Reverse Merger Attorney
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.
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Section 3(a)(10) Debt Conversions In a Shell Company Pre-Reverse Merger
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.
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SEC Staff Review of Super 8-K’s
On September 14, 2011 the Securities and Exchange Commission (SEC), Division of Corporate Finance issued disclosure guidance entitled “Staff Observations in the Review of Forms 8-K Filed to Report Reverse Mergers and Similar Transactions.” This blog is a summary of that guidance.
The SEC guidance is a summary of common SEC staff comments in response to Form 8-Ks filed following a reverse merger or similar transaction which results in a company ceasing to be a shell company (commonly referred to as a Super 8-K ). The SEC has discovered that filings often fail to provide all the necessary disclosures under Items 2.01, 5.01 and 9.01 of Form 8-K. Moreover, the SEC frequently asks companies to support their conclusion that they are not a shell company as defined by Rule 12b-2 of the Securities Exchange Act of 1934.
Item 2.01 of Form 8-K entitled, Completion of Acquisition or Disposition of Assets, generally requires a company to provide information following a transaction that is outside the ordinary course of business. The SEC reminds companies that an asset acquisition can result in a company no longer being a shell company in the same way that a business acquisition can. In the event that the asset acquisition results in the Company no longer being a shell company, all information required in a Form 10 Registration Statement, must be filed in a Super 8-K within four (4) days of the closing of the transaction. The SEC disclosure guidance states that “we frequently remind companies that Instruction 2 to Item 2.01 makes clear that the term “acquisition” includes every purchase, acquisition by lease, exchange, merger, consolidation, succession or other acquisition”. Moreover, when a company’s reverse merger or similar transaction includes an asset acquisition as defined in Item 2, then an Item 2.01 disclosure is also required.
Item 5.01 requires disclosures regarding a change of control. The SEC frequently reminds filers that they must include all the disclosures required by this Item when filing a Super 8-K.
Item 9.01 is the Financial Statements and Exhibits section of the Form 8-K. The SEC frequently reminds filers that they must include historical financial statements of the acquired private operating business. In particular, the Form 8-K must include two years of audited financial statements and unaudited, reviewed stub periods to the date of filing. In addition, a Company must include pro forma financial information accounting for the combined companies.
Furthermore, in addition to filing Form 10 information on the acquired company, a company must file Form 10 exhibits on the acquired company, such as significant contracts. If these documents are not in English (as is often seen with Chinese companies and corresponding reverse mergers), the exhibits must also include a translation into English.
The SEC also provided guidance on the Form 10 information disclosure required by a Super 8-K. The SEC indicated that it often requests that a filer enhance its discussion of its business operations under Item 101 of Regulation S-K to include additional information about the planned future operations of the now non-shell Company. In particular, the SEC likes to see clear disclosure on how a company generates or intends to generate revenue.
In a company’s management discussion and analysis provided pursuant to Item 3.03, the SEC often asks companies to identify any elements of historical income or loss that will discontinue as a result of the reverse merger or similar transaction.
In its discussion of directors and executive officers, the SEC often has to remind companies to include all of the information required on the new officers and directors and to discuss their respective experiences, qualifications, attributes and skills that resulted in them being in an executive position.
Finally, the SEC often issues comments requesting more extensive and detailed disclosure on executive compensation and related party transactions following a reverse merger or similar transaction.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
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Management’s Discussion and Analysis of Financial Condition and Results of Operation (MD&A)
Management’s discussion and analysis of financial condition and results of operation, commonly referred to as MD&A is an integral parts of annual (Form 10-K) and quarterly (Form 10-Q) reports filed with the Securities and Exchange Commission (SEC). MD&A is also included in registration statements filed under both the Securities Exchange Act of 1934 (Form 10) and Securities Act of 1933 (Form S-1). MD&A requires the most input and effort from officers and directors of a company and due to the many components of required information, often generates SEC review and comments. Item 303 of Regulation S-K sets forth the required content for MD&A.
A MD&A discussion for quarterly reports on Form 10-Q is abbreviated from the requirements for annual reports on Form 10-K and registration statements. Although quarterly reports must discuss each item enumerated below the discussion is expected to be more focused concentrating on the most relevant and material items. In addition, as with my other blogs, this discussion will be limited to the requirements for small public companies (i.e. those with revenues of less than $75 million).
The SEC has issued guidance and interpretation on MD&A, which is helpful in understanding its required content. Pursuant to the SEC, MD&A has three primary purposes. These are:
• to provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management;
• to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and
• to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.
Management, and company counsel, should keep these purposes in mind in drafting and finalizing MD&A. The content should not be overly technical, but neither should it be a forum for marketing content. Now, onto the specific MD&A requirements as set forth in Item 303 of Regulation S-K.
