Securities Law Update: OTCBB Reverse Mergers Flourish (Part 2)

Added: (Wed Oct 07 2009)

Pressbox (Press Release) - By Laura E. Anthony, Attorney at Law
Founding Partner, Legal & Compliance, LLC

West Palm Beach, FL - Upon the identification of a reporting domestic (United States) OTCBB shell company (one with minimal or no operations), legal counsel can perform preliminary due diligence; kicking the tires so to speak. Counsel should also consider whether the Company is registered under the 1933 Act or 1934 Act, or both. This determination is important because only Company’s registered under the 1934 Act are subject to the Exchange Act proxy rules as set out in Exchange Act Section 14 and the rules promulgated thereunder.

In the event that the reverse merger or change in control would require a shareholder vote by the reporting public company, a 1934 Act Company would require full compliance with the proxy rules, incurring additional time and expense. The attorney should then consider whether shareholder approval could be obtained by consent as opposed to the necessity of holding a shareholder meeting.

Due Diligence

Initial due diligence will determine if the shell is even worth pursuing before the private company seeking public status invests considerable time and money.

Preliminary due diligence includes, but is not limited to;

• Retrieving the company’s file from the current transfer agent in order to determine current share structure as well as the shell’s historical chain of control
• Running simple background searches on the shell company and its current officers and directors to find any state or federal regulatory problems
• Hiring a PCOAB (Public Company Oversight Accounting Board) accounting firm in order to run a tax search to locate any outstanding tax liabilities
• Running asset, debt and judgment searches;
• Reviewing the books and records of the Company, including all filings with the state of incorporation

If the shell company makes it through the first round of due diligence, then the process can be taken further in order completely qualify the subject shell company. Complete due diligence is then completed.

Legacy Shells and Manufactured Shells

For companies that are seeking trading status on the OTCBB as a stepping stone to move onto the NASDAQ exchange, the subject shell should be closely examined to determine if it is a manufactured or, inversely, a “legacy” shell.
Manufactured Shells

A manufactured shell is one in which a Company initiates a small operating business and then completes a small public offering with the sole and exclusive purpose of avoiding the requirements of the Securities Act of 1933, as amended, Rule 419. All offerings by a blank check or shell company need to comply with Rule 419 under the Securities Act. Following the offering the Company rolls out the operating business and then offers itself as a reverse merger vehicle to private entities seeking to go public using this method.

The provisions of Rule 419 apply to every registration statement filed under the Securities Act of 1933, as amended, by a shell company. Rule 419 requires that the shell company filing such registration statement deposit the securities being offered and proceeds of the offering into an escrow or trust account pending the execution of an agreement for an acquisition or merger. The registrant is also required to file a post- effective amendment to the registration statement containing the same information as found in a Form 10 Registration Statement, upon the execution of an agreement for such acquisition or merger. The rule provides procedures for the release of the offering funds in conjunction with the post-effective acquisition or merger.

When a shell has been manufactured such to avoid complying with Rule 419, the shell has potential and foreseeable regulatory issues and should not be used as a reverse merger vehicle.

Legacy Shells

Legacy Shells, by comparison, are generally older, more seasoned companies. Whereas a Manufactured Shell is typically less than three years old and has a history or trading on the OTCBB only, Legacy Shells may have traded on the OTC Bulletin Board, the NASDAQ or even the American Stock Exchange (AMEX). The Company once possessed bonafide assets and substantial operations but for one reason or another, the Company simply failed.

Legacy Shells are the vehicle of choice for reverse mergers.

Attorney Laura E. Anthony is the founding partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm. Ms. Anthony can be reached at LauraAnthonyPA@aol.com or through her websites www.LegalAndCompliance.com or www.Securities-Law-Blog.com.