficient additional shares
to issue him the percentage agreed in the Acquisition Agreement. We
will also need shares to complete the acquisition of Freedom CY
when the required regulatory approvals to transfer ownership to
BMBM are received. After giving effect to the acquisitions of FFIN,
Freedom RU and Freedom CY, Mr. Turlov will own up to approximately
95% of our post-reverse split shares then issued and
outstanding.
Our Business
We
believe the Freedom Companies serve an emerging capitalistic and
investing segment of the economies of Russia and Kazakhstan that is
interested in saving, investing, and diversifying risk through
foreign investment. Under the existing regulatory regimes in Russia
and Kazakhstan, Freedom RU and Freedom KZ are limited in
their ability to grant their customers access to the U.S.
securities markets. Currently, many of the customers of Freedom RU
and Freedom KZ access the U.S. securities markets through Freedom
CY.
The
Freedom Companies are seeking a sustainable, long-term strategy to
allow our customer base in Russia and Kazakhstan to participate in
the U.S. markets because of what we perceive to be the growing
disfavor of omnibus clearing accounts for foreign financial
institutions among regulators and U.S. financial institutions as
well as customer concerns that the Freedom Companies expose them to
attendant political, regulatory, currency, banking, and economic
risks and uncertainties in their respective countries of
operation.
The Freedom Companies
Since
the organization of Freedom RU in 2010 and the acquisitions of
Freedom KZ, FFIN Bank and FSS, they have serviced a growing
customer base with increasing amounts invested. Freedom RU and
Freedom KZ together have approximately 33,000 total customer
accounts. FFIN Bank has approximately 400 total active customer
accounts, with total deposits of approximately $3.5 million. The
customers of the Freedom RU and Freedom KZ typically execute
approximately 25,000 transactions per month, with an aggregate
transaction value of approximately $1 billion. The customers of
Freedom RU and Freedom KZ range from retail traders that frequently
execute large transactions to relatively small, inactive accounts
that hold securities positions long-term. In the preceding year,
approximately 80% or more of the aggregate trading dollar volume
was generated by about two dozen margin day traders. The Freedom RU
and Freedom KZ customers principally invest in exchange-traded
securities. The customers of FFIN Bank are generally individuals.
Approximately 77% of the FFIN Bank customers are also Freedom RU
customers.
For the
fiscal years ended March 31, 2017 and 2016, Freedom RU and its
subsidiaries together had consolidated profits of approximately
$7.3 million and $9.2 million, respectively on revenues of about
$19.4 million and $17.3 million, respectively. As of March 31, 2017
and 2016, the consolidated total assets of the Freedom RU were
approximately $111.7 million and $39.1 million. Collectively,
Freedom RU employs approximately 130 people in Russia and 140
people in Kazakhstan.
In
recent years,
Freedom RU has pursued
an aggressive growth strategy both in terms of customer acquisition
and business acquisitions. We anticipate this will continue as we
seek to expand the footprint of our brokerage, banking and
financial services business in Russia, Kazakhstan and other
markets.
Freedom RU
Freedom RU
provides financial services in the Russian Federation in accordance
with the Russian government’s open-ended licenses for
brokerage, dealer, and depository operations and for activities in
securities management. The Federal Financial Markets Service of
Russia and the Central Bank of the Russian Federation provide
governmental regulation of company operations and the protection of
the interests of its customers.
Freedom KZ
Freedom
RU acquired Freedom KZ in 2013 from unrelated parties. When Mr.
Turlov acquired Freedom KZ, it was controlled by Korean nationals
and principally facilitated Korean investment in Kazakhstan.
Freedom KZ provides professional services in the capital
markets. Since 2006, Freedom KZ has been a professional
participant of the Kazakhstan Stock Exchange, which enables it to
manage investment portfolios for its clients. Freedom KZ is
regulated by the Committee for the Control and Supervision of the
Financial Market and Financial Organizations of the National Bank
of the Republic of Kazakhstan.
FFIN Bank
FFIN
Bank was acquired by Freedom RU in April 2016. FFIN Bank has a
license issued by the Central Bank of the Russian Federation for
execution of banking operations in rubles and foreign currencies
for individuals and legal entities and is regulated by the Central
Bank. In accordance with federal law in Russia, the Deposit
Insurance Agency of Russia insures 100% of deposits of individuals
up to 1.4 million Russian rubles. FFIN Bank derives revenue from
providing banking services, including money transfers, foreign
currency exchange operations, interbank lending and deposits.
Currently, FFIN Bank’s operation is focused on servicing the
Group’s brokerage customers. FFIN Bank is an authorized
Visa/MasterCard issuer, and has introduced internet banking and
mobile applications for Android/iOS for companies and individuals.
In addition FFIN Bank has completed development of several
investment and structured banking products (insured deposits with
option feature and currency risk hedging products.) We anticipate
FFIN Bank will continue to expand the banking services it provides
to the customers of FFIN bank and Freedom RU. We also anticipate
geographical expansion of FFIN Bank to complement Freedom RU
locations.
First Stock Store
FSS was
launched to be the first online securities marketplace for retail
customers in Russia. FSS was launched to attract new brokerage
clients for Freedom RU by providing a medium for individual
investors to buy and sell securities traded on the Russian and US
stock exchanges. We consider FSS to currently be one of the most
dynamic fin tech projects in the Russian Federation. With the
addition of the FSS project, Freedom RU is currently adding
approximately 600 customer accounts each month.
KZ Branch
KZ
Branch serves as the representative office of Freedom RU in
Kazakhstan.
Freedom CY
Freedom CY was
organized in August 2013 and completed its regulatory licensing in
May 2015. In 2016 Freedom CY activated its licenses to receive,
transmit and execute customer orders, establish custodial accounts,
engage in foreign currency exchange services and margin lending.
Freedom CY is in the process of obtaining its dealer license to
trade its own investment portfolio. Freedom CY provides
transaction handling and intermediary services to Freedom RU
and Freedom KZ and is regulated by the CySEC.
Customer Base and Marketing Plan
The
Freedom Companies’ principal marketing efforts are focused on
offering brokerage, banking and financial services to their
customers. The Freedom Companies’ customers are a mix of
individual retail customers, including family or small business
entities owned and controlled by individuals, family asset planning
or holding companies, and private equity funds.
Competition
Since
the customer base of the Freedom Companies is located in Russia and
Kazakhstan, their principal competitors are in those countries,
each of which has a vigorous and aggressive competitive investment
and securities markets. There are both local and large financial
services firms that offer an array of financial products and
services in these countries. The financial service firms with which
the Freedom Companies compete for customers in Russia include JSC
Brokerage House Otkrytiye, LLC Company BrokerCreditService, LLC KIT
Finance, and FINAM Group and in Kazakhstan include JSC Halyk
Finance,
JSC BCC Invest
and JSC Centras Securities. The bank’s principal competitors
include JSC Tinkoff Bank and LLC BCS.
We
believe competition is based principally on the ability of the
Freedom Companies to provide access to the U.S. securities markets,
the level of their service, the convenience of their services,
their ability to provide personalized service, and their charges to
customers. Customer costs include transaction execution fees,
commissions and charges as well as margin interest rates the
Freedom Companies charge their customers investing on
margin.
Many of
the firms with which the Freedom Companies compete are larger,
provide more diversified services and products, provide access to
more international markets, and have greater management, technical,
and financial resources. We cannot assure that the Freedom
Companies will be able to compete effectively.
Regulation
Overview
The
business of the Freedom Companies and the securities and banking
industries in general are subject to extensive
regulation.
Foreign Corrupt Practices Act
In the
U.S., the 1970 Foreign Corrupt Practices Act, or FCPA, broadly
prohibits foreign bribery and mandates recordkeeping and accounting
practices. The anti-bribery provisions make it illegal for us,
either directly or through any subsidiary that we may acquire, to
bribe any foreign official for the purpose of obtaining business.
The term “public official” is defined broadly to
include persons affiliated with government-sponsored or owned
commercial enterprises as well as appointed or elected public
officials. The recordkeeping provisions require that we and our
subsidiaries make and maintain books that, in reasonable detail,
reflect our transactions and dispositions of assets and devise and
maintain a system of internal accounting controls that enables us
to provide reasonable assurance that transactions are properly
recorded in accordance with management’s authorizations, that
transactions are recorded as necessary to permit the preparation of
financial statements, that access to our funds and other assets is
permitted only in accordance with management’s
authorizations, and that the recorded accounts for assets are
compared periodically with the existing assets to assure
conformity.