In each annual report on Form 10-K, and registration statements on either Forms 10 or S-1, a company must discuss its financial condition, changes in financial condition and results of operations. In addition to the four areas of discussion listed below, a company must include any other relevant information within its knowledge, which information provides a better or more complete understanding of their finances and financial condition. The four areas of financial discussion include:
A company must identify any known trends or known demands, commitments, events or uncertainties that will result in or reasonably could result in an increase or decrease in liquidity. In addition, a company must identify sources and uses of liquidity and any known changes thereto. Explanations of the information provided is required. In layman terms, liquidity is a discussion of sources of cash and uses of cash, and factors that could change or impact either, both as reflected in the financial period covered by the subject report, and for the future. Although not all inclusive, the discussion, at a minimum, should address all items included in the statement of cash flows provided as part of the financial statements. This item, together with the second area of discussion, capital resources, are considered so important the SEC has issued an interpretive release addressing these two areas separately from the rest of MD&A.
A discussion of capital resources includes all material commitments for capital expenditures, the purpose and the source of funds for these commitments. This would include outstanding debts and obligations and simply put, where the money will come from to pay them. In addition, capital resources include a discussion of trends, favorable and unfavorable, that could impact capital resources. An obvious example would be a change in government regulation directly related to the company’s business.
Results of operations include four areas of discussion: (i) unusual or infrequent events that have impacted on a company’s financial condition. An example would be a discontinuance of a specific product line, or sale of company subsidiary. (ii) trends that could have an impact on sales or revenues or income in general, including trends impacting costs and expenses; (iii) a narrative discussion of increases or decreases in sale or revenues; and (iv)impact of inflation and other external financial conditions.
Off balance sheet arrangements have gained notoriety as a result of the recent economic turmoil caused by the mortgage scandal. An off balance sheet arrangement is any arrangement that could have an impact on a balance sheet, the most obvious example being a guarantee of a third party’s obligation. Accordingly, if a company has such an arrangement to report, they are required to provide a detailed analysis including the potential impact and relative importance of the arrangement.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
« Form 10-Q – Quarterly Reports SEC Staff Review of Super 8-K’s »
Mergers and AcquisitionsConfidentiality, Non-Disclosure Agreements
A confidentiality agreement or non-disclosure agreement (“NDA”) is an agreement among the parties to a proposed transaction to keep information secret and in confidence. In the context of a merger and acquisition transaction, NDA’s are important for both the target and acquiring entities. It is critical that an NDA be signed prior to the exchange of any due diligence or embarking upon substantive transaction negotiations.
Protecting Trade Secrets
Generally in a merger and acquisition transaction, the target entity is a closely held private corporation. Accordingly it is critical for the target company to maintain the confidential nature of both its business information, and the fact that it is considering a going public transaction. During the due diligence process, the public acquiring company will be given access to non-public trade secrets, technology, business processes, customer lists, and material information regarding shareholders, debt and equity financing and financial statements.
Loose Lips Sink Ships
If this information were made public or used for any purpose other than to evaluate a potential business transaction, it could materially and adversely affect the value of the target company. Moreover, if a transaction doesn’t go through, a potential acquirer could misuse the information to compete with, or solicit customers or employees from the target company, without the protection of a NDA. Just the knowledge that a transaction is being considered could affect the target’s relationship with its current customers, suppliers and/or employees.
Generally, the public acquiring entity is subject to the disclosure requirements of the Securities Exchange Act of 1934 and its information is already publicly available. However an NDA is still important to protect the public company. That is, if it became publicly known that acquirer was focusing on a particular target, other potential buyers may come to the table to compete.
Shielding Corporate Reputation, Controlling Rumors
Moreover, the acquirer’s business strategy regarding that particular acquisition would become publicly known prior to being legally required. If the acquirer changes its mind and the information was already public, investors may wonder as to why the transaction evaporated and subsequently lose confidence in both entities. An NDA can help protect against unnecessary market rumors and conjecture and potential exposure to insider trading liability. Obviously, an NDA should contain a strong obligation on the part of both parties to keep review information confidential.
Typically an NDA will permit the parties to disclose the information to its affiliates, advisors and key management on a “need to know” basis provided that each information recipient agree to the terms of the NDA.
Limitations of Non-Disclosure Agreements
An NDA only covers confidential information. That is, excluded is information that (i) is already in the possession of the recipient; or (ii) is or becomes available to the public (other than by a breach of the NDA). A properly drafted NDA will provide for procedures in the event a party is compelled, via subpoena or otherwise, to disclose information. Generally, the NDA will provide for an opportunity to learn of and fight the compelling document prior to disclosure.
Lastly, most NDA’s contain some sort of standstill or no shop provision. That is prior to expending time, money, attorney’s fees, other professional fees, etc., the parties will want assurance that the deal is not being shopped around for at least some period of time.
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.
« Reverse Mergers, Acquisitions and Due Diligence Mergers and Acquisitions – Disclosure Matters »
Reverse Mergers, Acquisitions and Due Diligence
Due diligence refers to the legal, business and financial investigation of a business prior to entering into a reverse merger transaction. Although the due diligence process can vary depending on the nature of a transaction (a relatively small acquisition vs. a going public reverse merger)it is arguably the most important component of a transaction (or at least equal with documentation).
Reverse Mergers and Public Shells
In a reverse merger transaction involving a public shell acquiring a private operating business, the bulk of the due diligence will be by the acquiring shell on the target. Although some due diligence is also necessary on the public shell, as a Company subject to the reporting requirements of the Exchange Act of 1934, most, if not all, pertinent information is publicly available on the Securities and Exchange Commission’s (“SEC”) EDGAR database. In the case where the public shell is a non-reporting entity, both sides to the transaction will need to complete extensive, in-depth due diligence on each other.
