SEC Has Approved A Two-Year Tick Size Pilot Program For Smaller Public Companies
Posted by Securities Attorney Laura Anthony | July 29, 2015 Tags: , , , , , , , , , , , , , , ,

On May 6, 2015 the SEC approved a two-year pilot program with FINRA and the national securities exchanges that will widen the minimum quoting and trading increments, commonly referred to as tick sizes, for the stocks of smaller public companies.  The goal of the program is to study whether wider tick sizes improve the market quality and trading of these stocks.

The basic premise is that if a tick size is wider, the spread will be bigger, and thus market makers and underwriters will have the ability to earn a larger profit on trading.  If market makers and underwriters can earn larger profits on trading, they will have incentive to make markets, support liquidity and issue research on smaller public companies.  The other side of the coin is that larger spreads and more profit for the traders equates to increased costs to the investors whose accounts are being traded.

The tick size program includes companies that meet the following $3 billion or less in market capitalization, an average trading volume of one million shares or less, and a volume weighted average price of at least $2.00 for every trading day.  The pilot study group includes a control group of 1400 securities and three test groups with 400 securities in each.   Notably, the tick size program will not include micro-cap securities with a weighted average price of less than $2.00 per day.

During the pilot the control group will be quoted at the current tick size increment of $.01 per share and will trade at the currently permitted increments.  The first test group will be quoted in increments of $.05 but will continue to trade at any price increment that is currently permitted.  The second test group will be quoted in increments of $.05 and will also trade at $.05 minimum increments subject to certain exceptions.  The third test group will be quoted in increments of $.05 and will be subject to an additional “trade at” requirement to prevent price matching.  The third test group will have the same exceptions as the second and an additional block size exception.

Background and Reasoning for the Program

Since the inception of decimalization in 2001 and minimum price variation of one penny for exchange-traded companies, there has been a significant change in the nature of trading and role of market participants.  Many market participants believe that underwriters and market makers have lost their incentive to make markets and produce research for micro-, small- and mid-capitalization companies.

The JOBS Act directed the SEC to conduct a study and report to Congress on how decimalization affected the number of IPO’s and the liquidity and trading of stock in smaller public companies.  The JOBS Act also gives the SEC the authority to designate a minimum increment for the trading of emerging growth companies that is more than $.01 but less than $.10.  In July 2012 the SEC submitted the “Decimalization Report” to Congress, failing to reach a firm conclusion and instead realizing further research was needed, including by pursuing a pilot program to study the impact of wider tick sizes.  The SEC believes that the current approved tick size pilot program will provide the necessary information to determine whether to permanently change tick sizes for these smaller companies.

As mentioned, the goal of the program is to study whether wider tick sizes improve the market quality and trading of these stocks.  The basic premise is that if a tick size is wider, the spread will be bigger, and thus market makers and underwriters will have the ability to earn a larger profit on trading.  If market makers and underwriters can earn larger profits on trading, they will have incentive to make markets, support liquidity and issue research on smaller public companies.  Moreover, additional market makers may enter the market as they see an opportunity to earn value.  Additional market makers will equate to additional liquidity, which in turn attract more investors.

Issuers benefit from increased liquidity and market activity and quality in several ways.  More trading activity and increased investor awareness could reduce the company’s cost of capital and improve opportunities to attract capital.  That is, more investors will be willing to invest directly into the company, through PIPE transactions, registered secondary offerings, equity lines and the like as they will see a strong exit strategy.  Moreover, with higher liquidity and market value, the ultimate exit by these investors will have less of a downward impact on trading price.  Where the investment instrument was convertible (such as convertible debt, warrants and options) using a market price formula, less downward pressure on trading price will mean fewer shares will need to be issued in the conversion and the existing shareholders will suffer less dilution.

In addition, one of the main purposes of going public is to use capital stock as currency in making acquisitions and attracting key executives. Where the company has an active trading market, market maker support and strong liquidity, the value of the capital stock is likewise higher. Not only will the capital cost of making stock-based acquisitions and attracting and retaining high-quality key executives be reduced but for some issuers, it will make the difference of being able to utilize this benefit of being public at all.

Although there is no doubt that improved liquidity, market activity and market maker and underwriter support is extremely beneficial to all public companies, and in serious need for improvement for smaller public companies, it is not known whether the increased tick size will have the desired outcome.

The other side of the coin is that larger spreads and more profit for the traders with the increased tick size equates to increased costs to the investors whose accounts are being traded.  Moreover, the program itself will be complex and costly to implement for market participants.  Market participants have stringent rules to follow for each test group to ensure a valid test result.  Each participant must adopt written policies and procedures and monitor and report results.

Conclusion

It is important that the SEC and market participants actively seek to improve the market quality for smaller public companies, and this is just one measure in that wheelhouse.  However, it is a two-year program.  I’m anxious to see more timely efforts in this arena, such as through the launch of venture exchanges.

The Author

Attorney Laura Anthony
LAnthony@LegalAndCompliance.com
Founding Partner, Legal & Compliance, LLC
Corporate, Securities and Business Transaction Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the host of LawCast.com, the securities law network.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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Reverse Merger Attorney
Posted by Securities Attorney Laura Anthony | May 8, 2014 Tags: , , , , , ,

What is a reverse merger? What is the process?

A reverse merger is the most common alternative to an initial public offering (IPO) or direct public offering (DPO) for a company seeking to go public. A “reverse merger” allows a privately held company to go public by acquiring a controlling interest in, and merging with, a public operating or public shell company. The SEC defines a “shell company” as a publically traded company with (1) no or nominal operations and (2) either no or nominal assets or assets consisting solely of any amount of cash and cash equivalents.

In a reverse merger process, the private operating company shareholders exchange their shares of the private company for either new or existing shares of the public company so that at the end of the transaction, the shareholders of the private operating company own a majority of the public company and the private operating company has become a wholly owned subsidiary of the public company. The pre-closing controlling shareholder of the public company either returns their shares to the company for cancellation or transfers them to individuals or entities associated with the private operating business. The public company assumes the operations of the private operating company. At the closing, the private operating company has gone public by acquiring a controlling interest in a public company and having the public company assume operations of the operating entity.

