The Reverse Merger & SPAC Blog

Guest Blogger Tim Keating Weighs in on Rule 144(i) Changes...Let the Debate Begin

noreply@blogger.com (David N. Feldman) — Fri, 18 Jul 2008 15:09:00 +0000

Intro from me: I have asked my good friend and client Tim Keating, with whom I have a respectful disagreement as to the impact of certain aspects of the recent SEC changes to Rule 144, to write a piece setting forth his view of the issue to be posted here, and he has offered the below. Take a read since, as you know, I always do my best here to offer a fair and balanced view of all issues relating to the RM world. I may wait to respond until after the SEC provides a response to my request for interpretive guidance on this issue:

SEC Rule 144 Changes:
The Glass is Half Empty for Reverse Merger Sponsors

Timothy J. Keating
President, Keating Investments, LLC

July 17, 2008 - Last month, I delivered a speech to the Reverse Merger Conference in Los Angeles titled: “Self-Filings: The New Preferred Private-to-Public Path.” My thesis was that certain of the rule changes to Rule 144 that went into effect on February 15, 2008 were clearly not understood by most of the participants in the PIPEs/reverse merger industry and disastrous for reverse merger sponsors. My good friend David Feldman argues that the changes to Rule 144 which shortened the waiting period from one year to six months were the best thing that has happened to the PIPEs industry in many years. Since I primarily look at the world through the lenses of a reverse merger sponsor, I wholeheartedly disagree. In fact, I see the Rule 144 change glass as half empty—at best.

For reverse merger sponsors, there are three major causes for concern in the Rule 144 changes.

First, the SEC explicitly created a doctrine of “separate, but not equal” by adding an extra six-month holding period to PIPE investments made at the time of a reverse merger. Based on excellent disclosure reforms codified in law in 2005, there is no conceivable justification or rationalization for this extra waiting period. One can only conjecture that certain senior SEC staffers still have a visceral allergic reaction to reverse mergers and felt compelled to “do something” to maintain an official taint on this activity.

Second, and far worse, the SEC’s change to the definition of a shell company contained in Footnote 172 (which states that a “start up” company or one with limited operations is not a shell company) on the one hand will benefit a handful of tiny public companies. On the other hand, it has flung Pandora’s Box wide open by providing massive financial incentive to scammers through the creation of hundreds of phony public companies. By not thinking through the unintended consequences of certain aspects of this footnote, the SEC has unwittingly fostered an environment for small cap stock fraud like never before.

Third, and worst of all, Section 144(i) now states that if a company was ever a shell company, and is not current with its financial filings, then its restricted securities held by persons who acquired such securities when the issuer was a shell or former shell can never be freely traded. What does this mean? Providing that a former shell issuer is current with all of its required SEC filings over the previous 12 months, an investor in a shell or former shell can still sell under Rule 144 beginning one year after the reverse merger is completed (or pursuant to an effective resale registration statement). But if a former shell issuer fails at any time to file a periodic report and thus is no longer current with its SEC reporting requirements, under these circumstances (and this is the part that the PIPEs/reverse merger community is not grasping), an investor in a shell or former shell cannot sell under Rule 144 even if the investor has held the stock for more than a year after the reverse merger. This restriction remains in effect unless and until the former shell issuer becomes current with its SEC reporting requirements. This operative word is “ever” (as in ever a shell company), and the law is retroactive. Investors in companies that were once shells and that “go dark” by delisting and/or trading on the Pink OTC Market are screwed forever unless of course they are fortunate enough to have sold their stock when the issuer was current in its SEC filings. Shares held by a shell or former shell investor will never be freely tradable under the new Rule 144(i), and we surmise that no attorney would be willing to opine to have the restrictive legend removed from such certificates other than in connection with an actual 144 sale when the issuer is current in its reporting obligations. The simple consequence is that investors in shell and former shell companies no longer ever have stock that is freely tradable as was the case under old Rule 144(k).

David Feldman has written a letter to the SEC requesting interpretive guidance that the new Rule 144(i) not be applied retroactively. Who knows whether this retroactive relief will be forthcoming? Even if this relief is granted, without further rule changes, it does nothing to help repeal the rule going forward.

In 2007, there were nine traditional IPOs that raised less than $25 million in new capital. Also in 2007, there were 222 reverse mergers, 107 of which involved a simultaneous PIPE financing. In other words, over 90% of the companies that went public last year did so through the combination of a reverse merger and PIPE.

Even though the SEC may not like reverse mergers, it should nonetheless adopt a neutral stance as to how capital is formed, take immediate action to provide a bright line definition of a shell, create a level playing field that does not disadvantage honest reverse merger sponsors, halt trading in stocks that merge with Footnote 172 shells (which are simple to identify) and equalize the Rule 144 holding period for any PIPE investor to six months. If the SEC truly wants to deter reverse merger activity over the long term, it should form a blue ribbon committee to explore and understand the reasons why the U.S. small cap IPO has nearly become extinct. Antiquated and irrelevant rules will surely figure in the findings.

Text of My Request for Interpretive Guidance to the SEC on Rule 144(i)

noreply@blogger.com (David N. Feldman) — Wed, 16 Jul 2008 17:45:00 +0000

A number of blogees have emailed me asking if I can post the letter I sent to the SEC requesting interpretive guidance with respect to whether or not the "evergreen" requirement in new Rule 144(i) is retroactive. I hereby do so. I have been informed that the SEC has received and is reviewing the letter, though it is not clear when a response will come. Until then, I will reserve further comment on the matter. Thus, the letter.

FELDMAN WEINSTEIN & SMITH LLP

420 Lexington Avenue

New York, New York 10170

T: (212) 869-7000

F: (212) 997-4242

www.feldmanweinstein.com

Thomas Kim, Esq.
Associate Director and Chief Counsel
Division of Corporation Finance
Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549

Gerald Laporte, Esq.
Director of Small Business Policy
Division of Corporation Finance
Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549

June 12, 2008

Re: Interpretive Letter Request Regarding Securities Act Rule 144(i)

Gentlemen:

We are writing on behalf of a number of our law firm’s clients to request interpretive guidance that the specific language of amended Rule 144 under the Securities Act of 1933, as amended (“Rule 144”), that makes the exemption thereunder unavailable if the issuer was at any time in the past a shell company and has not completed all its periodic report filings in the 12 months preceding the date of intended sale, is not retroactive to issuers that ceased to be a shell prior to the effectiveness of the amendments on February 15, 2008 (Release No. 33-8869, dated December 6, 2007 (the “Release”)).

We believe that the interpretive guidance described below would facilitate the process by which issuers that ceased to be shell companies prior to the effectiveness of the amendments conduct private offerings.

Background of the Issue

In adopting the changes to Rule 144, the Commission appeared to express some concern about reverse mergers with shell companies. Under the new Rule 144(i), if a company ever was a shell company, the company must have completed all its periodic Commission filings for the last 12 months or Rule 144 is simply not available. This means that any company that was ever a shell remains subject to this, even if it has not been a shell for many decades.

Problems Presented

This “evergreen” requirement to stay current creates several problems. The first problem presented is in connection with fashioning registration rights if a company might be considering a private offering of securities. In the past in private investments in public equity (“PIPEs”) and other private placements, companies generally were required to register the applicable securities in a resale registration statement and keep that registration statement effective until the earlier of (i) the sale of all shares that were registered; and (ii) such time as the holder could sell without any restrictions under Rule 144. Prior to the rule change, for non-affiliates in most cases this period was two years.

Post-rule change, this period (other than with respect to sales of securities by shell companies) for non-affiliates is now one year (since even though one can start to sell in six months, the company must remain current for the next six months, thus creating a potential restriction). In a situation involving a company that was ever a shell, this period now never ends.

This is true because even five, ten or more years after a company ceases to be a shell, under the new rule a holder cannot utilize Rule 144 if the company is not current in its filings at the time of sale. Thus, it is quite confusing to determine how to deal with these registration rights, and investors have not been able to properly address this concern to their satisfaction.

The second and more vexing problem this creates is the removal of restrictive legends. Stock certificates issued to private placement or PIPE investors, as well as any holder who acquires shares from a company that are unregistered or "restricted" contain a legend on the back of the certificate stating that the shares cannot be sold unless registered or an exemption from registration applies. Freely tradable shares have no such legend and delivering the unlegended stock certificate to a brokerage firm generally provides free tradability.

It is common to have the legend removed at the time of a sale where a holder seeks to sell utilizing the exemption under Rule 144. That process is somewhat cumbersome and an occasionally time-consuming process which involves the company, the transfer agent and company counsel giving an opinion, among other things. In the past, a Form 144 also had to be filed. Thankfully this requirement has since been eliminated for non-affiliates and smaller sales by affiliates under the new rule.

Convention has developed allowing the legend to be removed when the holder has held the shares long enough so that they can be sold without any restrictions under Rule 144, rather than in connection with a sale. Removing the legend in advance is advantageous because it saves time at the time of sale by avoiding the difficult process described above. Occasionally, a company also may refuse to remove a legend at the time of sale or counsel may have issue with delivering an opinion. Removing the legend in advance takes away this very real concern for investors.

