Small-Cap Reverse Mergers Poised for a Comeback

The good news about reaching bottom is that the only place to go from there is up. As I have blogged about recently, since 2009, the small cap and reverse merger market has diminished greatly. According to industry statistics, 2011 was the slowest year for reverse mergers since 2004.

To reiterate my previous blogs, I can identify at least seven main reasons for the downfall of the reverse merger market. Briefly, those reasons are: (1) the general state of the economy, plainly stated, it’s not good; (2) backlash from a series of fraud allegations, SEC enforcement actions, and trading suspensions of Chinese company’s following reverse mergers; (3) the 2008 Rule 144 amendments including the prohibition of use of the rule for shell company and former shell company shareholders; (4) problems clearing penny stock with broker dealers and FINRA enforcement of broker dealer due diligence on penny stocks; (5) DTC scrutiny and difficulty in obtaining clearance following a reverse merger or other corporate restructuring; (6) increasing costs of reporting requirements, including the new XBRL requirements; and (7) the new listing requirements imposed by NYSE, AMEX and NASDAQ and prohibition against immediate listing following a reverse merger.

However, despite these issues and the chill in the reverse merger market, the fact is that going public is and remains the best way to access capital markets. Public companies will always be able to attract a PIPE investor. For cash poor companies, the use of a trading valuable stock is the only alternative for short term growth and acquisitions. At least in the USA, the stock market, day traders, public market activity and the interest in capital markets will never go away; it will just evolve to meet ever changing demand and regulations.

That very evolution has created new opportunities, including the opportunity for a revived, better, reverse merger market. Certainly there are alternatives to a reverse merger, for instance a company can go public directly either through a private placement followed by S-1 registration statement; a direct public offering (DPO) or especially for those in the internet or tech business, trading on a private company market place (PCMP).

However, each of these alternatives can be difficult and time consuming. Many companies abandon DPO’s or private offerings prior to completion. Raising money for a trading public company is difficult, for a non-trading pre-public company, it can be impossible. Unscrupulous unregistered companies and individuals prey on these entities, taking their time and money and leaving a mess that can take years and more money to clean up.

A reverse merger remains the quickest and cleanest way for a company to go public. The increased difficulties in general and scrutiny by regulators may be just what the industry needed to weed out the unscrupulous players and invigorate this business model. Shell companies will necessarily require greater due diligence up front, if for no other reason than to ensure DTC eligibility and broker dealer tradability. Increased due diligence will result in fewer post merger issues.

The over the counter market should regain credibility and support higher stock prices, since exchanges are forcing companies to trade there for a longer period of time before becoming eligible to move up. Rule 419 SPAC’s may increase providing clean new entities to complete reverse mergers. Resale registration statements, and thus disclosure, may increase to combat the Rule 144 prohibitions. We have already seen greater disclosure by non-reporting entities trading on otcmarkets.com.

In summary, we believe that the issues and setbacks of the reverse merger market since 2008 have primed the pump and created the perfect conditions for a revitalized, better reverse merger market beginning in mid to late 2012.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Change in NYSE and AMEX Listing Requirements For Companies Completing Reverse Mergers with Public Shell Companies

On November 8, 2011 the SEC granted an accelerated approval to a proposed rule change initiated by the NYSE AMEX, whereby the NYSE AMEX amended its rules so that a Company that goes public via a reverse merger with a shell company, must wait at least one year to apply for listing on the NYSE exchange. The NASDAQ exchange proposed, and presumably will have approved, a substantially similar rule. The complete rule change is available on the SEC website.

In response to recent reverse merger abuses, primarily involving accounting fraud related to Chinese company reverse mergers, in July, 2011, the NYSE, AMEX and NASDAQ exchanges proposed more stringent listing requirements for companies seeking to become listed following a reverse merger with a shell company. The rule change prohibits a reverse merger company from applying to list until the combined entity had traded in the U.S. over the counter market, on another national securities exchange, or on a regulated foreign exchange, for at least one year following the filing of all required information about the reverse merger transaction, including audited financial statements. In addition, new rules require that the new reverse merger company has filed all its required reports for the one year period, including at least one annual report.

In addition, the new rule requires that the reverse merger company “maintain a closing stock price equal to the stock price requirement applicable to the initial listing standard under which the reverse merger company is qualifying to list for a sustained period of time, but in no event for less than 30 of the most recent 60 trading days prior to the filing of the initial listing application.”

The rule includes some exceptions for companies that complete a firm commitment offering resulting in net proceeds of at least $40 million dollars.

In addition to the specific additional listing requirements contained in the new rule, the Exchange may “in its discretion impose more stringent requirements than those set forth above if the Exchange believes it is warranted in the case of a particular reverse merger company based on, among other things, an inactive trading market in the reverse merger company’s securities, the existence of a low number of publicly held shares that are not subject to transfer restrictions, if the reverse merger company has not had a Securities Act registration statement or other filing subjected to a comprehensive review by the SEC, or if the reverse merger company has disclosed that it has material weaknesses in its internal controls which have been identified by management and/or the reverse merger company’s independent auditor and has not yet implemented an appropriate corrective action plan.”

In discussing and approving the new rules the SEC noted that the listing standards “provide the means for an exchange to screen issuers that seek to become listed, and to provide listed status only to those that are bona fide companies with sufficient public float, investor base, and trading interest likely to generate depth and liquidity sufficient to promote fair and orderly markets.”

Theoretically, making it more difficult and expensive for reverse merger Companies to list on a major exchange will result in a massive resurgence of issuers seeking to trade on the OTCBB (OTCQB). When all is said and done, and no one has a crystal ball, the OTCBB and OTCQB may be the new home for even larger more established reverse merger companies simply because they are required to trade as such for twelve months before graduating to a larger exchange or because they fall short of listing requirements by so much as a single criteria.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Rule 144 Seller’s Representation Letter

Securities Act of 1933 (“Securities Act”) Rule 144 sets forth certain requirements for the use of Section 4(1) for the resale of securities. Section 4(1) of the Securities Act provides an exemption for a transaction “by a person other than an issuer, underwriter, or dealer.” “Issuer” and “dealer” have pretty straight forward meanings under the Securities Act but the term “underwriter” does not. Rule 144 provides a safe harbor from the definition of “underwriter”. If all the requirements for Rule 144 are met, the seller will not be deemed an underwriter and the purchaser will receive unrestricted securities.

Following the amendments to Rule 144 in 2008, a shareholder cannot simply have a legend removed from restricted shares following the holding period, but rather, must have a present intent to sell in order to have a legend removed. Moreover, following the revisions in 2008, Rule 144 is not available to shell companies, or former shell companies that are not current in their Exchange Act filing requirements. The requirements of Rule 144 must exist as of the date of sale.

Although not set out in the statute, all transfer agents and Issuers, and most clearing and brokerage firms, require an opinion of counsel as to the application of Rule 144 prior to removing the legend from securities and allowing their sale under Rule 144. An opinion letter is generally valid for ninety (90) days from the date of issuance. Accordingly, an attorney may issue an opinion and a transfer agent act to remove a restrictive legend, following which, the requirements of Rule 144 may no longer be valid (such as if a former shell company fails to file its quarterly report or ceases operations and becomes a shell, etc..)

In other words, attorneys, transfer agents and brokers must be certain that all of the conditions of Rule 144 are met prior to taking action to remove a restrictive legend, but only the Seller can ensure that all the conditions are present at the actual time of sale. In order to protect themselves in issuing opinion letters and removing legends, transfer agents and most attorneys now require a letter from the Seller making certain representations and affirmations regarding their eligibility to rely on Rule 144 in the sale of their securities. This letter is commonly referred to as a Seller’s Representation Letter.

The affirmations commonly required and contained in the Seller’s Representation Letter, are:

1. The Seller is the beneficial owner of the subject securities;

2. The Seller has been the beneficial owner of the subject securities for the required holding period (the holding period varies from six months to one year depending on whether the Issuing Company is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended);

3. Confirmation that the Seller is not an affiliate of the Issuing Company and has not been an affiliate for at least 3 months, or that the Seller is an affiliate and is therefore subject to the Rule 144 volume restrictions on sales (drip rules);

4. Confirmation that the Seller is not an underwriter and is not selling the securities for the purpose of making a distribution for or on behalf of the Issuer;

5. Confirmation that the Seller is selling for his/her own account and not for the benefit of a third party, or the Issuer; and

6. Confirmation that the Seller is aware of the Rule 144 requirements and will sell only in accordance with such requirements, including the manner of sale requirements (through a broker).