A reverse merger is often structured as a reverse triangular merger. In that case, the public shell forms a new subsidiary which new subsidiary merges with the private operating business. At the closing the private company, shareholders exchange their ownership for shares in the public company and the private operating business becomes a wholly owned subsidiary of the public company. The primary benefit of the reverse triangular merger is the ease of shareholder consent. That is because the sole shareholder of the acquisition subsidiary is the public company; the directors of the public company can approve the transaction on behalf of the acquiring subsidiary, avoiding the necessity of meeting the proxy requirements of the Securities Exchange Act of 1934.

The SEC requires that a public company file Form 10 type information on the private entity within four days of completing the reverse merger transaction (a super 8-K). Upon completion of the reverse merger transaction and filing of the Form 10 information, the once private company is now public. Form 10 information refers to the type of information contained in a Form 10 Registration Statement. Accordingly, a Super 8-K is an 8-K with a Form 10 included therein.

Like any transaction involving the sale of securities, the issuance of securities to the private company shareholders must either be registered under Section 5 of the Securities Act or use an available exemption from registration. Generally, shell companies rely on Section 4(a)(2) or Rule 506 of Regulation D under the Securities Act for such exemption.

The Transaction

A reverse merger is a merger transaction with the difference being that the target ultimately ends up owning a majority of the acquirer. However, the documentation and process to complete the transaction is substantially the same as a forward merger.

Generally the first step in a reverse merger is executing a confidentiality agreement and letter of intent. 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, a confidentiality agreement should be executed first.

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 associated with conducting due diligence and 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. Along with an LOI, the parties’ attorneys prepare a transaction checklist which includes a “to do” list along with a “who do” identification.

Following the LOI, the parties will prepare a definitive agreement which is generally titled either a “Share Exchange Agreement” or a “Merger Agreement.” In a nutshell, the Merger Agreement sets out the financial terms of the transaction and legal rights and obligations of the parties with respect to the transaction. The Merger Agreement sets forth closing procedures, preconditions to closing and post-closing obligations, and sets out representations and warranties by all parties and the rights and remedies if these representations and warranties are inaccurate.

The main components of the Merger Agreement and a brief description of each are as follows:

1. Representations and Warranties – Representations and warranties generally provide the buyer and seller with a snapshot of facts as of the closing date. From the seller the facts are generally related to the business itself, such as that the seller has title to the assets, there are no undisclosed liabilities, there is no pending litigation or adversarial situation likely to result in litigation, taxes are paid and there are no issues with employees. From the buyer the facts are generally related to legal capacity, authority and ability to enter into a binding contract. The seller also represents and warrants its legal ability to enter into the agreement.

2. Covenants – Covenants generally govern the parties’ actions for a period prior to and following closing. An example of a covenant is that the private company must continue to operate the business in the ordinary course and maintain assets pending closing and if there are post-closing payouts that the seller continues likewise. All covenants require good faith in completion.

3. Conditions – Conditions generally refer to pre-closing conditions such as shareholder and board of director approvals, that certain third-party consents are obtained and proper documents are signed. Closing conditions usually include the payment of the compensation by the buyer. Generally, if all conditions precedent are not met, the parties can cancel the transaction.

4. Indemnification/remedies – Indemnification and remedies provide the rights and remedies of the parties in the event of a breach of the agreement, including a material inaccuracy in the representations and warranties or in the event of an unforeseen third-party claim related to either the agreement or the business.

5. Schedules – Schedules generally provide the meat of what the seller is purchasing, such as a complete list of customers and contracts, all equity holders, individual creditors and terms of the obligations. The schedules provide the details.

6.In the event that the parties have not previously entered into a letter of intent or confidentiality agreement providing for due diligence review, the Merger Agreement may contain due diligence provisions. Likewise, the agreement may contain no-shop provisions, breakup fees, and/or non-compete and confidentiality provisions if not previously agreed to separately.

The next and final steps are the actual closing in which the shares of stock and reverse merger consideration change hands and a Super 8-K is filed with the SEC.

Reverse Merger Consideration/The Cost of the Shell

In a reverse merger transaction, the private operating business must pay for the public shell company. That payment may be in cash, equity or both. Although the cash price of shell entities can vary and changes over time as does the value of all assets, as of the day of this blog, the average cash value of a fully reporting public entity with no liabilities, no issues (such as a DTC chill) and which is otherwise “clean” is between $280,000 – $400,000. The price variance depends on many factors, such as pre- and post-closing conditions (such as a requirement that the public entity complete a name change and/or stock split prior to closing); the ultimate percent ownership that will be owned by the private operating company shareholders; how quickly the transaction can close; whether the private entity has its “ducks in a row” (see below); whether the entities have complete due diligence packages prepared; and whether any broker-dealers or investment bankers must be paid in association with the transaction.

Where the private operating business is paying for the public shell entity with equity, the current shareholders of the public shell company keep a larger portion of their pre-closing equity and therefore own a greater percent of the new combined companies post-closing. That is, the current public company shareholders have a lower level of dilution in the transaction.

For example, in a cash reverse merger transaction, generally the current control shareholders of the public company cancel or otherwise divest themselves of all of their share ownership and the post-closing share ownership is anywhere from 80%/20% to 99%/1% with the private operating company shareholders owning the majority. In an equity transaction, the current control shareholders keep some or all of their current share ownership. In addition, the final post-closing capitalization will generally be anywhere from 51%/49% to 80%/20% with the private operating company shareholders owning the majority.

The percentage of ownership maintained by the public company shareholders will depend on the perceived value of the private operating company and an expectation of what the value of their share ownership could be in the future. Clearly there is risk involved for the public company shareholders. That is, control shareholders may have to decide whether to accept $300,000 today or maintain a stock ownership level that they hope will be worth much more than that at some time in the future. From the private operating company’s perspective, they are diluting their current ownership and giving up a piece of the pie.