Impact of Evergreen Requirement

Unfortunately, a holder of shares in a company that was ever a shell now can never have his or her legend removed in advance of a sale. This is because if a year has passed and no volume restrictions apply, there remains forever another restriction: that at the time of sale the company must have been current for the past year. Since one cannot know this in advance, it is impossible to remove the legend until the time of sale. If the legend was removed any earlier, and a holder sought to sell at a later time, and the company was not current, the holder would be in violation of Rule 144.

This limitation paints every former shell with a “scarlet letter,” suggesting that the Commission believes these companies forever require greater regulatory oversight. If the Staff determines to apply retroactivity to this restriction, it will apply to Berkshire Hathaway, Occidental Petroleum, Texas Instruments, Blockbuster Entertainment, Tandy Corp. (Radio Shack), Waste Management, Jamba Juice, Muriel Siebert and every former special purpose acquisition company (SPAC), even if it raised $1 billion. One hopes, as requested below, that the Staff can confirm that this was not the Commission’s intention in adopting this particular change.

In future discussions with the Staff it is hoped that we can address the question of whether any legitimate investor protection goal is served by this significant restriction which continues to apply many years after a company ceases to be a shell. The hope is for the Commission to consider taking another look at the evergreen aspect of this new rule with the possibility of limiting it in a future rulemaking.

Request for Interpretive Guidance to Ensure Evergreen Requirement is not Retroactive

In this request for interpretive guidance we seek a much more limited goal, namely an interpretation by the Staff that the requirement for a former shell to remain current for the past 12 months as a condition to utilizing Rule 144 to effect a sale be declared inapplicable to companies that ceased to be shells prior to the effectiveness of the new rule changes on February 15, 2008 and that this portion of the amended rule is not retroactive.

All other aspects of the Rule 144 changes benefit the investor and public company community through retroactivity, as the shortened holding periods and elimination of certain forms are positive changes. However, the requirement to remain current creates an additional burden on shareholders of public companies. Former shell companies which completed transactions pursuant to which they ceased to be a shell prior to the effectiveness of the rule did so with no knowledge or anticipation that a rule such as this might be passed in the future. It is conceivable that some of these holders might have reconsidered investing in a former shell if they were aware that this restriction might apply in the future.

It is simply unfair to retroactively burden investors and companies with a restriction that impacts what was done prior to the rule’s adoption. A determination of inapplicability of the rule for these particular companies is also a reasonable interpretation of the rule.

These former shells, including the well-known companies listed above, will now learn that if they conduct any private offering of securities, it will be impossible to remove a restrictive legend on shares that are not registered. This is not what any of these issuers signed up for when they went public through a reverse merger with a shell company, nor what their investors assumed when completing their investments. I am hopeful the Staff can confirm that the Commission did not intend for the rule change to apply to famed investor Warren Buffett, whose reverse merger occurred decades ago without any knowledge or ability to anticipate this burden.

I thank you for your consideration of this interpretive guidance, which would be a significant step in rectifying any impression that the Commission’s intent was to burden all former shell companies, even those so far-removed as Occidental Petroleum from the 1950s.

Please do not hesitate to contact me at (212) 869-7000 with any questions or requests for further information with respect to the matters set forth in this letter. I look forward to your response.

Sincerely yours,

David N. Feldman

Cc: Honorable Christopher Cox, Chairman, Securities & Exchange Commission
John White, Director, Division of Corporation Finance, Securities & Exchange Commission

What's Important

noreply@blogger.com (David N. Feldman) — Sun, 13 Jul 2008 17:21:00 +0000

Heading back from our family's annual summer trip, which was incredible bonding time as usual. My two kids, nephew and one of my daughter's friends made it extra special.

There is simply nothing more important in life than the joy of your loved ones. For some people it is a favorite sister or cousin. Some raised by grandparents. Some revel in their spouse, children or grandchildren.

In our American culture summertime offers the opportunity to enjoy what's important. Make the most of it. I recently lost a close friend I've known since high school back in the 1970s, who succumbed to cancer at a way too early age leaving a wife and two young kids. As we watch too many folks taken from us too early, remember that every day is a gift.

Back to RM world this coming week...interesting things coming up..

Venture Capitalists - The Last Holdouts on IPO Alternatives

noreply@blogger.com (David N. Feldman) — Sat, 28 Jun 2008 13:10:00 +0000

I began my career at a law firm (now known as Fulbright & Jaworski in New York) that represented a number of leading venture capital firms. I worked on dozens of venture deals back in the go-go 1980s that led in many cases to lucrative initial public offerings that brought millions to the vc's and the institutional investors in their funds. So I believe I have a sense of the vc mindset when it comes to "exit strategies" (every venture investor puts money into a private company with a long-term plan to be able to cash out at some point).

In the past these exits were about evenly split between an acquisition of one of their portfolio companies and an IPO. More recently, however, the exits are more like 90% acquisition and 10% IPO, and that 10% number continues to decline. Most vc's will admit that they are more likely to obtain a higher ultimate return on their investment following an IPO than an acquisition. So why have the number of venture-backed company exits structured as IPOs fallen so much?

On June 29, the New York Times reported, "So far this has been a challenging year for companies hoping to go public. But it has been even rougher on venture capitalists who were hoping to get a big payday from such an offering...In the second quarter of this year not a single company backed by venture capitalists has gone public. It is the first time that has happened since 1978, according to a venture capital industry group."

Yet despite these difficulties, the vc and private equity community (other than in the biotech space) have steered clear of taking their portfolio companies public through reverse mergers, self-filings or other IPO alternatives. So why are the number of IPOs down so much? Why do these investors avoid IPO alternatives? How can we fix that? Let's explore.

Why is it tougher to complete IPOs?

The vc's have clearly hit a new low if this is the last time since your humble blogger was in high school where a quarter went by without a venture-backed IPO. The main reasons that IPOs for venture-backed companies are so much harder to complete are (1) smaller IPOs have disappeared and (2) the IPO market has been extremely rocky, even for larger companies, since the market crash of 2000. Let's take each one of these separately.

Death of Smaller IPOs. Why have smaller IPOs disappeared? As I described in my book, in the 1980s and 1990s, many small brokerage houses took smaller companies public through IPOs and would raise $10-50 million on average- some even less. Many of these companies were venture-backed. Many started trading on Nasdaq, the exchange of choice for most vc's. Some fared well and others didn't.

It should be noted that even during the IPO heyday, reverse mergers also remained strong. Why? Because as fast as one could take an Internet company public in 1997, some wanted to be public even faster (and cheaper). The reverse merger still offered (and continues to offer today) a faster, simpler, cheaper and less dilutive alternative to an IPO.

In any event, following the crash of the Internet stocks and the market as a whole around April 2000, the IPO market initially disappeared entirely. Then entered our former (now disgraced) New York Governor Elliot Spitzer. Spitzer decided to go after the small brokerage firms, a number of which were engaged in questionable activities such as "pump and dump" and issuing rosy research reports without clearly disclosing conflicts of interest.

Once a number of high profile criminal cases were brought, and major investigations about issuing of research reports, well, it all just stopped. Soon thereafter these small brokerage firms, or the ones that survived the market shakeout in the first place, discovered that life is easier raising money for companies through PIPE transactions that do not involve regulatory scrutiny prior to an investment, and hence one of the reasons for the explosion in PIPEs, now an $80 billion a year industry.

So that's why smaller IPOs are virtually nonexistent. In 2007 only six IPOs involved companies raising $25 million or less. The average market capitalization of a company completing an IPO in 2007 was $330 million.

Difficult IPO Market. So why has the IPO market, even for larger companies, been rocky since 2000? It is hard to predict the opening and closing of the so-called "IPO window." Sometimes IPOs cease even when the overall stock markets are fine. Sometimes a difficult market for technology stocks alone will cause the IPO market to take a hit.

But since 2000 the IPO market simply has never gotten close to back where it was in the heydays of the 1990s. I'm sure others can put up tons of statistics on that, so no need to do so here. Why so difficult?

First, the overall market has been difficult and that never helps. Second, enter again Spitzer. In the mid-2000s as New York Attorney General, he went after virtually every underwriter of large IPOs from Merrill Lynch on down. He claimed that in the IPOs of the 1990s even they engaged in illegal actions including improperly setting aside shares of IPO stocks for favored investment banking customers, and again that whole research thing. These firms ponied up literally billions of dollars to settle with Spitzer, who this time had the SEC and the US Justice Department working with him.

So bottom line, the regulators took all the fun out of the game. Yes there are still IPOs and 2007 was a better year (though 2008 has been a horrible year again). But again the underwriters have determined that it is not worth playing the game unless the company is of a very substantial size.

Why have vc's shunned reverse mergers and IPO alternatives?