Analyzing Private Companies Going Public
This article focuses on due diligence by the public acquirer on the private target. At the outset, in addition to requesting copies of corporate records and documents, all contracts, asset chain of title documents, financial statements and the like, the securities attorney for the public acquirer should make themselves familiar with the target’s business, including an understanding of how they make money, what assets are important in revenues, who are their commercial partners and suppliers, and common off balance sheet and other hidden arrangements in that business. It is important to have a basic understanding of the business in order to effectively review the documents and information once supplied, to know what to ask for and to isolate potential future problems.
Addressing Post Closing Issues
In addition to determining whether the transaction as a whole is worth pursuing, proper due diligence will help in structuring the reverse merger transaction and preparing the proper documentation to prevent post closing issues (such as making sure all assignments of contracts are complete, or where an assignment isn’t possible, new contracts are prepared).
Public Records Search
In addition to creating due diligence lists of documents and information to be supplied, counsel for the public acquirer should perform separate checks for publicly available information. In today’s internet world, this part of the process has become dramatically easier. SEC legal counsel should be careful not to miss the basics, such as UCC lien searches, judgment searches, recorded property title and regulatory issues with any of the principals or participants involved in the deal.
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.
« Reverse Merger Attorneys Mergers and AcquisitionsConfidentiality, Non-Disclosure Agreements »
Reverse Merger Attorneys
Many of the Chinese companies that go public in the United States do so via a Reverse Merger. The reverse merger methodology versus the traditional Initial Public Offering (IPO) is the preferred method used by the Chinese and their US-based legal and auditing advisors. Many of these Chinese companies believe, erroneously, that by utilizing the reverse merger process, they can avoid the in-depth disclosure requirements and scrutiny associated with an IPO. However, legally this is not the case.
The failure of Chinese company legal, accounting and market makers to understand the fundamental elements required of Foreign Corporations trading stock on US markets has led to numerous shareholder class action lawsuits, trading suspensions and enforcement actions against publicly traded Chinese companies.
Auditors and Market Makers Fall Short on Due Diligence
Many of the problems resulting from Chinese reverse mergers are due to the failure of corporate counsel, auditors and market makers to thoroughly complete due diligence on the company’s officers, directors, operations and financial statements. Under ordinary circumstances, when preparing SEC filings, legal and accounting professionals can rely on the representations of their clients. However, when the subject Company has opted NOT to list their securities on their country of origin exchange, additional measures must be taken to ensure transparency.
Verify, Then Verify Again
It is always advisable to “kick the tires” of the subject company (visit their facilities, confirm that copies of all agreements have been provided, etc.) but in the case of Chinese entities, it is doubly important (actually it is essential). When providing “going public” services to an operating Chinese business, one that is going public or already trades on the US markets, the key is to verify, verify, verify.
Moreso than in any other scenario, auditors, attorneys and market makers must act as gate keepers so as to keep their Chinese clients compliant with US securities laws. Obviously, due diligence can only go so far, no matter how thorough the evaluation process. In the end, ultimately, auditors, attorneys an market makers are in the unenviable position of relying, to one extent or another, on the documents and attestations provided to them by the officers of the subject company. Forged, fraudulent and outright fictitious corporate documents are becoming all too commonplace.
Further complicating the problems stemming from Chinese companies going public in the United States are the increasing number of subsequent capital raises comprised of domestic, US investors. Once trading on the OTCQB or NASDAQ, the now public entity has a myriad of financing options, to the chagrin of the unsuspecting investment public.
Some regard the Chinese stock market as essentially unregulated, therefore creating an attitude among some officers and directors that US Exchanges are just as forgiving in respect to compliance and overall transparency.
Other issues may stem from the language barrier. Some may even be a result of differences in cultural business practices. In any event, the Securities Act of 1933, as amended, requires that all sales of stock be via either a registration statement or legal exemption to registration. All registration statements require in-depth disclosure in accordance with the legal parameters set forth in Regulation S-K and accounting parameters set forth in Regulation S-X. US regulators and class action counsel have clearly set forth that these standards are not being met.
Failure of Corporate Governance
Also, the lack of corporate governance oversight has intensified the problem. In addition, there are significant accounting differences. Since China does not follow Generally Accepted Accounting Principles (GAAP), confusing, and sometimes irreconcilable, financial statements are provided to domestic, PCAOB, auditing firms.
Hence, with a relatively lax regulatory stock market environment in China (as compared to stringent regulatory oversight in the United States), fundamentally different accounting and auditing procedures, and divergent societal and political structures the Chinese reverse merger debacle should not come as a surprise to anyone.
Civil Suits Against Chinese Companies Mount
Years of poor due diligence practices by US accounting, auditing and law firms has resulted in numerous shareholder class action lawsuits being filed against Chinese companies that have completed a reverse merger or RTO (Reverse Takeover) in the United States.