Accordingly, in an equity transaction, the parties to the reverse merger will negotiate the value of the private operating business. For business entities with operating history, revenue, profit margins and the like, valuation is determined by mathematical calculations and established mathematically based matrixes (usually 1x to 8x EBITDA). For a development stage or start-up venture, the necessary elements to complete a mathematical analysis simply do not exist. In this case, valuation is based on negotiation and a best guess.

Establishing valuation for a development stage or start-up entity ultimately comes down to an investor’s (i.e., in a reverse merger, public company shareholders who agree to forgo cash and keep equity instead) perception of risk versus reward. Risk is easy to determine: If I could get $300,000 cash for the public shell today, I may lose that $300,000 by accepting equity instead. Reward, on the other hand, is an elusive prospect based on the potential success of a business.

In determining value, an analysis (due diligence) should be conducted on a minimum of the following: market data; competition; pricing and distribution strategies; assets and liabilities; hidden liabilities; inflated assets; technology risks; product development plans; legal structure; legal documentation; corporate formation documents and records; and management, including backgrounds on paper, and face-to-face assessments.

Areas of Consideration in Determining Valuation

The following areas should be researched and considered in valuation. The below list is in no particular order.

1. Investment comps: Have investors, either private or public, recently funded similar companies, and if so, on what terms and conditions and at what valuation;

2. Market Data: What is the product market; what is the size of the market; how many new players enter the market on a yearly basis and what is their success rate;

3. Competition: Who are the major competitors; what is their valuation; how does this company differ from these competitors;

4. Uniqueness of product or technology: How is the product or technology unique; can it easily be duplicated; patent, trademark and other intellectual property protections;

5. Pricing and Distribution Strategies: What are the major impediments to successful entry into the marketplace; what is the plan for successful entry into the marketplace; has order fulfillment, including transportation costs, been considered; connections to end users for the product or service; what are profit margins and will the margins increase as the business grows and scales;

6. Capital investments to date: What capital investments have been made to the company to date, including both financial and services;

7. Assets and liabilities: What does the balance sheet look like; are there hidden liabilities; any off-balance sheet arrangements; how are assets valued; are any assets either over- or undervalued; is there clear title to all assets;

8. Technology Risks: What technologies are relied upon; what is the state of evolvement of those technologies; can they keep up;

9. Product Development Plans: Are there a model and samples; have they been tested; have manufacturing channels been established; exclusive contracts with manufacturers; what is the overall plan to bring the product to market and subsequently become a competitor in the industry;

10. Legal Structure: Legal structure of current outstanding equity – just common equity or common and preferred, and if preferred, what rights are associated therewith (redemption rights; liquidation preferences; dividends; voting rights);

11. Legal documentation: Not only whether corporate records are in order, but are all contracts and arrangements properly documented;

12. Future financing needs: Will significant future financing be necessary to achieve the business plan; what is the risk of a future down round (note that a down round is a future financing at a lower valuation resulting in dilution to the current investors);

13. Exit strategies: How will the current shareholder be able to sell; will the shares have piggyback or demand registration rights; reliance on Rule 144?; lockup or other additional holding periods?;

14. Management: This is perhaps the most important consideration – Does the management team have a proven history of success; prior business experience in this and other industries; work ethic; general management skills; organization skills; presentation skills; research skills; coachability; ability to attract others with strong credentials who believe in the business and are willing to work to make the business a success; does management present well in meetings and face-to-face discussions;

16. Developmental milestones: Has the company achieved its developmental milestones to date?

Advantages of a Reverse Merger

The primary advantage of a reverse merger is that it can be completed very quickly. As long as the private entity has its “ducks in a row,” a reverse merger can be completed as quickly as the attorneys can complete the paperwork. Having your “ducks in a row” includes having completed audited financial statements for the prior two fiscal years and quarters up to date (or from inception if the company is less than two years old), and having the information that will be necessary to file with the SEC readily available. The reverse merger transaction itself is not a capital-raising transaction, and accordingly, most private entities complete a capital-raising transaction (such as a PIPE) simultaneously with or immediately following the reverse merger, but it is certainly not required. In addition, many companies engage in capital restructuring (such as a reverse split) and a name change either prior to or immediately following a reverse merger, but again, it is not required.

Raising money is difficult and much more so in the pre-public stages. In a reverse merger, the public company shareholders become shareholders of the operating business and no capital raising transaction needs to be completed to complete the process. Accordingly, companies that may be less mature in their development and unable to attract sophisticated capital financing can use a reverse merger to complete a going public transaction and still benefit from being public while they grow and mature. Such benefits include the ability to use stock and stock option plans to attract and keep higher-level executives and consultants and to make growth acquisitions using stock as currency.

Disadvantages of a Reverse Merger

There are several disadvantages to a reverse merger. The primary disadvantage is the restriction on the use of Rule 144 where the public company is or ever has been a shell company. Rule 144 is unavailable for the use by shareholders of any company that is or was at any time previously a shell company unless certain conditions are met. In order to use Rule 144, a company must have ceased to be a shell company; be subject to the reporting requirements of section 13 or 15(d) of the Exchange Act; filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months (or for such shorter period that the issuer was required to file such reports and materials), other than Form 8-K reports; and have filed current “Form 10 information” with the Commission reflecting its status as an entity that is no longer a shell company – then those securities may be sold subject to the requirements of Rule 144 after one year has elapsed from the date that the issuer filed “Form 10 information” with the SEC.

Rule 144 now affects any company that was ever in its history a shell company by subjecting them to additional restrictions when investors sell unregistered stock under Rule 144. The new language in Rule 144(i) has been dubbed the “evergreen requirement.” Under the so-called “evergreen requirement,” a company that ever reported as a shell must be current in its filings with the SEC and have been current for the preceding 12 months before investors can sell unregistered shares.