The
FCPA requires that we establish and maintain an effective
compliance program to ensure compliance with U.S. law. Failure to
comply with the FCPA can result in substantial fines and other
sanctions.
Foreign Account Tax Compliance Act
The
2010 Foreign Account Tax Compliance Act, or FATCA, was enacted in
the United States to target non-compliance by U.S. taxpayers using
foreign accounts. FATCA requires foreign financial institutions,
such as the Freedom Companies, to report to the United States
Internal Revenue Service (“IRS”) information about
financial accounts held by U.S. taxpayers, or by foreign entities
in which U.S. taxpayers hold a substantial ownership
interest.
The
United States has entered into intergovernmental agreements with a
number of countries establishing mutually agreed-upon rules for the
implementation of the data sharing requirements of FATCA. It has
not, however, entered into such an agreement with Russia. As a
result, Russia adopted legislation to allow financial institutions
to share foreign taxpayer data with foreign tax authorities, such
as the IRS, without breaching Russian data protection and
confidentiality laws. The Russian legislation sets forth extensive
rules relating to when and how the financial institution may gather
and share foreign taxpayer information. The Russian legislation
establishes extensive monitoring procedures requiring, among other
things, the notification to various Russian state bodies by the
financial institution of registration with a foreign tax authority,
receipt of requests for foreign taxpayer data, and the delivery to
Russian state bodies of foreign taxpayer data prior to delivery to
a foreign tax authority. Under the legislation, Russian regulators
retain the right to prohibit disclosure of foreign taxpayer
information in certain instances. Failure to comply with the
Russian legislation may result in monetary fines for the financial
institution and its officers. Because of the lack of an agreement
between the U.S. and Russia establishing mutually agreed-upon
guidelines for data sharing, inconsistencies in the two legal
regimes exist, which can place financial institutions in Russia,
such as Freedom RU and FFIN Bank, in the position of having to
decide whether to comply with Russian legislation or with FATCA.
For example, under Russian legislation, a financial institution may
share foreign taxpayer data only with the consent of the foreign
taxpayer, and even when consent is given, Russian regulators may,
in certain circumstances, prohibit disclosure. There is no
exemption for foreign financial institutions from the FATCA
disclosure requirements. Similarly, FATCA generally requires the
foreign financial institution to withhold 30% of designated
payments. However, the Russian legislation does not grant financial
institutions the authority to act as a withholding agent for a
foreign tax authority. The Russian legislation does allow financial
institutions to decline to provide services to foreign
taxpayers.
Kazakhstan and the
United States have entered an intergovernmental agreement
containing provisions regulating the process for Kazakh financial
institutions to collect information on U.S. taxpayer accounts and
provide that information to the IRS. In general, the requirements
of the agreement concern the analysis of new and existing customer
accounts to identify U.S. taxpayers. The agreement requires Kazakh
financial institutions to register with the IRS and define their
status in accordance with FATCA. Financial institutions are
obligated to identify their clients and analyze their products to
identify the accounts of customers affected by FATCA and collect
all necessary information to classify those accounts in compliance
with the requirements of FATCA. After classifying the accounts,
financial institutions are obligated to regularly present
information, including name, taxpayer identification number, and
account balance, to the Kazakh tax authorities for transfer to the
IRS.
Cyprus
and the United States have entered an intergovernmental agreement
that requires Cyprus financial institutions to determine accounts
maintained by U.S. tax residents, comply with verification and
enhanced due diligence procedures, and provide annual reporting on
these accounts to the Cyprus tax authorities who subsequently will
provide the reports to the IRS. In addition, Cyprus financial
institutions are required to make necessary tax withholdings to be
paid to the IRS. As a “Reporting Financial Institution”
under the intergovernmental agreement, Freedom CY will be required
to obtain required client documentation associated with the indicia
of his, her, or its U.S. tax residency status as well as all
related account information in order to report
accordingly.
The
failure to comply with FATCA could result in adverse financial and
reputational consequences to the Freedom Companies as well as the
imposition of sanctions or penalties including responsibility for
the taxes on any funds distributed without the proper withholdings
set aside.
Foreign Regulation
Russia
Freedom RU
provides professional services in the capital markets of the
Russian Federation and is a professional participant of the Moscow
and Saint Petersburg Stock Exchange. Freedom RU holds four
licenses issued by the Federal Service for Financial Markets of the
Russian Federation that allow it to provide brokerage, dealer,
depository and securities management services in Russia. Freedom RU
also provides foreign currency trading services.
FFIN
Bank provides banking services for legal entities and individuals
from the Federation of Russia (the “Central Bank”) and
other countries. FFIN Bank holds a license issued by the Central
Bank for the execution of banking operations in rubles and foreign
currency for individuals and legal entities.
In
Russia, a number of federal and industry regulatory agencies are
charged with safeguarding the integrity of the securities and other
financial markets and with protecting the interests of customers
participating in those markets. The Central Bank is the principal
financial industry regulator responsible for the regulation of
broker-dealers, banks, depositories, and securities managers doing
business in Russia. Industry self-regulatory organizations
(“SROs”), each of which has authority over the firms
that are its members, include the Association of Securities Market
Participants (“NAUFOR”), National Securities Market
Association (“NFA”) national securities exchanges such
as the Moscow Stock Exchange and the St. Petersburg Stock Exchange
on which securities are traded, and other SROs.
Freedom
RU and FFIN Bank are subject to overlapping schemes of regulation
that govern all aspects of their business. The regulations cover a
broad range of practices and procedures, including:
●
the use and
safekeeping of customers’ funds and securities;
●
recordkeeping and
reporting requirements;
●
customer identity,
clearance, and monitoring to identify and prevent money
laundering;
●
supervisory and
organizational procedures intended to monitor and assure compliance
with securities laws and to prevent improper trading
practices;
●
transaction
execution, clearance, and settlement procedures;
●
maximum loan and
bank guarantees concentration issued to shareholders;
●
credit risk
requirements;
●
liquidity risk
requirements;
●
qualification of
firm management; and
●
risk detection,
management, and correction.
The
Central Bank and NAUFOR regulations include rules governing
practices and procedures addressing the relationship between
financial institutions and their customers. As a result, many
aspects of the financial institutions’ customer relationship
are subject to regulation. These regulations include customer
identification and due diligence procedures, collection of customer
financial suitability documentation, anti-money laundering
monitoring and reporting, customer fees, clearing, settlements,
risk management and other matters.
Violations of
securities and banking laws and regulations by financial
institutions in Russia can subject them to a broad range of
disciplinary actions including remedial actions, imposition of
fines and sanctions, removal from managerial positions, loss of
licensing, and criminal proceedings.
Capital Requirements
The
Central Bank establishes minimum net capital requirements for
financial institutions including brokerages, dealers, depositories,
securities managers and banks. In the event the net capital of such
service provider drops below the minimum requirement, it is
obligated to notify the Central Bank, provide a plan to meet its
minimum capital requirements and perform all actions necessary to
bring it back into compliance with the net capital requirement. The
minimum net capital requirement of Freedom RU to provide brokerage,
dealer, depository, securities management is approximately
$790,000, and for foreign currency trading services is
approximately $2,360,000, which it currently has. The minimum net
capital requirement of FFIN Bank to provide banking services is
approximately $5,320,000, which it currently has.
In the
event a financial institution fails to maintain its minimum net
capital, it must immediately notify the Central Bank. The Central
Bank may take any of the following actions, (i) require the
financial institution to submit a detailed plan to increase its net
capital to at least the minimum requirement, (ii) impose financial
penalties in the event the financial institution does not provide a
detailed explanation as to the reasons for the decrease below the
minimum requirement, (iii) cause the financial institution to cease
operations until it meets the minimum net capital requirement, (iv)
suspend the financial institution’s licenses for a period of
time, and (v) in case of failures, the Central Bank can withdraw
licensing and disqualify the firm’s management from working
within the industry. This disqualification can be for up to a
three-year period for the general director, controller and the head
of the compliance department of the financial
institution.
Compliance with
minimum capital requirements could limit Freedom RU and FFIN
Bank’s expansion into activities and operations that require
the intensive use of capital. Minimum capital requirements could
also restrict our ability to withdraw capital from Freedom RU and
FFIN Bank, which in turn could limit our ability to transfer funds
among our subsidiaries. Additionally, the failure of Freedom RU or
FFIN Bank to maintain its minimum net capital requirement could
result in penalties or other sanctions.