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

SEC Staff Review of Super 8-K’s

On September 14, 2011 the Securities and Exchange Commission (SEC), Division of Corporate Finance issued disclosure guidance entitled “Staff Observations in the Review of Forms 8-K Filed to Report Reverse Mergers and Similar Transactions.” This blog is a summary of that guidance.

The SEC guidance is a summary of common SEC staff comments in response to Form 8-Ks filed following a reverse merger or similar transaction which results in a company ceasing to be a shell company (commonly referred to as a Super 8-K ). The SEC has discovered that filings often fail to provide all the necessary disclosures under Items 2.01, 5.01 and 9.01 of Form 8-K. Moreover, the SEC frequently asks companies to support their conclusion that they are not a shell company as defined by Rule 12b-2 of the Securities Exchange Act of 1934.

Item 2.01 of Form 8-K entitled, Completion of Acquisition or Disposition of Assets, generally requires a company to provide information following a transaction that is outside the ordinary course of business. The SEC reminds companies that an asset acquisition can result in a company no longer being a shell company in the same way that a business acquisition can. In the event that the asset acquisition results in the Company no longer being a shell company, all information required in a Form 10 Registration Statement, must be filed in a Super 8-K within four (4) days of the closing of the transaction. The SEC disclosure guidance states that “we frequently remind companies that Instruction 2 to Item 2.01 makes clear that the term “acquisition” includes every purchase, acquisition by lease, exchange, merger, consolidation, succession or other acquisition”. Moreover, when a company’s reverse merger or similar transaction includes an asset acquisition as defined in Item 2, then an Item 2.01 disclosure is also required.

Item 5.01 requires disclosures regarding a change of control. The SEC frequently reminds filers that they must include all the disclosures required by this Item when filing a Super 8-K.

Item 9.01 is the Financial Statements and Exhibits section of the Form 8-K. The SEC frequently reminds filers that they must include historical financial statements of the acquired private operating business. In particular, the Form 8-K must include two years of audited financial statements and unaudited, reviewed stub periods to the date of filing. In addition, a Company must include pro forma financial information accounting for the combined companies.

Furthermore, in addition to filing Form 10 information on the acquired company, a company must file Form 10 exhibits on the acquired company, such as significant contracts. If these documents are not in English (as is often seen with Chinese companies and corresponding reverse mergers), the exhibits must also include a translation into English.

The SEC also provided guidance on the Form 10 information disclosure required by a Super 8-K. The SEC indicated that it often requests that a filer enhance its discussion of its business operations under Item 101 of Regulation S-K to include additional information about the planned future operations of the now non-shell Company. In particular, the SEC likes to see clear disclosure on how a company generates or intends to generate revenue.

In a company’s management discussion and analysis provided pursuant to Item 3.03, the SEC often asks companies to identify any elements of historical income or loss that will discontinue as a result of the reverse merger or similar transaction.

In its discussion of directors and executive officers, the SEC often has to remind companies to include all of the information required on the new officers and directors and to discuss their respective experiences, qualifications, attributes and skills that resulted in them being in an executive position.

Finally, the SEC often issues comments requesting more extensive and detailed disclosure on executive compensation and related party transactions following a reverse merger or similar transaction.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Management’s Discussion and Analysis of Financial Condition and Results of Operation (MD&A)

Management’s discussion and analysis of financial condition and results of operation, commonly referred to as MD&A is an integral parts of annual (Form 10-K) and quarterly (Form 10-Q) reports filed with the Securities and Exchange Commission (SEC). MD&A is also included in registration statements filed under both the Securities Exchange Act of 1934 (Form 10) and Securities Act of 1933 (Form S-1). MD&A requires the most input and effort from officers and directors of a company and due to the many components of required information, often generates SEC review and comments. Item 303 of Regulation S-K sets forth the required content for MD&A.

A MD&A discussion for quarterly reports on Form 10-Q is abbreviated from the requirements for annual reports on Form 10-K and registration statements. Although quarterly reports must discuss each item enumerated below the discussion is expected to be more focused concentrating on the most relevant and material items. In addition, as with my other blogs, this discussion will be limited to the requirements for small public companies (i.e. those with revenues of less than $75 million).

The SEC has issued guidance and interpretation on MD&A, which is helpful in understanding its required content. Pursuant to the SEC, MD&A has three primary purposes. These are:

• to provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management;

• to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and

• to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.

Management, and company counsel, should keep these purposes in mind in drafting and finalizing MD&A. The content should not be overly technical, but neither should it be a forum for marketing content. Now, onto the specific MD&A requirements as set forth in Item 303 of Regulation S-K.

In each annual report on Form 10-K, and registration statements on either Forms 10 or S-1, a company must discuss its financial condition, changes in financial condition and results of operations. In addition to the four areas of discussion listed below, a company must include any other relevant information within its knowledge, which information provides a better or more complete understanding of their finances and financial condition. The four areas of financial discussion include:

A company must identify any known trends or known demands, commitments, events or uncertainties that will result in or reasonably could result in an increase or decrease in liquidity. In addition, a company must identify sources and uses of liquidity and any known changes thereto. Explanations of the information provided is required. In layman terms, liquidity is a discussion of sources of cash and uses of cash, and factors that could change or impact either, both as reflected in the financial period covered by the subject report, and for the future. Although not all inclusive, the discussion, at a minimum, should address all items included in the statement of cash flows provided as part of the financial statements. This item, together with the second area of discussion, capital resources, are considered so important the SEC has issued an interpretive release addressing these two areas separately from the rest of MD&A.

A discussion of capital resources includes all material commitments for capital expenditures, the purpose and the source of funds for these commitments. This would include outstanding debts and obligations and simply put, where the money will come from to pay them. In addition, capital resources include a discussion of trends, favorable and unfavorable, that could impact capital resources. An obvious example would be a change in government regulation directly related to the company’s business.

Results of operations include four areas of discussion: (i) unusual or infrequent events that have impacted on a company’s financial condition. An example would be a discontinuance of a specific product line, or sale of company subsidiary. (ii) trends that could have an impact on sales or revenues or income in general, including trends impacting costs and expenses; (iii) a narrative discussion of increases or decreases in sale or revenues; and (iv)impact of inflation and other external financial conditions.

Off balance sheet arrangements have gained notoriety as a result of the recent economic turmoil caused by the mortgage scandal. An off balance sheet arrangement is any arrangement that could have an impact on a balance sheet, the most obvious example being a guarantee of a third party’s obligation. Accordingly, if a company has such an arrangement to report, they are required to provide a detailed analysis including the potential impact and relative importance of the arrangement.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Form 10-Q – Quarterly Reports

All companies that are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are required to file quarterly reports on Form 10-Q. As my clients are all smaller reporting companies (less than $75 million a year in revenues) and non-accelerated filers, this article will be limited to a discussion of those filers. Form 10-Q must be filed within 45 days of the end of each of the first 3 fiscal quarters of the Company.

A Form 10-K is filed following the end of the fourth fiscal quarter and will be the subject of an upcoming article.

Each filer has the right to file for an extension on Form 12b-25 which will not result in the filing being deemed delinquent. Extensions must be filed no later than the due date of the 10-Q and extends the filing time for up to 5 calendar days.

The cover page of the Form 10-Q contains basic company information, including the type and date of the report, the companies’ name and address, SEC filer name, federal tax id number and telephone number. In addition, on the cover page each company must state whether it is a shell company or not by checking a yes or no box. This small piece of information has big ramifications.

Companies that are, or ever were a shell company are severely restricted in the use of Rule 144, may not register the sale of securities accept in accordance with Rule 419 and must file a Super 8-K containing Form 10 type information within four days of a transaction resulting in them no longer being a shell. Attorney practitioners requested to perform services, or investors considering an investment (either through a PIPE or on the open market) should make it standard operating procedure to review historical 10-Q’s for shell company status.

Item 1 of Part I and the bulk of the Form 10-Q are the financial statements. Rule 8-03 regarding interim financial statements for smaller reporting companies provides that “Interim financial statements may be unaudited; however, before filing, interim financial statements included in quarterly reports on Form 10-Q must be reviewed by an independent public accountant using professional standards and procedures for conducting such reviews, as established by generally accepted auditing standards, as may be modified or supplemented by the Commission.”

Interim financial statements must include a balance sheet as of the end of the companies’ most recent fiscal quarter, a balance sheet as of the end of the preceding fiscal year, and income statements and statements of cash flows for the interim period up to the date of such balance sheet and the comparable period of the preceding fiscal year. In addition, the financial statements must include footnotes.

