August 29, 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 accounting fraud, (2) suspension of trading or registration of some reverse merger companies, (3) an SEC enforcement action against an auditing firm involved with reverse mergers and (4) the issuance of an SEC bulletin on reverse mergers.
In response to these points, I am surprised to see such a dramatic proposal in response to "allegations" of fraud. Virtually all of these allegations 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 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 suspension of trading, these were mostly companies that were delinquent in their filings or had issued questionable press releases (a total of less than 20 companies as I understand). These companies would not likely have survived the Exchange's review in any event.
One SEC enforcement action against one auditing firm, several years ago, seems not sufficient to warrant such a draconian response. And the SEC bulletin also was a response to these similar points.
The Exchange's solution to require over-the-counter trading for one year without a large underwritten public offering would not meaningfully reduce these concerns. As we know the governance and other obligations on the OTC markets are substantially less than on the Exchange. 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 proposal does provide an exemption from seasoning for a company coming to the Exchange with a firm commitment underwritten public offering raising at least $40 million at the time of or after the reverse merger. This exception is very important and it is most disappointing that the Nasdaq has eliminated that exemption from their proposal. However, it is unfortunate that the Exchange chose a minimum to be raised (the Nasdaq initially did not), and also that it chose the same minimum amount to be raised in this exemption as its affiliate, the New York Stock Exchange (NYSE).
As we know, all of the Exchange's basic initial and maintenance listing standards are generally lower than that of the NYSE, to provide an opportunity for companies to go public that are not quite ready or large enough for listing on the "big board." Yet this proposal requires the same minimum as the more senior exchange.
The proposal also requires that the minimum price to be initially listed on the Exchange be maintained for a 'sustained period' while the company is 'seasoning' on the OTC. This is even more difficult than obtaining this price upon initial listing on the Exchange, 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.
As the proposal correctly notes, the Exchange 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, the Exchange 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 an exemption for any firm commitment underwritten public offering. If there is to be a minimum to be raised to obtain an exemption from seasoning, I propose it be much lower than $40 million, maybe $15 million. In a firm commitment public offering of that size with an SEC and Financial Industry Regulatory Authority (FINRA)-registered underwriter, investors are provided the same level of protection as in a $40 million offering.
I also propose that, if any seasoning is required, that trading of the stock not be a requirement. A period where all SEC filings are made timely and completely and can be examined by Exchange officials would seem sufficient. To require the maintenance of a price that is the same as the expected initial price on the Exchange is unfair and unrealistic to achieve on the OTC markets. And an Exchange application should be able to be processed during the seasoning period.
Finally, the timing should mirror the Nasdaq proposal and be limited to a six month 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