Because of the highly publicized problems of Chinese reverse merger fraud, some individuals incorrectly assert that the reverse merger process itself is somehow a dubious device used to gain access to domestic exchanges. Nothing could be further from the truth. Since the majority of companies going public in the US are completed via a reverse merger, it stands to reason that that the majority of Chinese companies going public domestically will use the same process.
Chinese Stock Fraud is not Limited to Reverse Mergers
Class action law firms and the investment public are now discovering that Chinese stock fraud is not limited to reverse mergers. Chinese companies that have gone public via S-1 Registration Statements, full blown IPO’s, and alternative methods such as WestPark Capital’s unique WRASP ™ (Public Offering and a Share Exchange hybrid) program have collapsed under close scrutiny as well. Certain reverse mergers or RTO’s were simply the first to fall.
In conclusion the fact of the matter is that the reverse merger process is a legitimate cost-effective and completely legal method of going public and has been used by such companies as: Yahoo, Turner Broadcasting Systems, Occidental Petroleum, Berkshire Hathaway, Texas Instruments and Blockbuster Entertainment to name a few.
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.
« Merger and Acquisitions, Part One – Structuring the Transaction Reverse Mergers, Acquisitions and Due Diligence »
Performing Due Diligence on Subject Companies During Reverse Mergers
Due diligence is a critical component of structuring any business transaction. In a reverse merger scenario there are two sides to the due diligence equation. There is the due diligence performed by the private company merging with the public shell (“Public Shell”) and there is the performance by the shell company of due diligence on the private company (“Private Company”).
Successful Reverse Mergers
In order to successfully complete a reverse merger it is essential for the Public Shell to perform appropriate financial, legal, corporate, market, and management due diligence on the private company merging with the Public Shell. At the most basic level the Public Shell needs to satisfy itself that the Private Company has all information completed and ready to file its Super 8-K within 4 days of completing the merger, including having audited financial statements prepared by a PCAOB licensed auditor.
As far as due diligence is concerned, particularly from a functionality standpoint, understanding management’s reasons for going public, as well as knowing the extent of their knowledge regarding public company operations, is critical to success and timeliness. Investors typically do not invest in the horse, but rather the jockey.
Reporting Requirements
Post merger, the once private company will need to file quarterly, annual and periodic reports pursuant to the Securities Exchange Act of 1934, as amended, and must have the internal controls in place to ensure compliance with these reporting requirements. Hence, determining beforehand the qualifications of management is invaluable to ensuring a successful post merger operation.
Due Diligence Questions
Essential questions to be answered during the personal interview phase are set forth in the reporting requirements enumerated in Items 401 through 404 of Regulation S-K. From a fundamental business perspective, these Items will help current and future shareholders determine:
1. Is management competent?
2. How many years of experience in the industry do they possess?
3. Has management been successful in running the operation to date?
4. Does management understand the difference between running a private company verses the rigorous legal, investor relations and accounting demands of a public company?
5. Are there any legal roadblocks to future offerings or extremely detrimental disclosure items (i.e. bad boy provisions)?
Furthermore, the shell company’s due diligence should gain insight as to the ability of the private company, through management and/or hired professionals, to address and remain compliant with: Sarbanes Oxley, GAAP, Exchange Act reporting requirements, including yearly 10-K’s, quarterly 10-Q’s and periodic 8-K’s, Investor Relations, internal controls, Annual Report filings and annual meeting, as well as other basics concerning the general daily operational factors of a public company.
Review Corporate Books and Records
At the corporate level of the due diligence process the public shell needs to review basic corporate records to determine that the Private Company is in legal corporate good standing and has maintained adequate books and records.
Legal due diligence encompasses such things as ensuring loans by insiders have been documented, extensions on outstanding obligations have been memorialized and documented, title to ownership of assets (including intellectual property and real estate) is in the corporate name and if not, proper linking documents (such as a lease agreement or assignment) have been prepared and executed. Does the Private Company rely on a distribution network? Make sure it’s in writing. In short, legal due diligence involves crossing the T’s and dotting the I’s and is part and parcel with the auditor’s job.
Identifying Potential Legal Issues
In addition to the personal matters there also exist the typical concerns of pending or anticipated litigation issues. These issues include, but are not limited to, product liability; hazardous waste; real estate liens; employment discrimination suits; other environmental concerns and other legal issues that could have a “material” negative impact in the future.
As stated, where relevant to the particular private company, environmental issues are an extremely important legal due diligence point. Environmental laws and the gaining power of the Environmental Protection Agency make this a critical factor. Failure to ensure that appropriate Phase I and Phase II environmental reports are in order could lead to expensive future cleanup and litigation costs. Furthermore, it is suggested that any potential future liability be signed off on by the appropriate agency or authority.
Now to the most important due diligence matter: financial due diligence. If the target entity does not have or cannot obtain completed audited financial statements, prepared by a PCAOB qualified auditor in accordance with GAAP, there exists no rationale to move forward with the merger.
Audited Financial Statements
Financial due diligence is the key element in the due diligence process. The Public Shell Company should be meticulous in reviewing the financials, margins, inventory and equipment lists of the private company going public. In addition there may be patents, intellectual property and employee compensation agreements that need to be reviewed. The Public Shell should be comfortable with the footnotes as well as the line item financial statements.