Another disadvantage concerns undisclosed liabilities, lawsuits or other issues with the public shell. Accordingly, due diligence is an important aspect of the reverse merger process, even when dealing with a fully reporting current public shell. The third primary disadvantage is that the reverse merger is not a capital-raising transaction (whereas an IPO or DPO is). An entity in need of capital will still be in need of capital following a reverse merger, although generally, capital-raising transactions are much easier to access once public. The fourth disadvantage is immediate cost. The private entity generally must pay for the public shell with cash, equity or a combination of both. However, it should be noted that an IPO or DPO is also costly.

In addition, the NYSE, NYSE MKT (formerly AMEX) and NASDAQ exchanges have enacted 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 of its required reports for the one-year period, including at least one annual report. 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.

Finally, whether an entity seeks to go public through a reverse merger or an IPO, they will be subject to several, and ongoing, time-sensitive filings with the SEC and will thereafter be subject to the disclosure and reporting requirements of the Securities Exchange Act of 1934, as amended.

The Author

Attorney Laura Anthony

LAnthony@LegalAndCompliance.com

Founding Partner, Legal & Compliance, LLC

Securities, Reverse Merger and Corporate Attorneys

Corporate and Securities Attorney Laura Anthony’s legal expertise includes but is not limited to registration statements, including Forms S-1, S-4, S-8 and Form 10, PIPE transactions, debt and equity financing transactions, private placements, reverse mergers, forward mergers, asset acquisitions, joint ventures, crowdfunding, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K, the proxy requirements of Section 14, Section 16 filings and Sarbanes-Oxley mandated policies. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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How Does My Company Go Public?
Posted by Securities Attorney Laura Anthony | May 8, 2014 Tags: , , , , , , , ,

Introduction

For at least the last twelve months, I have received calls daily from companies wanting to go public.  This interest in going public transactions signifies a big change from the few years prior.

Beginning in 2009, the small-cap and reverse merger, initial public offering (IPO) and direct public offering (DPO) markets diminished greatly.  I can identify at least seven main reasons for the downfall of the going public transactions.  Briefly, those reasons are:  (1) the general state of the economy, plainly stated, was not good; (2) backlash from a series of fraud allegations, SEC enforcement actions, and trading suspensions of Chinese companies 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’s enforcement of broker-dealer and clearing house due diligence requirements related to penny stocks; (5) DTC scrutiny and difficulty in obtaining clearance following a reverse merger or other corporate restructuring and significantly DTC chills and locks; (6) increasing costs of reporting requirements, including the relatively new XBRL requirements;  and (7) the updated listing requirements imposed by NYSE, AMEX and NASDAQ and twelve-month waiting period prior to qualifying for listing following a reverse merger.

However, despite these issues, 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, equity line or similar financing (the costs and quality of these financing opportunities is beyond the scope of this blog).  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; they will just evolve to meet ever-changing demand and regulations.

What is a reverse merger?  What is the process?

A reverse merger is the most common alternative to an initial public offering (IPO) or direct public offering (DPO) for a company seeking to go public.  A “reverse merger” allows a privately held company to go public by acquiring a controlling interest in, and merging with, a public operating or public shell company.  The SEC defines a “shell company” as a publically traded company with (1) no or nominal operations and (2) either no or nominal assets or assets consisting solely of any amount of cash and cash equivalents.

In a reverse merger process, the private operating company shareholders exchange their shares of the private company for either new or existing shares of the public company so that at the end of the transaction, the shareholders of the private operating company own a majority of the public company and the private operating company has become a wholly owned subsidiary of the public company.  The public company assumes the operations of the private operating company.  At the closing, the private operating company has gone public by acquiring a controlling interest in a public company and having the public company assume operations of the operating entity.

A reverse merger is often structured as a reverse triangular merger.  In that case, the public shell forms a new subsidiary which the new subsidiary merges with the private operating business.  At the closing the private company shareholders exchange their ownership for shares in the public company, and the private operating business becomes a wholly owned subsidiary of the public company.  The primary benefit of the reverse triangular merger is the ease of shareholder consent.  That is because the sole shareholder of the acquisition subsidiary is the public company; the directors of the public company can approve the transaction on behalf of the acquiring subsidiary, avoiding the necessity of meeting the proxy requirements of the Securities Exchange Act of 1934.

Like any transaction involving the sale of securities, the issuance of securities to the private company shareholders must either be registered under Section 5 of the Securities Act or use an available exemption from registration.  Generally, shell companies rely on Section 4(a)(2) or Rule 506 of Regulation D under the Securities Act for such exemption.

The primary advantage of a reverse merger is that it can be completed very quickly.  As long as the private entity has its “ducks in a row,” a reverse merger can be completed as quickly as the attorneys can complete the paperwork.  Having your “ducks in a row” includes having completed audited financial statements for the prior two fiscal years and quarters up to date (or from inception if the company is less than two years old), and having the information that will be necessary to file with the SEC readily available.  The SEC requires that a public company file Form 10 type information on the private entity within four days of completing the reverse merger transaction (a super 8-K).  Upon completion of the reverse merger transaction and filing of the Form 10 information, the once private company is now public.  The reverse merger transaction itself is not a capital-raising transaction, and accordingly, most private entities complete a capital-raising transaction (such as a PIPE) simultaneously with or immediately following the reverse merger, but it is certainly not required.  In addition, many Companies engage in capital restructuring (such as a reverse split) and a name change either prior to or immediately following a reverse merger, but again, it is not required.

There are several disadvantages of a reverse merger.  The primary disadvantage is the restriction on the use of Rule 144 where the public company is or ever has been a shell company.  Rule 144 is unavailable for the use by shareholders of any company that is or was at any time previously a shell company unless certain conditions are met.  In order to use Rule 144, a company must have ceased to be a shell company; be subject to the reporting requirements of section 13 or 15(d) of the Exchange Act; filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months (or for such shorter period that the Issuer was required to file such reports and materials), other than Form 8-K reports; and have filed current “Form 10 information” with the Commission reflecting its status as an entity that is no longer a shell company, then those securities may be sold subject to the requirements of Rule 144 after one year has elapsed from the date that the Issuer filed “Form 10 information” with the SEC.