I have spoken at several conferences for vc's and private equity investors, including one specifically titled "alternative exit strategies." At each one I explain the benefits of reverse mergers and suggest that while not for every deal it can be an efficient way to help take a company to the next level. I try to employ what I learned at a sales seminar I took when I used to own a radio station, namely, that selling is the process of overcoming objections. Here are the main objections vc's raise to reverse mergers and my response to them:

Objection #1: Reverse mergers are shady. If there is one thing I can be pleased about, it is that it appears this objection has been virtually eliminated. It is true that 5-7 years ago, many vc's, often advised by then ill-informed major law firms, believed that only bad guys were involved in reverse mergers. Virtually all the vc's (and their lawyers) now understand that there are a number of legitimate players. They look, for example, at SPACs and realize that some major big time success stories are seeing the legitimacy of these alternatives.

Objection #2: Better to wait for an IPO. The vc's argue that, even if it takes an extra year or two, the IPO will result in a better ultimate pay-day for them. The best companies, they say, will ultimately qualify. The "dogs" (badly performing portfolio companies) are not worth trying to salvage. The medium success stories, doing OK but behind expectations, they say, are not worth taking public because there are problems that need to be dealt with before. My response: (a) that hoped-for IPO may never come based on the discussions above, even for some of the best ones, leaving them with only an acquisition exit which likely will be less lucrative, (b) there are quite a number of reverse merger success stories that belie the theory that an IPO provides a better pay-day and (c) medium success stories can benefit from being public if they have a continuing need for capital and are having trouble raising it, thus making an IPO alternative attractive. It should be noted that this has been the most stubborn of the objections, despite my entreaties to the contrary.

Objection #3: I will never be able to liquidate my investment. Many vc's express the concern that companies completing reverse mergers never build trading in their stock. They say, "I don't want to have to become an investor in a public company, that's not what I know how to do."

My responses: (a) Although the stock doesn't generally "pop" as it does after an IPO, as I have written here and in the book many times, market support builds over time after a reverse merger - assuming the company deserves the support and engages qualified professionals to assist in educating Wall Street. They should talk to the many CEOs whose company stock has built very strong trading and moved up to higher exchanges - or talk to my client Rick Rappaport about his WRASP structure to take a private company public through a merger with a virgin shell followed by a small public offering and immediate trading on the American Stock Exchange.

(b) After an IPO of a venture-backed company, the vc becomes an investor in a public company, so it is not correct to suggest they do not do this. Most vc's are required to lock-up their shares for at least six months following an IPO, and most do not simply sell the minute the six months is over. They sometimes sell some and hold some and voila, they have become an investor in a public company. If they view the reverse merger not as the liquidity event but a step in the path to liquidity, that big pay day may yet await them.

I would love the chance to continue this dialogue with my super-smart friends in the vc and private equity community. Maybe some of their big firm lawyers who are regular blogees will help in suggesting these alternatives as legitimate, transparent and as effective as leaving a company private while struggling to grow and raise money.

Rule 415 and 144 Update Panel: Glimmer of Hope on Evergreen Requirement

noreply@blogger.com (David N. Feldman) — Thu, 26 Jun 2008 18:23:00 +0000

Sorry, in this entry I'm going to use a bit of securities-lawyer speak, so I apologize in advance for those who were smart enough to skip law school.

I just attended a "webinar" put on by DealFlow Media on Rule 415, Rule 144, Form S-3 and Rule 145 changes, interpretations and the like. I attended in particular because former Associate Chief Counsel of the SEC's Division of Corporation Finance Carol McGee was on the panel. She is now at Alston & Bird, but is well known as one of the key architects of the SEC's increased enforcement of its position on Rule 415 which resulted in limiting the amount of shares that can be registered for resale following a PIPE or similar transaction.

Ms. McGee defended what they did on 415, that it was a response to some players getting somewhat out of hand registering 2 or 3 times the public float. The reaction (my view overreaction) of the staff, as I have laid out in prior posts, was to limit registration to 1/3 of the non-affiliate stock unless other circumstances exist.

Frankly there was not much new information about 415, as Ms. McGee went through the chronology of what led to the new interpretation and standards and answered a few questions about specific situations. As to 415 applied after reverse mergers, she agreed that in those cases with very little float it often made sense for the staff to be more flexible, which in many cases they have been (though lately there have been some anecdotal cases of them being tough).

More interesting was the Rule 144 discussion, which did include a fair amount of talk about 144(i) and the new rules relating to reverse mergers. First, more and more folks believe there may be an ability to remove a restrictive legend on stock, even in the presence of the "evergreen" requirements to remain current, because Rule 144 is not the only way to be exempt from registration. Other methods exist and these were discussed.

As to the evergreen requirement, Ms. McGee admitted there have been a number of questions about it and said there "may eventually be some rethinking about it." Other panelists saw this as good news - that she believes there may be another look taken at this. Another panelist talked about the "thorn in our side" resulting from the issues raised in Rule 144(i).

I posted a question and they asked it - I let them know (and I have not posted this here till now) that I have submitted a request for interpretive guidance to ask the SEC staff to determine that the new requirement to stay current only apply to companies that cease to be shells after the new rule was effective - in other words, that this part of the rule not be retroactive to companies that completed reverse mergers long before the rule was changed this past February. The panelists seem to believe that it might be difficult to get such relief, but I remain hopeful and we shall see.

I asked if the panelists believed that the Worm/Wulff letters were superseded by the new rule. They said, as I also believe and have been told by SEC staff, that the interpretation that Rule 144 is never available to former shell shareholders has been superseded since 144 now is available one year after a reverse merger and release of Form 10 information, but that other aspects of the letters, such as the prohibition on selling shares privately to a third party under Section 4(1), still apply.

OK....

"Cash and Carry" of Form 10 Shells Becomes More Popular

noreply@blogger.com (David N. Feldman) — Thu, 26 Jun 2008 12:15:00 +0000

In my office we are seeing an noticeable increase in private companies going public through a merger with a virgin shell where, rather than convincing the shell owner to merge with them and leave the shell's owners with a percentage of the equity, the private company takes over 100% of the shell's stock. This is done through cash being put into the entity upon a merger, whereupon the former shell repurchases the stock of the former shell owners. Many in the industry refer to this as a "cash and carry" transaction.

What are the advantages of this approach? One major one is that the negotiation process between the private company and the shell becomes non-existent. The merger agreement is a virtual non-event, as the owners of the shell know they are being cashed out and do not really focus on things like representations and warranties of the private company.

Second, there is no process of convincing the shell owner of the value of your business so they will provide the shell to you. Since you are paying cash, it is simply a matter of agreeing on a price for the shell (which happens quickly) and the discussion is over.

Third, the counsel for the shell (if there even is one for this) is not likely to spend any time at all doing due diligence on the company merging in. Again, that process is to protect shareholders, all of whom will be gone upon closing. Of course the private company will review the due diligence of the shell, but for Form 10 shells this is an extremely simple process.

Prices vary over time so I don't think it appropriate to discuss the market prices (as the old saying goes, hire me and I'll tell you!). Virtually all of my clients that have set up virgin shells did so with the intention of using them in reverse mergers where they are providing or arranging financing as well and retaining equity after the transaction. However, a number have told me that they would be willing to sell one or two (if they have five, say) for cash if a buyer is out there. This helps defray the costs of setting up the shells.

Why wouldn't someone set up their own Form 10 shell for less money rather than buy one for more? Several reasons. First, if you are the company hoping to merge, you cannot set up a Form 10 shell if you know the company you will merge in. If so, the SEC requires you to disclose substantial information about that company. Second, it takes about three to four months to germinate a new shell and get it public. Most of these cash and carry deals at a higher price (which in all cases is substantially lower than buying a controlling interest in a "legacy" shell with a history of operations) are with companies that do not wish to wait that long for a shell to be created, and need a transaction now.

What about the shareholder base? Buying out the current shareholders of a Form 10 shell usually involves a small handful, often less than five shareholders. Thus you don't lose too much on your shareholder count. It is important that upon closing, the company merging in has at least 35-40 unaffiliated shareholders to qualify for listing on the OTC Bulletin Board, and a small "friends and family" round of share sales can usually take care of that.

Several years ago a handful of Form 10 shells changed hands this way when new dealmaker clients agreed to set up groups of shells with us but realized they wanted one to use immediately. Other clients would step up and sell one. Since then, most clients preferred to wait until their shells were ready, rather than buy one. The price for these cash and carry deals has gone down rather significantly, but it still usually comfortably exceeds the cost of setting one up, thus rewarding the seller for doing so.

More recently, it is not the dealmakers but the companies themselves that are requesting the option to simply cash out the shell holders. A number of my clients seem more than happy to oblige. Anything that speeds and simplifies the process at manageable cost is a valuable additional arrow in the quiver of those of us structuring deals in RM land.

Where are you from?

noreply@blogger.com (David N. Feldman) — Sun, 22 Jun 2008 12:28:00 +0000

An earlier post talked about all the different countries blogees here are representing. I thought I would give you a flavor of what types of companies and enterprises are here. Google has some incredible analytic tools that keep track of what networks our visitors come from- and each month you come from nearly 1000 different network locations. You should always know with whom you are keeping company! Here's my unscientific review of the categories of folks who are here just in the past month (in no particular order):

1. My competitors: I am glad to see a number of my competitors (smaller law firms focusing on this space) are regular visitors. It's OK guys, happy to see you, since you are all friendly competitors. In fact one of my competitors is one of my top visitors (good to see you at the conference this week)!