Unforeseen Merger Issues
It must be understood that there are always going to be some sort of issues. However, the Public Shell Company’s objective is to address significant material issues via the due diligence process. By doing so the Shell Company enhances the probability of a successful reverse merger.
In summary, the due diligence process is designed to uncover material facts that may adversely impact the transaction. The process is not designed to destroy the deal but moreso to address key issues in order to strengthen the transaction and protect shareholders. Inversely, properly completed due diligence on the Public Shell Company to be acquired ensures that the merging Private Company reaps the benefits of a viable public entity by which to grow and enhance shareholder value.
Comprehensive, detailed and meticulous due diligence creates a foundation of integrity, authenticity and transparency on which a strong, operating public company can be built. The due diligence process can be time consuming, but it is most easily completed when all parties involved operate reasonably and professional cooperation is maintained throughout the due diligence process.
The Author
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« Potential Liabilities In The IPO Process– Part III OTCQB and OTCQX Compared and Contrasted »
The End Of An Era; The OTCBB Has Been Replaced By The OTCQB
A few months ago I wrote an article predicting that the new “OTC Markets,” formerly known as the Pink Sheets, and it’s OTCQX and OTCQB quotation tiers were replacing the antiquated, formerly FINRA-run OTCBB. Current events add further evidence to this view. Recently, more than 1000 Companies which were trading on both the OTCBB and OTCQB were delisted from the OTCBB and now trade exclusively on the OTCQB tier of the OTC Markets. These entities are quickly becoming known by their new moniker, OTCQB Companies.
The Investment Banking firm of Rodman & Renshaw acquired the OTCBB from FINRA last year.
An OTCBB By Any Other Name
For more than a year leading up to this large scale, mass delistment, it has been impossible to decipher between an OTCBB Company and a Reporting Pink Sheet Company when viewing the OTC Markets website. Both entities appeared under the heading of “OTCQB.” It was essential to reference other source material in order to make the distinction.
The now privately owned and operated OTCBB quietly delisted approximately 1,000 fully reporting and current, public companies from its quotation medium, initially citing “failure to comply with Rule 15c2-11”. Subsequent delistments cited “Ineligible for quotation on OTCBB due to quoting inactivity under SEC Rule 15c2-11.”
Delistments Means Little to Nothing
Most, if not all, of these companies did not receive notice of their “delisting”. Moreover, most, if not all, of these companies still do not know that they are no longer OTCBB quoted companies. In fact, the change has had little if no impact on these companies and will likely not have future impact. Each of these companies continue to be quoted on the OTCQB on the website for OTC Markets.
Issuer Reporting Obligations
Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC. Although the entire Over the Counter is regulated by the SEC and FINRA, the OTC Markets and the OTCBB are both now privately owned and merely serve as quotation mediums. However, and most importantly, the OTC Markets is more user friendly and factually up to date and accurate than the website for the OTCBB. So, if all Over the Counter quotes can be found at www.otcmarkets.com and companies trading on the OTCQB have the exact same standards as the OTCBB, and FINRA is no longer directly associated with the OTCBB, is there any reason for the OTCBB to even exist?
The fact sheet on www.otcmarkets.com has this to say regarding OTCQB quoted securities:
“With over 94% of all market maker quotes in OTC securities published on OTC Markets Group’s platform vs. 6% on the FINRA BB, it is important that OTC Markets Group provide a separate designation to identify OTC-traded companies that are U.S. registered and reporting. OTC Markets Group has launched the OTCQBtm marketplace to help investors easily identify SEC reporting companies and regulated banks that are current with their disclosure obligations.”
In summary, the curtains have closed on the OTCBB in name only and its business as usual for the new OTCQB.
The Author
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance. LLC for a free initial consultation or second opinion on an existing matter.
Alternatives To Going Public – Private Company Financing Options »
A confidentiality agreement or non-disclosure agreement (“NDA”) is an agreement among the parties to a proposed transaction to keep information secret and in confidence. In the context of a merger and acquisition transaction, NDA’s are important for both the target and acquiring entities. It is critical that an NDA be signed prior to the exchange of any due diligence or embarking upon substantive transaction negotiations.
Generally in a merger and acquisition transaction, the target entity is a closely held private corporation. Accordingly it is critical for the target company to maintain the confidential nature of both its business information, and the fact that it is considering a going public transaction. During the due diligence process, the public acquiring company will be given access to non-public trade secrets, technology, business processes, customer lists, and material information regarding shareholders, debt and equity financing and financial statements.
If this information were made public or used for any purpose other than to evaluate a potential business transaction, it could materially and adversely affect the value of the target company. Moreover, if a transaction doesn’t go through, a potential acquirer could misuse the information to compete with, or solicit customers or employees from the target company, without the protection of a NDA. Just the knowledge that a transaction is being considered could affect the target’s relationship with its current customers, suppliers and/or employees.
Generally, the public acquiring entity is subject to the disclosure requirements of the Securities Exchange Act of 1934 and its information is already publicly available. However an NDA is still important to protect the public company. That is, if it became publicly known that acquirer was focusing on a particular target, other potential buyers may come to the table to compete.
