August 30, 2011
As an attorney I have been involved in dozens of reverse mergers in my 26 years of practice. I have also written a text on the subject, Reverse Mergers (Bloomberg Press, 2009), now in its second edition. My blog on the topic, www.reversemergerblog.com, is visited by over 3000 professionals each month. I write this comment in my individual capacity and I am not speaking for my law firm or any of its clients.
I strongly object to the premise of the proposed "seasoning" requirement, and believe a broad brush application to all transactions of a particular type may have the chilling effect of discouraging exciting growth companies from pursuing all available techniques to obtain the benefits of a public listed stock and greater access to capital while still maintaining appropriate investor protections.
The Exchange's justifications include (1) allegations of fraud raised by the financial press, short sellers and others, (2) concerns raised that certain promoters have regulatory histories or are involved in transactions that are "disproportionately beneficial" to them, (3) the Public Company Accounting Oversight Board (PCAOB) has cautioned accounting firms having "identified issues" with audits of these companies, (4) an SEC enforcement action against an auditing firm involved with reverse mergers and (5) Nasdaq's being aware of situations where it appeared that efforts to manipulate prices took place to meet Nasdaq's minimum price.
In response to these points, I am surprised to see such a dramatic proposal in response to mere allegations of fraud, much less the source. I am not aware of any rule adopted because the financial press and short sellers made allegations. We are not aware of the "others" the proposal is referring to.
Virtually all of these suggestions of wrongdoing involve Chinese companies that completed reverse mergers. The proposal fails to note that a number of other Chinese companies that completed full traditional initial public offerings with major underwriting and accounting firms face the very same allegations. In addition, many of the Chinese companies facing allegations went public through a reverse merger followed by a fully underwritten, SEC-reviewed public offering before a single share of stock traded. So if these allegations turn out to be true, it would not be a result of the manner in which the companies went public.
As to the backgrounds of promoters, one would think that Nasdaq is able to review the regulatory histories and financial arrangements made with promoters in these transactions and can choose not to list companies where the issues are great. It is not clear to me how requiring a company to list over-the-counter for six months addresses this issue at all.
The PCAOB's concerns follow the same issues above - namely allegations of wrongdoing yet to be proven in almost all cases. But again, the Nasdaq has the ability to list a company based in part on its comfort with the auditors involved, and it is not clear that looking at two quarterly filings before listing would change that.
One SEC enforcement action against one auditing firm, several years ago, seems not sufficient to warrant such a draconian response.
And the concerns raised about artificially inflating trading prices can be examined individually six months of trading would not prevent this abuse. Indeed, in many transactions we work on with reverse mergers with non-trading Form 10 shells, there is no trading at all until a firm commitment underwriting is completed and Nasdaq application approved. In those cases, this issue is removed completely.
Nasdaq's solution to require over-the-counter trading for six months and to maintain a $4.00 stock price for 30 days would not in any meaningful way reduce these concerns, and it places substantial and undue burdens on companies seeking the benefit of an exchange listing against very few offsetting positives.
As we know the governance and other obligations on the OTC markets are substantially less than on Nasdaq. It is much more difficult to generate trading volume in stocks traded over-the-counter because analysts do not generally follow these stocks and certain funds and brokerages are prohibited from purchasing their stock.
The original Nasdaq proposal in April did provide an exemption from seasoning for a company coming to Nasdaq with a firm commitment underwritten public offering. Unfortunately, the June 8 amended proposal eliminated this exemption. Even the New York Stock Exchange and the NYSE Amex, in their similar proposals, provide for an exemption from seasoning for a firm commitment public offering. To suggest that a company can come to Nasdaq with a traditional initial public offering without concern, but not with an equally investor-protective secondary public offering after a reverse merger seems illogical.
The requirement to maintain a $4 trading price for 30 days before application is also unfair. It is even more difficult to reach this price trading over-the-counter than obtaining this price upon initial listing on Nasdaq, when one has all the benefits of the major exchange, including analyst coverage and institutional investor opportunity. Thus, by requiring minimum trading qualifications the proposal could well result in the next great software or defense company being denied the opportunity for an uplisting because of the very challenges of the trading platform that the proposal would relegate them to.
Nasdaq already has broad discretionary authority with respect to what companies it wishes to have listed. The traditional initial public offering market remains out of reach or unduly expensive or risky for many legitimate growth companies that could absolutely benefit from a publicly traded stock and can bear the costs of being public. I propose, therefore, that the seasoning proposal be rejected in its entirety as an overreaction to a specific and limited problem with a relatively small group of companies against which, almost universally, no wrongdoing has been proven.
In the alternative, it appears to have become much more common for the SEC to complete full reviews of "super" Forms 8-K filed following reverse mergers with reporting shell companies. In lieu of the seasoning requirement, Nadaq could simply require that the "super" 8-K review be complete to the SEC's satisfaction before an application can be made.
If it not possible to reject this proposal, I propose that the original proposal providing for an exemption for any firm commitment underwritten public offering be adopted. In a firm commitment public offering with an SEC and Financial Industry Regulatory Authority (FINRA)-registered underwriter, investors are provided the same level of protection as in any initial public offering.
I also propose that, if any seasoning is required, trading of the stock not be a requirement. A period where all SEC filings are made timely and completely and can be examined by Nasdaq officials would seem sufficient. To require the maintenance of a price that is the same as the expected initial price on Nasdaq is unfair and unrealistic to achieve on the OTC markets. And a Nasdaq application should be able to be processed during the seasoning period.
In 2010, at the SEC's Government-Business Forum on Small Business Capital Formation, SEC Chairman Mary L. Schapiro said, "Reliable data suggests that small businesses have created 60-to-80 percent of net new American jobs over the last ten years. Making sure small businesses can attract the investments they need to grow and thrive is vital to America's economic recovery."
Let us hope that the Commission's actions mirror Chairman Schapiro's words by doing all it can to reduce impediments to capital formation for these key engines of the American economy, with an appropriate balance to ensure that small company investors are well protected.
David N. Feldman