2. Big law firms: As I have noted in previous posts, I am most heartened to see that large law firms have opened their minds to learn more about reverse mergers and IPO alternatives. Visitors are from the likes of Duane Morris, Skadden Arps, Morrison & Foerster, Troutman Sanders, Cooley Godward, Jones Day, Milbank Tweed, K&L Gates, Kirkpatrick & Lockhart, Kaye Scholer, O'Melveny & Myers, Akin Gump, Andrews & Kurth, Debevoise & Plimpton, Kirkland & Ellis, Pepper Hamilton, Pillsbury Madison, Thelen Reid, Baker & Botts, Clifford Chance, Davis Polk, Fried Frank, Goodwin Proctor, Greenberg Traurig, Holland & Knight, Mayer Brown, Preston Gates, Proskauer Rose, Cahill Gordon, Curtis Mallet-Provost, Dechert, Foley & Lardner, Gibson Dunn, Hale & Dorr, Latham & Watkins, Mintz Levin, Orrick Herrington and Paul Hastings.

3. The regulators: Yep, the US Securities and Exchange Commission monitors us, and I'm very happy to have them. Of course I would never write in any way other than respectfully to our regulators, even when I respectfully disagree. We also welcome visitors from the Nasdaq and the Toronto Stock Exchange to our humble blog. Also FINRA is here (although their network name is still National Association of Securities Dealers, their former name)! We also have visits from the Federal Trade Commission and the US Department of Justice.

4. Dealmakers: I know most of you and thanks for being here! Houlihan Lokey, Gruss & Company, GH Venture, Roth Capital, Jesup & Lamont, Keefe Bruyette, Maxim Group, Rodman & Renshaw, Sanders Morris, etc.

5. The big brokerage houses: CIBC, JP Morgan Chase, Lehman Brothers, Credit Suisse, Morgan Stanley, Royal Bank of Canada, Brown Brothers Harriman, Legg Mason Wood Walker have all taken a look. In truth, every major house is now involved in financings related to reverse mergers and SPACs.

6. Educators & Students are also here from Harvard University, Columbia University, Georgetown University, Dartmouth College, Johns Hopkins University, Northwestern University, New York University, Baruch College, University of Wisconsin (Madison), University of Bologna, Central Missouri State, Concorida University, Fuzhou University, Korea University, Pepperdine University, Southern California University, University of Miami, University of Rochester and University of Stellenbosch. This is cool and bodes well for the future of our industry as those coming from academia learn the benefits of these alternatives.

7. Accountants: My friends from Rothstein Kass, Deloitte & Touche, Stonefield Josephson, and others. Where are the rest of you? Probably too busy!

8. Chinese visitors: My friends from dozens of different locations. Welcome!

9. Press: Welcome Crain Communications, Boston Globe, DealFlow Media and others.

There are many others who visit from bigger networks such as AOL or a cable company that are all lopped together, but I know you are out there! Thanks again to all for your support. In just a week's time I'm off with the family for our annual trip to paradise...see you all soon!

Great conference!

noreply@blogger.com (David N. Feldman) — Thu, 19 Jun 2008 21:54:00 +0000

Just left (a little early) the 2-day reverse merger conference here in Los Angeles. The turnout was tremendous, participants interested, and our sponsor booth got a lot of traffic! Thanks to so many of you who came up and mentioned not only reading the book but being regular blogees.

It does appear our industry is healthy and growing. One attorney panelist asked, "Why don't we do small IPOs anymore?" I answered, "Because all the underwriters who did them are gone, and this is a great alternative for companies that can benefit from a public trading stock." I went on to say that if IPOs were cheap, simple, quick and assured, reverse mergers might not even exist. But IPOs are none of the above, and as a result our industry exists.

Some highlights of the conference for me:

1. The friendly "spat" between Tim Keating and me about whether the new "evergreen" requirement, mandating that any former shell's shareholders cannot use Rule 144 if the company has not been current in its filings, is an unmitigated disaster or just an annoyance that was unnecessary but not the end of the world (I took the latter view). I will be writing more on this soon as I am in the process of interfacing with the SEC on something relating to this issue. Tim and I agree that these changes make a self-filing a more attractive option than previously.

2. If the 2000 election was all about "Florida Florida Florida," the subheading here may have been "China China China." There were some great panels on today's issues, which include some real challenges while strong opportunities remain.

3. A fascinating academic study of hundreds of reverse mergers from 1996 to today with some interesting and a few head-scratching tidbits.

4. My partner Joe Smith on a panel regarding financing and the challenge of building liquidity. His point: investors putting money into reverse mergers need to understand that they will likely be holding their stock for 1-2 years. Those who want near-term liquidity have mostly gotten out of the reverse merger game.

5. My panel on the pros and cons of Form 10 shells including a presentation by Rick Rappaport of WestPark Capital on his now famous "WRASP" structure to take a company public by merging with a virgin shell and trading directly to the American Stock Exchange.

6. The humanizing moment when the adorable young son of one of my competitors (in full tie and jacket) told the panel during the Q&A that he is happy because the stage is clean, and when he has been at other meetings like this the stage is always dirty. Warning: might just have to bring my 6-year old next time!

7. Good networking and good food at the Millennium Biltmore Hotel. And I spotted a few folks taking that victory lap around the hotel I spoke of in an earlier entry...

Heading home!

The Case For Form 10 Shells - Reprinted from The Reverse Merger Report

noreply@blogger.com (David N. Feldman) — Sun, 15 Jun 2008 11:25:00 +0000

I now have permission to post the guest column I wrote that was included in the May issue of the Reverse Merger Report. In anticipation of my panel next week in LA (see last post), I thought it might be helpful for you blogees who may not have caught the RMR to take a look, so here it is:

The Case for Form 10 Shells

During the past three years, the formation of shell companies through the use of the Securities and Exchange Commission’s Form 10 has proliferated. Many in the reverse merger and PIPE space find these shells an efficient and valuable tool to take a company public. Some have defended and others have criticized, and there are certainly pros and cons to these so-called “virgin” shells.

Virgin shells take advantage of the fact that SEC restrictions on taking a shell company public do not apply to filings such as Form 10, which allows the creation of a fully reporting shell company with no history of operations to scrub in due diligence.

One perceived drawback is that virgin shell stock is not permitted to trade until after a reverse merger and subsequent SEC registration of shares. A further drawback often cited is that virgin shells have very few shareholders, and a shareholder base must be built to qualify for trading.

However, there are circumstances where a virgin shell can be valuable in comparison to a self-filing, where a company files its own SEC registration without a shell. Self-filing can take many months longer than a merger with a virgin shell. This matters if a company needs to close a larger sized financing sooner and an investor insists on being public to do so. In such cases, the shell merger’s speed is important. However, if a company is not in urgent need of financing, or can raise money while remaining private and waiting for completion of its self-filing, it may indeed be a better alternative.

A virgin shell also has several attributes that a “legacy” shell with a history of operations doesn’t have. Virgin shells are much less expensive to set up and maintain, and there are no past liabilities to worry about. Its shareholders, even if small in number, support the target merging in whereas legacy shell shareholders’ reactions to a proposed transaction can be unpredictable.

A legacy shell can, however, be valuable in several situations. First, if a company desires to apply to Nasdaq or the American Stock Exchange immediately following a reverse merger, the legacy shell could provide sufficient shareholders to qualify for a listing, whereas virgin shells typically do not. One exception to this is WestPark Capital’s WRASP structure, which is a way to work from a virgin shell directly to the AMEX.

Legacy shells also can be valuable where PIPE investors insist on being able to mark their investment to market every day. The lack of trading for several months following a virgin shell merger would not work for this type of investor.

I believe trading in a shell prior to a merger can actually be a negative, and that the market misperceives the value of trading. Illegal insider trading creates problems in too many deals. Thin trading following a merger can actually send a stock price down until shares are registered.
The public shareholder base represents only a tiny percentage of the outstanding stock following a deal and therefore cannot be depended on to provide any real trading until shares are registered. Some seemingly “clean” legacy shells, in fact, result from fraudulent attempts to bypass SEC restrictions on blank-check company IPOs, as noted in the famous footnote in the SEC’s reverse merger rulemaking.

Still, many continue to fork over $500,000 to $800,000 or more in order to acquire a controlling interest in a legacy shell. Unless one of the advantages above applies, all one buys is three months of trading. Trading in a virgin shell, which is sold at a significant discount and requires minimal due diligence, will most likely begin about three months after the merger.

In a merger where there is no concurrent imminent financing, a shell may indeed be unnecessary. But anytime there is a contemporaneous PIPE or other financing, a virgin shell can be a very efficient vehicle. The company does not care if trading takes a few months, because they have raised money. And investors’ primary concern is that there is a trading market by the time their shares are registered, which there likely will be.

There are absolutely situations where a self-filing or legacy shell makes sense, but there are just as many others where a totally clean, AMEX and SEC-favored virgin shell can put a company on the fast track to public status.

