June 3, 2004
Although I serve as Chair of the Subcommittee on Limited Offerings of the Committee on State Regulation of Securities of the Business Law Section of the American Bar Association and the Private Placement Broker-Dealer Task Force of that Section, these comments are not submitted on behalf of any Committee of the ABA but solely on behalf of myself and this law firm.
Over a decade ago I served on the ABA Task Force that drafted what is now the Form U-7 of the Small Company Offering Registration adopted by the North American Securities Association and subsequently adopted by the Commission as Offering Circular Model A of the Form 1-A Offering Statement under the Securities Act of 1933. In part as a result of this effort, both I and this firm have over the years represented many emerging small businesses in the Pacific Northwest in public and private financings.
Our experience confirms that of the Commission and the Staff that corporate shells have been used as vehicles to commit fraud and abuse, and we include among the victims of fraudulent corporate shell schemes many of the legitimate small companies and their founders that are often enticed into those schemes by unscrupulous promoters when other means of financing appear difficult or unavailable. Over the years we have observed a number of small companies and their managements which have been enticed by (often offshore) promoters into implementing reverse merger and back-door registration corporate shell transactions in which the promoters have been able to induce "hyping" of the stock, to liquidate their stock positions and then to disappear, while leaving compromised management to deal with the resulting irate shareholders that have purchased stock at artificially inflated prices and with securities regulators seeking to hold management responsible as willing participants. Although we often hear corporate shell proposals characterized as useful for "legitimate corporate structuring purposes," we are unable to confirm such use from our experience. We also direct your attention to the use by promoters of small, once significant but now "living dead," operating public companies as the vehicles in reverse merger and back-door registration transactions that have essentially the same manipulative effect as those involving the pure corporate shells covered by the proposals set forth in Release No. 33-8407. A plethora of both public and private "living dead" emerging companies has arisen since the bursting of the internet stock bubble some months ago, and their desperation renders them and their owners and management particularly vulnerable to these analogous fraudulent stock manipulation schemes.
You indicate in Release No. 33-8407 that corporate shells may be used for "many legitimate corporate structuring purposes." To the extent that this may be so, we question whether elimination of the 71-day reporting window and requiring reporting full '34 Act registration information on Form 8-K within four business days after completion of the transaction would not as a practical matter present too formidable an obstacle to such legitimate use. In light of this, we suggest for your consideration a more flexible alternate approach that should prove to be adequate in precluding manipulative abuses. Such an approach would be to retain the 71-day reporting window but to prohibit outright by Rule any direct or indirect trading by affiliates, including executive officers, directors and significant shareholders, of either of the constituent corporations during that 71-day reporting window. We also suggest that such a trading prohibition be extended to cover affiliates of the constituent corporations in reverse merger and back-door registration transactions involving one or more "living dead" operating public companies. "Living dead" operating public companies (to which a less flamboyant term should probably be applied in any Rule) might be defined as those with only "minimal" or "limited" operations and might be restricted to those traded on the OTC Bulletin Board or the Pink Sheets. In any event, that definition should have bright-line criteria in terms of their current financial circumstances and recent operating results.
We are aware of the difference in the ability of the Staff to monitor failures to comply with the filings mandated by the proposals of Release No. 33-8407, as compared with the Staff's ability to monitor failures to comply the above trading prohibition suggestion if the surviving company should be non-reporting under the '34 Act, but if there truly are "many" legitimate corporate structuring purposes for corporate shell transactions, as you indicate in Release No. 33-8407, any additional compliance monitoring efforts that may be required would seem justified.
We hope the above suggestions may prove useful to the Commission and the Staff in evaluating the proposals set forth in Release No. 33-8407.
Mike Liles, Jr.
Karr Tuttle Campbell