June 3, 2004
FELDMAN WEINSTEIN LLP
420 Lexington Avenue
New York, NY 10170
Facsimile: 212 997-4242
May 24, 2004
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Attention: Jonathan G. Katz, Secretary
Via e-mail: email@example.com
Re: File No. S7-19-04, Securities and Exchange Commission Release Nos. 33-8407 and 34-49566 the Proposed Rules
Ladies and Gentlemen:
I am writing in response to the Staffs request for comments to the Proposed Rules. My firm has represented numerous companies in reverse merger transactions, and I have led a number of seminars and symposia on the subject, including those sponsored by the Practising Law Institute.
The legitimate use of the reverse merger technique historically has been overshadowed by abusive schemes which were, and to some extent still are, all too common. For a company that can benefit from a public trading market where a traditional initial public offering either is unavailable, unrealistic or ill-advised, however, the reverse merger technique is a valuable alternative to be considered.
A company seeking to grow by acquisition using publicly traded stock as currency, reward executives with valuable stock options, seek greater and easier access to capital or simply provide liquidity to founders and investors, can benefit from being publicly held as part of a long-term strategy. In many cases, however, a company that could indeed see such benefit may be too small or too early stage for a traditional IPO, or may simply lack the Wall Street sizzle that underwriters seek from certain industries. Also, many companies prefer not to deal with the risk, delays, diversion of management attention and ownership dilution of an IPO even if it is a realistic option.
Many things have changed since the Commission passed Rule 419 in 1992. First, many abuses relating to the IPOs and trading of blank check companies ended, and many of the questionable players moved on. Second, the major Wall Street firms, which previously shunned financings for companies that had completed reverse mergers, happily financed them during the Internet boom. These two developments helped remove most of the taint on Wall Street for this technique.
All the major stock exchanges now willingly list the stock of these companies on their merits and generally not by virtue of the manner in which they became public. Successful companies that went public through reverse mergers include Blockbuster Entertainment, Muriel Siebert, Tandy Corp., Occidental Petroleum, Turner Broadcasting, Waste Management and others. While some abuses clearly continue, over the last several years the participants in reverse merger transactions from investment bankers to promoters have curbed a number of the abuses and fraud historically associated with these types of transactions.
My suggestions for adjustments to the Proposed Rules focus on seeking a balance between the real need to further reduce and eliminate inappropriate behavior and the equally real need to minimize the disincentive for legitimate companies, working with quality professionals, to utilize this valuable technique.
Introduction to Comments. In general, the Proposed Rules, while very well-intentioned and properly directed, impose unnecessarily severe burdens on newly public operating companies in regard both to the scope and timing of required disclosures. As indicated in other comments, this additional cost and delay will hurt the ability of legitimate companies to become publicly traded through a reverse merger and unreasonably delay their access to the capital markets. We also believe that non-trading companies should be exempt from these onerous requirements.
My first group of comments will address the Staffs proposal to require a shell company to file a Current Report on Form 8-K containing full Form 10 or Form 10-SB, as applicable information within four business days of the completion of a reverse merger transaction. My concerns to be expressed relate to the scope of disclosure, the timing, and the definition of public shell. I then offer a suggested exemption for non-trading companies. Finally I offer my comments to the definition of public shell. After this discussion I will turn briefly to the proposed ban on the use of Form S-8 by public shells.
Scope of Disclosure. I believe requiring full Form 10 disclosure following the completion of a reverse merger is not necessary. I can understand the need for financial statements and notes, a Managements Discussion and Analysis section, principal stockholder information and possible risk factors, all of which are extremely important Basic Disclosure. The balance of the disclosure Additional Disclosure, while also helpful to an investor, could be deferred for some period, especially since any item which results in a material risk to investors would be disclosed in risk factors. If the Commission believes that waiting for the next Form 10-K or 10-KSB is not acceptable for the Additional Disclosure, I suggest it be made at the earlier of the next Form 10-K or 10-KSB or 90 days after closing the reverse merger, whichever comes first. Requiring a private company entering into a reverse merger to prepare and file the Additional Disclosure earlier could effectively delay and increase the costs of legitimate transactions, as well as deter companies that could benefit from being public from entering into reverse merger transactions altogether.
Timing of Disclosure. The proposed four-day filing requirement is too short. This also could increase the costs of completing a reverse merger transaction, and deny legitimate companies access to the capital markets. We suggest that an initial Form 8-K with summary information about the merger transaction and a copy of the merger agreement be filed within four business days of closing and that Basic Disclosure be made within 30 days of the closing of a reverse merger transaction.