Moreover, the acquirer’s business strategy regarding that particular acquisition would become publicly known prior to being legally required. If the acquirer changes its mind and the information was already public, investors may wonder as to why the transaction evaporated and subsequently lose confidence in both entities. An NDA can help protect against unnecessary market rumors and conjecture and potential exposure to insider trading liability. Obviously, an NDA should contain a strong obligation on the part of both parties to keep review information confidential.
Typically an NDA will permit the parties to disclose the information to its affiliates, advisors and key management on a “need to know” basis provided that each information recipient agree to the terms of the NDA.
An NDA only covers confidential information. That is, excluded is information that (i) is already in the possession of the recipient; or (ii) is or becomes available to the public (other than by a breach of the NDA). A properly drafted NDA will provide for procedures in the event a party is compelled, via subpoena or otherwise, to disclose information. Generally, the NDA will provide for an opportunity to learn of and fight the compelling document prior to disclosure.
Lastly, most NDA’s contain some sort of standstill or no shop provision. That is prior to expending time, money, attorney’s fees, other professional fees, etc., the parties will want assurance that the deal is not being shopped around for at least some period of time.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
« Reverse Mergers, Acquisitions and Due Diligence Mergers and Acquisitions – Disclosure Matters »
Reverse Mergers, Acquisitions and Due Diligence
Due diligence refers to the legal, business and financial investigation of a business prior to entering into a reverse merger transaction. Although the due diligence process can vary depending on the nature of a transaction (a relatively small acquisition vs. a going public reverse merger)it is arguably the most important component of a transaction (or at least equal with documentation).
In a reverse merger transaction involving a public shell acquiring a private operating business, the bulk of the due diligence will be by the acquiring shell on the target. Although some due diligence is also necessary on the public shell, as a Company subject to the reporting requirements of the Exchange Act of 1934, most, if not all, pertinent information is publicly available on the Securities and Exchange Commission’s (“SEC”) EDGAR database. In the case where the public shell is a non-reporting entity, both sides to the transaction will need to complete extensive, in-depth due diligence on each other.
This article focuses on due diligence by the public acquirer on the private target. At the outset, in addition to requesting copies of corporate records and documents, all contracts, asset chain of title documents, financial statements and the like, the securities attorney for the public acquirer should make themselves familiar with the target’s business, including an understanding of how they make money, what assets are important in revenues, who are their commercial partners and suppliers, and common off balance sheet and other hidden arrangements in that business. It is important to have a basic understanding of the business in order to effectively review the documents and information once supplied, to know what to ask for and to isolate potential future problems.
In addition to determining whether the transaction as a whole is worth pursuing, proper due diligence will help in structuring the reverse merger transaction and preparing the proper documentation to prevent post closing issues (such as making sure all assignments of contracts are complete, or where an assignment isn’t possible, new contracts are prepared).
In addition to creating due diligence lists of documents and information to be supplied, counsel for the public acquirer should perform separate checks for publicly available information. In today’s internet world, this part of the process has become dramatically easier. SEC legal counsel should be careful not to miss the basics, such as UCC lien searches, judgment searches, recorded property title and regulatory issues with any of the principals or participants involved in the deal.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
« Reverse Merger Attorneys Mergers and Acquisitions
Reverse Merger Attorneys
Many of the Chinese companies that go public in the United States do so via a Reverse Merger. The reverse merger methodology versus the traditional Initial Public Offering (IPO) is the preferred method used by the Chinese and their US-based legal and auditing advisors. Many of these Chinese companies believe, erroneously, that by utilizing the reverse merger process, they can avoid the in-depth disclosure requirements and scrutiny associated with an IPO. However, legally this is not the case.
The failure of Chinese company legal, accounting and market makers to understand the fundamental elements required of Foreign Corporations trading stock on US markets has led to numerous shareholder class action lawsuits, trading suspensions and enforcement actions against publicly traded Chinese companies.
Many of the problems resulting from Chinese reverse mergers are due to the failure of corporate counsel, auditors and market makers to thoroughly complete due diligence on the company’s officers, directors, operations and financial statements. Under ordinary circumstances, when preparing SEC filings, legal and accounting professionals can rely on the representations of their clients. However, when the subject Company has opted NOT to list their securities on their country of origin exchange, additional measures must be taken to ensure transparency.
It is always advisable to “kick the tires” of the subject company (visit their facilities, confirm that copies of all agreements have been provided, etc.) but in the case of Chinese entities, it is doubly important (actually it is essential). When providing “going public” services to an operating Chinese business, one that is going public or already trades on the US markets, the key is to verify, verify, verify.
Moreso than in any other scenario, auditors, attorneys and market makers must act as gate keepers so as to keep their Chinese clients compliant with US securities laws. Obviously, due diligence can only go so far, no matter how thorough the evaluation process. In the end, ultimately, auditors, attorneys an market makers are in the unenviable position of relying, to one extent or another, on the documents and attestations provided to them by the officers of the subject company. Forged, fraudulent and outright fictitious corporate documents are becoming all too commonplace.
Further complicating the problems stemming from Chinese companies going public in the United States are the increasing number of subsequent capital raises comprised of domestic, US investors. Once trading on the OTCQB or NASDAQ, the now public entity has a myriad of financing options, to the chagrin of the unsuspecting investment public.