Off to the Reverse Merger Conference - hope you all join!

noreply@blogger.com (David N. Feldman) — Sat, 14 Jun 2008 10:42:00 +0000

The Reverse Merger Conference, produced by DealFlow Media, takes place this week in Los Angeles. I think to summarize the state of our RM world, it is flux. But truthfully, when was it not thus? And isn't that what makes it exciting to wake up every day? The conference should be quite interesting. Here are a few tidbits of the panels and my thoughts on some:

1. On Wednesday, just after lunch (I know, not great time), I am on a panel talking about the pros and, yes cons of Form 10 shells.

2. Tim Keating will be talking about self-filings as a more attractive option than prior to the recent SEC rule changes (I agree!).

3. My partner Joe Smith will be on a panel talking about trends in financing and how to close deals in a "less than liquid" trading environment. For those of you who have never heard Joe speak at a PIPE conference, buckle your seat belts!

4. An academic study of 1900 reverse mergers since 1996 will be presented - really looking forward to that.

5. Another panel talks about where your post-merger company's stock should trade.

6. I love this totally objective topic heading: why regulators hate reverse mergers (I think some do, but many do not).

7. An update on China, SAFE 106 and such is another one I'm looking forward to. Has everyone now adopted the "sell the company to an unaffiliated BVI company and then have make-goods for the former owners allowing them to earn back the lost shares through performance" model? Some are going directly for government approval rather than these Rube Goldberg-type structures, what about that? Anyway, let's see what the experts say.

8. The last speaker is talking about how to analyze the cleanliness of a shell and will talk about footnote 32 shells. One thing I will say for those of you following my commentary on footnote 32. The SEC and those of us supporting them in issuing the footnote are fighting the equivalent of the US war on drugs. Except, unlike the US which is spending billions and managing to try to empty the ocean with a bucket, unfortunately the SEC has not even devoted the necessary enforcement resources to go after fraudulent footnote 32 shells.

All in all, as usual, Steven, Brett and Eric at DealFlow have picked the hot topics that we all want to hear more about. Also make sure you all join us at the cocktail party on Wednesday as drinks are on us at Feldman Weinstein & Smith (we are sponsoring the event)! And of course stop by our table in the sponsors' area if you want a free pen!

To my law colleagues in the RM world, thanks for a year in which we banded together to strategize about our advocacy approach to the SEC as major rule changes came about. I thank you all for that as well as for your continued professionalism and "high road" approach to your practices and work in RM. I'll post a post-mortem next weekend...

My publisher made me post this!

noreply@blogger.com (David N. Feldman) — Wed, 11 Jun 2008 18:25:00 +0000

I am, seriously, honored that my book has recently received its second award, this time from the Axiom Business Book Awards which "recognize and promote the world's best business titles." My award was in the category of business reference books and was one of three such awards.

As I just recently posted, the impact of the book continues to amaze me. Who knows? All your support may just convince Bloomberg Press that we should consider updating it at some point with a second edition!

Thanks again for all your good wishes. Reverse Mergers makes a great Father's Day gift!

Transitions

noreply@blogger.com (David N. Feldman) — Sat, 07 Jun 2008 11:32:00 +0000

My fabulous 18-year old daughter is graduating high school in just a few weeks. She leaves for college at the end of August. We will still revel in the hysterics our 6-year old son brings to every day, thank goodness, but we will miss her tremendously of course (actually my son may well miss her more than any of us).

Of course we will see her every few weeks, we will visit her up there, she will come home (probably to get laundry done). But she will be gone. On her own. We have done a good job and she is ready. Are we ready? Well that's probably another story.

They say when your first goes to college it's all about the child, will they adjust, how will the roommate be, classes, social life and the like. But when your last goes to college it's all about you - the empty nest, new phase of life and so on. Well we have yet a dozen years to deal with that as my son graduates in 2020! So for now, it's all about her..

College is much different today. Laundry service, storage service, there's a service for everything we tough, hardy college students of yesteryear did for ourselves. But at the same time today's colleges are pressure cookers of competition, each angling for that extra point on a test or slighter higher GPA. Just as high school seemed all about getting into college, college nowadays seems all about getting into graduate school for most.

My hopes for my daughter: achieve and succeed academically and find that area of study that sparks excitement. But not to the point of losing perspective. Have fun. Laugh all night and order pizza at 3 am. And explore all that college has to offer from extra-curriculars to community service. And make the most of the faculty that are there - get to know them and have as much one-on-one time as you can. But also - have fun.

Most kids heading to college don't realize that college is for most people the freest time of their life. No restrictions they had growing up, and no responsibilities to a job, spouse, children and so on that await them after. My wife and I envy my daughter as we recall our college years with such fondness. But it is not always a cakewalk - one of the big secrets of college is it isn't always fun.

As I often write here - one can work hard and also enjoy life or as some say - play hard. I hope my daughter finds that fabulous balance we all hope to achieve. And I hope she calls her folks a lot.

Adios Mr. Weiss

noreply@blogger.com (David N. Feldman) — Tue, 03 Jun 2008 13:17:00 +0000

Notorious class-action lawyer Melvyn Weiss was sentenced yesterday to 30 months in prison by a Federal District Court judge in Los Angeles. Over four decades he built the biggest powerhouse specializing in suing large corporations for alleged wrongdoing to shareholders. His crime: paying people to serve as "lead plaintiffs" at the ready so he could be the first to file suit, giving him the greatest chance to be lead counsel in a major class action case and reap the largest rewards for his firm.

Paying plaintiffs, of course, is an illegal kickback. Several of Weiss' partners were also convicted, and the firm itself is still under indictment. A class action law passed in 2006 made it harder to bring these cases, which has reduced the overall case load. In the meantime, Weiss personally made over $200 million between 1985 and 2006 and became an active philanthropist and Democratic party fundraiser.

As I reported in my book, at the height of his success in 2005, Mr. Weiss was on the cover of Forbes magazine with the heading, "The most feared man in corporate America." Rumors circulated that associates in his firm rotated spending a week each in front of a Bloomberg screen looking for stocks taking a precipitious drop, which could lead to a lawsuit.

I have heard Mr. Weiss speak several times. There is no question that his eloquent assertions that the "little guy" was being trounced upon by evil management and he was there to protect them were great sound bites. And indeed there were a number of cases where Weiss and his firm took down some serious bad guys.

But I watched too many times where a major class action was brought with no apparent wrongdoing whatsoever - other than a dropping stock price. Some felt it was pure extortion - settle with us or we'll keep you in court for years, etc. Many settled as a cost of doing business. Some fought. Weiss dropped some cases when some fought him too hard.

What does this have to do with reverse mergers and the smallcap market? Everything. Every company considering going public has to take into account the potential negative that being public increases the likelihood of facing lawsuits from shareholders. Our overly litigious society creates this risk and makes it less desirable for some companies to consider taking advantage of the benefits of a publicly trading stock. It also leads some companies, among other reasons, to consider going public outside the United States where the culture is different.

Hopefully the playing field has been leveled a bit in the world of class actions with the fall of Weiss' firm and the new law. The rest will have to wait and see how our US elections turn out in November. But all in all, a positive development for public companies.

Goldman Cancels its SPAC

noreply@blogger.com (David N. Feldman) — Fri, 30 May 2008 11:40:00 +0000

Sad news yesterday for the SPAC world. According to yesterday's Wall Street Journal, because the IPO of Goldman Sachs' planned SPAC, Liberty Lane Acquisition Corp., failed to price, the SPAC announced that it had canceled its proposed IPO due to market conditions.

Originally Goldman had hoped to start trading Liberty Lane's stock last week, then they postponed to this week, and now this cancellation. Observers seem to differ as to whether Goldman's planned changes to the SPAC structure were partially to blame for their failure to attract investors, or whether the failure heralds a declining interest in SPACs generally.

Goldman had planned to reduce the interest in the SPAC granted to its management team, and require less money up front from them. They also reduced their underwriting fee from what is traditional. To blame failure to price on this, however, seems strange as these changes were meant to benefit initial investors as well as the acquisition targets.

There are still a number of quality players out there churning out new SPACs with high quality management teams and lots of ambition. There are still a number of good acquisitions being made. There has been a slowdown that is hopefully due more to the saturation of the market than anything else. Some players are beginning to examine the potential of radical changes in the structure.

In any event, let's hope there is a strong future for this useful vehicle.

Thank You Thank You Thank You

noreply@blogger.com (David N. Feldman) — Wed, 28 May 2008 10:49:00 +0000

I was just informed by Bloomberg Press, the publisher of my book, that Reverse Mergers: Taking a Company Public Without an IPO, is about to enter its third printing. I cannot overstate my appreciation for the support I have received from readers, blogees, clients and friends. Of course I also thank everyone at Bloomberg, as their efforts at spreading the word have been phenomenal. They have been running radio ads for months on Bloomberg Radio and supporting me in my various appearances.

I am very pleased that the publishing of this first-ever comprehensive resource for our RM world helped legitimize what we do and, as one commentator of the book said, "lifted the veil" on this previously little known set of techniques. I am truly humbled by all the nice words and support I have received. Thanks so much to you all.

