By Morris N. Simkin,
Sandra Holtzman
And David Schmidt

   Neogenix Oncology was organized in 2004 when Dr. Ariel Hollinswhead, professor of medicine and head of the George Washington University Cancer Research Laboratory, assigned her research on developing therapeutic and diagnostic products to treat pancreatic, colon, lung, prostate and colorectal cancers to the company. Its efforts focused primarily on the development of therapeutic monoclonal antibodies targeted against pancreatic and colorectal cancer. To fund itself through the start-up and developmental stages it relied on the sale of its common stock to third parties. And this is where our tale of woe begins.¹

   Between 2004 and 2011 Neogenix raised $47.1 million through the sale of shares using third-party finders who were not registered to sell stock either with the Securities and Exchange Commission or any state securities commission. These finders made a total of 83 placements and were paid $3.8 million.²

   But all of this had to surface. The Securities Exchange Act at the time required companies with over $10 million in assets and over 500 shareholders of record to register with the SEC and file quarterly and annual reports.

   Neogenix registered its stock with the SEC in April 2006. In its filings with the SEC, Neogenix disclosed these numerous sales of its common stock using finders.³

The JOBS Act doesn't really help the small companies seeking capital through private placements without the use of SEC-registered broker-dealers.

   In October 2011 the SEC's Philadelphia Regional Office wrote Neogenix asking for an explanation of its numerous sales of stock through the use of finders that were not SEC-registered broker-dealers.⁴ Under the Securities Exchange Act it is illegal to sell a company's common stock through the use of third parties that are not registered as broker-dealers with the SEC. Transactions in violation of the Securities Exchange Act can be voided by the party who did not violate the act. In addition, many state securities laws or "blue sky" laws provide a right of rescission to the buyer of securities sold by a finder that is not licensed under that state's securities laws. Neogenix may have had an inkling of this because in May 2011 it terminated its chief financial officer.

   This letter from the SEC caused great consternation at the company and with its accountants. How should they account for the possible liability since these various sales of common stock using finders could be rescinded? It took Neogenix and its accountants some six months to resolve this.⁵ Neogenix got the SEC's Chief Accountant's Office to agree that until suits were filed for rescission of these sales, it would disclose the sales in possible violation of the law as a footnote to its financial statement and estimate its contingent liability. In the footnotes to its Dec. 31, 2011, financial statements, Neogenix stated that no suits had been filed and estimated its contingent liability could be as much as $31 million. These same financial statements showed the company had total assets of $6,341,626 and a net worth of $4 million.

   With these disclosures their sources of capital dried up. They retained an investment banking firm in mid-2011 to raise capital. But with no success. They retained another investment banking firm in 2012 to advise them what to do—merge, sell to another company or reorganize under the Bankruptcy Code.⁶ Reorganizing under the Bankruptcy Code would allow the successor to Neogenix to take over the research that had been performed but without assuming any liability for the sales of shares using unregistered finders.⁷

   The end result was that Neogenix filed under Chapter 11 of the Bankruptcy Code, and sold itself to a company organized by several of its insiders. As a result of the bankruptcy process, the contingent liability of Neogenix from the sale of its stock using unlicensed finders was wiped out and was not assumed by the buyer of its assets. Part of this sale included a distribution of the buyer's stock to the then shareholders of Neogenix, but nowhere near the number of shares that these shareholders held in Neogenix.

    And to rub salt in their wounds, the buyer offered to sell its shares to the existing Neogenix shareholders.⁸

   The JOBS Act Doesn't Help

   The Jumpstart Our Business Startups Act (JOBS Act) passed in 2012 makes several changes to the securities laws that on their face appear to make the capital-raising process easier for startup companies. But it doesn't really help the small companies seeking capital through private placements without the use of SEC-registered broker-dealers. First, it provides an exemption from the requirement to register with the SEC as a broker-dealer for companies/finders that make or arrange private placements under SEC Rule 506 (sales to accredited investors, no general solicitations). However, that exemption is only from SEC and not state broker-dealer registration requirements, and the exemption is only available if the broker/finder does not receive any transaction-based compensation,e.g., based on sale of such securities.

The JOBS Act provides for crowdfunding. But the crowdfunding must be through an entity that is either registered with the SEC as a broker-dealer or crowdfunding portal and is also a member of FINRA.

    Second, the JOBS Act provides for crowdfunding. But the crowdfunding must be through an entity that is either registered with the SEC as a broker-dealer or crowdfunding portal and is also a member of the Financial Industry Regulatory Authority (FINRA). Neither the SEC nor FINRA have yet adopted, much less proposed, any rules regarding this registration process and the related rules governing the activities of such crowdfunding portals. In October 2012, the SEC in its publication of its rule-making agenda provided no time frame for the issuance of or proposal of such rules.