Item 2 of Part I of the Form 10-Q is the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A). In addition to the financial statements, MD&A is arguably the most important part of a Company’s reporting requirement. Moreover, it is MD&A that requires the most effort and care by company management. In a separate blog, following this blog, I will discuss in-depth the requirements for MD&A. However, in short MD&A is a discussion, in layman’s terms, of a Company’s plans of operation, results of operations, liquidity and capital resources.

Item 3 of Part I of the Form 10-Q, Quantitative and Qualitative Disclosures About Market Risk, is not applicable to smaller reporting companies.

Item 4 (4T for smaller companies) of Part I of the Form 10-Q is an attestation of Controls and Procedures. This item requires the Companies’ principal executive and principal financial officers to attest to the Company’s disclosure controls and procedures and financial controls and procedures. This attestation is in addition to the certifications required at the end of both 10-Q’s and 10-K’s. Both this attestation and the certifications are the result of the enactment of the Sarbanes Oxley Act of 2002.

Item I of Part II of Form 10-Q, Legal Proceedings, requires a disclosure of either a new legal proceeding or one in which there has been material development during that particular quarter. Ongoing legal proceedings should be disclosed by reference to the 10-Q in which it was first reported. The disclosure should include the name of the court or agency in which the proceedings are pending, the date instituted, and the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought. Moreover, the Company must include similar information as to any such proceedings known to be contemplated by governmental authorities.

Item 1A of Part II of the Form 10-Q, Risk Factors, is not applicable to smaller reporting companies.

Item 2 of Part II of Form 10-Q, Unregistered Sales of Equity Securities and Use of Proceeds, requires that the Company disclose all unregistered issuances of securities, the person(s) to whom issued, the value of the issuance (price paid, debt cancelled, value of services, etc..) and the exemption relied upon for the issuance. Together with registered issuances, an analyst should be able to balance the total reported outstanding securities for each quarter and year, by reviewing a Companies’ Exchange Act reports, including this section of Form 10-Q. The Use of Proceeds disclosure requirement under this Section refers to a disclosure of the Use of Proceeds of any securities sold pursuant to an effective registration statement, if applicable. Finally, a Company must also report any repurchases of its own securities in this section.

Item 3 of Part II of Form 10-Q, Defaults Upon Senior Securities, requires that Companies’ report if there has been any material default in the payment of principal, interest, a sinking or purchase fund installment, or any other material default not cured to any indebtedness exceeding 5% of its total assets.

Item 4 of Part II of Form 10–Q has been removed and is being reserved by the SEC for future use.

Item 5 of Part II of Form 10-Q, Other Information, requires that Companies disclose other material information not otherwise disclosed in this report or previously in a Form 8-K.

Item 6 of Part II of Form 10-Q is a list of exhibits to be included with the Form, including certifications.

A form 10-Q must be signed by the principal executive and principal financial officers. These same individuals are required to execute separate certifications which are attached as exhibits to each Form 10-Q and Form 10-K. By signing the Form 10-Q and certifications, the principal executive and financial officers are attesting personally to the contents of the Form and to the attestations in the certificates and are subject to personal liability therefore.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Mergers and Acquisitions – Deal Protection Measures

Many clients ask me how to protect their interests while trying to negotiate a merger or acquisition. During the negotiation period both sides will inevitably incur a certain, acceptable, expenditure of time and expense, and will provide one and other with confidential information. Although a confidentiality agreement protects confidential information, it does not protect against unnecessarily wasting time and expense. Fortunately, there are other measures that can be enacted to safeguard against a flat-out waste of time and money.

Many, if not all, letters of intent contain some sort of exclusivity provision. In deal terminology these exclusivity provisions are referred to as “no shop” or “window shop” provisions. A “no shop” provision prevents one or both parties from entering into any discussions or negotiations with a third party that could negatively affect the potential transaction, for a specific period of time. That period of time may be set in calendar time, such as sixty days, or based on conditions, such as completion of an environmental study, or a combination of both.

A “window shop” provision allows for some level of third-party negotiation or inquiry. Examples of a window shop provision may be that a party cannot solicit other similar transactions, but are not prohibited from hearing out an unsolicited proposal. A window shop provision may also allow the board of directors of a party to shop for a better deal, while giving a right of first refusal if such better deal is indeed received. Window shop provisions generally provide for notice and disclosure of potential “better deals” and either matching or topping rights.

Generally both no shop and window shop provisions provide for a termination fee or other detriment for early termination. The size of the termination fee varies, however, drafters of a letter of intent should be cognizant that if the fee is substantial it likely triggers a reporting and disclosure requirement, which in and of itself could be detrimental to the deal.

Much different from either a no shop or window shop provision is a “go shop” provision. To address a board of directors fiduciary duty in some instances to maximize dollar value for its shareholders, a potential acquirer may request that the target “go shop” for a better deal up front to avoid wasted time and expense. A go shop provision is more controlled than an auction and allows both target and acquiring entities to test the market prior to expending resources.

Another common deal protection is a standstill agreement. A standstill agreement prevents a party from making business changes outside of the ordinary course, during the negotiation period. Example include prohibitions against selling off major assets, incurring extraordinary debts or liabilities, spinning of subsidiaries, hiring or firing management teams and the like.

Finally, many companies protect their interest by requiring significant stockholders to agree to lock-up agreements pending a deal closure. Some lock-ups require that the stockholder agree that they will vote their shares in favor of the deal as well as not transfer or divest themselves of such shares.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Mergers and Acquisitions – Disclosure Matters

In a merger and acquisition transaction, there are three basic steps that could invoke the disclosure requirements of the federal securities laws: (i) the negotiation period or pre-definitive agreement period; (ii) the definitive agreement; and (iii) closing.

Generally speaking, the federal securities laws do not require the disclosure of a potential merger or acquisition until such time as the transaction has been reduced to a definitive agreement. Companies and individuals with information regarding non-public merger or acquisition transactions should be mindful of the rules and regulations preventing insider trading on such information. However, there are at least three cases when pre-definitive agreement disclosure may be necessary or mandated.

Item 303 of Regulation S-K which governs the disclosure requirement for Management’s Discussion and Analysis of Financial Condition and Results of Operations requires, as part of this disclosure that the registrant identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way. Further, descriptions of known material trends in the registrant’s capital resources and expected changes in the mix and cost of such resources are required.

Disclosure of known trends or uncertainties that the registrant reasonably expects will have a material impact on net sales, revenues, or income from continuing operations is also required. Finally, the Instructions to Item 303 state that MD&A “shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”

At first read it would seem clear that a potential merger or acquisition would fit firmly within the required MD&A discussion. However, realizing that disclosure of such negotiations and inclusion of such information could, and often would, jeopardize completing the transaction at all, the SEC has provided guidance. In SEC Release No. 33-6835 (1989) the SEC eliminated uncertainty regarding disclosure of preliminary merger negotiations by confirming that it did not intend for Item 303 to apply, and has not applied, and does not apply to preliminary merger negotiations. In general, the SEC’s recognition that companies have an interest in preserving the confidentiality of such negotiations is clearest in the context of a company’s continuous reporting obligations under the Exchange Act, where disclosure on Form 8-K of acquisitions or dispositions of assets not in the ordinary course of business is triggered by completion of the transaction (more on this below). Clearly, this is a perfect example and illustration of the importance of having competent legal counsel assist in interpreting and unraveling the numerous and complicated securities laws disclosure requirements.

In contrast, when a company registers securities for sale under the Securities Act, the SEC requires disclosure of material probable acquisitions and dispositions of businesses, including the financial statements of the business to be acquired or sold. Where the proceeds from the sale of the securities being registered are to be used to finance an acquisition of a business, the registration statement must disclose the intended use of proceeds.

Again, accommodating the need for confidentiality of negotiations, registrants are specifically permitted not to disclose in registration statements the identity of the parties and the nature of the business sought if the acquisition is not yet probable and the board of directors determines that the acquisition would be jeopardized. Although beyond the scope of this blog, many merger and/or acquisition transactions require registration under Form S-4.

Accordingly, when disclosure is not otherwise required, and has not otherwise been made, the MD&A need not contain a discussion of the impact of such negotiations where, in the company’s view, inclusion of such information would jeopardize completion of the transaction. Where disclosure is otherwise required or has otherwise been made by or on behalf of the company, the interests in avoiding premature disclosure no longer exist. In such case, the negotiations would be subject to the same disclosure standards under Item 303 as any other known trend, demand, commitment, event or uncertainty.