Some regard the Chinese stock market as essentially unregulated, therefore creating an attitude among some officers and directors that US Exchanges are just as forgiving in respect to compliance and overall transparency.
Other issues may stem from the language barrier. Some may even be a result of differences in cultural business practices. In any event, the Securities Act of 1933, as amended, requires that all sales of stock be via either a registration statement or legal exemption to registration. All registration statements require in-depth disclosure in accordance with the legal parameters set forth in Regulation S-K and accounting parameters set forth in Regulation S-X. US regulators and class action counsel have clearly set forth that these standards are not being met.
Also, the lack of corporate governance oversight has intensified the problem. In addition, there are significant accounting differences. Since China does not follow Generally Accepted Accounting Principles (GAAP), confusing, and sometimes irreconcilable, financial statements are provided to domestic, PCAOB, auditing firms.
Hence, with a relatively lax regulatory stock market environment in China (as compared to stringent regulatory oversight in the United States), fundamentally different accounting and auditing procedures, and divergent societal and political structures the Chinese reverse merger debacle should not come as a surprise to anyone.
Years of poor due diligence practices by US accounting, auditing and law firms has resulted in numerous shareholder class action lawsuits being filed against Chinese companies that have completed a reverse merger or RTO (Reverse Takeover) in the United States.
Because of the highly publicized problems of Chinese reverse merger fraud, some individuals incorrectly assert that the reverse merger process itself is somehow a dubious device used to gain access to domestic exchanges. Nothing could be further from the truth. Since the majority of companies going public in the US are completed via a reverse merger, it stands to reason that that the majority of Chinese companies going public domestically will use the same process.
Class action law firms and the investment public are now discovering that Chinese stock fraud is not limited to reverse mergers. Chinese companies that have gone public via S-1 Registration Statements, full blown IPO’s, and alternative methods such as WestPark Capital’s unique WRASP ™ (Public Offering and a Share Exchange hybrid) program have collapsed under close scrutiny as well. Certain reverse mergers or RTO’s were simply the first to fall.
In conclusion the fact of the matter is that the reverse merger process is a legitimate cost-effective and completely legal method of going public and has been used by such companies as: Yahoo, Turner Broadcasting Systems, Occidental Petroleum, Berkshire Hathaway, Texas Instruments and Blockbuster Entertainment to name a few.
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.
« Merger and Acquisitions, Part One – Structuring the Transaction Reverse Mergers, Acquisitions and Due Diligence »
Performing Due Diligence on Subject Companies During Reverse Mergers
Due diligence is a critical component of structuring any business transaction. In a reverse merger scenario there are two sides to the due diligence equation. There is the due diligence performed by the private company merging with the public shell (“Public Shell”) and there is the performance by the shell company of due diligence on the private company (“Private Company”).
In order to successfully complete a reverse merger it is essential for the Public Shell to perform appropriate financial, legal, corporate, market, and management due diligence on the private company merging with the Public Shell. At the most basic level the Public Shell needs to satisfy itself that the Private Company has all information completed and ready to file its Super 8-K within 4 days of completing the merger, including having audited financial statements prepared by a PCAOB licensed auditor.
As far as due diligence is concerned, particularly from a functionality standpoint, understanding management’s reasons for going public, as well as knowing the extent of their knowledge regarding public company operations, is critical to success and timeliness. Investors typically do not invest in the horse, but rather the jockey.
Post merger, the once private company will need to file quarterly, annual and periodic reports pursuant to the Securities Exchange Act of 1934, as amended, and must have the internal controls in place to ensure compliance with these reporting requirements. Hence, determining beforehand the qualifications of management is invaluable to ensuring a successful post merger operation.
Essential questions to be answered during the personal interview phase are set forth in the reporting requirements enumerated in Items 401 through 404 of Regulation S-K. From a fundamental business perspective, these Items will help current and future shareholders determine:
1. Is management competent?
2. How many years of experience in the industry do they possess?
3. Has management been successful in running the operation to date?
4. Does management understand the difference between running a private company verses the rigorous legal, investor relations and accounting demands of a public company?
5. Are there any legal roadblocks to future offerings or extremely detrimental disclosure items (i.e. bad boy provisions)?
Furthermore, the shell company’s due diligence should gain insight as to the ability of the private company, through management and/or hired professionals, to address and remain compliant with: Sarbanes Oxley, GAAP, Exchange Act reporting requirements, including yearly 10-K’s, quarterly 10-Q’s and periodic 8-K’s, Investor Relations, internal controls, Annual Report filings and annual meeting, as well as other basics concerning the general daily operational factors of a public company.
At the corporate level of the due diligence process the public shell needs to review basic corporate records to determine that the Private Company is in legal corporate good standing and has maintained adequate books and records.
Legal due diligence encompasses such things as ensuring loans by insiders have been documented, extensions on outstanding obligations have been memorialized and documented, title to ownership of assets (including intellectual property and real estate) is in the corporate name and if not, proper linking documents (such as a lease agreement or assignment) have been prepared and executed. Does the Private Company rely on a distribution network? Make sure it’s in writing. In short, legal due diligence involves crossing the T’s and dotting the I’s and is part and parcel with the auditor’s job.