Rule 144 now affects any company who was ever in its history a shell company by subjecting them to additional restrictions when investors sell unregistered stock under Rule 144.  The new language in Rule 144(i) has been dubbed the “evergreen requirement.”  Under the so-called “evergreen requirement,” a company that ever reported as a shell must be current in its filings with the SEC and have been current for the preceding 12 months before investors can sell unregistered shares.

The second biggest disadvantage concerns undisclosed liabilities, lawsuits or other issues with the public shell.  Accordingly, due diligence is an important aspect of the reverse merger process, even when dealing with a fully reporting current public shell.  The third primary disadvantage is that the reverse merger is not a capital-raising transaction (whereas an IPO or DPO is).  An entity in need of capital will still be in need of capital following a reverse merger, although generally, capital raising transactions are much easier to access once public.  The fourth disadvantage is immediate cost.  The private entity generally must pay for the public shell with cash, equity or a combination of both.  However, it should be noted that an IPO or DPO is also costly.

Finally, whether an entity seeks to go public through a reverse merger or an IPO, they will be subject to several, and ongoing, time-sensitive filings with the SEC and will thereafter be subject to the disclosure and reporting requirements of the Securities Exchange Act of 1934, as amended.

What is a Direct Public Offering?  What is the process?

One of the methods of going public is directly through a public offering.  In today’s financial environment, many Issuers are choosing to self-underwrite their public offerings, commonly referred to as a Direct Public Offering (DPO).  An IPO, on the other hand, is a public offering underwritten by a broker-dealer (underwriter).   As a very first step, an Issuer and their counsel will need to complete a legal audit and any necessary corporate cleanup to prepare the company for a going public transaction.   This step includes, but is not limited to, a review of all articles and amendments, the current capitalization and share structure and all outstanding securities; a review of all convertible instruments including options, warrants and debt; and the completion of any necessary amendments or changes to the current structure and instruments.  All past issuances will need to be reviewed to ensure prior compliance with securities laws.  Moreover, all existing contracts and obligations will need to be reviewed including employment agreements, internal structure agreements, and all third-party agreements.

Once the due diligence and corporate cleanup are complete, the Issuer is ready to move forward with an offering.  Companies desiring to offer and sell securities to the public with the intention of creating a public market or going public must file with the SEC and provide prospective investors with a registration statement containing all material information concerning the company and the securities offered.  Such registration statement is generally on Form S-1.  For a detailed discussion of the S-1 contents, please see my white paper here.  The average time to complete, file and clear comments on an S-1 registration statement is 90-120 days.  Upon clearing comments, the S-1 will be declared effective by the SEC.

Following the effectiveness of the S-1, the Issuer is free to sell securities to the public.  The method of completing a transaction is generally the same as in a private offering.   (i) the Issuer delivers a copy of the effective S-1 to a potential investor, which delivery can be accomplished via a link to the effective registration statement on the SEC EDGAR website together with a subscription agreement; (ii) the investor completes the subscription agreement and returns it to the Issuer with the funds to purchase the securities; and (iii) the Issuer orders the shares from the transfer agent to be delivered directly to the investor.  If the Issuer arranges in advances, shares can be delivered to the investors via electronic transfer or DWAC directly to the investors brokerage account.

Once the Issuer has completed the sale process under the S-1 – either because all registered shares have been sold, the time of effectiveness of the S-1 has elapsed, or the Issuer decides to close out the offering – a market maker files a 15c2-11 application on behalf of the Issuer to obtain a trading symbol and begin trading either on the over-the-counter market (such as OTCQB).  The market maker will also assist the Issuer in applying for DTC eligibility.

A DPO can also be completed by completing a private offering prior to the filing of the S-1 registration statement and then filing the S-1 registration statement to register those shares for resale.  In such case, the steps remain primarily the same except that the sales by the company are completing prior to the S-1 and a the 15c2-11 can be filed immediately following effectiveness of the S-1 registration statement.

Basic differences in DPO vs. Reverse Merger Process

Why DPO:

As opposed to a reverse merger, a company completing a DPO does not have to worry about potential carry-forward liability issues from the public shell.

A company completing a DPO does not have to wait 12 months to apply to the NASDAQ, NYSE MKT or other exchange and if qualified, may go public directly onto an exchange.

A DPO is a money-raising transaction (either pre S-1 in a private offering or as part of the S-1 process).   A reverse merger does not raise money for the going public entity unless a separate money-raising transaction is concurrently completed.

As long as the company completing the DPO has more than nominal operations (i.e., it is not a very early-stage start-up with little more than a business plan), it will not be considered a shell company and will not be subject to the various rules affecting entities that are or ever have been a shell company.  To the contrary, many public entities completing a reverse merger are or were shells.

A DPO is less expensive than a reverse merger.  The total cost of a DPO is approximately and generally $100,000-$150,000 all in.  The cost of a reverse merger includes the price of the public vehicle, which can range from $250,000-$500,000.  Accordingly, the total cost of a reverse merger is approximately and generally $350,000-$650,000 all in.  Deals can be made where the cost of the public shell is paid in equity in the post-reverse merger entity instead of or in addition to cash, but either way, the public vehicle is being paid for.  NOTE: These are approximate costs.  Many factors can change the cost of the transactions.

Why Reverse Merger

Raising money is difficult and much more so in the pre-public stages.  In a reverse merger, the public company shareholders become shareholders of the operating business and no capital raising transaction needs to be completed to complete the process.

A reverse merger can be much quicker than a DPO.

Raising money in a public company is much easier than in a private company pre going public.  A reverse merger can be completed quickly, and thereafter the now public company can raise money.

Reverse Mergers and DPO’s are both excellent methods for going public

As I see it, the evolution in the markets and regulations have created new opportunities, including the opportunity for a revived, better reverse merger market and a revived, better DPO market.  A reverse merger remains the quickest way for a company to go public, and a DPO remains the cleanest way for a company to go public.  Both have advantages and disadvantages, and either may be the right choice for a going public transaction depending on the facts, circumstances and business needs.