Yes, this is in the correct category, the material definitive agreement referred to here is a letter of intent or confidentiality agreement. Item 1.01 of Form 8-K requires a company to disclose the entry into a material definitive agreement outside of the ordinary course of business. A “material definitive agreement” is defined as “an agreement that provides for obligations that are material to and enforceable against the registrant or rights that are material to the registrant and enforceable by the registrant against one or more other parties to the agreement, in each case whether or not subject to conditions.”

Agreements relating to a merger and acquisition are outside the ordinary course of business. Moreover, although most letters of intent are non-binding by their terms, many include certain binding provisions such as confidentiality provisions, non-compete or non-circumvent provisions, no-shop and exclusivity provisions, due diligence provisions, break up fees and the like. On its face, it appears that a letter of intent would fall within the disclosure requirements in Item 1.01.

Once again, the SEC has offered interpretative guidance. In its final rule release no. 33-8400, the SEC recognizing that disclosure of letters of intent could result in destroying the underlying transaction, as well as create unnecessary market speculation, specifically eliminated the requirement that non-binding letters of intent be disclosed. Moreover, the SEC has taken the position that the binding provisions of the letter, such as non-disclosure and confidentiality are not necessarily “material” and thus do not require disclosure. However, it is important that legal counsel assist the company in drafting the letter, or in interpreting an existing letter to determine if the binding provisions reach the “materiality” standard and thus become reportable. For example, generally large break-up fees or extra-ordinary exclusivity provisions are reportable.

Regulation FD or Fair Disclosure prevents selective disclosure of non-public information. Originally Regulation FD was enacted to prevent companies from selectively providing information to fund managers, big brokerage firms and other “large players” in advance of providing the same information to the investment public at large. Regulation FD requires that in the event of an unintentional selective disclosure of insider information, the company take measures to immediately make the disclosure to the public at large through both a Form 8-K and press release.

The definitive agreement is disclosable in all aspects. In addition to inclusion in Form 10-Q and 10-K, a definitive agreement must be disclosed in Form 8-K within four (4) days of signing in accordance with Item 1.01 as described above. Moreover, following the entry of a definitive agreement, completion of conditions, such as a shareholder vote, will require in-depth disclosures regarding the potential target company, including their financial statements.

The Closing is disclosable in all aspects as is the definitive agreement. Moreover, in addition to item 1.01, the Closing may require disclosures under several or even most of the Items in Form 8-K. Such as Item 2.01 – Completion of disposal or acquisition of Assets; Item 3.02 – Unregistered sale of securities; Item 4.01 – Changes in Certifying Accountant; Item 5.01 Change in Control, etc…

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Mergers and Acquisitions

Confidentiality, Non-Disclosure Agreements

A confidentiality agreement or non-disclosure agreement (“NDA”) is an agreement among the parties to a proposed transaction to keep information secret and in confidence. In the context of a merger and acquisition transaction, NDA’s are important for both the target and acquiring entities. It is critical that an NDA be signed prior to the exchange of any due diligence or embarking upon substantive transaction negotiations.

Generally in a merger and acquisition transaction, the target entity is a closely held private corporation. Accordingly it is critical for the target company to maintain the confidential nature of both its business information, and the fact that it is considering a going public transaction. During the due diligence process, the public acquiring company will be given access to non-public trade secrets, technology, business processes, customer lists, and material information regarding shareholders, debt and equity financing and financial statements.

If this information were made public or used for any purpose other than to evaluate a potential business transaction, it could materially and adversely affect the value of the target company. Moreover, if a transaction doesn’t go through, a potential acquirer could misuse the information to compete with, or solicit customers or employees from the target company, without the protection of a NDA. Just the knowledge that a transaction is being considered could affect the target’s relationship with its current customers, suppliers and/or employees.

Generally, the public acquiring entity is subject to the disclosure requirements of the Securities Exchange Act of 1934 and its information is already publicly available. However an NDA is still important to protect the public company. That is, if it became publicly known that acquirer was focusing on a particular target, other potential buyers may come to the table to compete.

Moreover, the acquirer’s business strategy regarding that particular acquisition would become publicly known prior to being legally required. If the acquirer changes its mind and the information was already public, investors may wonder as to why the transaction evaporated and subsequently lose confidence in both entities. An NDA can help protect against unnecessary market rumors and conjecture and potential exposure to insider trading liability. Obviously, an NDA should contain a strong obligation on the part of both parties to keep review information confidential.

Typically an NDA will permit the parties to disclose the information to its affiliates, advisors and key management on a “need to know” basis provided that each information recipient agree to the terms of the NDA.

An NDA only covers confidential information. That is, excluded is information that (i) is already in the possession of the recipient; or (ii) is or becomes available to the public (other than by a breach of the NDA). A properly drafted NDA will provide for procedures in the event a party is compelled, via subpoena or otherwise, to disclose information. Generally, the NDA will provide for an opportunity to learn of and fight the compelling document prior to disclosure.

Lastly, most NDA’s contain some sort of standstill or no shop provision. That is prior to expending time, money, attorney’s fees, other professional fees, etc., the parties will want assurance that the deal is not being shopped around for at least some period of time.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Reverse Mergers, Acquisitions and Due Diligence

Due diligence refers to the legal, business and financial investigation of a business prior to entering into a reverse merger transaction. Although the due diligence process can vary depending on the nature of a transaction (a relatively small acquisition vs. a going public reverse merger)it is arguably the most important component of a transaction (or at least equal with documentation).

In a reverse merger transaction involving a public shell acquiring a private operating business, the bulk of the due diligence will be by the acquiring shell on the target. Although some due diligence is also necessary on the public shell, as a Company subject to the reporting requirements of the Exchange Act of 1934, most, if not all, pertinent information is publicly available on the Securities and Exchange Commission’s (“SEC”) EDGAR database. In the case where the public shell is a non-reporting entity, both sides to the transaction will need to complete extensive, in-depth due diligence on each other.

This article focuses on due diligence by the public acquirer on the private target. At the outset, in addition to requesting copies of corporate records and documents, all contracts, asset chain of title documents, financial statements and the like, the securities attorney for the public acquirer should make themselves familiar with the target’s business, including an understanding of how they make money, what assets are important in revenues, who are their commercial partners and suppliers, and common off balance sheet and other hidden arrangements in that business. It is important to have a basic understanding of the business in order to effectively review the documents and information once supplied, to know what to ask for and to isolate potential future problems.

In addition to determining whether the transaction as a whole is worth pursuing, proper due diligence will help in structuring the reverse merger transaction and preparing the proper documentation to prevent post closing issues (such as making sure all assignments of contracts are complete, or where an assignment isn’t possible, new contracts are prepared).

In addition to creating due diligence lists of documents and information to be supplied, counsel for the public acquirer should perform separate checks for publicly available information. In today’s internet world, this part of the process has become dramatically easier. SEC legal counsel should be careful not to miss the basics, such as UCC lien searches, judgment searches, recorded property title and regulatory issues with any of the principals or participants involved in the deal.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Chinese Reverse Merger (and IPO) Companies Disregard US Regulations and SEC Registration Requirements

Many of the Chinese companies that go public in the United States do so via a Reverse Merger. The reverse merger methodology versus the traditional Initial Public Offering (IPO) is the preferred method used by the Chinese and their US-based legal and auditing advisors. Many of these Chinese companies believe, erroneously, that by utilizing the reverse merger process, they can avoid the in-depth disclosure requirements and scrutiny associated with an IPO. However, legally this is not the case.

The failure of Chinese company legal, accounting and market makers to understand the fundamental elements required of Foreign Corporations trading stock on US markets has led to numerous shareholder class action lawsuits, trading suspensions and enforcement actions against publicly traded Chinese companies.

Many of the problems resulting from Chinese reverse mergers are due to the failure of corporate counsel, auditors and market makers to thoroughly complete due diligence on the company’s officers, directors, operations and financial statements. Under ordinary circumstances, when preparing SEC filings, legal and accounting professionals can rely on the representations of their clients. However, when the subject Company has opted NOT to list their securities on their country of origin exchange, additional measures must be taken to ensure transparency.

It is always advisable to “kick the tires” of the subject company (visit their facilities, confirm that copies of all agreements have been provided, etc.) but in the case of Chinese entities, it is doubly important (actually it is essential). When providing “going public” services to an operating Chinese business, one that is going public or already trades on the US markets, the key is to verify, verify, verify.

Moreso than in any other scenario, auditors, attorneys and market makers must act as gate keepers so as to keep their Chinese clients compliant with US securities laws. Obviously, due diligence can only go so far, no matter how thorough the evaluation process. In the end, ultimately, auditors, attorneys an market makers are in the unenviable position of relying, to one extent or another, on the documents and attestations provided to them by the officers of the subject company. Forged, fraudulent and outright fictitious corporate documents are becoming all too commonplace.