In addition to the personal matters there also exist the typical concerns of pending or anticipated litigation issues. These issues include, but are not limited to, product liability; hazardous waste; real estate liens; employment discrimination suits; other environmental concerns and other legal issues that could have a “material” negative impact in the future.
As stated, where relevant to the particular private company, environmental issues are an extremely important legal due diligence point. Environmental laws and the gaining power of the Environmental Protection Agency make this a critical factor. Failure to ensure that appropriate Phase I and Phase II environmental reports are in order could lead to expensive future cleanup and litigation costs. Furthermore, it is suggested that any potential future liability be signed off on by the appropriate agency or authority.
Now to the most important due diligence matter: financial due diligence. If the target entity does not have or cannot obtain completed audited financial statements, prepared by a PCAOB qualified auditor in accordance with GAAP, there exists no rationale to move forward with the merger.
Financial due diligence is the key element in the due diligence process. The Public Shell Company should be meticulous in reviewing the financials, margins, inventory and equipment lists of the private company going public. In addition there may be patents, intellectual property and employee compensation agreements that need to be reviewed. The Public Shell should be comfortable with the footnotes as well as the line item financial statements.
It must be understood that there are always going to be some sort of issues. However, the Public Shell Company’s objective is to address significant material issues via the due diligence process. By doing so the Shell Company enhances the probability of a successful reverse merger.
In summary, the due diligence process is designed to uncover material facts that may adversely impact the transaction. The process is not designed to destroy the deal but moreso to address key issues in order to strengthen the transaction and protect shareholders. Inversely, properly completed due diligence on the Public Shell Company to be acquired ensures that the merging Private Company reaps the benefits of a viable public entity by which to grow and enhance shareholder value.
Comprehensive, detailed and meticulous due diligence creates a foundation of integrity, authenticity and transparency on which a strong, operating public company can be built. The due diligence process can be time consuming, but it is most easily completed when all parties involved operate reasonably and professional cooperation is maintained throughout the due diligence process.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance, LLC for a free initial consultation or second opinion on an existing matter.
« Potential Liabilities In The IPO Process– Part III OTCQB and OTCQX Compared and Contrasted »
The End Of An Era; The OTCBB Has Been Replaced By The OTCQB
A few months ago I wrote an article predicting that the new “OTC Markets,” formerly known as the Pink Sheets, and it’s OTCQX and OTCQB quotation tiers were replacing the antiquated, formerly FINRA-run OTCBB. Current events add further evidence to this view. Recently, more than 1000 Companies which were trading on both the OTCBB and OTCQB were delisted from the OTCBB and now trade exclusively on the OTCQB tier of the OTC Markets. These entities are quickly becoming known by their new moniker, OTCQB Companies.
The Investment Banking firm of Rodman & Renshaw acquired the OTCBB from FINRA last year.
An OTCBB By Any Other Name
For more than a year leading up to this large scale, mass delistment, it has been impossible to decipher between an OTCBB Company and a Reporting Pink Sheet Company when viewing the OTC Markets website. Both entities appeared under the heading of “OTCQB.” It was essential to reference other source material in order to make the distinction.
The now privately owned and operated OTCBB quietly delisted approximately 1,000 fully reporting and current, public companies from its quotation medium, initially citing “failure to comply with Rule 15c2-11”. Subsequent delistments cited “Ineligible for quotation on OTCBB due to quoting inactivity under SEC Rule 15c2-11.”
Delistments Means Little to Nothing
Most, if not all, of these companies did not receive notice of their “delisting”. Moreover, most, if not all, of these companies still do not know that they are no longer OTCBB quoted companies. In fact, the change has had little if no impact on these companies and will likely not have future impact. Each of these companies continue to be quoted on the OTCQB on the website for OTC Markets.
Issuer Reporting Obligations
Issuers on the OTCQB must be fully reporting and current in their reporting obligations with the SEC. Although the entire Over the Counter is regulated by the SEC and FINRA, the OTC Markets and the OTCBB are both now privately owned and merely serve as quotation mediums. However, and most importantly, the OTC Markets is more user friendly and factually up to date and accurate than the website for the OTCBB. So, if all Over the Counter quotes can be found at www.otcmarkets.com and companies trading on the OTCQB have the exact same standards as the OTCBB, and FINRA is no longer directly associated with the OTCBB, is there any reason for the OTCBB to even exist?
The fact sheet on www.otcmarkets.com has this to say regarding OTCQB quoted securities:
“With over 94% of all market maker quotes in OTC securities published on OTC Markets Group’s platform vs. 6% on the FINRA BB, it is important that OTC Markets Group provide a separate designation to identify OTC-traded companies that are U.S. registered and reporting. OTC Markets Group has launched the OTCQBtm marketplace to help investors easily identify SEC reporting companies and regulated banks that are current with their disclosure obligations.”
In summary, the curtains have closed on the OTCBB in name only and its business as usual for the new OTCQB.
The Author
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance. LLC for a free initial consultation or second opinion on an existing matter.
Alternatives To Going Public – Private Company Financing Options »