Anti-Money Laundering
The law
on the Prevention of Money Laundering and the Financing of
Terrorism (“AML Law”) establishes laws designed to
prevent money laundering activities and financing of terrorism. The
AML Law is supported by recommendations, binding instructions and
regulations of the Central Bank and other authorities. The AML Law
requires institutions dealing with cash operations, including all
kinds of financial institutions, which includes professional
participants in the securities markets and banks, to establish
mandatory internal protocols for client and payment acceptance. In
particular, regulated entities must perform due diligence
procedures to ascertain the identity of the customer and monitor
transactions for suspicious activity. Regulated entities must
identify and report transactions falling within certain categories.
If either party to such transactions is suspected of being
connected to terrorist activity the transaction is subject to
mandatory control regardless of the nature of the
transaction.
The
Central Bank may take preventative or enforcement measures against
regulated financial institutions involved in transactions that
infringe on anti-money laundering legislation. Preventative
measures may include issuing an order to cease a violation and
provide the Central Bank with a program for improvement and
establishing additional monitoring measures. Enforcement measures
may include the imposition of fines and withdrawal of licenses. The
failure of Freedom RU and FFIN Bank to comply with the AML Law
could subject them to material legal action, which could have a
material adverse effect on our business and results of
operations.
Kazakhstan
Freedom KZ
provides professional services in the capital markets of Kazakhstan
and is a professional participant of the Kazakhstan Stock Exchange,
which enables Freedom KZ to manage investment portfolios for
its clients. Freedom KZ is regulated by the Committee for the
Control and Supervision of the Financial Market and Financial
Organizations of the National Bank of the Republic of
Kazakhstan.
In
Kazakhstan the National Bank of the Republic of Kazakhstan (the
“NBK”) and the Kazakhstan Stock Exchange (the
“KASE”) are the principal organizations tasked with
safeguarding the stability of financial markets and financial
institutions. The NBK and KASE are responsible for setting the
standards for regulating the activities of financial institutions
and participants in the financial services industry and for
monitoring compliance. Settlement services for securities
transactions are primarily governed by the rules and procedures of
the Central Depositary.
Freedom
KZ is licensed to provide broker-dealer services with the right to
carry customer accounts and to provide investment portfolio
management services. Freedom KZ has 13 offices located in 13 cities
in Kazakhstan.
Freedom
KZ is subject to overlapping schemes of regulation that govern all
aspects of its securities business. The regulations cover a broad
range of practices and procedures, including:
●
the use and
safekeeping of customers’ funds and securities;
●
recordkeeping and
reporting requirements;
●
customer identity,
clearance, and monitoring to identify and prevent money
laundering;
●
supervisory and
organizational procedures intended to monitor and assure compliance
with securities laws and to prevent improper trading
practices;
●
transaction
execution, clearance, and settlement procedures;
●
qualification of
firm management; and
●
risk detection,
management and correction.
NBK and
KASE regulations include rules governing practices and procedures
addressing the relationship between broker-dealers and their
customers. As a result, many aspects of the broker-dealer customer
relationship are subject to regulation. These regulations include
customer identification and due diligence procedures, collection of
customer financial suitability documentation, anti-money laundering
and anti-terrorism funding monitoring and reporting, customer fees,
clearing, settlements, and other matters.
The
Republic of Kazakhstan has adopted extensive regulation regarding
the responsibility for wrongdoing by broker-dealers and investment
portfolio managers, ranging from disciplinary action to criminal
punishment. The penalties available to the NBK in the event of
wrongdoing include cancelation of licenses, removal of management,
monetary damages and criminal prosecution. The NBK may also impose
remedial requirements, such as requiring the wrongdoer to provide a
plan of remediation to ensure the wrongdoing is prevented in the
future. Action may be taken against the broker-dealer, the
management board of the broker-dealer or both depending on the
severity of the violation.
Capital Requirements
Kazakhstan
regulation establishes minimum share capital requirements for
broker-dealers and investment portfolio managers. In the event the
net capital of a broker-dealer or investment portfolio manager
falls below the requirement, it is obligated to notify the NBK,
provide a plan to meet is minimum capital requirements and perform
all actions to bring it back into compliance with the requirement.
The minimum capital for broker-dealers with a license to provide
investment portfolio management services is approximately $835,000.
The net capital requirement must be calculated on a daily
basis.
The
failure of a broker-dealer to maintain its minimum capital
requirement could result in the NBK taking any of the following
enforcement measures, (i) require a letter of commitment to comply,
(ii) execution of a written agreement to comply; (iii) issue a
warning; (iv) issue a written prescription to eliminate the
violation; and (v) impose penalties. Enforcement measures may be
imposed on the broker-dealer or on top management of the
broker-dealer or both depending on the severity of the
violation.
Compliance with
minimum capital requirements could limit Freedom KZ’s
expansion into activities and operations that require the intensive
use of capital. Minimum capital requirements could also restrict
our ability to withdraw capital from Freedom KZ, which in turn
could limit our ability to transfer funds among our subsidiaries.
Additionally, if Freedom KZ falls below it minimum capital
requirements the NBK could impose penalties or other sanctions on
Freedom KZ.
Anti-Money Laundering
The Law
on Anti-Money Laundering and Combating of Terrorism Financing
(“AML/CFT”) establishes laws designed to combat money
laundering and funding of terrorist activities. By regulation
adopted by the NBK, companies operating in the financial services
industry in Kazakhstan are required to establish procedures
designed to ensure, among other things, that the
broker-dealer:
●
undertake adequate
due diligence of its customers;
●
perform financial
monitoring of operations related to transfers of cash and
property;
●
monitor
transactions and report suspicious activities to appropriate
authorities; and
●
provide periodic
reporting to appropriate authorities.
The
failure of Freedom KZ to comply with AML/CFT requirements could
subject it to material sanctions, including penalties and fines,
which could have a material adverse effect on the business and
results of operations of Freedom KZ.
Cyprus
Freedom
CY has applied for and been granted licensure by CySEC to provide
investment and ancillary services as a Cypriot Investment Firm
(“CIF”). In 2016, Freedom CY activated its licenses to
receive, transmit and execute orders on behalf of clients,
establish custodial accounts for financial instruments and related
services, engage in foreign currency exchange services and margin
lending. Freedom CY is in the process of obtaining its dealer
license to trade its own investment portfolio. Freedom CY’s
activities are regulated by and under the supervision CySEC, an
independent public supervisory authority, responsible for the
supervision of the investment services market and transactions in
transferable securities carried out in the Republic of Cyprus. As a
CIF, the activities of Freedom CY are subject to various laws
including the Cyprus Investment Act of 2002-2005, which provides
the legal framework for the operation and supervision of CIFs, the
rules and regulations of the Cyprus Stock Exchange and the Markets
in Financial Instruments Directive II and Regulation
(“MiFID”).
The
MiFID is aimed at creating a single, more transparent market in
financial services across all EU member states, to (i) improve the
competitiveness and integration of EU financial markets by creating
a single market for investment services and activities, (ii) ensure
a high degree of harmonized protection for investors in financial
instruments, (iii) increase market transparency, and (iv) promote
easier cross border business. The MiFID allows registered
investment firms to provide services throughout the EU on the basis
of home country supervision.
Freedom
CY is subject to an overlapping scheme of regulation that covers
all aspects of its securities business. These regulations cover a
broad range of matters, including:
●
safekeeping of
clients’ funds and assets;
●
recordkeeping and
reporting requirements;
●
client
identification, clearance and monitoring to identify and prevent
money laundering and funding of terrorism and facilitate FATCA
reporting;
●
supervisory and
organizational procedures intended to monitor and assure compliance
with the relevant laws and regulations and to prevent improper
trading practices;
●
employee-related
matters, including qualification and certification of personnel;
and
●
provision of
investment and ancillary services, clearance, and settlement
procedures.
Serious
or systematic infringement of rules, regulations and directives of
the laws, rules and regulations of Cyprus securities laws and/or
the directives issued pursuant relevant EU regulations could
subject Freedom CY, its principals and other employees to
disciplinary proceedings or civil or criminal liability, including
withdrawal of CySEC licensure, administrative fines, temporary
suspension or permanent bar from the performance of Freedom
CY’s business activities. Any such proceeding could have an
adverse material effect upon the business activity of Freedom
CY.
