What Are Public Shell Companies?
In recent years, the Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”) have taken steps to limit transactions involving private companies going public using reverse mergers with public shell companies. One limitation requires that the securities of shell companies be restricted securities unless the issuer complies with specific requirements. This limitation has had a significant impact on private companies who go public in reverse merger transactions with public shells. Issuers seeking to raise capital using going public transactions involving reverse mergers are finding the securities of their post reverse merger entity are unable to qualify for electronic trading through Depository Trust Company (“DTC”) and securities subject to DTC Chills or global locks.
In some circumstances, unsuspecting issuers learn that their purported “clean” public shell has been the subject of corporate identity theft or even an SEC trading suspension.
What is a Shell Company?
A shell company, as defined in Rule 405 of the Securities Act, is an issuer with no or nominal operations and either no or nominal assets, assets consisting solely of cash and cash equivalents, or assets consisting of cash and cash equivalents and nominal other assets.
What are Restricted Securities?
Restricted securities are securities that have been acquired in transactions exempt from the registration requirements of Section 5 of the Securities Act of 1933, as amended (the “Securities Act”).
Restricted securities include, among other things, stock that is issued:
♦ prior to an issuer’s initial public offering (“IPO”);
♦ in private placements;
♦ privately from an affiliate of an issuer;
♦ in Rule 144A transactions; and
♦ equity securities of U.S. issuers acquired in a transaction subject to the conditions of Rule 901 or Rule 903 of Regulation S of the 1933 Act.
Rule 144 provides a safe harbor and permits public resales of restricted securities without registration with the SEC of the following securities:
♦ unregistered securities acquired directly from an issuer, referred to as “restricted” securities; and
♦ unrestricted securities held by affiliates of the issuer, referred to as “control” securities.
Rule 144’s Shell Rules
A person selling restricted or control securities who satisfies the conditions of Rule 144 in connection with the transaction is deemed not to be an “underwriter” as defined in Section 2(a) (11) of the 1933 Act, and may rely on the Section 4(1) exemption for the resale of securities.
The SEC amended Rule 144 effective February 15, 2008. The amendments placed significant limitations and restrictions on the use of Rule 144 by shareholders of shell companies. A shell company, as defined in Rule 405 of the Securities Act, is an issuer with no or nominal operations and either no or nominal assets, assets consisting solely of cash and cash equivalents, or assets consisting of cash and cash equivalents and nominal other assets.
Rule 144(i) provides that Rule 144 may become available for the resale of securities that were originally issued by a shell company if certain conditions are met.
These conditions are:
♦ that the issuer is no longer a shell company of the company;
♦ that the issuer is an SEC reporter;
♦ that the issuer has filed all required reports during the preceding 12 months or any shorter period during which the company has been subject to reporting requirements; and
♦ has filed current “Form 10 information” with the SEC reflecting that it is no longer a shell company.
What this means to OTCMarkets Pink companies that have engaged in reverse mergers or acquisitions is that Rule 144 is not available until the above conditions are met. In other words, if a Pink went public in a reverse merger with a company that had at any time in its past (even 20 years ago) been a shell company, Rule 144 is not available to its shareholders.
Under these circumstances, the former shell company’s shareholders cannot receive free trading shares upon the conversion of preferred stock, notes, debt wraparound agreements or similar instruments without complying with the requirements of 144(i) above or registering the relevant securities under the Securities Act regardless of the age of the debt or terms of the instrument.
In the past two years, numerous enforcement actions have been brought by the SEC against dilution funders using debt wraparound agreements that do not comply with the requirements of Rule 144.
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 www.securitieslawyer101.com. 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 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
Telephone: (561) 416-8956
Facsimile: (561) 416-2855