Monthly Archives: February 2014

What is a Reverse Merger?

A Private Company’s Assets or Operations are Vended Into a Public Vehicle

In a reverse merger (or reverse takeover) the controlling shareholders of a public vehicle acquire the business operations or assets of a private company.  Once the reverse takeover (“RTO”) transaction is complete, the private company is either “vended in” as a subsidiary of the Issuer, in which case all of its financials become reported under the umbrella of the public company, or the assets are purchased.

This is usually accomplished via a Share Exchange Agreement in which the shareholders of the private company receive a majority stake or “controlling interest” in the public company.

New Officers and Directors are Appointed from the Private Company in an RTO

With that change in control, new officers and directors are usually appointed from the management of the private company.  The change in control is the reason why reverse mergers are sometimes referred to as a reverse takeover or RTO.

Interestingly, Issuers seeking private company candidates for reverse merger are often called “public shells” even if they have enough assets and operations to avoid classification as a “shell company” under Rule 144.

Super 8-K Type Disclosures Must Be Provided to Investors After a Reverse Merger

Once the reverse merger is complete, the Issuer provides disclosures regarding the private company’s assets and operations using a “Super 8-K” if an SEC reporting company, or an Information and Disclosure Statement if an OTC Markets Pink Sheet using the Alternative Reporting Standard.

The Private Company Now “Trades” on the Public Market

After this disclosure process, the private company’s management is  in control of the public vehicle (which may be a former shell) and its stock is now quoted and trades under the same ticker or trading symbol.  At this point, it often makes sense for the new management to change the name of the company, and its symbol, in order to emphasize the new business operations to investors.

Famous Companies That Went Public Via Reverse Merger or RTO

Some household names which are reported to have gone public via reverse merger or reverse takeover include Berkshire Hathaway, Blockbuster, Waste Management, Jamba Juice, Turner Broadcasting (which later became CNN), Occidental Petroleum,and Texas Instruments.

Entrepreneurs seeking a public shell for a reverse takeover or Issuers looking for private companies to “vend in” can contact securities lawyer Matt Stout at (410) 429-7076 or mstout@otclawyers.com.

What is the Role of a Market Maker Under Rule 15c2-11?

Market Makers File Form 211 With FINRA

If a private company is using Rule 15c2-11 to become public, the company first needs a relationship with a sponsoring Market Maker that can file the Form 211 application with FINRA.   An experienced securities attorney works with several Market Makers and can recommend one willing to offer sponsorship.

Just as the SEC can provide comments on an Issuer’s S-1 Registration Statement, FINRA may also have comments to the company’s Form 211 application.  When FINRA does have comments, the company’s securities lawyer and Market Maker must respond to them in a timely fashion.

Market Makers Obtain the Company’s Trading Symbol and Quote the Bid and Ask Price

After the question and answer process, if FINRA believes the company’s disclosures meet the requirements of Rule 15c2-11, FINRA assigns the company a “ticker” or trading symbol which will allow the sponsoring Market Maker to provide a bid and ask quote for the company’s stock.

Other Market Makers Can Piggyback to Quote the Company’s Stock After 30 Days

When the ticker symbol and initial quotations are in place, these will be found on  OTCMarkets.com.   After the company’s sponsoring Market Maker has published quotations for the company’s stock for 30 days, other market makers can “piggy back” in order to also publish quotations for the security without doing their own due diligence or submitting another Form 211.

Can Market Makers Charge Fees for 15c2-11?

Market Makers sponsoring companies by filing the Form 211 are technically not allowed to charge or accept a fee for work specific to 15c2-11.  As a practical matter, Issuers do pay fees for other services that are needed in connection with the Form 211, in the sense that Market Makers can refer the due diligence package to a securities lawyer of their choice, and Market Makers often also provide DTC eligibility consulting by working alongside a securities lawyer like Matt Stout in the process of helping companies become DTC eligible.

Matheau J. W. Stout works with Issuers seeking assistance in the 15c2-11 process and can help companies find Market Maker sponsorship for Form 211.  Companies with questions about the costs and timeline of going public by 15c2-11, or about the DTC eligibility process can reach Matt Stout at (410) 429-7076 or mstout@otclawyers.com.

Supporting Documentation for Rule 144 Legal Opinions

One of the most common questions a securities lawyer receives is “What do I need to provide in order to have the restricted legend removed from my certificate?”   The best answer is always for the Shareholder to provide all of the documentation in his or her possession showing the origin and history of the shares.

