FINRA Continues Crackdown on Footnote 32/172 Shells

I am hearing more and more anecdotal evidence that the Financial Industry Regulatory Authority (FINRA) is doing more to challenge the real intentions of tiny startup companies seeking to go public. In too many cases, these “companies” will be marketed as trading shells immediately following the completion of going public. As I have written in my book and here many times, often these companies possess mining rights, or rights to entertainment projects, or are in the consulting business.

They do this to get around SEC restrictions on obtaining a trading stock if you are indeed a true blank check company whose real business plan is to acquire another business and strip out whatever assets exist initially. By not disclosing their true intentions, the argument is that the public is being misled.

In 2005, in the famous footnote 32 of its reverse merger rulemaking, the SEC made clear they do not find this practice acceptable. Yet the practice continued unabated since the SEC, frankly devoted no enforcement resources to this problem which, admittedly, is not easy to address, as it is not always easy to determine the real intentions of people. And promoters putting these deals together manage to stay in the shadows, not acquiring their interest until after a merger, after which they will stay below five percent of the ownership and never have to reveal their interest.

The SEC made the problem more intractable in its Rule 144 rulemaking in the newly famous footnote 172. There they made clear that a legitimate startup, which may have as little as one employee or a small office rented, is enough to be considered a real business and not a shell. Knowing this was coming, dozens and dozens of shells started going public pretending to be real startups. And they pretty much all got through the SEC and got their trading symbol from FINRA.

In the last year or so, though, FINRA has been stepping up the pressure on these companies; some little birdie (nope, not me), must have whispered in someone’s ear down there. They require the company to confirm in writing that they are not intending to market the entity as a shell. If they believe they might be hiding their true intentions, they often make them go back and amend all their old filings to check the shell box. This triggers the various limitations on Rule 144 that only apply to former shells.

Good work, FINRA. As I have stated, until the rules change, I believe Form 10 shells, or real trading shells with years of real operations ending with a sale or termination of operations, are the way to go. But I hope the SEC, at some point, will take a new look at Rule 419 to allow the creation of a shell, admitting it is such, with trading immediately upon a merger, and no requirement to delay the deal with a complex proxy.

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