Where is the next China?

noreply@blogger.com (David N. Feldman) — Sat, 24 May 2008 11:07:00 +0000

To paraphrase Garrett Morris on the original Saturday Night Live, the People's Republic of China has been very, very good to the reverse merger and SPAC world. In 2007 about one quarter of all reverse mergers involved companies from China going public through a merger with a US shell. According to the Reverse Merger Report, that trend continued through the first quarter of this year. Many SPACs have been focused on deals in China.

The "yuan rush," as I called it in my book (a Google search leads me to believe I may have actually coined this phrase), has led to successful deals for many. Yes a few klunkers along the way, and even a scam artist or two has made it through. But the vast majority of the Chinese deals have been strong, interesting growth companies.

The challenge with any rush is that everybody and their brother wants to join in. The number of players working to develop deals in China has exploded. The competition for deals has become greater. The Chinese government has placed speed bumps in the way of getting deals done because of their concern about too many Chinese companies being controlled by foreigners.

Investors are still snapping up these deals, and the market for Chinese reverse mergers remains strong, with very favorable valuations for these companies as they complete their process of going public in the US. But it is getting a little harder because of the reasons described above.

Thus, a number of key RM players who had set up major operations in China have now begun to hedge their bets a bit and look elsewhere. Some might have thought the other "BRIC" countries of Brazil, Russia and India ("C" of course being China) might be winners. Well, Russia and India are still not seeing much action.

(By the way, according to Wikipedia, "the term BRIC was first prominently used in a thesis of Goldman Sachs. The main point of this 2003 paper was to argue that the economies of the BRICs are rapidly developing and by 2050 will eclipse most of the current richest countries of the world. The Goldman Sachs thesis is not that these countries are a political alliance, like the European Union, or a formal trading association, but they have the potential to form a powerful economic bloc.")

However, it appears the next place to head for RM deals is Latin and South America (yes including BRIC country Brazil). I believe a combination of factors is leading players there. First, these countries are simply closer to home, and those who go to Asia every other month can attest to the wear and tear it takes on them having to leave our hemisphere, not to mention that fabulous 12-hour time difference.

Second, language barriers are fewer as many, if not most, folks speak English. Third, there is generally less political uncertainty in most of these countries than in China. Fourth, in most of these countries, as in China, there is not a well-organized local stock exchange that helps companies go public without leaving the country. Fifth, at least for the moment there are very few players seeking to finance and take public businesses in the region. Sixth, as the Goldman Sachs report attests, there are a number of countries in Latin and South America where economic growth is significant.

What of the concerns often expressed that corruption and fraud are rampant in these areas? As with China, the players will work with experienced partners on the ground in each country to do their best to steer clear of the criminals. What of the juntas, the dictators, the anti-US sentiment in some countries? Again, not every country in the region will be ripe for opportunity, but a number of them will. It has been widely reported that major RM player Tim Keating has chosen Colombia to establish his regional operation.

Personally, I have no particular objection to a major due diligence exercise in Rio de Janiero. Go southern hemisphere!

Our thoughts are with the families of our fallen soldiers on this Memorial Day weekend in the US.

Signs of the Times

noreply@blogger.com (David N. Feldman) — Sat, 17 May 2008 11:42:00 +0000

I went to a dinner this past week for a well-known charity, an advocacy group. It was their annual "Wall Street dinner," run by hedge fund managers and private equity types. Top notch speaker, good food, good company. I had attended the dinner last year. The one difference: last year the room, at famous Cipriani's in midtown Manhattan, was absolutely packed to the rafters - they put tables in places that probably broke the fire codes. This year, tables comfortably spread out and no exits blocked. A visibly smaller crowd.

Another sign - a client who told me a year ago his meetings with potential investors in PIPE deals would end with requests for wire instructions to send money. These days, he says, the meeting ends with investors saying, "Thanks for inviting me, I'll get back to you."

Wall Street is hurting. Major layoffs are taking place at pretty much every brokerage house. The New York Times reported that these layoffs are more "stealth," being done a bit at a time rather than en masse. The M&A world was rocked by the subprime mess leading to tight credit for deals. That is only now beginning to thaw just a bit. The Dow is all over the place. The country is in a recession and real estate values are plunging in many areas.

However, in parts of the finance world, there is continued activity. In the RM world, we see no reduction in deal flow in my law firm. Quite the opposite in fact. There remain many growth companies around that can benefit from being publicly held. They are less concerned about today's market conditions and know that, as always, this down cycle will lead to an up cycle.

PIPEs took a brief pause in the first quarter, but public companies still need money, and they can only wait so long when their stock price dips before they need to raise the money no matter what, so sure enough we are now busier than ever representing investors and broker-dealers in PIPEs. SPACs have slowed slightly, but that appears to be more a function of the need to absorb the deals that are in the marketplace than any negative long term trend.

So it is difficult to watch friends at places like Bear Stearns get hurt. But anyone who has been through a down market knows (a) that it is inevitable and (b) this too shall pass. Next upturn, make sure to put something away for a rainy day. In the meantime, let's be pleased to be in an area of finance that, while it doesn't shoot for the moon when things are great, it also isn't as badly affected when things turn down.

The Case for Form 10 Shells- Valuable But Not for Every Deal

noreply@blogger.com (David N. Feldman) — Sun, 11 May 2008 13:49:00 +0000

In the latest issue of the Reverse Merger Report, just out this week, I provided a guest column with the above title. At some point down the road I hope to post it here, but for now it is in the safe hands of the RMR and its subscribers. If you haven't subscribed yet, you can (and should) do so at www.dealflowmedia.com.

Within our RM community there are leading figures who have their "thing." Some are strong proponents of self-filings. Others believe it is simply easier to complete a merger with a legacy OTCBB shell with an operating history. Still others have seen the value of using clean virgin shells in shell mergers. And yet still others believe that the flexibility provided by shells trading on the OTC Pink Sheets are the way to go. There are even those who have suggested that questionable so-called "footnote 32 shells" can be a viable alternative. And last are those who love to work with SPACs.

In many cases, those who oppose others argue that choosing one technique as one's primary suggested approach is based upon their source of income for their own business, whether it be law, investment banking, shell principal or the like. In my case, I prefer not to be known as someone who only does one thing. In fact, while I admit to being a very strong believer in the many benefits of the virgin shells in transactions involving a simultaneous financing, in the guest commentary you will see I talked about circumstances where a self-filing or merger with a legacy shell is indeed preferable. And in fact we work on all these types of transactions with our clients.

In talking about virgin shells a few years ago, a client said, "Just make sure you don't suggest that this is the anti-SPAC." And I believe I have not. Whether in my book or this blog, I believe I have taken a fair and balanced view of all these alternatives, recognizing each of their advantages and disadvantages (including virgin shells - note the subheading above), and acknowledging that every company considering its strategic alternatives is different.

I hope we can all do the right thing - namely, to be sure to provide those we work with, clients, business contacts and so on, with a frank analysis of the costs and benefits of all these approaches, regardless of what may be our "thing."

Happy Mother's Day to all my US blogees.....

Tip of the Week: How are Shell Companies Valued?

noreply@blogger.com (David N. Feldman) — Fri, 09 May 2008 13:34:00 +0000

A shell company is a company with no or nominal operations, and with no or nominal assets or assets consisting solely of cash and cash equivalents. To identify and value an appropriate shell for a specific company’s purpose, it is necessary to understand six important characteristics of the shell. These give the prospective buyer a way to gauge the shell’s value and utility for the purpose at hand.

1. How was the shell created?

Shells are created in one of two ways. A shell is created from scratch when a founder or group takes public an empty company whose business plan is to acquire a private company. A shell can also be created after the termination of operations of a “real” public company.

2. Does it have assets and liabilities?

Assets of shells can be significant amounts of cash, an old claim the company is asserting against a third party from its operations, or potentially valuable intellectual property.
In some cases shells also carry liabilities. These liabilities have to be included in the value of the shell, so often management tries to eliminate these liabilities or convert them to equity prior to or upon closing a merger.

3. Is the shell trading or non-trading?

Shells formed from scratch (other than SPACs) generally do not and cannot have their stock trading prior to a merger. Public shells resulting from a former public operating business typically do continue trading. The marketplace for shells deems trading to be positive, and generally values a trading shell higher than one that is not trading.

4. Is the shell reporting or non-reporting?

Some public shells “report” under SEC rules; others do not. A reporting company is obligated to file quarterly, annual, and other regular reports with the SEC and is subject to other rules. Companies that trade on the Pink Sheets often do so without being required to report. A company can also be a “voluntarily reporting” company. These companies are not subject to the reporting requirements but continue to file quarterly and annual reports with the SEC and have their financials audited. The marketplace generally assigns a higher value to a shell that is required to report and is current in those reports.

5. What is the size of its shareholder base?

One major asset a shell has to offer is a shareholder base. The only way meaningful trading in a stock can build is through the addition of a good number of shareholders. Simply put, a public company with 2,000 to 3,000 shareholders is more valuable than one with twenty to thirty. However, the identities of the shareholders, the percentage of the company’s float which they will represent, and the manner in which they became holders all may affect their value to the shell.