Capital Requirements
Freedom
CY is subject to the capital requirements of the CRD IV package of
the Capital Requirements Directives of the European Union. A CIF
must maintain a minimum initial capital requirement of
approximately $220,000 if it holds client assets or client
financial instruments and provides any of the following services:
(i) receiving and transmitting orders, (ii) executing orders on
behalf of clients; (iii) providing portfolio management; or (iv)
providing investment advice. The minimum initial capital
requirement for a CIF providing any of the above services without
holding client assets or client financial instruments is
approximately $87,000, with some exceptions. Freedom CY holds
client assets and client financial instruments and has a minimum
initial capital requirement of approximately $384,360. Freedom CY
anticipates receiving a dealer license in 2017, which will increase
its minimum capital requirement to $1,100,000.
At all
times Freedom CY’s minimum net capital must meet or exceed
certain target capital ratios. The capital ratio is a percentage
calculated by dividing: (a) the total of the firm’s Basel III
Tier 1 capital (the sum of its common shares, share surplus,
retained earnings, accumulated other comprehensive income, and
other disclosed reserves and common shares issued by consolidated
subsidiaries that meet the criteria for inclusion, subject to
regulatory adjustments) and its Basel III Tier 2 capital
(instruments that meet the criteria for Tier 2 capital that are not
included in Tier 1 capital, share premium resulting from
instruments included in Tier 2 capital, instruments issued by
consolidated subsidiaries and held by third parties that are not
included in Tier 1 capital and certain loan loss provisions,
subject to regulatory adjustments applied in calculation of Tier 2
capital); by (b) the sum of risk-weighted exposures (including
credit, currency and operational risk exposures. Currently, Freedom
CY must maintain a minimum total capital ratio of 8% and a minimum
total Tier 1 capital ratio of 6%.
Cyprus
securities rules require all CIFs to have processes in place to
assess and maintain the minimum capital requirements on an ongoing
basis. These processes are subject to regular internal review to
ensure that they remain comprehensive and proportionate to the
nature of the activities of the CIF. If a CIF fails to maintain its
minimum capital requirement, the CIF is required to timely notify
CySEC of such failure. CySEC may, at its discretion, set a deadline
by which the CIF must remedy the situation. If a CIF violates the
net capital requirements and the directives issued by CySEC, CySEC
may, in its absolute discretion based on the gravity of the
violation, impose measures, penalties and sanctions including, (i)
withdraw or suspend CIF authorization, (ii) publicly censure the
CIF and the individuals responsible, (iii) issue cease and desist
orders against the CIF and the individuals committing such
violations, (iv) temporarily ban the individuals responsible for
the violation and members of the CIF’s board of directors
from exercising functions for a CIF, and (v) impose financial
penalties upon the CIF and the individuals responsible for the
violation.
Compliance with
regulatory minimum capital requirements could limit Freedom
CY’s expansion into activities and operations that require
the intensive use of capital, such as dealing on its own account or
underwriting or placing securities. Minimum capital requirements
also could restrict our ability to withdraw capital from Freedom
CY, which in turn could limit our ability to transfer funds among
our subsidiaries.
Investor Compensation Fund
Pursuant to current
CySEC legislation, CIFs are required to register as members of the
Investor Compensation Fund (the “ICF”) for the
protection of CIF clients, and must comply with the obligations of
the ICF. The ICF was established to compensate CIF covered clients
as to covered investment services and ancillary services. Payment
of compensation by the ICF is subject to the existence of a
well-founded claim by the client against a member of the Fund. The
amount of compensation payable to each covered client is calculated
in accordance with the legal and contractual terms governing the
relationship of the covered client with the CIF, subject to the
off-set rules applied for the calculations of claims. The current
maximum pay out by the ICF is approximately $22,000.
Anti-Money Laundering
The
Prevention and Suppression of Money Laundering and Terrorist
Financing Law of 2007, imposes laws and regulations designed to
prevent the use of the Cyprus financial system for the purpose of
money laundering and terrorist financing. The law places special
responsibilities on financial institutions, including CIFs, to
implement and adhere to prescribed procedures for customer
identification, record keeping and internal reporting and reporting
of suspicious money laundering transactions. This law imposes
requirements on such institutions to ensure that all employees are
aware of their obligations under the law and receive adequate
training designed to assist them in recognizing and reporting
suspicious transactions. Freedom CY’s failure to comply with
these provisions could have a material adverse effect on its
business and expose it to possible sanctions, including substantial
fines and penalties. Freedom CY’s obligations respecting
anti-money laundering will extend to its customers in Russia and
Kazakhstan.
Monetary Policy
Our
earnings are and will be affected by domestic economic conditions
and the monetary and fiscal policies of the Russian, Kazakh, Cyprus
and United States governments. The monetary policies of these
countries may have a significant effect upon our operating
results. It is not possible to predict the nature and
impact of future changes in monetary and fiscal
policies.
Employees
With
the closing of the acquisition of Freedom RU, we now have
approximately 310 total employees, including 273 full-time
employees.
In addition to the negative implications of all information and
financial data included in or referred to directly in this report,
you should consider the following risk factors. This report
contains forward-looking statements and information concerning us,
our plans, and other future events. Those statements should be read
together with the discussion of risk factors set forth below,
because those risk factors could cause actual results to differ
materially from such forward-looking statements.
Risks Related to Our Acquisitions and Proposed
Acquisitions
We believe our proposed acquisition of Freedom CY, which
operates as a broker-dealer in Cyprus and provides our clients in
Russia and Kazakhstan greater access to the U.S. markets is
probable, but we cannot predict when the acquisition, may be
completed.
The
Acquisition Agreement, under which we propose to acquire
Freedom CY, specifies that the acquisition is conditioned on
the satisfaction of specified regulatory requirements in Cyprus.
While we have been working with CySEC for some time to obtain the
necessary regulatory approvals to transfer ownership of Freedom CY
to the Company, and now believe receipt of such approval is
probable, there is no time limit to when approval may be given and
we cannot guarantee we will receive approval to close the
acquisition of Freedom CY. As many of our Russian and Kazakh
customers access the U.S. markets through Freedom CY, we may be
required to revise our business model if we are unable to obtain
the necessary regulatory approvals to transfer ownership of Freedom
CY to the Company.
The percentage ownership of our stockholders has been reduced
substantially as a result of our acquisition of FFIN and the
closing of the Freedom RU acquisition and will be further
substantially reduced. We may also identify and pursue additional
acquisitions that could require the issuance of additional stock,
which would likely further reduce the percentage ownership of our
stockholders
As a
result of the acquisition of FFIN, stockholders that previously
owned 100% of our outstanding stock (the “original BMB
stockholders”) were reduced to owning approximately 19.9% of
our stock. With the closing of the Freedom RU acquisition, that
percentage was reduced to approximately 13.2% and we have agreed,
following a reverse split of our common stock, to issue additional
shares to Mr. Turlov that would reduce the holdings of the original
BMB stockholders to approximately 7%. If the reverse split and
proposed acquisition of Freedom CY are completed, the ownership of
the original BMB stockholders will be reduced to approximately 5%
of our common stock. We cannot assure that the value of the
retained stock of the original BMB stockholders is or will be
greater when their ownership is reduced to approximately 13.2%, 7%
or 5% as a result of the transfer of assets and operations to the
Company as consideration for the issuance of a controlling interest
in the Company.
We may
acquire or make investments in businesses, whether complementary or
otherwise, as a means to expand our business if appropriate
opportunities arise. Although we cannot give assurances that we
will be able to identify future suitable acquisitions or investment
candidates, or, if we do identify suitable candidates, that we will
be able to make the acquisitions or investments on reasonable terms
or at all. The financing of any such acquisition or investment, or
of a significant general expansion of our business, may not be
readily available on favorable terms. Any significant acquisition
or investment, or major expansion of our business, may require us
to explore external financing sources, such as an offering of our
equity or debt securities. We cannot be certain that in the future
these financing sources will be available to us or that we will be
able to negotiate commercially reasonable terms for any such
financing, or that our actual cash requirements for an acquisition,
investment or expansion will not be greater than anticipated. In
addition, any indebtedness that we may incur in such a financing
may inhibit our operational freedom, while any equity securities
that we may issue in connection with such a financing may further
reduce the percentage ownership of our then-existing
stockholders.
In
addition, we do not have extensive experience in integrating
acquisitions and we could experience difficulties incorporating an
acquired company's personnel, operations, technology or products
and service offerings into our own or in retaining and motivating
key personnel from these businesses. We may also incur
unanticipated liabilities. Any such difficulties could disrupt our
ongoing business, distract our management and employees, increase
our expenses and adversely affect our results of operations.
