Tip of the Week- Watch Your Trading Patterns

If a private company is seeking to complete a reverse merger with a shell whose stock is trading, there are three different periods of time where questionable trading can occur. One hopes, as in most deals these days, that normal trading patterns develop and there is no reason for concern. But vigilance as the deal progresses is important, and you should watch the stock all throughout the process. The three time periods are as follows:

Before the Announcement. If a stock’s volume picks up noticeably in the days and weeks before announcing even a letter of intent, be cautious and ask questions. Anyone trading on material nonpublic information is committing a crime. And don’t always assume the person trading is connected with the shell, it could be someone on the private company side looking to cash in a bit. If the illegal trader is a control person of the shell, it may not be just their problem. The company could be held liable on an “alter ego” theory, and the private company inherits that liability upon the merger.

After Announcing an LOI or Agreement. If a stock’s volume picks up dramatically immediately after announcing a deal (but before completing the deal), it may be a sign that the shell’s control people and friends were teeing up their trades to hit the minute the announcement came. That could be illegal, because the shell’s affiliates know much more about the possible deal than is typically included in a press release to announce a letter of intent or signed agreement. In most deals, because analysts do not cover shell stocks and broker-dealers do not follow them, it takes awhile for word to get out, and the stock picks up, if at all, over a period of a week or two after the deal, not the same day as the announcement. Truth is in most deals I’m involved in the stock barely moves on the announcement, which is a sign that insiders are appropriately not trading and keeping mum.

After Closing the Merger. If a pre-revenue biotechnology company is trading at a $300 million market cap after closing a revese merger, be cautious. It may indeed be worth that and not a concern, but rapid rises in stock following a merger to stratospheric levels may be a sign that someone is over-hyping the stock, possibly through questionable investor relations tactics. Why do we care? If the person orchestrating this activity is connected to the company, the company is responsible. Second, these meteroric rises almost always lead to SEC or NASD investigations, and who needs that?

Best Case Scenario. Ideally, the shell’s stock does almost nothing before and after the announcement, and begins to move slowly after the deal is consummated. It can take a number of months after closing a reverse merger to put in place strong, legitimate investor relations and begin to have an impact on the trading market. Patience is a virtue in these situations, and when a stock rises too rapidly, well as Newton found out, everything that goes up…well you know the rest.

Here’s to our Presidents and enjoy the holiday weekend!

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