The SEC Issues Alert For Reverse Mergers

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On June 9, 2011, the Securities and Exchange Commission (the “SEC”) issued an Investor Bulletin (the “Bulletin”) cautioning the public about risks associated with issuers that enter U.S. markets through reverse mergers with public shell companies.

In the news release announcing the Bulletin, Lori J. Schock, the Director of the SEC’s Office of Investor Education and Advocacy was quoted as saying, “Given the potential risks, investors should be especially careful when considering investing in the stock of reverse merger companies … As with any investment, investors should thoroughly research the company – including ensuring there is accurate and up-to-date information – before making a decision to invest.”

Reverse mergers permit private companies, including those located outside the U.S., to access U.S. investors and markets by merging with an existing public shell company. The SEC and U.S. stock exchanges frequently suspend trading in reverse merger companies due to a lack of current and accurate information about them, particularly about their  financial condition. In a reverse merger transaction, an existing public “shell company,” which is a publicly traded SEC reporting company with few or no operations, acquires a private operating company that wants its securities to be publicly traded. Most often, the shareholders of the private operating company exchange their shares for a large majority of the shares of the public company. Although the public shell company survives the merger, the private operating company’s shareholders gain control of the public entity including its management and outstanding securities.  The assets and business operations of the post-reverse merger entity are those of the private company.

The SEC’s Investor Bulletin is summarized below.

Perceived Benefits of Reverse Mergers

A private operating company may seek a reverse merger with a public shell because:

♦ To gain access to the public markets because publicly traded companies potentially have access to funding from a broader pool of investors;

♦ A reverse merger is perceived to be a quicker method of “going public” than an initial public offering (IPO);

♦ The legal and accounting fees associated with a reverse merger are typically lower than for an IPO; and

♦ While the public shell company is required to report the reverse merger in a Form 8-K filing with the SEC, there are no registration requirements under the Securities Act of 1933 as there would be for an IPO.

♦ Being public may give a company in­creased value in the eyes of potential acquirers.

 Trading of Reverse Merger Companies

Shares of reverse merger companies are traded on both stock exchanges and the over-the-counter market (“OTC Market”).

 Exchange Markets

If the reverse merger company’s securities are listed and traded on an exchange, the listed company must meet the exchange’s initial listing standards to be eligible for listing. The listed company must also satisfy the exchange’s maintenance or continued listing standards to remain listed and must comply with the its rules, federal securities laws, and other applicable provisions of the law.

When certain market or company events occur, an exchange may halt trading in the securities of a listed company, and if the company fails to meet the exchange’s continued listing standards the exchange may initiate proceedings to delist its securities.


The OTC Markets Group operates on a decentralized, interdealer quotation system. In order to be quoted, a market maker must file a Form 211 with the Financial Industry Regulatory Authority (FINRA) and demonstrate that the com­pany meets the requirements of Rule 15c2-11 under the Securities Exchange Act of 1934 (Exchange Act) as well as FINRA’s rules.

Risks of Investing in Reverse Merger Companies

Investors should proceed cautiously when considering whether to invest in reverse merger companies because:

♦ Many companies either fail or struggle to remain viable following a reverse merger;

♦ There have been numerous instances of fraud involving reverse mergers with public shell companies;

♦ Many foreign issuers that access the U.S. markets using a reverse merger with a public shell engage insufficient au­diting firms, causing accounting failures.

Risk Disclosure

Publicly traded companies are required to disclose the risks of investing in their securities.  Reverse Merger issuers should make disclosure similar to the following:

♦  Because we became public through a “reverse merger,” we may not be able to attract the attention of major brokerage firms.

♦   Additional risks may exist as a result of our reverse merger transaction. Securities analysts of major brokerage firms may not provide coverage of us since there is little incentive for brokerage firms to recommend the purchase of our common stock. We cannot assure you that brokerage firms will want to conduct any secondary offerings on behalf of our company in the future.

♦ The transaction involves a reverse merger of a foreign company into a domestic shell company; as a result, we have no history of compliance with United States securities laws and accounting rules.

♦ Our management has no experience in managing and operating a public company. Any failure to comply or adequately comply with federal securities laws, rules or regulations could subject us to fines or regulatory actions, which may materially adversely affect our business, results of operations and financial condition.

♦ We will incur significant costs to ensure compliance with United States corporate governance and accounting requirements.

♦ We may not be able to meet the filing and internal control reporting requirements imposed by the SEC resulting in a possible decline in the price of our common stock and in our inability to obtain future financing.

♦ As a public company, we are obligated to maintain effec­tive internal controls over financial reporting. Our inter­nal controls may not be determined to be effective, which may adversely affect investor confidence in us and, as a result, decrease the value of our ordinary shares.

♦ The relative lack of public company experience of our man­agement team may put us at a competitive disadvantage.

In the last few years, the SEC has suspended trading and revoked the registration of hundreds of public shell companies and reverse merger issuers.

Investors should use caution when investing in the stocks of reverse merger companies They should take care to:

♦ Research the Company and evaluate its finances, organization, and business pros­pects;

♦ Review the Company’s SEC Filings;

♦Be Aware of Companies that do not File Reports with the SEC;  and

♦Be Skeptical whenever someone gives you a “hot” tip, always inquiring about the source’s motivation.


As with any investment, investors should proceed cautiously when considering whether to invest in a reverse merger company. Many public companies either fail or struggle to remain viable following a reverse merger. There have been numerous instances of fraud and other abuses; many companies have had their registration revoked, rendering their stock worthless, and in some cases, members of management have been subjected to criminal prosecution. Investors should consider their own financial situation and risk tolerance, consult their financial adviser, and perform thorough research before making any investment decisions concerning these types of companies.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit   This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
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