Furthermore, we cannot provide any assurance that we will realize
the anticipated benefits and/or synergies of any such acquisition
or investment.
Timur Turlov will be subject to significant conflicts of interest
in connection with the Acquisition Agreement.
Timur
Turlov will be required to make decisions about his performance
under and compliance with the terms and conditions to which he is
subject under the Acquisition Agreement while he is also our
chairman, chief executive officer, and controlling stockholder and,
therefore, has a fiduciary duty to us and our stockholders.
Accordingly, he will be subject to substantial conflicts of
interest in such matters. We have not adopted procedures to resolve
these conflicts of interest in our favor. Further, we cannot assure
that our intent to have all of our decisions respecting our
performance under and compliance with the terms and conditions to
which we are subject under the Acquisition Agreement determined by
a majority of our disinterested, independent directors will
eliminate all conflicts of interest to which such disinterested,
independent directors may be subject.
Because we are a “controlled company” within the
meaning of the NYSE and NASDAQ corporate governance standards, and
as a result, may qualify for exemptions from certain corporate
governance requirements, you may not have the same protections
afforded to stockholders of companies that are subject to such
requirements.
Mr.
Turlov currently holds 88.6% of our issued and outstanding common
stock, with the right to receive an additional 4.4% following
completion of a reverse stock split. If we receive approval to
transfer ownership of Freedom CY to BMBM, his ownership interest
may increase to up to 95% of our outstanding common
stock.
As a
result of Mr. Turlov’s acquisition of greater than 50% of the
voting power of BMBM, we became a “controlled company”
under the corporate governance standards of the NYSE and NASDAQ.
Controlled companies are exempt from compliance with the listing
standards of the NYSE and NASDAQ regarding majority board
independence or the independence requirements relating to certain
compensation and nominating committee decisions, and in the case of
the NYSE, corporate governance committees. We are not currently
subject to the corporate governance standards of the NYSE or
NASDAQ, but should we at some future date become subject to such
standards while still being a controlled company, we could be
eligible to take advantage of the exemptions from compliance with
such corporate governance standards. If we take advantage of the
exemptions from compliance with such corporate governance
standards, you may not have the same protections afforded to
stockholders of companies that are subject to such
requirements.
Mr. Turlov has control over key decision making as a result of his
ownership of a majority of our voting stock.
Mr. Turlov, our chief executive officer and
chairman of our board of directors, beneficially owns approximately
88.6% of our outstanding common stock, which could increase to as
much as 95%. Mr. Turlov currently has sole voting control of BMBM
and can control the outcome of matters submitted to
stock
holders for approval, including the election of
directors, a reverse stock split and recapitalization the Company,
and any merger, consolidation, or sale of all or substantially all
of our assets. In addition, Mr. Turlov has the ability to control
our management and affairs as a result of his position as our chief
executive officer and his ability to control the election of our
directors. Additionally, in the event that Mr. Turlov controls BMBM
at the time of his death, control may be transferred to a person or
entity that he designates as his successor. As a board member and
officer, Mr. Turlov owes a fiduciary duty to our stockholders
and must act in good faith and in a manner he reasonably believes
to be in the best interests of our stockholders. As a stockholder,
even a controlling stockholder, Mr. Turlov is entitled to vote
his shares in his own interests, which may not always be in the
interests of our stockholders generally.
Risks Related to Effecting Securities Transactions for Foreign
Customers
The Freedom Companies’ business would be negatively impacted
if Freedom CY is unable to maintain its relationship with a U.S.
securities broker-dealer and clearing firm willing to receive and
transmit funds internationally.
Funds
invested by customers of the Freedom Companies’ in U.S.
securities are transmitted to a U.S. securities broker-dealer and
clearing firm and by the U.S. securities broker-dealer and clearing
firm back to the Freedom Companies’ customers through
international banking electronic transfers, which can experience
clerical and administrative mistakes, be subject to technical
interruption, be delayed, or otherwise fail to work as planned.
Neither Freedom CY, nor the Freedom Companies have any control over
these funds transfers. Failures or substantial delays in funds
transfers could impair the Freedom Companies’ customer
relationships.
The Freedom Companies must comply with the U.S. Foreign Corrupt
Practices Act (“FCPA”) in their operations in Russia
and Kazakhstan.
The
Freedom Companies will be required to conduct their activities in
compliance with the FCPA and similar anti-bribery laws that
generally prohibit companies and their intermediaries from making
improper payments to foreign government officials for the purpose
of obtaining or retaining business. Enforcement officials interpret
the FCPA’s prohibition on improper payments to government
officials to apply to officials like those of the state-operated
Federal Financial Markets Service of Russia and the Committee for
the Control and Supervision of the Financial Market and Financial
Organizations of the National Bank of the Republic of Kazakhstan,
the principal regulatory bodies that would control and monitor our
operations in Russia and Kazakhstan. While the employees and agents
of Freedom Companies will be required to acknowledge and comply
with these laws, we cannot assure that their internal policies and
procedures will always protect us from violations of these laws,
despite our commitment to legal compliance and corporate ethics.
The occurrence or allegation of these types of risks may expose us
to fines and other sanctions and adversely affect our business,
performance, prospects, value, financial condition, reputation, and
results of operations.
Foreign laws, regulations, and policies may change in ways that
could adversely impact our business.
The Freedom
Companies
securities broker-dealer and banking activities
for customers in Russia and Kazakhstan are and will continue to be
subject to ongoing uncertainties and risks, including:
●
possible changes in
government personnel, the development of new administrative
policies, practices, and political conditions in Russia,
Kazakhstan, or Cyprus that may affect the enforcement or
administration of laws and regulations;
●
possible changes to
the laws, regulations, and policies applicable to their customers
or the securities business generally;
●
the potential
adoption of entirely new regulatory regimes for foreign investment,
the transfer of funds to or from foreign countries, and the
permitted financial activities of residents;
●
uncertainties as to
whether the laws and regulations will be applicable in any
particular circumstance;
●
uncertainty as to
whether the Freedom Companies will be able to demonstrate, to the
satisfaction of the applicable governing authorities, their
compliance with governmental requirements;
●
currency exchange
rates, regulations, or limitations;
●
political
instability and possible changes in government;
●
local and national
tax requirements;
●
expropriation or
nationalization of private enterprises and other risks arising out
of foreign government sovereignty over properties in Russia and
Kazakhstan; and
●
possible
significant delays in obtaining governmental authorizations,
consents, or approvals of applicable requirements.
Our
customers are concentrated in Russia and Kazakhstan such that any
impediment to their investments and other activities could have a
material adverse effect on our business, financial condition, and
results of operations.
Russia and Kazakhstan have changing regulatory regimes, regulatory
policies, and interpretations.
Russia
and Kazakhstan have regulatory regimes governing the operation of
broker-dealers within those countries, the transfer of funds to and
from such countries, and other aspects of the finance, investment
and banking industries. These provisions were promulgated during
changing political circumstances, are continuing to change, and may
be relatively untested, particularly insofar as they apply to
foreign investments by residents. Therefore, there is little or no
administrative or enforcement history or established practice that
can aid us in evaluating how the regulatory regimes will affect the
Freedom Companies’ operations. It is possible that those
governmental policies will change or that new laws and regulations,
administrative practices or policies, or interpretations of
existing laws and regulations will materially and adversely affect
the Freedom Companies’ activities in Russia or Kazakhstan.
Further, since the history and practice of industry regulation is
sparse, the Freedom Companies’ activities may be particularly
vulnerable to the decisions and positions of individuals, who may
change, be subject to external pressures, or administer policies
inconsistently. Internal bureaucratic politics may have
unpredictable and negative consequences. The
profitability of the Freedom Companies could also
be affected by changes to rules and regulations that impact the
business and financial communities generally, including changes to
the laws governing taxation, electronic commerce, client privacy
and security of client data. In addition, changes to these
rules and regulations could result in limitations on the lines of
business the Freedom Companies conduct, modifications to their
business practices, more stringent capital and
liquidity requirements, or additional costs. These
changes may also require the Freedom Companies to invest
significant management attention and resources to evaluate and make
necessary changes to their compliance, risk management, treasury
and operations functions.
International currency exchange rates may affect the investment
practices of the customers of the Freedom Companies.