Further complicating the problems stemming from Chinese companies going public in the United States are the increasing number of subsequent capital raises comprised of domestic, US investors. Once trading on the OTCQB or NASDAQ, the now public entity has a myriad of financing options, to the chagrin of the unsuspecting investment public.
Some regard the Chinese stock market as essentially unregulated, therefore creating an attitude among some officers and directors that US Exchanges are just as forgiving in respect to compliance and overall transparency.

Other issues may stem from the language barrier. Some may even be a result of differences in cultural business practices. In any event, the Securities Act of 1933, as amended, requires that all sales of stock be via either a registration statement or legal exemption to registration. All registration statements require in-depth disclosure in accordance with the legal parameters set forth in Regulation S-K and accounting parameters set forth in Regulation S-X. US regulators and class action counsel have clearly set forth that these standards are not being met.

Also, the lack of corporate governance oversight has intensified the problem. In addition, there are significant accounting differences. Since China does not follow Generally Accepted Accounting Principles (GAAP), confusing, and sometimes irreconcilable, financial statements are provided to domestic, PCAOB, auditing firms.

Hence, with a relatively lax regulatory stock market environment in China (as compared to stringent regulatory oversight in the United States), fundamentally different accounting and auditing procedures, and divergent societal and political structures the Chinese reverse merger debacle should not come as a surprise to anyone.

Years of poor due diligence practices by US accounting, auditing and law firms has resulted in numerous shareholder class action lawsuits being filed against Chinese companies that have completed a reverse merger or RTO (Reverse Takeover) in the United States.

Because of the highly publicized problems of Chinese reverse merger fraud, some individuals incorrectly assert that the reverse merger process itself is somehow a dubious device used to gain access to domestic exchanges. Nothing could be further from the truth. Since the majority of companies going public in the US are completed via a reverse merger, it stands to reason that that the majority of Chinese companies going public domestically will use the same process.

Class action law firms and the investment public are now discovering that Chinese stock fraud is not limited to reverse mergers. Chinese companies that have gone public via S-1 Registration Statements, full blown IPO’s, and alternative methods such as WestPark Capital’s unique WRASP ™ (Public Offering and a Share Exchange hybrid) program have collapsed under close scrutiny as well. Certain reverse mergers or RTO’s were simply the first to fall.

In conclusion the fact of the matter is that the reverse merger process is a legitimate cost-effective and completely legal method of going public and has been used by such companies as: Yahoo, Turner Broadcasting Systems, Occidental Petroleum, Berkshire Hathaway, Texas Instruments and Blockbuster Entertainment to name a few.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Merger and Acquisitions, Part One – Structuring the Transaction

Mergers and acquisitions come in all sizes, financially speaking, but the sequence of events preceding the transaction is usually fixed. The same procedural points must be addressed regardless of the size of the subject Companies.

Generally the first step in an M&A deal is executing a confidentiality agreement and letter of intent (LOI). These documents can be combined or separate. If the parties are exchanging information prior to reaching the letter of intent stage of a potential transaction, they should proceed with execution of a confidentiality agreement right away.

In addition to requiring that both parties keep information confidential, a confidentiality agreement sets forth important parameters on the use of information. For instance, a reporting entity may have disclosure obligations in association with the initial negotiations for a transaction, which would need to be exempted from the confidentiality provisions. Moreover, a confidentiality agreement may contain other provisions unrelated to confidentiality such as a prohibition against solicitation of customers or employees (non-competition) and other restrictive covenants. Standstill and exclusivity provisions may also be included, especially where the confidentiality agreement is separate from the letter of intent.

Next is the letter of intent (“LOI”). An LOI is generally non-binding and spells out the broad parameters of the transaction. The LOI helps identify and resolve key issues in the negotiation process and hopefully narrows down outstanding issues prior to spending the time and money drafting the transaction contracts and supporting documents. Among other key points, the LOI may set the price or price range, the parameters of due diligence, necessary pre-deal recapitalizations, confidentiality, exclusivity, and time frames for completing each step in the process. It is always highly advisable that an LOI be executed.

Along with an LOI, the parties attorney’s should prepare a “to do” list including a “who do” identification. Setting out a to do list and clarifying who is responsible for what documents and items will help move things along and avoid misunderstandings among the professionals representing the different parties to the transaction.

The next step in the transaction process is due diligence. Although generally the client is responsible for putting together due diligence items, the attorney should correlate and organize the items to ultimately save time and keep the items organized. Prior to exchanging documents the attorneys should be sure that a confidentiality agreement has been executed, either separately or as part of the LOI.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Registering an IPO on Form S-1, Part Three

The second half of the Form S-1 registration statement contains supplemental information and formal legal requirements. This section is compromised of the subject Company’s financial information, sales and issuances of unregistered securities, the legal information regarding the exemptions relied upon in making such sales and issuances. In addition, a list of exhibits and information regarding these items is included as well.

Regulation S-X sets forth the form, content and requirements as to the financial statements that must be reviewed and audited by a PCAOB licensed accounting firm.

Item 601 of Regulation S-K lists required exhibits that must be filed with a Form S-1 (for example, original articles of incorporation and all amendments thereto; material contracts; auditor consent letter; legal opinions, etc.). These exhibits must be filed with the S-1 to become available for public review.

All registration statements must be written in “Plain English”, as opposed to technical legal or financial industry terminology. The Plain English rule requires that the registration statement be written using the following English grammatical principles: active voice; short sentences; definite, concrete, everyday words; tabular presentations of financial information and other applicable data; bullet lists for complex and material data, whenever possible; avoidance of legal jargon; avoidance of highly technical business terms; and no multiple negatives. The SEC enforces the plain English rule and will not hesitate to request that paragraphs or sections be re-written.

Once the Form S-1 is filed with the SEC, using the EDGAR and XBRL requirements, the SEC will inform the Issuer if the S-1 will be reviewed. The SEC assigns a team of legal and accounting experts to review the document and provide comments to the Issuer.

In response, the Issuer prepares and files an amendment to the S-1, making the required changes and addressing the comments put forth by the SEC. The issuer then prepares and files a responsive letter which sets forth written direct answers to each of the SEC’s comments. The comment process can, at times, be arduous and repetitive; however, Issuers should note that this is all part of the S-1 process. When the comments are addressed to the satisfaction of the SEC, the commission will issue an order allowing the registration statement to go effective.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Registering an IPO on Form S-1, Part Two

In my first blog on this topic, I set out very generally the time periods involved in an offering, the pertinent regulations and a very brief description of the contents of a registration statement. This Part II begins to explore, on a more in-depth level, the contents of a Form S-1 registration statement. The format of the S-1 is as follows: (i) cover page; (ii) Part I (the prospectus); (iii) Part II (supplemental disclosure); (iv) undertakings; (v) signatures and power of attorneys; (vi) consents; and (vii) exhibits.

The cover page of a Form S-1 is required to set out the following basic information about the issuer and the offering: (i) the issuer’s exact legal name; (ii) the issuer’s state of incorporation; (iii) the issuer’s SIC code; (iv) the Issuer’s tax id number; (v) the address and telephone number of the issuer’s principal executive offices and of its agent for service of process; (vi) the maximum amount of securities proposed to be offered and amount of registration fee; (vii) the approximate date of commencement of the offering; and (viii) whether any of the securities are being registered “on the shelf” pursuant to Rule 415.

Part I of the Form S-1 sets forth line items specifying required information by referencing the appropriate sections of Regulations S-K and S-X. The following is a brief description of each of the items required in Part 1 of Form S-1.

1. Description of Business, Properties and Legal Proceedings (Items 101 – 103 of Reg. S-K)

Item 101 of Reg S-K requires a description of the business over the prior 5 years (or 3 years for small public companies) or from inception as appropriate. Item 101 sets forth a list of required information (including, for example, year and state of incorporation; products and services; sources of raw materials; environmental issues; government regulations, research and development and number of employees). In addition, parts of Item 101 require discussion of future plans, for example, plans for expansion or increase in employees. Item 101 also requires a description of the Issuer’s competitors specifically and in the industry in general. This paragraph is a brief summary and examples of only a few of the numerous items that must be specifically disclosed and discussed in accordance with Item 101.

Item 102 of Reg S-K requires that the Issuer set forth the location and general character of the physical properties of the Issuer, including how titled and a description of any liens, mortgages or encumbrances.

Item 103 of Reg S-K requires that the Issuer disclose any pending or contemplated legal proceedings, including specifically required information about these proceedings. An Issuer need not disclose legal proceedings in the ordinary course of its business.