Shareholders seeking Rule 144 legal opinions should first create PDF files of the stock certificates, and any other supporting documents which can show that the elements of Rule 144 are met.  Then email all of this to the securities lawyer.  The securities lawyer’s process cannot really begin until this information is reviewed and very few questions can be answered until then since most answers depend on the specific facts of the Rule 144 transaction.

SEC and OTC Markets Filings That Mention the Rule 144 Transaction

If the Shareholder is aware of a past SEC filing (10-Q, 10-K, 8-K) or OTC Markets filing (Quarterly Report, Annual Report, or Information and Disclosure Statement) that mentions their transaction, they should note this.   A reference in a public filing to their shares, or the transaction which originated their shares is perhaps the most helpful, and the most rare piece of documentation that can be provided.

Aside from documentation in the Issuer’s public filings, depending on the transaction which originated the shares, this documentation could include:

Documents in Support of a Debt Conversion Under Rule 144

Not all of these documents may be available to the Shareholder in every Rule 144 transaction, but in a best case scenario, all of these would be provided:

  1. Promissory Note; and
  2. Debt Purchase Agreement, if applicable; and
  3. Conversion Agreement signed by the Issuer, if possible; and
  4. Conversion Notice; and
  5. Board Resolutions in which the Issuer acknowledges the debt and the conversion; and
  6. Proof of payment via check or wire transfer; and
  7. Non Affiliate letters signed by the Shareholder and the Prior Debt Holder.

Documents in Support of a Private Stock Purchase Under Rule 144

Many of these documents may not be available, but they are helpful to establish the chain of ownership under Rule 144.  Since the Issuer is not usually involved, there are less Board Resolutions and documents provided:

  1. Stock Purchase Agreement (“SPA”); and
  2. Proof of payment via check or wire transfer; and
  3. Non Affiliate letters signed by Shareholder and the Prior Holder (unless the SPA clearly states this); and
  4. Documents showing how the Seller acquired the Shares in the first place.

Documents in Support of Shares Earned Under a Consulting Agreement Under Rule 144

Not all of these may be in a Shareholder’s packet, but more is better:

  1. Consulting Agreement between Shareholder and Issuer, which hopefully sets forth exactly when the Shares are considered fully “paid for” or earned under Rule 144; and
  2. Board Resolution acknowledging Consulting Agreement and confirming how and when the Shares were earned.  This essentially takes the place of “proof of payment” in the other examples; and
  3. Non Affiliate letter signed by Consultant unless non affiliate status is addressed in the Consulting Agreement.

It is rare when Shareholders have all of these documents handy when they go to sell restricted stock, since this is often years after the Shares were originally acquired.   On those occasions, a securities lawyer with expertise in drafting legal opinions under Rule 144 looks at the total picture and can request additional letters, affidavits and information when necessary.

Shareholders can contact securities lawyer Matt Stout with questions regarding Rule 144 legal opinions, Section 4(1) opinion letters and clearing restricted stock in general at (410) 429-7076 or mstout@otclawyers.com.

 

 

What are the Most Important Elements of a 3(A)(10) Exchange?

The most important elements of a Section 3(a)(10) transaction are

  1. The claims held by the Plaintiff must be “bona fide”; and
  2. The Plaintiff exchanging the bona fide claims for the Issuer’s securities cannot secretly be an Affiliate; and
  3. The Issuer cannot be colluding with the Plaintiff in order to use the free trading securities obtained from the 3(a)(10) exchange as a backdoor, undisclosed method of “funding” the Company.

Not surprisingly, when any of these elements are missing, the SEC is not pleased, and both the Issuer and claim holder can expect close scrutiny and severe penalties.

Issuers Benefit By Providing Full Disclosure of the 3(a)(10) Exchange

That being said, more disclosure is a good thing and often preempts any question as to impropriety.   Issuers can choose to be transparent in their filings by attaching the 3(a)(10) court documents as exhibits to their 8-Ks or OTC Markets Information and Disclosure Statements.

3(a)(10) Requires Bona Fide Claims That Can Be Documented

As always, this is a substance over form issue, and if the claims being exchanged in a 3(a)(10) transaction are real, and can be documented through valid promissory notes or actual invoices owed by the public company and referenced in the Issuer’s filings, then Section 3(a)(10) provides a good opportunity for both parties when working with experienced securities counsel.

Issuers and 3(a)(10) claim holders seeking further information on the potential pitfalls of using the 3(a)(10) exemption from registration, or with questions on fairness hearings can contact securities lawyer Matt Stout at (410) 429-7076 or mstout@otclawyers.com.

 

What Information Does a Court Need to Approve the Fairness of a 3(a)(10) Transaction?