The
customers of the Freedom Companies seek to invest in U.S.
securities in part to dampen the financial risk of domestic
currency fluctuations and to invest in dollar-denominated
securities. Even though the Freedom Companies’
customers’ investments in U.S. securities are
dollar-denominated, the funds available to customers to invest will
depend on the rates at which the dollar is convertible into the
currency of the country in which they reside—principally the
Russian ruble and the Kazakh tenge. Declines in the value of the
Russian ruble or the Kazakh tenge compared to the U.S. dollar
reduce the amounts that residents of those countries have to invest
in the U.S. Conversely, increases in the value of the Russian ruble
and the Kazakh tenge relative to the U.S. dollar reduces the
financial advantage of investing in U.S. securities. Customer
expectations respecting applicable currency exchange rates may
affect the timing, number, and amounts of customer transactions in
U.S. securities. Accordingly, the Freedom Companies’
businesses may be affected substantially by currency exchange rate
fluctuations.
It may be difficult for us to enforce any civil liabilities against
our customers that are outside the United States.
The
customers of the Freedom Companies are residents of countries
outside of the U.S. and beyond the jurisdiction of U.S. courts. As
a result, it may be difficult for us to enforce within the U.S. any
claims or seek any remedies against such foreign persons, including
claims, remedies, or judgments predicated upon the civil liability
provisions of the securities laws of the U.S. or any state.
Instead, we, or our subsidiaries, may as a practical matter, be
forced to rely on remedies under foreign laws as interpreted and
enforced by foreign courts, which generally would not enforce U.S.
laws or enforce or interpret contracts consistent with U.S. legal
principles or precedent. Further, such foreign courts and laws in
Russia and Kazakhstan are based on non-Western principles of
jurisprudence and may not provide the same kinds of remedies,
relief, or procedural safeguards that are familiar in U.S. or
Western legal systems.
International currency exchange rates will affect the investment
practices of our customers.
The
customers of the Freedom Companies seek to invest in U.S.
securities in part to dampen the financial risk of domestic
currency fluctuations and to invest in dollar-denominated
securities. Even though the Freedom Companies’
customers’ investments are dollar-denominated, the funds
available to customers to invest will depend on the rates at which
the dollar is convertible into the currency of the country in which
they reside—principally the Russian ruble and the Kazakh
tenge. Declines in the value of the Russian ruble or the Kazakh
tenge compared to the U.S. dollar reduce the amounts that residents
of those countries have to invest in the United States. Conversely,
increases in the value of the Russian ruble and the Kazakh tenge
relative to the U.S. dollar reduces the financial advantage of
investing in U.S. securities. Customer expectations respecting
applicable currency exchange rates may affect the timing, number,
and amounts of customer transactions in U.S. securities.
Accordingly, our business may be affected substantially by currency
exchange rate fluctuations.
Risks Related Generally to our Business
We may not be able to generate positive cash flow and
profitability.
Our
ability to generate positive cash flow and profitability depends on
the ability of the Freedom Companies to generate and maintain
revenue greater than the level of expenses we incur. Their ability
to do this depends, among other things, on:
●
maintenance and
increase of their customer base;
●
management of the
quality of their services;
●
effective
competition with existing and potential competitors;
●
further development
of their business activities;
●
attraction and
retention of qualified personnel;
●
ability to limit
operating costs;
●
integration of
their activities and the broader development of an integrated
securities brokerage and banking business;
●
compliance with the
regulatory regimes in each of the jurisdictions in which they
operate; and
●
maintenance of
adequate working capital.
We will
be unable to achieve/maintain profitability if the Freedom
Companies fail to do any of the foregoing. We cannot be certain
that the Freedom Companies will be able to consistently generate
positive cash flow and profitability in the future. Their inability
to consistently generate profitability or positive cash flow could
result in disappointing financial results, impede implementation of
their growth strategy, or have an adverse impact on the trading
price or volume of our common stock. Accordingly, we cannot assure
that we will be able to generate the cash flow and profits
necessary to sustain our business.
Developments in the business, economic, and geopolitical
environment could negatively impact the business of the Freedom
Companies.
The
businesses of the Freedom Companies can be adversely affected by
the general environment, including economic, corporate, securities
market, regulatory, and geopolitical developments all play a role
in client asset valuations, trading activity, interest rates and
overall investor engagement, and are outside their control.
Deterioration in the credit markets, reductions in short-term
interest rates, and decreases in securities valuations negatively
impact their results of operations and capital
resources.
Failure to meet capital adequacy and liquidity guidelines could
affect the financial condition of the Freedom
Companies.
The
Freedom Companies must meet certain capital and liquidity
standards, subject to qualitative judgments by regulators about the
adequacy of their capital and internal assessment of their capital
needs. These net capital rules may limit the ability of each
Freedom Company to transfer capital to the Company or any other
Freedom Company. New regulatory capital, liquidity, and stress
testing requirements may limit or otherwise restrict how each
Freedom Company utilizes its capital, and may require a Freedom
Company to increase its capital and/or liquidity or to limit its
growth. Failure by any Freedom Company to meet its minimum capital
requirements could result in certain mandatory and additional
discretionary actions by regulators that, if undertaken, could have
a negative impact on us.
A significant decrease in liquidity could negatively affect the
business and financial management of the Freedom Companies as well
as reduce client confidence.
Maintaining
adequate liquidity is crucial to the business operations of the
Freedom Companies. They meet their liquidity needs primarily
through cash generated by client activity and operating earnings,
as well as cash provided by external financing. Fluctuations in
client cash or deposit balances, as well as changes in regulatory
treatment of client deposits or market conditions, may affect their
ability to meet their liquidity needs. A reduction in their
liquidity position could reduce customer confidence, which could
result in the loss of customer accounts, or could cause them to
fail to satisfy their liquidity requirements. In addition, if they
fail to meet regulatory capital guidelines, regulators could limit
their operations.
Factors
which may adversely affect their liquidity position include having
temporary liquidity demands due to timing differences between
brokerage transaction settlements and the availability of
segregated cash balances, unanticipated outflows of company cash,
fluctuations in cash held in banking or brokerage customer
accounts, a dramatic increase in customer lending activities
(including margin and personal lending), increased capital
requirements, changes in regulatory guidance or interpretations,
other regulatory changes, or a loss of market or customer
confidence.
If
cash generated by customer activity and operating earnings is not
sufficient for their liquidity needs, they may be forced to seek
external financing. During periods of disruptions in the credit and
capital markets, potential sources of external financing could be
reduced, and borrowing costs could increase. Financing may not be
available on acceptable terms or at all due to market conditions or
disruptions in the credit markets.
The Freedom Companies may suffer significant losses from credit
exposures.
The
business of the Freedom Companies is subject to the risk that a
customer, counterparty or issuer will fail to perform its
contractual obligations, or that the value of collateral held to
secure obligations will prove to be inadequate. While the Freedom
Companies have policies and procedures designed to manage this
risk, the policies and procedures may not be fully effective to
protect the Freedom Companies against the risk of loss. The
exposure of the Freedom Companies results principally from margin
lending, clients’ options trading, futures activities,
securities lending, their role as a counterparty in financial
contracts, investing activities, and indirectly from proprietary
investing of the Freedom Companies own funds.
When
customers purchase securities on margin, borrow on lines of credit
collateralized by securities, or trade options or futures, the
Freedom Companies are subject to the risk that customers may
default on their obligations when the value of the securities and
cash in their accounts falls below the amount of the
customers’ indebtedness. Abrupt changes in securities
valuations and the failure of customers to meet margin calls could
result in substantial losses.
The
Freedom Companies have exposure to credit risk associated with
their investments. Those investments are subject to
price fluctuations as a result of changes in the Russia, Kazakhstan
and U.S. financial markets’ assessment of credit quality.
Loss of value of securities can negatively affect earnings if
management determines that such securities are other than
temporarily impaired. The evaluation of whether
other-than-temporary impairment (OTTI) exists is a matter of
judgment, which includes the assessment of several factors. If
management determines that a security is OTTI, the cost basis
of the security may be adjusted and a corresponding loss may be
recognized in current earnings. Deterioration in the performance
of available for sale securities could result in the
recognition of future impairment charges. Even if a security is not
considered OTTI, if the Freedom Company holding the security
were ever forced to sell the security sooner than intended prior to
maturity due to liquidity needs, that Freedom Company would have to
recognize any unrealized losses at that time.
The Freedom Companies’ investments expose them to a
significant risk of capital loss.