2. Securities (Items 201 and 202 of Reg S-K)

Items 201 and 202 requires a description of the securities offering as well as past and future information regarding these securities and all of the Issuers outstanding securities, including, for example, prior market and pricing activity, rights and preferences, outstanding warrants, and dividends.

3. Financial Information (Items 301-305 of Reg S-K)

Small Issuers (under $75 mil in revs) are not required to make disclosure under Items 301 and 302 which require that the Issuer provide a summary of financial data that is contained in the financial statements. All Issuers are required to provide disclosure under Item 303 – Management Discussion and Analysis of Financial Condition and Results of Operation (MD&A). MD&A often makes up the bulk of narrative discussion in a registration statement and is arguably the most important portion of the registration statement for investors to understand the Issuer and its management plans. A detailed discussion of the requirements of this section could fill up multiple blogs on the topic alone. However, very briefly, MD&A requires discussion of key financial elements and changes in those items over the prior 12 months. For example, MD&A would disclose revenues for the current term and prior year and explain why that number increased or decreased (for example, the company may have expanded or cut back on its sales force).

In addition, MD&A requires a detailed discussion of the Issuer’s future plans and the costs and intended source of financing for those plans. An Issuer cannot simply state that it plans to open 10 new locations, but instead would be required to give details as to where those locations were, what progress, if any had been made towards the plan, the costs of the plan and where the money is going to come from.

MD&A requires discussion regarding liquidity and capital resources. This would include breaking out balances owed or owing on various obligations sources and uses of funds for 12, 24 and 36 month periods. MD&A requires a discussion of the industry and competition, both generally and as may specifically effect the Issuer. Again, this is a very brief outline of MD&A.

4. Management and Certain Security Holders (Items 401-404 of Reg S-K)

Items 401 through 404 of Reg S-K requires disclosure of certain information regarding directors, executive officers, key employees and those that own 5% or more of the outstanding securities of the Issuer. Item 401 requires the Issuer to disclose certain biographical information about officers, directors and key employees. This information includes 5 years of business background, name, age, familial relationships among other disclosed individuals, related party transactions, and involvement in certain legal proceeding over the prior 10 years (such as convictions of crimes, governmental enforcement actions, and involvement in bankruptcies). Item 402 requires disclosure of executive compensation, both past, current and as obligated in the future. Item 404 requires disclosure of financial related party transactions.

5. Registration Statement and Prospectus Provisions (Item 501-512 of Reg S-K)

Items 501-512 (often referred to as standardized items) requires different disclosures and information throughout the Form S-1, including specific information on the front and back cover and throughout the Form S-1. For example, how the offering price was determined (Item 505); risk factors (Item 503); use of proceeds (Item 504); dilution (Item 506); disclosure of selling security holders if a secondary offering (Item 507); plan of distribution (Item 508); experts (Item 509); offering expenses (Item 511); and undertakings (Item 512).

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Registering An IPO On Form S-1, Part One

Pursuant to Section 5 of the Securities Act of 1933, as amended (“Securities Act”), it is unlawful to “offer” or “sell” securities without a valid effective registration statement, unless an exemption is available. Companies desiring to offer and sell securities to the public must file with the SEC, and provide prospective investors, all material information concerning the company and the securities offered. The Securities Act sets forth in-depth rules on what constitutes material information, and on what forms and in what format, that material information must be disclosed.

There are generally three regulated time periods in an offering process:

(i) the pre-filing period – which begins when the Issuer decides to proceed with an offering. During this period, counsel prepares the registration statement and prospectus and the Issuer negotiates with underwriters, if applicable (the Issuer may determine to proceed with a self underwritten IPO which is commonly known as a DPO or direct public offering);

(ii) the “quiet period” – which is the time from the filing of the registration statement until it is declared effective. During this time the Issuer can engage in limited marketing (offers only) of the offering through the use of the filed registration statement, which must clearly indicate that it is not the final document (often referred to “red herring”).

(iii) post effective period – the registration statement is effective and the Issuer can proceed with sales of the securities registered

In addition to disclosure and regulations related to the offering during all three periods, marketing and public communications of the Issuer are restricted. For more information on this aspect please see other blogs I’ve written on this subject.

Rule 404(a) of the Securities Act sets forth the basic requirements for a registration statement. Rule 404(a) reads in part:

“A registration statement shall consist of the facing sheet of the applicable form; a prospectus containing the information called for by Part 1 of such form; the information, list of exhibits, undertakings and signatures required to be set forth in Part II of such form; financial statements and schedules; exhibits; any other information or documents filed as part of the registration statement; and all documents or information incorporated by reference in the foregoing.”

Over the years the SEC has created and eliminated various registration forms. Currently all domestic issuers must use either form S-1 or S-3. Form S-3 is limited to larger filers with a minimum of $75 million in annual revenues, among other requirements. All other Issuers must use form S-1. This blog solely discusses form S-1. In this series of blogs I will discuss the preparation and filing of a Form S-1.

There are four primary regulations governing the preparation and filing of Form S-1:

(i) Regulation C – contains the general requirements for preparing and filing the Form S-1. Including within Regulation C are regulations and procedures related to (a) the treatment of confidential information; (b) amending a registration statement prior to effectiveness; (c) procedures to file a post-effective amendment; and (d) the “Plain English” rule.

(ii) Regulation S-T – requires that all registration statements, exhibits and documents be electronically filed through the SEC’s EDGAR system – though it should be noted that the SEC is in the process of changing this system to XBRL filing

(iv) Regulation S-K – sets forth, in detail, all the disclosure requirements for all the sections of the S-1. Regulation S-K is the who, what, where, when and how requirements to complete the S-1.

(v) Regulation S-X – sets forth the requirements with respect to the form and content of financial statements to be filed with the SEC. Regulation S-X includes general rules applicable to the preparation of all financial statements and specific rules pertaining to particular industries and types of businesses.

Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.

OTCQB and OTCQX Compared and Contrasted

Over the past few years, the historical PinkSheets has undergone some considerable changes, starting with the creation of certain tiers of Issuers and culminating in its refurbished website and new URL “OTCMarkets.com”.

The new OTCMarkets.com divides Issuers into three (3) levels: OTCQX; OTCQB and PinkSheets. From a fundamental perspective, Issuers on the OTCQX must be fully reporting and current in their reporting obligations with the SEC and also undergo a quality review by industry professionals. Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC but do not undergo additional quality review.

Issuers on the OTCQB are analogous to previous OTCBB listed entities. Although the OTCBB technically still exists, it is losing company quotations daily, mainly as market makers choose the full service, one stop shopping of the OTC Markets, to quote the stock of over the counter trading Issuers. OTCQB Issuers are current with their reporting requirements to the SEC pursuant to the Exchange Act of 1934. Market Makers quoting the stock of OTCQB Issuers either have a current 15c2-11 or are relying on the piggy back qualification.

Issuers with stock quoted on the OTCQX are not only current with their reporting obligations, but have undergone industry professional review. That is, in addition to meeting the requirements of the securities laws and SEC, these entities have opted to undergo greater scrutiny from the industry. The benefits to Investors in being able to rely on this quality review are enormous.

OTC Markets has established standardized methods for professionals to review the quality of Issuer information. In addition, OTC Markets has set forth standards for the qualifications of those responsible for undertaking the quality review. Lastly, OTC Markets maintains a strict accountability policy for securities attorneys, PCAOB auditors and other professionals who do not perform their review obligations properly and/or who do not adhere to OTC Markets standards. Issuer service providers that report false information to OTC Markets may ultimately find themselves blacklisted from the website. Consequently, it is essential that attorneys, auditors and any other professionals who submit Issuer data to OTC Markets confirm with absolute certainty that they their information is correct and complete.

Prior to the enactment of the OTCQX tier by the OTC Markets, for quality of disclosure review, Investors had to rely on either the SEC review process or analyst reports. However, these sources are not consistent and as for the later, not necessarily reliable. The SEC does not review all documents filed by all Issuers, not even close. They simply do not have the resources nor personnel to do so. Accordingly, the quality of disclosure of any given Issuer may not meet even basic legal requirements and an Investor would have no easy way of determining which filings have been reviewed and which have not.

Relying on analysts’ reports entails tremendous risk because not all of them are licensed. Many “analysts” are simply stock promoters being paid to write glowing recommendations about a particular stock. Even the most well-intentioned analysts do not always verify the information provided to them by the issuer. Many are seeking to line their own pockets by selling their shares in an inflated market after their favorable report is disseminated. Inversely, others have shorted the stock and will profit in the down market after their unfavorable report reaches the street. Ultimately, there is no easy way for an Investor to discern whether a given report is prepared by a licensed, unbiased, honest professional – until now.