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 necessarily require greater due diligence up front, if for no other reasons than to ensure DTC eligibility and broker dealer tradability, prevent future regulatory issues, and ensure that no “bad boys” are part of the deal or were ever involved in the shell.  Increased due diligence will result in fewer post-merger issues.

The over-the-counter market has regained credibility and supports higher stock prices, especially since exchanges are forcing companies to trade there for a longer period of time before becoming eligible to move up.  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.

The bottom line is that issues and setbacks for going public transactions since 2008 have primed the pump and created the perfect conditions for a revitalized, better reverse merger and DPO market beginning in 2014.

The Author

Attorney Laura Anthony

Founding Partner, Legal & Compliance, LLC

Securities, Reverse Merger and Corporate Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms.

Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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Mergers and Acquisitions; Merger Documents Outlined
Posted by Securities Attorney Laura Anthony | May 8, 2014 Tags: , , ,

An Outline Of the Transaction

The Confidentiality Agreement

Generally the first step in an M&A deal is executing a confidentiality agreement and letter of intent.  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, a confidentiality agreement should be executed first.

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.

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 associated with conducting due diligence and 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.  Along with an LOI, the parties’ attorneys prepare a transaction checklist which includes a “to do” list along with a “who do” identification.

Many clients ask me how to protect their interests while trying to negotiate a merger or acquisition.  During the negotiation period, both sides will incur time and expense, and will provide the other with confidential information.  The way to protect confidential information is through a confidentiality agreement, but that does not protect against wasted time and expense.  Many other protections can be used to avoid wasted time and expense.

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.  An example of a window shop provision may be that a party cannot solicit other similar transactions but is 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 a no shop or window shop provision is a “go shop” provision.  To address a board of directors’ fiduciary duty and, 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.  Examples 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 interests by requiring significant stockholders to agree to lock-ups 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.

The Merger Agreement

In a nutshell, the Merger Agreement sets out the financial terms of the transaction and legal rights and obligations of the parties with respect to the transaction.  It provides the buyer with a detailed description of the business being purchased and provides for rights and remedies in the event that this description proves to be materially inaccurate.  The Merger Agreement sets forth closing procedures, preconditions to closing and post-closing obligations, and sets out representations and warranties by all parties and the rights and remedies if these representations and warranties are inaccurate.

The main components of the Merger Agreement and a brief description of each are as follows:

Representations and Warranties – representations and warranties generally provide the buyer and seller with a snapshot of facts as of the closing date.  From the seller the facts are generally related to the business itself, such as that the seller has title to the assets, there are no undisclosed liabilities, there is no pending litigation or adversarial situation likely to result in litigation, taxes are paid and there are no issues with employees.  From the buyer the facts are generally related to legal capacity, authority and ability to enter into a binding contract.  The Seller also represents and warrants its legal ability to enter into the agreement.

Covenants – covenants generally govern the parties’ actions for a period prior to and following closing.  An example of a covenant is that a seller must continue to operate the business in the ordinary course and maintain assets pending closing and if there are post-closing payouts that the seller continues likewise.  All covenants require good faith in completion.

Conditions – conditions generally refer to pre-closing conditions such as shareholder and board of director approvals, that certain third-party consents are obtained and proper documents are signed. Closing conditions usually include the payment of the compensation by the buyer.  Generally, if all conditions precedent are not met, the parties can cancel the transaction.

Indemnification/remedies – indemnification and remedies provide the rights and remedies of the parties in the event of a breach of the agreement, including a material inaccuracy in the representations and warranties or in the event of an unforeseen third-party claim related to either the agreement or the business.

Schedules – Schedules generally provide the meat of what the seller is purchasing, such as a complete list of customers and contracts, all equity holders, individual creditors and terms of the obligations.  The schedules provide the details.

In the event that the parties have not previously entered into a letter of intent or confidentiality agreement providing for due diligence review, the Merger Agreement may contain due diligence provisions.  Likewise, the agreement may contain no shop provisions, breakup fees, non-compete and confidentiality provisions if not previously agreed to separately.

Disclosure Matters

In a merger or 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.

(i) Negotiation Period (Pre-Definitive Agreement)

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 where pre-definitive agreement disclosure may be necessary or mandated.

1.  The first would be in the Management, Discussion and Analysis section of a Company’s quarterly or annual report on Form 10-Q or 10-K respectively. 

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.  Furthermore, 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.”

It seems pretty 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, where 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, where 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.

2.  The second would be in Form 8-K, Item 1.01 Entry into A Material Definitive Agreement.

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 or 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, breakup 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 breakup fees or extraordinary exclusivity provisions are reportable.

3.  The third would be in response to a Regulation FD issue.

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.

(ii) The Definitive Agreement

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.

(iii) The Closing

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.

The Author

Attorney Laura Anthony

Founding Partner, Legal & Compliance, LLC

Securities, Reverse Merger and Corporate Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms.

Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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14C Information Statement Requirements for a Pre-Merger Recapitalization
Posted by Securities Attorney Laura Anthony | May 8, 2014 Tags: , , , , ,

Background on 14C Information Statements

All companies with securities registered under the Securities Exchange Act of 1934, as amended, (i.e., through the filing of a Form 10 or Form 8-A) are subject to the Exchange Act proxy requirements found in Section 14 and the rules promulgated thereunder.  The proxy rules govern the disclosure in materials used to solicit shareholders’ votes in annual or special meetings held for the approval of any corporate action requiring shareholder approval.  The information contained in proxy materials must be filed with the SEC in advance of any solicitation to ensure compliance with the disclosure rules.

Solicitations, whether by management or shareholder groups, must disclose all important facts concerning the issues on which shareholders are asked to vote.  The disclosure information filed with the SEC and ultimately provided to the shareholders is enumerated in SEC Schedules 14A.