The
Freedom Companies use a portion of their own capital in a variety
of investment activities, each of which involves risks of
illiquidity, loss of principal and revaluation of assets. The
companies in which they invest may concentrate on markets which are
or may be disproportionately impacted by pressures in the sectors
on which they focus, and their existing business operations or
investment strategy may not perform as projected. As a result, they
have suffered losses in the past and may suffer losses from their
investment activities in the future.
The
Freedom Companies’ investments are concentrated in relatively
few companies and industries and a consequence of this
investment strategy is that their investment returns will be
materially and adversely affected if the companies or the
industries they target perform poorly. As a result, if a
significant investment fails to perform as they anticipated their
business, financial condition and results of operations could be
more negatively affected and the magnitude of the loss could be
more significant than if they had made smaller investments in more
companies and industries.
Even
if the Freedom Companies make appropriate investment decisions
based on the intrinsic value of an enterprise, we cannot assure you
that the market value of the investment will not decline, perhaps
materially, as a result of general market conditions or changes in
law. For example, an increase in interest rates, a general decline
in the stock markets, or other market conditions adverse to
companies or investment funds of the type in which the Freedom
Companies invest could result in a decline in the value of their
investments. Additionally, changes in existing laws, rules or
regulations, or judicial or administrative interpretations thereof,
or new laws, rules or regulations could have an adverse impact on
the business and industries in which the Freedom Companies
invest.
Changes in interest rates could negatively affect the value of
investments the Freedom Companies make with their
capital, which could result in reduced earnings or
losses.
From
time to time, the Freedom Companies invest capital in interest rate
sensitive securities. “Long” investments that are
sensitive to interest rate fluctuations will decline in value if
long-term interest rates increase, and “short”
investments that are sensitive to interest rate risk will decline
in value if long-term interest rates decrease. Declines in market
value may ultimately reduce earnings or result in losses to
us.
Freedom RU and Freedom KZ are subject to risks associated with
their securities lending business.
Freedom
RU and Freedom KZ have an active securities borrowed and loaned
business in which they borrow securities from one party and lend
them to another. As a result, market risk in their
securities lending business arises when the market value of
securities borrowed declines relative to the cash they post as
collateral with the lender; and when the market value of securities
they have loaned increases relative to the cash they have received
as collateral from the borrower. Market value fluctuations in
their securities lending business are measured daily and any
exposure versus cash received or posted is settled daily with
counterparties. In addition, credit risk from their
securities lending operations arises if a lender or borrower
defaults on an outstanding securities loan or borrowing transaction
and the cash or securities they are holding is insufficient to
cover the amount they owe the Freedom Companies for that
receivable. Finally, there is systemic risk associated with
the concentration of clearing and related functions in covered
clearing agencies involved in securities lending activities. The
market and credit risks associated with their securities lending
business have the potential of adversely impacting their business,
financial condition and results of operations.
Operating risks associated with Freedom RU and Freedom KZ’s
securities lending business may result in counterparty losses,
and in certain circumstances, potential financial
liabilities.
As
part of their securities lending business, Freedom RU and Freedom
KZ lend securities to banks and broker-dealers on behalf of certain
of their clients. In these securities
lending transactions, the borrower is required to provide and
maintain collateral at or above regulatory
minimums. Securities on loan are marked to market daily
to determine if the borrower is required to pledge additional
collateral. The Freedom Companies must manage this
process and are charged with mitigating the associated operational
risks. Failure to mitigate such operational risks could
result in financial losses for counterparties in the securities
lending business (separate from the risks of collateral
investments) of Freedom RU and Freedom KZ. Additionally,
in certain circumstances, Freedom RU or Freedom KZ could
potentially be held liable for the failure to manage any such
risks.
Larger and more frequent capital commitments in the trading and
underwriting businesses of Freedom RU and Freedom KZ increase the
potential for them to incur significant losses.
Freedom
RU and Freedom KZ commit their capital to maintain trading
positions in the equity, convertible securities and debt markets.
They may enter into large transactions in which they commit their
own capital as part of their client trading activities. The number
and size of these large transactions may adversely affect our
results of operations in a given period. Although they may take
measures to manage market risk, such as employing inventory
position limits and using quantitative risk measures, they may
incur significant losses from their trading activities due to
market fluctuations and volatility in their results of operations.
To the extent that they own assets, i.e., have long positions,
in any of those markets, a downturn in the value of those assets or
in those markets could result in losses. Conversely, to the extent
they have sold assets they do not own, i.e., have short
positions, in any of those markets, an upturn in those markets
could expose them to potentially large losses as they attempt to
cover their short positions by acquiring assets in a rising
market.
We are a holding company and are dependent on our subsidiaries for
funds.
Since
we are a holding company, our cash flow and consequent ability to
satisfy our obligations is dependent upon the earnings of our
subsidiaries and the distribution of those earnings as dividends or
loans or other payments by those subsidiaries to us. Our
subsidiaries are subject to various capital adequacy requirements
promulgated by regulatory and other authorities. These regulatory
rules may restrict our ability to withdraw capital from our
subsidiaries by dividends, loans or other payments. Additionally,
our ability to participate as an equity holder in any distribution
of assets of any subsidiary upon liquidation is generally
subordinate to the claims of creditors of the
subsidiary.
The operations and infrastructure of the Freedom Companies may
malfunction or fail.
The
broker-dealer, financial services and banking businesses are highly
dependent on processing, on a daily basis, a large number of
communications and increasingly complex transactions across diverse
markets, in different languages. The financial, accounting, or
other data processing systems the Freedom Companies, or the firms
that clear transactions on behalf of their customers, use may fail
to operate properly or become disabled as a result of events that
are wholly or partially beyond their control, including a
disruption of electrical or communications services or their
inability to occupy one or more of our facilities. The inability of
these systems to accommodate an increasing volume of transactions
could also constrain their ability to expand their businesses. If
any of these systems do not operate properly or are disabled, or if
there are other shortcomings or failures in their internal
processes, personnel, or systems, they could suffer impairment to
their liquidity, financial loss, a disruption of business,
liability to clients, regulatory intervention, or reputation
damage.
They
also face the risk of operational failure of any of the exchanges,
depositories, clearing houses, clearing firms or other financial
intermediaries they use to facilitate their securities
transactions. Any such failure or termination could adversely
affect their ability to effect transactions and to manage their
exposure to risk.
Their
ability to conduct business may be adversely impacted by a
disruption in the infrastructure that supports their business and
the communities in which they and third parties with which they
conduct business are located, including disruption involving
electrical, communications, transportation, or other services,
whether due to fire, other natural disaster, power or
communications failure, act of terrorism, war, or otherwise. The
Freedom Companies have employees in a number of cities in Russia
and Kazakhstan, all of who need to work and communicate as an
integrated team. If a disruption occurs in one location and their
employees in that location are unable to communicate with or travel
to other locations, their ability to service and interact with
their clients may suffer, and they may not be able to successfully
implement contingency plans that depend on communication or travel.
We do not maintain insurance policies to mitigate these risks
because it may not be available or may be more expensive than the
perceived benefit. Further, any insurance that we may purchase to
mitigate certain of these risks may not cover these
losses.
Their
operations rely on the secure processing, storage, and transmission
of confidential and other information in our computer systems and
networks. Their computer systems, software, and networks may be
vulnerable to unauthorized access, computer viruses or other
malicious code, and other events that could have a security impact.
The occurrence of one or more of these events could:
(a) jeopardize confidential and other information processed
by, stored in, and transmitted through their computer systems and
networks or the computer systems and networks of their customers or
other third parties with which they conduct business; or
(b) otherwise cause interruptions or malfunctions in their
operations or the operations of their customers or third parties
with which they conduct business. They may be required to expend
significant additional resources to modify their protective
measures or to investigate and remediate vulnerabilities or other
exposures, and they may be subject to litigation and financial
losses that are either not insured against or not fully covered
through any insurance.
In
addition to the risk of systems failures or interruption from
benign but nevertheless disruptive causes, the systems they use and
rely on may also be vulnerable to intentional unauthorized access,
vandalism, software interruption, data corruption, or other
mischief by unauthorized third parties, or “hackers.”
Such efforts may be directed at them and their business
specifically, which might disrupt their operations, or generally to
broadly based, international financial, banking, and communications
systems, which could disrupt broad segments of the financial and
banking systems worldwide. Any such disruptions could adversely
affect our business and results of operations.