The risk of abusive trading is as prevalent in a four-day period as it is in a 30-day period. This still substantially reduces the current filing time of up to 75 days after closing even just to release financial statements. An alternative may be that the 30-day suggested period apply for the next two years only and that the four-day rule apply thereafter unless a further hearing determines that the 30-day rule has yielded the desired impact on abuses without unduly burdening legitimate parties. I believe a 30-day requirement would strike an appropriate balance between protecting against abuses and not unduly discouraging worthwhile use of the reverse merger technique.
Delay for Non-Trading Stock. The proposed rapid disclosure rule primarily targets the sometimes abusive trading occurring in the former public shell after the merger but before disclosure of substantive information concerning the private company that has taken over the public shell. I would suggest that the disclosure be permitted to be deferred in the situation where either the stock of the former public shell is not listed for trading or is not available to trade publicly, or where the board of the former public shell is willing to suspend trading. In such situations where there is no trading I suggest that disclosure may be deferred for up to 90 days after closing or the next Form 10-K or Form 10-KSB, whichever comes first. This would apply both to Basic and Additional Disclosure.
Definition of Public Shell. I agree with some of the comments that the proposed definition of public shell could be improved. I believe the Commissions definition of blank check company, carefully developed as part of Securities Act Rule 419 in 1992, should be adopted here but with some changes. The problem with the proposed public shell definition is that a legitimate start-up or early stage company with no or nominal assets and no or nominal operations would be subject to the rule, which I believe is not the Staffs intent. Also, a number of shells resulting from former operating businesses maintain certain assets and even minimal operations after jettisoning or liquidating their former business. These assets may include rights as a plaintiff under a lawsuit or potentially valuable intellectual property. I do not believe it makes sense to allow these companies to be exempt from the proposed rules where shells not so lucky to have left over assets would be subject to these new requirements. Also, I expect there would be endless requests for no-action relief as to what constitutes a nominal amount of assets or operations.
Therefore, I believe the blank check definition of a company with either no business plan or one whose business plan is simply to merge with or acquire another company makes sense to apply here as the definition of public shell. But I do have two concerns with this definition.
First, a number of unsavory types who have created bogus startup companies to evade Rule 419 and would probably attempt to do the same here. Thus, I believe an apparent operating business or startup should not be exempt from my proposed definition unless it shows demonstrable steps towards pursuing its business plan beyond simply declaring its mission. You could provide a 4-6 item list of these steps and suggest that a showing of any two or three of them would be sufficient for exemption. This list could include things like entering into a lease or purchase of real estate, employing management and/or Board members with specific experience in the intended business, conducting research and development activities, engaging in market research, purchasing or leasing equipment, etc. This exception could exempt absolute pure startups, which may be for the best in any event.
My second concern with the no business plan definition is that some have attempted to put a stakeholder small business in a public entity to avoid meeting the definition of blank check company, or as I am suggesting, public shell. There are several ways to deal with this. First, I suggest you consider public shell status if the only operating business is one that traditionally has virtually no likelihood of growing beyond its current status, such as a barber shop or small consulting firm. This may require a revenue cap of, say, 200,000. Second, you should add the right for the Commission to take action against any promoter or group of related or affiliated parties who persistently puts small businesses into public companies and then effects reverse mergers immediately after which the small business is removed from the public company.
With these two changes, I believe the blank check company definition serves the publics purpose better than the proposed definition of public shell.
Use of Form S-8. My firms clients generally are not involved with the use of Form S-8 in shell or blank check companies, so this item is not of great concern to me. However, it does seem appropriate to continue to permit a public shell to use Form S-8 to register stock of actual employees or officers or directors of the shell who are performing legitimate services to keep the shell going, looking for possible transactions, and so on. I do not believe it is necessary to allow Form S-8 to be used for consultants or other third parties, and agree with the Staff in that regard. Allowing the form to be used for employees should also address the concern expressed by the American Society of Corporate Secretaries, Inc.
Conclusion. In conclusion, I believe the Proposed Rules represent a very positive step in seeking to curb real abuses that have taken place in the period after reverse mergers have been consummated and prior to full disclosure. I hope, however, that the Commission will soften the most draconian aspects of the proposal so as not to hurt the rapidly growing number of quality players who are entering this field and recognizing this technique as a legitimate alternative to a public offering.
Thank you for your consideration of our comments in this matter.
David N. Feldman, Managing Partner
Feldman Weinstein LLP