Where a shareholder vote is not being solicited, such as when a Company has obtained shareholder approval through written consent in lieu of a meeting, a Company may satisfy its Section 14 requirements by filing an information statement with the SEC and mailing such statement to its shareholders.  In this case, the disclosure information filed with the SEC and mailed to shareholders is enumerated in SEC Schedule 14C.  As with the proxy solicitation materials filed in Schedule 14A, a Schedule 14C Information Statement must be filed in advance of final mailing to the shareholder and is reviewed by the SEC to ensure that all important facts are disclosed.  However, Schedule 14C does not solicit or request shareholder approval (or any other action, for that matter), but rather informs shareholders of an approval already obtained and corporate actions which are imminent.

In either case, a preliminary Schedule 14A or 14C is filed with the SEC, who then reviews and comments on the filing.  Upon clearing comments, a definitive Schedule 14A or 14C is filed and mailed to the shareholders as of a certain record date.

Generally, the information requirements in Schedule 14C are less arduous those in a Schedule 14A in that they do not include lengthy material regarding what a shareholder must do to vote or approve a matter.  Moreover, the Schedule 14C process is much less time-consuming, as the shareholder approval has already been obtained.  Accordingly, when possible, Companies prefer to utilize the Schedule 14C Information Statement as opposed to the Schedule 14A Proxy Solicitation.

Pre-Merger Recapitalization

Generally, public company shareholders do not have the right to vote on a merger or acquisition transaction.  Such mergers or acquisitions are usually structured such that the public company completes the merger or acquisition via the issuance of shares of common or preferred stock.  In such cases, where the merger or acquisition is being accomplished via the issuance of authorized but previously unissued stock of a public company, the board of directors has the full power and authority to complete the transaction without shareholder approval.

However, in many instances the public company requires a pre-transaction recapitalization involving a reverse stock split and/or increase in authorized capital stock in order to have the available capital stock to issue at the closing of the merger or acquisition transaction and to provide the target entity and its shareholders with the agreed-upon share ownership and capital structure.  Shareholders do have the right to vote on recapitalization transactions, including a reverse stock split and a change in authorized capital stock.

Here is the catch.  Item 1 of Schedule 14C requires that the company provide information that would be required as if a vote were being solicited via a 14A Proxy Solicitation and specifically provides “[N]otes A, C, D, and E to Schedule 14A are also applicable to Schedule 14C.”  Note A to Schedule 14A provides:

“Where any item calls for information with respect to any matter to be acted upon and such matter involves other matters with respect to which information is called for by other items of this schedule, the information called for by such other items also shall be given. For example, where a solicitation of security holders is for the purpose of approving the authorization of additional securities which are to be used to acquire another specified company, and the registrants’ security holders will not have a separate opportunity to vote upon the transaction, the solicitation to authorize the securities is also a solicitation with respect to the acquisition. Under those facts, information required by Items 11, 13 and 14 shall be furnished.”

In other words, if you are filing a Schedule 14C for a pre-merger or acquisition recapitalization, you must provide all the information related to that merger or acquisition as if the shareholders were voting on the merger or acquisition even though the shareholders are only voting on the recapitalization and even though the shareholders have no legal right to vote on the merger or acquisition itself.

Specific Disclosure Requirements in the Pre-Merger 14C

As enumerated in Note A to Schedule 14A, a pre-merger recapitalization 14C Information Statement must include the information required by Items 11, 13 and 14 of Schedule 14A.  Items 11, 13 and 14 of Schedule 14A require in-depth disclosures on the merger or acquisition transaction itself and on both the target and acquiring companies, including audited financial statements and stub periods to date and pro forma financial statements on the combined entities.  Management discussion and analysis must also be provided for both entities.

In addition to financial information, Item 14 also requires, for example, in-depth disclosure regarding the business operations and disclosures related to regulatory approvals, transaction negotiations and property descriptions.  Many reading this will notice that the disclosures are analogous to a Super 8-K. The analogy is accurate, although the Super 8-K has additional requirements as well.

For entities engaging in a merger or acquisition transaction that would require the filing of a Super 8-K (i.e., where the public company is a shell company), the positive side is that the attorneys, accountants and auditors are putting together documents and information and engaging in efforts that would need to be completed for the Super 8-K in any event, just with an altered earlier timeline.  The efforts can be seen as a head start on the Super 8-K preparation.

However, for entities that would not be required to file a Super 8-K, such as where the public company is not a shell company, the efforts and altered timeline are substantially different.  When a public company that is not a shell company completes a merger or acquisition that requires the preparation and filing of financial statements on the acquired company (the determination of financial statement requirements is beyond the scope of this blog), it has 71 days following the closing to file such financial information via Form 8-K.  In the case of a pre-merger recapitalization 14C filing, the financial information, including audited financial statements, must be completed and filed prior to the closing.

Conclusion

Companies with securities registered under the Securities Exchange Act of 1934 and the target companies that they are planning to acquire or merge with must be prepared to file audited financial statements, pro forma financial statements, management discussion and analysis and other in-depth disclosure in a pre-merger 14C Information Statement where such Information Statement is for the purpose of a pre-merger recapitalization.

The Author

Attorney Laura Anthony

Founding Partner, Legal & Compliance, LLC

Securities, Reverse Merger and Corporate Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms.

Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

Follow me on Facebook  and LinkedIn

 


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Section 3(a)(10) Debt Conversions In a Shell Company Pre-Reverse Merger
Posted by Securities Attorney Laura Anthony | May 8, 2014 Tags: , , , , ,

Section 3(a) (10) of the Securities Act of 1933, as amended (“Securities Act”) is an exemption from the Securities Act registration requirements for the offers and sales of securities by Issuers.  The exemption provides that “Except with respect to a security exchanged in a case under title 11 of the United States Code, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court, or by any official or agency of the United States, or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval.”