6. Is it clean or unclean?

Problems in a shell’s past history or management can adversely affect its current value. The cleaner a shell is the more valuable it is.

Tip of the Week: Need a Reverse Split? Avoid a Merger Proxy

noreply@blogger.com (David N. Feldman) — Wed, 30 Apr 2008 16:54:00 +0000

When a public shell is in the process of completing a reverse merger it often finds itself with too many issued and outstanding shares or not enough authorized shares. One solution is a reverse stock split. A reverse stock split is a pro rata reduction in the number of shares of capital stock of a company that are outstanding. It is often used to increase per-share price, or to make more authorized shares available in order to complete a reverse merger. At the time of the split, each shareholder still owns the same overall percentage interest in the company. Most states’ laws require a reverse stock split to be approved by shareholders, and this requires a proxy or information statement under SEC rules, if the shell is subject to the SEC’s reporting requirements. If the reverse split is a condition of the reverse merger, the SEC requires a much more complex merger proxy.

There are three lawful ways to avoid an involved merger proxy:

If sufficient shares are available for issuance in order to consummate the transaction, the reverse merger is closed with the number of shares already existing. After the merger is completed, the combined company could then seek a reverse split that is not a condition to the merger and only a reverse split proxy is necessary.

Even if insufficient shares are available, the shell might be able to issue pre-authorized shares of preferred stock that converts into common stock when a reverse split or increase in authorized shares is approved after the reverse merger. Other strategies are possible even if the shell does not have so-called "blank check" preferred stock.

The SEC requires a full merger proxy when the reverse spilt is a condition to the merger. To address this provide in the merger agreement that the parties request a reverse split, contemplate it, but do not make it a condition to the transaction. Again, in this case only the much simpler reverse split proxy is necessary.

Quality Time

noreply@blogger.com (David N. Feldman) — Sun, 27 Apr 2008 15:23:00 +0000

Just got back from a fabulous cruise with my daughter, who's heading to Brandeis University next year. Just the father-daughter thing which was great. Really missed my son (he's 6 in a week), fabulous wife and wonder pup Toby, but had a really great time just relaxing, hitting the islands, nice dinners and yes a few trips to the blackjack table (daughter played too!) to help pay for it all...

In my office I've always had the rule that you lose your vacation if you don't use it. The reason is not to be a Scrooge, but rather the opposite - namely I want my staff to take all the vacation they are entitled to each year. If not, it is too easy to burn out. I've known people who left a job with 3 months of unused vacation, which to me is crazy.

Life is way too short not to make the most of every single stage. So if you are reading this as a young single, recently married, new children, teenagers, grown kids or even ready to retire, take that extra time with all the people who matter to you. No one on their death bed ever said, "I wish I spent more time at the office." Of course, in a perfect world you enjoy your work (as I do) and also make time for family and friends.

The people in our lives also keep us grounded. If anyone ever feeds my ego just a bit, I just have to go home and take out the garbage to put things in perspective. Lean on them as you deal with all that life throws at you. As for my daughter and me, well, that bittersweet moment where she begins life on her own is just a few months away, and I savored every second of our seven days alone together.

OK, back to the RM world this week!

Season of Renewal

noreply@blogger.com (David N. Feldman) — Thu, 17 Apr 2008 10:06:00 +0000

Ah Spring. The time for flowers, new relationships, new beginnings. When enjoying a warm, sunny day can elevate one's outlook and mood. For those of us who suffer cold and snowy winters (yes I know you folks in Canada have it rougher than us in New York), it is indeed a wonderful relief to hear the birds singing and my kids' cabin fever finally broken as T-ball, soccer and playgrounds all come back to life.

Not to stretch an analogy, but I feel the RM world has entered its Spring. Some have begun to call this the beginning of the "heyday" of alternative methods of taking companies public and providing financing. To me the door was slammed shut on RM's difficult past when Goldman Sachs recently announced that they are underwriting a SPAC. Citibank, Wachovia and others financing their operations with multi-billion dollar PIPEs. More and more calls to me from large firm lawyers taking venture and private-equity backed companies through reverse mergers with valuations well over $100 million. The IPO market completely shut down, leaving companies that could benefit from being publicly held with no other way to get there. Even the SEC getting into the game by easing the regulatory burden on smaller public companies to enhance the process of capital formation by reducing the Rule 144 holding period and other changes.

As many of us get ready to head to Los Angeles in June for the Reverse Merger Conference, the largest and most prestigious RM conference of the year (though there are a number of other excellent conferences as well), we can pause and possibly even allow ourselves a small victory lap around the Millennium Biltmore Hotel where it will be held.

Just a small one, though. Unlike some of my law clients and friends on Wall Street, while I am a supreme optimist, I worry when any trend heats up too much and too fast. How many of us said, "The Internet boom could last forever." "Real estate prices could continue to rise indefinitely." "Biotech stocks have no place to go but up." "We have defeated the business cycle." Those of us that have been around the block a few times (or the Millennium Biltmore) know that everything in business has cycles.

That said, I have enjoyed the fact that, for the most part, the RM and PIPE worlds are not market-sensitive or cyclical. Our business in both areas have steadily grown each year since the early 2000s. Indeed I was doing many reverse mergers during the Internet boom of the late 1990s, when companies could complete IPOs very easily. The problem then - some companies wanted to be public even faster than the six months or so it took to complete an IPO. So reverse mergers are an attractive alternative regardless of market conditions or the state of the IPO market.

As a entrepreneur, I am always shooting for the sky. Over time, however, watching myself and clients and friends, I have learned that the old adage "slow and steady wins the race" also can be a very successful, very lucrative way to approach one's business philosophy. I do believe that the RM world is not seeing a "bubble" which could burst disastrously as with the Internet boom, but much more of a slow and steady growth. Let's do our best to keep shooting for the sky while keeping our feet on the ground. But a nice little smile on a nice Spring day we have earned.

Private Placement Broker Registration - Finally?

noreply@blogger.com (David N. Feldman) — Mon, 14 Apr 2008 02:30:00 +0000

I spoke on a panel last Friday at the American Bar Association's Section of Business Law's Spring meeting in Dallas (don't ask about my awesome travel experience on American Airlines). My fellow speakers and I updated the attendees on the new rules for smaller companies, including Rule 144 and Form S-3 changes.

For me a very interesting part of the discussion, though brief, was welcome. Namely, it appears that the vexing "finder" problem in the private placement arena may be improved sooner rather than later. For a number of years an SEC task force has been working with several different SEC divisions to encourage registration with the SEC of folks who act to find privately placed money for both public and private companies. Many, many "investment bankers" help companies raise money but are not registered as broker-dealers with the SEC. Technically, probably most if not all of them should be.

However, the SEC does not have significant resources to go after these violators in the absence of a complaint, which frankly rarely comes. This further encourages these players not to register. It is a little tougher for the finders in dealing with public companies, but in raising money for private companies, there is currently very little incentive to go through the rigorous process of registering, then maintaining a registration, as a broker-dealer.

Prior to 2001, there was a stronger argument for finders to claim an exemption from registration. The SEC no-action letters until then suggested that if an intermediary simply made an introduction of a money source to a company and then stepped away, no registration was necessary even if the intermediary pocketed a fee representing a percentage of the money raised. So long as he did not provide financial advice or help structure or negotiate the transaction, he was OK.

Starting in 2001, however, a group of no-action letters started to suggest that virtually no situation was OK if the intermediary took a percentage of the proceeds. Even if they introduce and step away. This led to some legitimate advisors turning to consulting arrangements paying flat fees regardless of the amount raised, which may or may not have reduced their exposure.

In any event, one of the fairly important challenges for smaller public companies raised by the SEC's Advisory Committee on Smaller Companies, whose recommendations were issued in April 2006, was that many smaller companies are afraid to work with unregistered intermediaries and the regulatory environment was, at best, unclear. The Committee suggested a modified and simplified form of registration for such players.

It now appears, at long last, that the various necessary SEC divisions which must collectively get comfortable with this seem to be ready to do so in the near term. It is not yet clear, but a much simpler registration process appears to be in the works. It is hoped that these "registered private placement brokers" would not need to maintain net capital like other broker-dealers, might not even have to maintain monthly "focus reports," etc. It is not yet clear how the state regulators will react, but of course it is hoped that they cooperate and see the benefit of more information being available about these intermediaries, and more certainty for issuers about who they are dealing with and whether they are operating within the law.

If this goes through, the next step would be to do the same for merger & acquisition brokers. Many of the same issues apply.

Keep those fingers crossed!

The Wrinkle in New Rule 144(i) - A Former Shell Must Stay Current in SEC Filings Forever

noreply@blogger.com (David N. Feldman) — Tue, 08 Apr 2008 10:27:00 +0000

Almost everything in the new Rule 144 makes things better than they were before for shell operators and folks involved in reverse mergers generally. Even though the final release did pull things back from the original proposal, and even though shareholders of former shells must wait longer to have the exemption from registration available from Rule 144 than those that were not shells, the overall wait period and restrictions have improved over that which was the case prior to the rule change.