In a 3(a)(10) transaction, the Issuer must advise the Court before the fairness hearing that the Issuer plans to rely on the Section 3(a)(10) exemption and that this reliance will be based on the Court’s Order, approving the exchange of the bona fide claims for the Issuer’s securities.

The SEC takes the view that the Court making the fairness determination

“must have sufficient information before it to determine the value of both the securities, claims or interests to be surrendered and the securities to be issued in the proposed transaction.”

As a practical matter, if drafted properly, the Complaint, Answer, Settlement Agreement and draft Order that the Court reviews prior to the fairness hearing should provide all of the language necessary to satisfy this requirement.

Beneficial Ownership Reporting Under Exchange Act Sections 13(d) and 13(g)

Many Affiliate Shareholders of OTC microcap companies are familiar with the Rule 144 reporting requirements and volume trading limitations for the beneficial owners of greater than 10% of an Issuer’s securities.

Section 13 Applies to Exchange Act Reporting Issuers

However, many are unaware that all owners of greater than 5% in any Issuer which has registered a class of its equity securities under Section 240.13 of the Securities Exchange Act of 1934 (“Exchange Act”), are supposed to file Beneficial Ownership Reports with the SEC.

Investors Owning Greater than 5% Must File Schedule 13 Reports

Under Regulation 13D-G, beneficial owners must continue to file these Schedule 13D or the more abbreviated 13G reports as long as their holdings exceed 5%. These Beneficial Ownership Reports provide the SEC with certain background information as well as the investor’s “intentions” which is why these Schedule 13 reports are filed in connection with a tender offer.

Investors seeking further information on the reporting requirements in connection with a tender offer, or with questions on securities law compliance in general, can contact Matt Stout, securities lawyer at (410) 429-7076 or mstout@otclawyers.com.

 

How Do Stock Splits and Reverse Splits Affect Trading Volume Under Rule 144?

Affiliates of OTC Issuers Can Sell 1% Every 3 Months under Rule 144

Under Rule 144, Affiliates of OTC Bulletin Board (“OTCBB”) and OTC Markets OTCQB, OTCQX and Pink Sheet Issuers are only allowed to sell 1% of the total issued and outstanding shares during any 3 month period.

Affiliates of Exchange Listed Issuers Have a Choice Under Rule 144(e)

Affiliates of Issuers listed on national exchanges like the NASDAQ or NYSE MKT are allowed to sell either

  1. 1% percent of the issued and outstanding shares; or
  2. The average weekly trading volume during the 4 weeks before the Affiliate filed Form 144.

Stock Splits Do Not Affect the Affiliate’s Percentage of Ownership

Whether the Issuer is quoted on the Over-the-Counter markets or listed on a stock exchange, neither forward stock splits nor reverse stock splits will affect the trading volume limitations under Rule 144(e) since a forward or reverse split would not change the percentage of the Issuer’s stock that the Affiliate is allowed to sell during the time period chosen.

Calculate Available Volume Under Rule 144 Following a Stock Split

To calculate available trading volume following a forward stock split or reverse stock split, an Affiliate should measure the trading volume as if the split had occurred on the 1st day of the 3 month period, even if it occurs at some later point during the 3 months.

Affiliates of OTC, NASDAQ and NYSE MKT Issuers with questions regarding selling restricted stock under SEC Rule 144 can contact securities lawyer Matt Stout at (410) 429-7076 or mstout@otclawyers.com.

Are Shares Acquired By Anti-Dilution Rights Restricted Under Rule 144?

Anti-Dilution Rights Allow Shareholders to Maintain Their Ownership Percentage

In many cases, Shareholders who purchase restricted stock from an OTC Bulletin Board (“OTCBB”) or OTC Markets Pink Sheet Issuer in a Private Placement will be granted “anti-dilution” rights allowing them to increase and thereby maintain their ownership percentage in the public company even when the Issuer offers more shares to subsequent Investors.  The same is true for investors in NASDAQ and NYSE MKT securities.

Shares Acquired Under Anti-Dilution Clauses are Restricted Securities

When a Shareholder acquires more stock pursuant to the anti-dilution rights clause in that Private Placement, the new shares are considered restricted securities under SEC Rule 144.

What Is the Rule 144 Holding Period for the Anti-Dilution Shares?

Under SEC Rule 144, shares acquired by the exercise of anti-dilution rights in a Private Placement or other offering does not begin on the date the Transfer Agent issues the new shares.

The Holding Period Dates Back to the Original Purchase of Shares

As a benefit to Shareholders, since the acquisition of the Anti-Dilution shares was automatic, and not within the Shareholder’s control, the holding period on the Anti-Dilution shares dates back to the original purchase of shares, and not the exercise of the anti-dilution rights.