In addition, OTCQX offers Investors and Issuers various perks usually associated with trading on an Exchange (a stock exchange, such as the NASDAQ is different than the Over the Counter Market in that they have listing standards, such as price of stock, and have ongoing governance and compliance standards, such as audit committee review). These perks include, but are not limited to, real time quotes and various computerized communication resources for investor relations.

Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.

Performing Due Diligence on Subject Companies During Reverse Mergers

Due diligence is a critical component of structuring any business transaction. In a reverse merger scenario there are two sides to the due diligence equation. There is the due diligence performed by the private company merging with the public shell (“Public Shell”) and there is the performance by the shell company of due diligence on the private company (“Private Company”).

In order to successfully complete a reverse merger it is essential for the Public Shell to perform appropriate financial, legal, corporate, market, and management due diligence on the private company merging with the Public Shell. At the most basic level the Public Shell needs to satisfy itself that the Private Company has all information completed and ready to file its Super 8-K within 4 days of completing the merger, including having audited financial statements prepared by a PCAOB licensed auditor.

As far as due diligence is concerned, particularly from a functionality standpoint, understanding management’s reasons for going public, as well as knowing the extent of their knowledge regarding public company operations, is critical to success and timeliness. Investors typically do not invest in the horse, but rather the jockey.

Post merger, the once private company will need to file quarterly, annual and periodic reports pursuant to the Securities Exchange Act of 1934, as amended, and must have the internal controls in place to ensure compliance with these reporting requirements. Hence, determining beforehand the qualifications of management is invaluable to ensuring a successful post merger operation.

Essential questions to be answered during the personal interview phase are set forth in the reporting requirements enumerated in Items 401 through 404 of Regulation S-K. From a fundamental business perspective, these Items will help current and future shareholders determine:

1. Is management competent?
2. How many years of experience in the industry do they possess?
3. Has management been successful in running the operation to date?
4. Does management understand the difference between running a private company verses the rigorous legal, investor relations and accounting demands of a public company?
5. Are there any legal roadblocks to future offerings or extremely detrimental disclosure items (i.e. bad boy provisions)?

Furthermore, the shell company’s due diligence should gain insight as to the ability of the private company, through management and/or hired professionals, to address and remain compliant with: Sarbanes Oxley, GAAP, Exchange Act reporting requirements, including yearly 10-K’s, quarterly 10-Q’s and periodic 8-K’s, Investor Relations, internal controls, Annual Report filings and annual meeting, as well as other basics concerning the general daily operational factors of a public company.

At the corporate level of the due diligence process the public shell needs to review basic corporate records to determine that the Private Company is in legal corporate good standing and has maintained adequate books and records.

Legal due diligence encompasses such things as ensuring loans by insiders have been documented, extensions on outstanding obligations have been memorialized and documented, title to ownership of assets (including intellectual property and real estate) is in the corporate name and if not, proper linking documents (such as a lease agreement or assignment) have been prepared and executed. Does the Private Company rely on a distribution network? Make sure it’s in writing. In short, legal due diligence involves crossing the T’s and dotting the I’s and is part and parcel with the auditor’s job.

In addition to the personal matters there also exist the typical concerns of pending or anticipated litigation issues. These issues include, but are not limited to, product liability; hazardous waste; real estate liens; employment discrimination suits; other environmental concerns and other legal issues that could have a “material” negative impact in the future.

As stated, where relevant to the particular private company, environmental issues are an extremely important legal due diligence point. Environmental laws and the gaining power of the Environmental Protection Agency make this a critical factor. Failure to ensure that appropriate Phase I and Phase II environmental reports are in order could lead to expensive future cleanup and litigation costs. Furthermore, it is suggested that any potential future liability be signed off on by the appropriate agency or authority.

Now to the most important due diligence matter: financial due diligence. If the target entity does not have or cannot obtain completed audited financial statements, prepared by a PCAOB qualified auditor in accordance with GAAP, there exists no rationale to move forward with the merger.

Financial due diligence is the key element in the due diligence process. The Public Shell Company should be meticulous in reviewing the financials, margins, inventory and equipment lists of the private company going public. In addition there may be patents, intellectual property and employee compensation agreements that need to be reviewed. The Public Shell should be comfortable with the footnotes as well as the line item financial statements.

It must be understood that there are always going to be some sort of issues. However, the Public Shell Company’s objective is to address significant material issues via the due diligence process. By doing so the Shell Company enhances the probability of a successful reverse merger.

In summary, the due diligence process is designed to uncover material facts that may adversely impact the transaction. The process is not designed to destroy the deal but moreso to address key issues in order to strengthen the transaction and protect shareholders. Inversely, properly completed due diligence on the Public Shell Company to be acquired ensures that the merging Private Company reaps the benefits of a viable public entity by which to grow and enhance shareholder value.

Comprehensive, detailed and meticulous due diligence creates a foundation of integrity, authenticity and transparency on which a strong, operating public company can be built. The due diligence process can be time consuming, but it is most easily completed when all parties involved operate reasonably and professional cooperation is maintained throughout the due diligence process.

Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.

Potential Liabilities In The IPO Process– Part III

Rule 10(b) and 10b-5 of the Securities Exchange Act of 1934 (“Exchange Act”) is commonly known as the anti-fraud rule. Rule 10b-5 applies to any oral or written communication in connection with the purchase and sale of securities. To establish a claim under Rule 10b-5, the claimant must show fraud in the form of an omission or misstatement and that such fraud occurred in connection with the purchase or sale of a security. Rule 10b-5 provides a private cause of action by a purchaser of securities against any person who makes an untrue statement or omits a material fact, not just the Issuer.

To make a claim under 10b-5 a person must establish:

Misrepresentation or Omission of a Material Fact – the key point here being “material”. A fact is material if, in light of the totality of information, it is substantially likely it would impact a reasonable persons investment decision. The test is based on a reasonable man’s perspective, not necessarily the investor making the claim.

Scienter/State of Mind – Rule 10b-5 requires that the defendant be aware of the fraud. Awareness can be established either by actual awareness (defendant states that they have 5 contracts when there is only 3) or by showing that the defendant should have been aware with reasonable inquiry and diligence (defendant had the contracts available to review, but just didn’t).

Reliance – the plaintiff in a 10b-5 claim must show that they relied on the misinformation or lack of information. In other words there must be a link between the alleged fraud and the investment decision. It is presumed when material information is withheld there is reliance. The presumption of reliance can be rebutted by showing that the claimant’s decision to purchase or sell shares was not influenced by the alleged fraud, or that the alleged fraud did not alter or change the stock price.

Causation – the plaintiff in a 10b-5 claim must show that the fraud caused damages. Damages is a calculation of the monetary loss of the claimant and such damages must be linked to the fraud.

Damages – in addition to linking the damages to the fraud, the claimant must actually have damages. That is, they must have lost money.

Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.

Potential Liabilities In The IPO Process-Part II

Section 12(a)(1) of the Securities Act of 1933 (“Securities Act”) imposes liability on any person who offers or sells a security in violation of Section of the Securities Act. Part I of this blog series discussed the ability of the SEC to bring enforcement proceedings against persons who violate Section 5 of the Securities Act. Part I related to Section 12(a)(2) of the Securities Act. Section 12(a)(1) is the sister to that provision, providing a method for a purchaser of a security, i.e. another person, to bring a civil action against another person who has sold them a security in violation of Section 5.

Section 12(a)(1) provides that a single violation of the registration provisions at the time of an offer will create a cause of action available to all of the purchasers in the offering, even if the conditions of Section 5 are actually complied with at the time an individual sale is made. The possibility of a Section 12(a)(1) claim illustrates the importance of understanding what constitutes an “offer” during the period prior to and following the filing of the registration statement, but before the registration statement becomes effective.

Section 2(a)(3) of the Securities Act defines an “offer to sell”, “offer for sale”, or “offer” shall include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value. Preliminary negotiations or agreements between an issuer (or any person directly or indirectly controlling or controlled by an issuer, or under direct or indirect common control with an issuer) and any underwriter are excluded from the definition.

Securities Act claims, both by persons pursuant to this Section, or by the SEC in an enforcement proceeding, can be brought against any individual who signs the registration statement, in addition, to the Issuer. If state law allows, the officers or directors who sign the registration statement can seek indemnification from the Issuer. However, the SEC itself does not “agree” with the right to indemnification and requires all Issuers to include a statement setting forth the SEC’s position on indemnification in all registration statements.