The Securities and Exchange Commission (SEC) has given guidance on the operation of Section 3(a) (10) in its Division of Corporation Finance: Revised Staff Legal Bulleting No. 3.   In particular, in order to rely on the exemption, the following conditions must be met:

The securities must be issued in exchange for securities, claims, or property interests, not cash;A court or authorized governmental entity must approve the fairness of the terms and conditions of the exchange;

The reviewing court or authorized governmental entity must (i) find that the terms and conditions of the exchange are fair to those that the securities will be issued to; and (ii) be properly advised that the Issuer will be relying on the court’s findings to issuer securities;

The reviewing court or authorized governmental entity must hold a hearing before approving the fairness of the terms and conditions of the transaction;

A governmental entity must be expressly authorized by law to hold the hearing;

The fairness hearing must be open to everyone to whom securities would be issued in the proposed exchange;

Adequate notice must be given to all those persons; and

There cannot be any improper impediments to the appearance by those persons at the hearing.

Section 3(a) (10) does not preempt state law and accordingly, the implementing state statutes must also be abided by.  Many state securities law statutes that authorize a Section 3(a) (10) court process require that there be a majority shareholder vote approving the transaction prior to the hearing.

Re-sale of 3(a)(10) securities

Importantly, SEC Staff Bulletin 3 provides that the resale of securities issued in a Section 3(a) (10) transaction may be had without regard to Rule 144 if the seller is not an affiliate of the Issuer either before or after the Section 3(a) (10) transaction.  That is, as long as the Seller is not an affiliate of the Issuer, securities issued in a 3(a) (10) transaction are freely tradable.

If the seller is or will be an affiliate either before or after the Section 3(a) (10) transaction, resale’s are subject to Rule 144, except for the holding period and notice filing requirements.  That is, affiliates would still be subject to the drip rules, manner of sale and current public information requirements, but not the holding period requirements.

As a practical matter, many over-the-counter traded securities (over-the-counter bulletin board or OTCBB and pinksheets) have been utilizing the exemption found in Section 3(a) (10) to convert debt into common stock.  The conversion of debt into common stock can assist an Issuer in two ways.  First, and obviously, it eliminates the debt from the balance sheet and increases liquidity and solvency.  Second, and less obviously, is that the Section 3(a) (10) exemption can be used to convince lenders to make investments into a company without the investor relying solely on the Company cash flows for repayment.

3(a)(10) and shell company reverse mergers

As described herein, shareholders that receive their securities in a 3(a)(10) transaction by a shell company that subsequently completes a merger, reverse merger, reclassification or asset transfer will be restricted until (i) 6 months after issuance; and (ii) ninety (90) days after the reverse merger, reclassification or asset purchase has been completed.

Rule 145 promulgated under the Securities Act of 1933 governs the resale restrictions on shares of stock issued or received in a reclassification, merger or asset transfer.  Like Rule 144, Rule 145 contains prohibitions against the resale of securities in a shell company.

Shareholders of an entity that has completed a reverse merger, reclassification or asset transfer and that receive their securities pursuant to a 3(a)(10) transaction can resell their securities in accordance with revised resale provisions pursuant to Rule 145(d)(1) and (2) below, which provide that:

Rule 145….

 

(d) Resale provisions for persons and parties deemed underwriters. Notwithstanding the provisions of paragraph (c), a person or party specified in that paragraph shall not be deemed to be engaged in a distribution and therefore not to be an underwriter of securities acquired in a transaction specified in paragraph (a) that was registered under the Act if:

 

(1) The issuer has ceased to be a shell company, is reporting and has filed the requisite Exchange Act reports and filings reflecting that the issuer is no longer a shell company; and

 

(2) One of the following three conditions is met:

 

(i) The securities are sold in accordance with the Rule 144 restrictions and at least 90 days have elapsed since the date the securities were acquired from the issuer in the Rule 145 transaction;

 

(ii) The seller has not been, for at least three months, an affiliate of the issuer, and at least six months have elapsed since the date the securities were acquired from the issuer in the Rule 145 transaction, and current information regarding the issuer is publicly available; or

 

(iii) The seller has not been, for at least three months, an affiliate of the issuer, and at least one year has elapsed since the date the securities were acquired from the issuer in the Rule 145 transaction.

Although Rule 145(d) specifically refers to shares received in a reclassification, merger or asset transfer that was registered under the Act, the Rule specifically provides that transactions for which statutory exemptions under the Act, including those contained in sections 3(a)(9), (10), (11) and 4(2), are otherwise available are not affected by Rule 145.

The bottom line is that a shell company can complete a 3(a)(10) transaction prior to and in contemplation of a reverse merger transaction and such shares will become freely tradable 90 days after the closing of the reverse merger and after a total of a 6-month holding period from the date of issuance in the 3(a)(10) transaction.  The SEC analysis in Staff Legal Bulletin No. 3. supports this conclusion, and this firm’s personal and direct experience (including via SEC comment letters and responses) also support this conclusion.

The Author

Attorney Laura Anthony

Founding Partner, Legal & Compliance, LLC

Securities, Reverse Merger and Corporate Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms.

Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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Small-Cap Reverse Mergers Poised for a Comeback
Posted by Securities Attorney Laura Anthony | December 27, 2011 Tags: , , , , , , , , ,

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.

The Perfect Storm of Reverse Merger Stagnation

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.

The Need for Reverse Mergers Still Remains

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).

Reverse Merger Alternatives Are Unreliable

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.

A Higher Quality OTC Market

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.

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 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.


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Change in NYSE and AMEX Listing Requirements For Companies Completing Reverse Mergers with Public Shell Companies
Posted by Securities Attorney Laura Anthony | November 14, 2011 Tags: , , , , , , ,

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.

New Exchange Requirements

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.

“Special” Listing Requirements

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.”

Screening Issuers

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.”

The Future of the OTCBB and OTCQB

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.

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 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.


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Rule 144 Seller’s Representation Letter
Posted by Securities Attorney Laura Anthony | October 20, 2011 Tags: , , , , , , , ,

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.

Rule 144 and Shell Companies

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.

Legal Opinion Letters and Rule 144 Sales

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..)

Sellers Representation Letter

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).

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 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.


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SEC Staff Review of Super 8-K’s
Posted by Securities Attorney Laura Anthony | September 23, 2011 Tags: , , , , , , ,

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.

Completion of Acquisition or Disposition of Assets

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.

All Documents Must Be in English

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.

Management Discussion and Analysis

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.

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 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.


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