Shareholder who have purchased restricted stock under Private Placements can contact Matheau J. W. Stout with questions about anti-dilution rights or Rule 144 at (410) 429-7076 or mstout@otclawyers.com.

Can Stock in Shell Companies Be Sold Under Rule 144?

What is a Rule 144 Legal Opinion Letter?

A Rule 144 legal opinion is a letter drafted by a securities attorney to a Transfer Agent that states whether or not a specific transaction complies with the requirements of SEC Rule 144.  Rule 144 has separate elements or requirements that must be met, and supported with documentation, in order for a restricted stock certificate to be cleared for sale under Rule 144.

One of the requirements for compliance with Rule 144 is that the Issuer is not a shell company.

What is a Shell Company under Rule 144?

A shell company under SEC Rule 144 is an Issuer that has either

  1. No operations or nominal operations;
  2. Assets that consists only of cash and cash equivalents; or
  3. Assets that consist of any amount of cash and cash equivalents and nominal other assets.

 What if the Issuer Used to Be a Shell Company But is Not Currently a Shell?

If the Issuer was ever classified or declared a shell company in its past, then the Issuer must have provided current public information for a minimum period of time since it ceased to be a shell, and it must be current in its reporting to the SEC, not under the OTC Markets Alternative Reporting Standard.

SEC Reporting Companies That Used to Be a Shell under Rule 144

For SEC reporting companies that file Forms 10-Q, 10-K and 8-K, these Issuers must be current in their SEC quarterly and annual report filings.  If the Issuer was ever a shell in its past, it must have filed these reports for at least 12 months since it stopped being a shell.

These Issuers will be quoted on the OTC Markets OTCQB or OTCQX market tiers.  They may also be quoted on the OTC Bulletin Board, if the Issuer has chosen to apply for OTCBB.  But a current SEC reporting company that is “fully reporting” will be shown as an OTCQB, at least, on OTCMarkets.com.

Pink Sheets That Used to Be a Shell under Rule 144

Non SEC reporting companies (Pink Sheets) that are subscribed to OTC Markets OTCIQ system, will be shown as a “Pink Current” Issuer on OTCMarkets.com, meaning that the Issuer is current in its quarterly financials, annual financials and disclosure statement filings under the Alternative Reporting Standard.

If a Pink Sheet public company was ever a shell in its past, broker-dealers and clearing firms are not likely to ever accept a Rule 144 legal opinion to clear its stock even if it has ceased being a shell.  This is true under Rule 144 no matter how long ago the Pink Sheet ceased to be a shell.

Pink Sheets that are not current in their filings will be shown as “Pink Limited Information” or Pink Yield Sign, while those Pink Sheets that have missed several filings will be shown as “Pink No Information” or Pink Stop Sign.

Shareholders of Pink Sheet Issuers that were formerly shells can contact Matt Stout, securities attorney for further information on other SEC provisions which may be useful in clearing their Shares under the facts specific to their case.

Do OTC Markets Issuers Need Audited Financials?

Public companies quoted on the OTC Markets OTCQX and OTCQB marketplaces require financials audited by a PCAOB auditor.  Those securities quoted on the OTC Markets Pink Sheet market tier do not required audits, though many Pink Sheets do have audited financials.

Audited Financials Not Required for Non Sec Reporting Companies

FINRA does not require the financial statements of Pink Sheets, which are not SEC reporting companies, to be audited for the Form 211 in the 15c2-11 process. Non SEC reporting companies are those that do not publish their financials and disclosures using the 10-Q, 10-K and 8-K using the SEC’s EDGAR filing system.

Unaudited Financials of US Issuers Must Be Prepared in Accordance with GAAP

However, OTC Markets Pink Sheet Issuers that are US companies should have financials that are prepared in accordance with GAAP. Foreign Issuers, meaning those Issuers that are incorporated offshore as opposed to US corporations that have business headquarters or operations outside of the US, are allowed to post financials that do not follow GAAP if they are prepared in accordance with their home country’s accepted accounting standards.

PInk Current Issuers Without Audits Require an Attorney Letter

Whether a US or foreign Issuer, a public company that wants to maintain Pink Current status on OTCMarkets.com will require an Attorney Letter  with Respect to Current Information at least annually, if they do not file reports with the SEC and do not publish audited financials. Companies that want to maintain Pink Limited Information (Pink Yield Sign) are not required to have audited financials.

Issuers with questions regarding PCAOB audits or questions about filing Form 15 with the SEC to transfer to the OTC Markets Alternative Reporting Standard (thus avoiding audits) can contact Matheau J. W. Stout, Esq. at (410) 429-7076 or mstout@otclawyers.com.