The bottom line is that if an officer or director signs a registration statement which is filed with the SEC and which contains misstatements or fails to contain material information, they may be subject to liability on two fronts – from the SEC in an enforcement proceeding, and from individuals and entities in a private civil claim.

Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.

Potential Liabilities In The IPO Process

Both the Securities Act of 1933, as amended (“Securities Act”) and the Securities Exchange Act of 1934, as amended (“Exchange Act”) provide remedies to investors in the IPO process. The basic premise of such liability is that either an investor was not given an opportunity to review investment disclosure documents prior to making the investment, or such disclosure documents contained inaccurate information or failed to contain material information. In the coming months we will also analyze various IPO liability provisions.

Section 11(a) of the Securities Act covers material misstatements or omissions in the registration statement at the time the registration statement becomes effective (later clarifications do not necessarily “cure” defects). Section 11(a) provides relief to any person who has acquired a security registered in a registration statement, whether in the initial IPO or after market, who did not have knowledge of the misstatement or omission at the time of the purchase.

The liability under Section 11(a) extends to (1) the Issuer; (2) any person who signed the registration statement; (3) every director at the time of the filing of the registration statement; (4) every person who is named, with his consent, as being about to become a director; (5) experts named in the registration statement (such as accountants); and (6) underwriters. Section 11(a) is a strict liability provision, meaning that the investor does not have to prove that he relied on the misstatements or omissions, only that they existed. However, other than the Issuer, those facing liability can claim the defense of due diligence. For example, if a director takes all reasonable steps (including seeking the advice of experts, thoroughly reviewing all available documents and information, etc.) to verify the information in the registration statement, they may be relieved of liability.

The misstatements or omissions, however, must be material. Materiality is defined as whether the misstatements or omissions, considered in context, would affect the investment decision of a reasonable investor. The statute of limitations for Section 11 liability is one year from the discovery of the misstatements or omissions, but not more than three years from the effectiveness of the registration statement. Section 11 limits the damages available to the investor to “the difference between the amount paid for the security and either (1) the value of the security at the time bought; or (2) the price the security was later sold for, if already sold.

Section 12(a)(2) of the Securities Act imposes liability for false or misleading statements or omissions by prospectus or oral communications involved in the offer or sale of securities. This Section imposes liability upon sellers for offers or sales of any security by means of a prospectus or oral communication. The pertinent “moment of time” for considering liability is the time the investor makes a commitment for purchase. Use of this Section is only available to initial purchasers, not after market buyers. Liability is limited to persons who offer or sells the security; i.e. it does not automatically extend to directors, experts, etc. Section 12 requires that the investor proof causation that is, that they relied on the misleading information and as a result of relying on such information, they were damaged. Moreover, the seller of the securities can raise several defenses, such as proof that the investor had actual knowledge of the information or should have been aware of the information if they had taken reasonable care and inquiry.

Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.

Alternatives To Going Public – Private Company Financing Options

Many companies seek to go public as a source of obtaining capital financing. In order to make the most intelligent decision private financing options should also be considered.

Section 4(2) of the Securities Act of 1933, as amended (Securities Act) provides a broad based exemption for “transactions not involving any public offering.” The SEC has promulgated several Safe Harbor rules under Section 4(2) the most well known being Regulation D. The three private placement exemptions in Regulation D are Rule 504, 505 and 506, the difference being based on the size of the offering, the number and qualification of investors and restrictions on advertising and resale of the securities. Other than in certain instances under Rule 504, securities issued in a private placement are restricted and may not be resold unless they are registered or an exemption exists (such as Rule 144).

Briefly, Rule 504 allows a non-reporting public or private company to raise up to $1,000,000 from any number of individuals, which individuals do not need to be accredited. Rule 504 requires that the Issuer comply with applicable state law regarding the exemption. Each states rules and regulation vary widely and accordingly, relying on this exemption is only cost effective if the offering is limited to one or a small number of states.

Rule 505 allows an Issuer to raise up to $5,000,000 in a 12 month period, from up to 35 unaccredited investors and an unlimited number of accredited investors. Like Rule 504, an Issuer must comply with a complex and varying set of different state laws when relying on this exemption. Over the years this exemption has been used rarely.

Rule 506 allows an Issuer to raise an unlimited amount of capital form any number of accredited investors and no more than 35 unaccredited “sophisticated” investors. Sophisticated, in this case, means that the investor must have adequate experience in financial and business matters to understand the investment being made and the risk involved. Rule 506 offerings are guided by federal law which federal law pre-empts individual state requirements. However, individual states can require that an Issuer make minimal filings (a copy of the Form D filed with the SEC and a consent to service of process) and can require the payment of a fee.

Section 3(1)(11) of the Securities Act and Rule 147 promulgated thereunder provides an exemption from registration of securities as long as the Issuer is incorporated in the state where it offers the securities; conducts a significant amount of its business in that state; and makes offers and sales only to residents of that state. Federal law imposes no limits on the size of the offering, or the number or qualification of the investors, however, an Issuer must abide by the laws of the particular state it is making the offering in, which laws may impose such restrictions.

Regulation A is promulgated under Section 3(b) of the Securities Act, which Section allows the SEC to formulate exemptions for small public offerings under $5,000,000. Like a larger public offering, the Issuer must file a prospectus with the SEC and clear comments prior to embarking on the offering. However, unlike a larger public offering, following the effectiveness of the registration statement, the Issuer is not subject to any ongoing reporting requirements. Moreover, the Issuer has the option of remaining “private” or seeking to have their securities traded on the over the counter market.

There are many venture capital firms, angel investors, and private investor groups looking for ground floor opportunities with new business ventures. However, generally these investors seek large equity positions with a Company and often participate in management and operations of the Company.

This type of financing is more typical and similar to bank financing with higher costs and interest rates.

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.

The End Of An Era; The OTCBB Has Been Replaced By The OTCQB

A few months ago I wrote an article predicting that the new “OTC Markets,” formerly known as the Pink Sheets, and it’s OTCQX and OTCQB quotation tiers were replacing the antiquated, formerly FINRA-run OTCBB. Current events add further evidence to this view. Recently, more than 1000 Companies which were trading on both the OTCBB and OTCQB were delisted from the OTCBB and now trade exclusively on the OTCQB tier of the OTC Markets. These entities are quickly becoming known by their new moniker, OTCQB Companies.

The Investment Banking firm of Rodman & Renshaw acquired the OTCBB from FINRA last year.

An OTCBB By Any Other Name

For more than a year leading up to this large scale, mass delistment, it has been impossible to decipher between an OTCBB Company and a Reporting Pink Sheet Company when viewing the OTC Markets website. Both entities appeared under the heading of “OTCQB.” It was essential to reference other source material in order to make the distinction.

The now privately owned and operated OTCBB quietly delisted approximately 1,000 fully reporting and current, public companies from its quotation medium, initially citing “failure to comply with Rule 15c2-11”. Subsequent delistments cited “Ineligible for quotation on OTCBB due to quoting inactivity under SEC Rule 15c2-11.”  

Delistments Means Little to Nothing

Most, if not all, of these companies did not receive notice of their “delisting”. Moreover, most, if not all, of these companies still do not know that they are no longer OTCBB quoted companies. In fact, the change has had little if no impact on these companies and will likely not have future impact. Each of these companies continue to be quoted on the OTCQB on the website for OTC Markets.

Issuer Reporting Obligations

Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC. Although the entire Over the Counter is regulated by the SEC and FINRA, the OTC Markets and the OTCBB are both now privately owned and merely serve as quotation mediums. However, and most importantly, the OTC Markets is more user friendly and factually up to date and accurate than the website for the OTCBB. So, if all Over the Counter quotes can be found at www.otcmarkets.com and companies trading on the OTCQB have the exact same standards as the OTCBB, and FINRA is no longer directly associated with the OTCBB, is there any reason for the OTCBB to even exist?

The fact sheet on www.otcmarkets.com has this to say regarding OTCQB quoted securities:

“With over 94% of all market maker quotes in OTC securities published on OTC Markets Group’s platform vs. 6% on the FINRA BB, it is important that OTC Markets Group provide a separate designation to identify OTC-traded companies that are U.S. registered and reporting. OTC Markets Group has launched the OTCQBtm marketplace to help investors easily identify SEC reporting companies and regulated banks that are current with their disclosure obligations.”

In summary, the curtains have closed on the OTCBB in name only and its business as usual for the new OTCQB.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14.  In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”).  Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile. 

Contact Legal & Compliance. LLC for a free initial consultation or second opinion on an existing matter.