   Further, the JOBS Act prohibits the crowdfunding portal from compensating any promoter, finder or lead generators for providing it with information about potential investors, and amended the Securities Exchange Act to provide in the definition of a crowdfunding portal that it could not compensate employees, agents or others for soliciting or based on the sale of securities displayed or referenced on the crowdfunding portal's website.

      Dilemmas for Start-Ups

   What does all this mean for the startup and development stage company that badly needs capital? If you succeed, sooner or later you will have to either register your stock with the SEC, or have an audited financial statement and an opinion from counsel to get a major bank loan, when you sell out to a public company or go public yourself. As part of that process the sale of stock using unlicensed finders will be discovered, and will be reflected in a lower price or, worse yet, the bank, buyer or underwriter walking away from the potential liability.

   Neogenix is a perfect example of the decisions and dilemmas faced by every start-up company that is going to raise money and perhaps go public. (Other dilemmas include the decision to do PR and market or not and when, and included in that is what information to release to the public and analysts, and whether or not to listen to the Board of Advisors and/or Directors when their recommendations are dissimilar or outright contradictory to the path management wants to pursue). All along the way, advisors warned of problems but no one in the company listened, or merely brushed them off. Rational minds might have been overruled by others.

   The internal pressures to reach a liquidity milestone or event are enormous. The temptations to pursue shortcuts, legal, quasi-legal, and not legal at all are often overwhelming. In the race to reach these goals, shareholders, both internal and external, as well as the ultimate good of the company over the long run are often overlooked. Add in the arrogance of management, particularly scientist-founders, and the ingredients for a recipe guaranteed to cause indigestion (at the very least) after the meal are complete.

   In the current funding environment there is a lot of negativity expressed toward venture capitalists and the amount of control they want for their investment. However, in this example, had VCs been involved, the entire situation would have been avoided. Yes, certainly, there would have been other big issues. But the company would be further down the road toward proof-ofconcept and product or platform than they are today. Today, in-fighting over money and power takes precedence over the development of the company. Soon responsibility for decisions may be added to the mix if jail time or other substantial penalties become imminent.

   Everyday start-up companies are given good advice from internal or outside sources. It is up to them to choose the right road from the start. The question they must ask when they are desperate for money is, do I gamble and take a risk (always defined by the company as a shortcut) or do I do the right thing and delay gratification. The answer is often the key to the company's ultimate success.

  1. Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended Dec. 31, 2011, of Neogenix Oncology Inc. as filed on July 7, 2012 (2011 Form 10-K); Notification of Late Filing, Form 12b-25 for the period ended Sept. 30, 2011, filed by Neogenix Oncology Inc. Neogenix Oncology Inc. letter to shareholders dated June 29, 2012

  2. Neogenix Oncology Inc. 2011 Form 10-K. In 2004 after it originally issued its common stock to its founders, Neogenix made eight placements of stock totaling 958,000 shares. Four of these placements, totaling 521,000 shares for $521,000, were made through persons and entities that were not registered with the SEC or any state securities commission. In 2005 Neogenix sold 1,526,123 shares in 10 placements. Seven of these placements, totaling 941,123 shares and raising $1,172,248 were made using "finders." In 2006 it sold 481,966 shares in 13 placements. It made seven of these placements totaling 284,133 shares using finders and raised $822,399. In 2007 Neogenix sold 2,234,695 shares in 15 placements. It used finders in 10 placements. The finders sold 2,135,483 shares raising $7,195,670. In 2008 Neogenix sold 4,633,975 shares in 18 placements. It used finders in 12 placements to sell 2,139,725 shares raising $2,253,750. In 2009 it sold 1,949,183 shares in 13 placements. It used finders to make 12 placements totaling 3,196,058 shares and raised $10,103,265. In 2010 Neogenix sold 884,398 shares in 10 placements. It used finders to make all these placements raising $10,253,725. In 2011 Neogenix made four placements. It used finders to make three placements totaling 228,101 shares raising $14,817,550.

  3. Form 10 as filed by Neogenix Oncology Inc. with the Securities and Exchange commission on April 30, 2010.

  4. Neogenix Oncology Inc. 2011 Form 10-K. 5. Neogenix Oncology Inc. July 6, 2012, letter to shareholders, Neogenix Oncology Inc. 2011 Form 10-K.

  6. Neogenix Oncology Inc. 2011 Form 10-K. 7. Neogenix Oncology Inc. letter to shareholders of June 29, 2012.

  8. Neogenix Oncology Inc. Current Report on Form 8-K for Sept. 20, 2012.

Morris N. Simkin is a partner at McLaughlin & Stern. Sandra Holtzman is president and founder of Holtzman Communications, a marketing firm specializing in the life sciences. David Schmidt is a principal at Advanced Materials Advisory, a marketing and business development consulting company in Chester, N.J., that helps growing advanced technology companies.