The Freedom Companies are dependent on their executive management
teams, in particular Timur Turlov, and they may not be able to
execute their business plan in the event that members of their
executive management teams are no longer available to them and they
are unable to find suitable replacements for them or the members of
their executive management teams do not dedicate a sufficient
amount of their professional time to their endeavors.
The
Freedom Companies depend on the efforts, skill, reputations and
business contacts of the executive management teams of the Freedom
Companies, in particular Timur Turlov, and we believe their success
depends to a significant extent upon the experience of these
individuals, whose continued service is not
guaranteed. We have no assurance that the services of
these executive management teams will continue to be available to
the full extent of the needs of the Freedom Companies. If certain
members of the executive management teams leave or are otherwise no
longer available to their respective Freedom Company or are not
available to the full extent of their needs, they may not be able
to replace them with suitable management and may be unable to
execute their business plan.
It may be
difficult for our stockholders to enforce any civil liabilities
against us or our officers or directors, because many of our
officers and operations are, and are expected to be, outside the
United States.
The
assets of the Freedom Companies are located outside the United
States. Several of our directors and officers are nationals and/or
residents of countries other than the United States, with all or a
substantial portion of each person’s assets located outside
the United States. As a result, it may be difficult for investors
to enforce within the United States any judgments obtained against
us or our officers or directors, including judgments predicated
upon the civil liability provisions of the securities laws of the
United States or any state. Further, it may be difficult for
investors to enforce in foreign countries judgments obtained in the
United States.
Pricing and other competitive pressures may impair the revenue and
profitability of the Freedom Companies.
The
Freedom Companies derive their revenues from brokerage, banking and
financial services businesses serving customers in Russia and
Kazakhstan. Investing by retail customers, particularly in U.S.
securities, is an emerging market in those countries, and we expect
the Freedom Companies will encounter intense price competition in
this business as this industry matures with more competitive
service providers. We believe the Freedom Companies may experience
competitive pressures in these and other areas as existing or new
competitors seek to obtain market share by competing on the basis
of price or service. In addition, their retail brokerage business
will likely face pressure from larger competitors, which may be
better able to offer a broader range of complementary products and
services to retail brokerage clients in order to win their trading
business. The inability of the Freedom Companies to compete
effectively with their competitors in these areas would adversely
affect their business, financial condition, and results of
operations.
From time-to-time the Freedom Companies may be subject to
litigation and regulatory investigations and proceedings and may
not be successful in defending themselves against claims or
proceedings.
The
financial services industry faces significant litigation and
regulatory risks. From time-to-time the Freedom Companies may be
subject to claims and lawsuits in the ordinary course of business,
including arbitrations, class actions and other litigation, some of
which include claims for substantial or unspecified damages. From
time-to-time they may also be the subject of inquiries,
investigations, and proceedings by regulatory and other
governmental agencies.
Actions
brought against them may result in settlements, awards,
injunctions, fines, penalties or other results adverse to them
including reputational harm. Even if they are successful in
defending against such actions, the defense of such matters may
result in them incurring significant expenses. A substantial
judgment, settlement, fine, or penalty could be material to our
operating results or cash flows for a particular future period,
depending on our results for that period. In market downturns, the
volume of legal claims and amount of damages sought in litigation
and regulatory proceedings against financial services companies
have historically increased.
Risks Related to Owning our Stock
A significant percentage of our outstanding common stock is owned
or controlled by Timur Turlov, whose interests may differ from
those of other stockholders.
Timur
Turlov, our chairman and chief executive officer, owns
approximately 88.6% of our outstanding common stock, which could
increase to as high as 95% as contemplated by the Acquisition
Agreement. Therefore, Mr. Turlov will be able to control all
matters requiring approval by our stockholders, including the
election of directors, the approval of our proposed
recapitalization, and approval of significant corporate
transactions. This concentration of ownership may also have the
effect of delaying or preventing a change in control of us and
might affect the market price of our common stock.
Provisions of our organizational documents may be potentially
detrimental to our common stockholders.
Our
articles of incorporation authorize our board of directors to fix
the relative rights and preferences of our 20,000,000 shares of
authorized preferred stock, without approval from our stockholders.
This could affect the rights of our common stockholders regarding,
among other things, voting, distributions, dividends and
liquidation. We could also use the preferred stock to deter or
delay a change in control of our Company that may be opposed by our
management, even if the transaction might be favorable to our
common stockholders.
There is a limited trading market for our common
stock.
Although our common
stock is currently quoted on the OTC Pink market, our stock trades
sporadically, with limited volume. We cannot assure that a more
active trading market will develop. Accordingly, our stockholders
may not be able to sell our shares when they want or at the price
they want.
Penny stock regulations will impose certain restrictions on resales
of our securities, which may cause an investor to lose some or all
of its investment.
The SEC
has adopted regulations that generally define a “penny
stock” to be any equity security that has a market price (as
defined) of less than $5.00 per share that is not traded on a
national securities exchange or that has an exercise price of less
than $5.00 per share, subject to certain exceptions. As a result,
our common stock is subject to rules that impose additional sales
practice requirements on broker-dealers that sell these securities
to persons other than established customers and accredited
investors (generally those with assets in excess of $1,000,000 or
annual income exceeding $200,000, or $300,000 together with their
spouse). For transactions covered by these rules, the broker-dealer
must make a special suitability determination for the purchase of
these securities and have received the purchaser’s written
consent to the transaction before the purchase. Further, if the
price of the stock is below $5.00 per share and the issuer does not
have $2,000,000 or more net tangible assets or is not listed on a
registered national securities exchange, sales of such stock in the
secondary trading market are subject to certain additional rules
promulgated by the SEC. These rules generally require, among other
things, that brokers engaged in secondary trading of penny stocks
provide customers with written disclosure documents, monthly
statements of the market value of penny stocks, disclosure of the
bid and asked prices, and disclosure of the compensation to the
broker-dealer and the salesperson working for the broker-dealer in
connection with the transaction. These rules and regulations may
affect the ability of broker-dealers to sell our common stock,
thereby effectively limiting the liquidity of our common stock.
These rules may also adversely affect the ability of persons that
acquire our common stock to resell their securities in any trading
market that may exist at the time of an intended sale.
We are a smaller reporting company, and the reduced reporting
requirements applicable to smaller reporting companies may make our
common stock less attractive to investors.
We are
a “smaller reporting company” as defined in Section 12
of the Exchange Act. For as long as we continue to be a smaller
reporting company, we may take advantage of exemptions from various
reporting requirements that are applicable to other public
companies that are not smaller reporting companies, including not
being required to comply with the auditor attestation requirements
of Section 404 of Sarbanes-Oxley, reduced disclosure obligations
regarding executive compensation in our periodic reports and proxy
statements, and exemptions from the requirements of holding
nonbinding advisory votes on executive compensation, and
stockholder approval of any golden parachute payments not
previously approved. We could remain a smaller reporting company
until the last day of the fiscal year when the aggregate worldwide
market value of the voting and nonvoting common equity held by our
nonaffiliates is $75 million or more on the last business day of
our most recently completed second fiscal quarter, but less than
$700 million. We cannot predict if investors will find our common
stock less attractive because we may rely on these exemptions. If
some investors find our common stock less attractive as a result,
there may be a less active trading market for our common stock and
our stock price may be more volatile.
Item
1B.
U
nresolved Staff Comments
None.
With
the closing of the Freedom RU acquisition, our principal executive
office will be located at Office 1704, 4B Building, “Nurly
Tau” BC, 17 Al Farabi Ave. Almaty, Kazakhstan 050059 in
approximately 91 square feet of leased space. The Freedom Companies
also maintain a securities brokerage branch at this location. This
lease expires in December 2017. As of June 29, 2017, they also
lease 13 other securities brokerage branch locations in Kazakhstan,
one administrative office for their securities brokerage and
banking operations in Russia, 12 securities brokerage branch
locations and two bank branch locations in Russia, and our two
locations in Salt Lake City, Utah. The lease terms for these
offices range from month-to-month to year-to-year and expire at
various dates through December 2019. Monthly lease payment
obligations are currently approximately $104,000. All locations are
leased. We believe these offices are suitable and
adequate.
In the
normal course of our business, lawsuits and claims may be brought
against us and our subsidiaries.
While
the ultimate outcome of these proceedings cannot be predicted with
certainty, our management, after consultation with legal counsel
representing us in these proceedings, does not expect that the
resolution of these proceedings will have a material effect on our
financial condition, results of operations or cash
flows.