So when some complain that people involved in reverse mergers have to wait a year before Rule 144 is available, I remind them that before the rule change shell shareholders never had Rule 144 available (they do now), and that previously after one year those that did have it available had volume restrictions during the second year of hold (those volume restrictions are gone).

Almost going unnoticed, however, is a change imported from the requirements to avail oneself of "shelf" or short-form registration on Form S-3. That is, the requirement to have been current for the past year for S-3 to be available. In fact, to use S-3 each filing must have been made on a timely basis, not late. In new Rule 144(i), if a company ever was a shell company, the company must have done all its periodic SEC filings for the last 12 months or 144 is not available. The slightly good news is, unlike with Form S-3, the filings do not have to have been made on time. So a company could have missed a few filings but caught up prior to the attempt to utilize 144.

Why is this a pretty big deal? Well for one thing notice the italicized word above. Any company that ever was a shell is subject to this. I have learned the SEC views this requirement as retroactive. Thus the requirement to stay current applies to any company, even if it was a shell many years ago. So someone needs to tell Berkshire Hathaway, Occidental Petroleum, Texas Instruments, Blockbuster Entertainment and Jamba Juice (and every former SPAC) that this new rule applies to them.

The next problem comes in connection with fashioning registration rights. In the past in PIPEs, companies generally were required to complete a registration making shares tradable, and to keep that registration effective until the earlier of (i) the sale of all shares that were registered and (ii) such time as the holder can sell without any restrictions under Rule 144. Prior to the rule change, in most cases for non-affiliates the period in (ii) was two years. After the rule change, most agree that period (other than in shell situations) for non-affiliates is now one year (since even though one can sell starting in six months, the company must remain current for the next six months, thus creating a potential restriction). In a situation involving a company that was ever a shell, this period is now never.

Why is this? Because even five or ten years or more down the road, if a company was ever a shell, under the new rule you cannot use Rule 144 if the company is not current in its filings at the time of the exercise. Thus what to do now about registration? Require registration to be effective forever? Add additional penalties? We have developed solutions for a number of clients, and happy to share that upon request. Still, it's a real problem.

The third problem this creates is the removal of legends. PIPE investors, as well as any holder who acquires shares from a company that are unregistered or "restricted," contain a legend on the back of the certificate stating that the shares cannot be sold unless registered or an exemption from registration applies. Freely tradable shares have no such legend, and handing it to a brokerage firm generally provides free tradability without more questions.

It is most common to have a legend removed at the time of a sale where a holder seeks to sell utilizing the exemption under Rule 144. That is a somewhat cumbersome and sometimes time-consuming process involving the company, the transfer agent, company counsel giving an opinion, etc. In the past a Form 144 also had to be filed, though that has now thankfully been eliminated for non-affiliates under the new rule. Thankfully, for what it's worth, a legend will still be able to be removed at time of sale in this cumbsersome manner as a company can show it is current in its filings at that time.

The problem is that convention has developed allowing the legend to be removed not in connection with a sale, but when the holder has held the shares long enough so that they can be sold without any restrictions under Rule 144. Again, pre-rule change for non-affiliates that was generally two years, and post-rule change in non-shell situations for non-affiliates that is one year. Removing the legend in advance is very helpful as it saves time at the time of sale to avoid the difficult process described above. Plus occassionally a company refuses to remove a legend or counsel has some issue delivering an opinion, and so on. Removing the legend in advance takes away this worry.

Unfortunately, now a holder of shares in a company that ever was a shell can never have their legend removed in advance of a sale. Why? Because if a year has passed and no volume restrictions apply, there remains forever another restriction: that at the time of sale the company must have been current for the past year. Since you cannot know this in advance, it is not possible to remove the legend. If one did, and a holder sought to sell later, and the company was not current, they would be in violation of Rule 144.

One last problem. This additional restriction will further encourage those who create "bogus" shells pursuant to footnote 172 of the Rule 144 rulemaking, claiming as an apparently true startup that they are not a shell and therefore can have their stock trading, and now, be free of the requirement that applies to former shells to remain current for Rule 144 to be available. Luckily, a number of those lately trying to do this and avoid checking the "shell box" this way have been required by FINRA (formerly the NASD) to go back and amend their filings to check the box before allowing their stock to trade. Plus the SEC has made clear that there still need to be some actual operations in a business before it can avoid checking the box. This was not entirely clear when the rule was released.

In any event, I hope some enterprising reporter gets in touch with the shareholder relations people at some of the more famous reverse mergers to let them know this is now the case and note their reaction.

I respectfully find no logical basis that protects investors with this rule applying to shells forever. A company that completes an IPO or self-filing is not subject to this permanent restriction (by the way, this is now one additional advantage that self-filing brings). What makes reverse mergers so differerent? Apparently there are some within the SEC that believe the reverse merger technique is still abused by enough folks that complete a transaction, raise money, and then don't bother with silly things like keeping current in their filings so that investors are fully informed about the company at the time of sale.

As a concept I can see the benefit of this restriction for a short period of time. As mentioned above, in order to reduce the Rule 144 holding period in non-shell situations to six months, the staff required the company to remain current in its filings for the next six months. So even in non-shell situations, no legends can be removed until one year has passed from holding.

What makes absolutely no sense is a company completing a reverse merger being stuck with this three, five, ten, twenty years after the transaction. It paints the company with a "scarlet letter" suggesting it is somehow tainted for life. I implore the regulators to make a priority of taking another look at this restriction, possibly added in the haste of completing the drafting of a rule and not fully thinking out all the implications and unintended consequences. Does it really make sense that Warren Buffett's shareholders are subject to this? No, it does not.

Let me close as I opened. The new rulemaking (I am talking about this rule as a speaker on a panel at the American Bar Association Section of Business Law conference later this week in Dallas) was a major, positive step forward. The hard work of the SEC staff took many of the key recommendations of the blue-ribbon Advisory Committee on Smaller Public Companies and implemented them.

Our deal flow has never been better, and it shows that regulators can and do listen to what is happening in the marketplace and adjust to changes as they occur over time. It is a shame that with everything being better than it was before, this one change actually takes us backward to a restriction that did not exist in the past. That, unfortunately, makes the champagne we just popped a little flatter than we had hoped.

The WRASP: The Smartest Ideas are the Simplest

noreply@blogger.com (David N. Feldman) — Mon, 31 Mar 2008 13:27:00 +0000

Congratulations to my client Rick Rappaport and his team at WestPark Capital in LA. They have pioneered a new structure to take companies public without an IPO, without a trading shell, without a self-filing and moving from being private directly to trading on the American Stock Exchange.

Dubbed a "WRASP," the structure is very straightforward. First Rick sets up a Form 10 "virgin" shell. He then finds a private company that would qualify for listing on the AMEX but for not having a trading stock and at least 400 shareholders with at least 100 tradable shares each.

The next step is to complete a routine reverse merger with the virgin shell along with a contemporaneous PIPE financing, a traditional APO or alternative public offering. Then three things happen at once. First, a registration statement is filed with the SEC to register PIPE investors' shares for resale, again a typical step. Second, a registration is filed for the post-merger company to effect a secondary public offering, which is underwritten by WestPark. Third, the application to the AMEX is filed and begun to be processed while the two registrations are pending.

At the end of the process, the first trades for the post-merger company take place on the AMEX among the new purchasers of the secondary public offering and the PIPE investor whose shares are also registered. For those who would prefer to bypass trading on the OTC Bulletin Board, this is a major advantage indeed. All this starting with the humble virgin shell.

It took Rick and his team two years get the process cleared through the regulators and it took eight months to get the first one through the AMEX, and now they have done several. It works. But this is very much a "don't try this at home" thing. As with some complex reverse mergers, this is not for the uninitiated. There are a number of tricks and traps that Rick's team has learned along the way. Plus it is not clear that AMEX is ready to have other players simply come in and try to copy Rick.

Thus, what to do? Rick has made clear he welcomes new entrants to the WRASP world. Even his investment banking competitors. He will happily partner on deals with others the first time around, even though he knows that may lead them to pursue it on their own thereafter. Disclaimer: My firm set up Rick's shells for him that he is using for these transactions.

Some players complain that virgin shells do not have enough shareholders, and that only a trading shell with a history can be used when that is important. In most deals, however, the number of shareholders present at the time of the merger is not that important. As I discussed in my book, the shareholder base can be built over time with the help of capable investor relations and other advisers. Thus, many players have seen the benefits of virgins over trading shells in many situations.

The WRASP takes these benefits to the next level. Most agree that trading in a trading shell is not that important in the first few months after a merger. But many still feel that the shareholder base offered by a trading shell can be valuable, especially where a company has a near term plan to move to a higher exchange. In that situation, however, the WRASP provides a cleaner solution. The new shareholders in the secondary public offering are investing in the company in question, not left over shareholders from some other company. You start with a clean virgin shell instead of a shell with a history that needs to be scrubbed over weeks of due diligence. The cost of acquiring the shell is significantly less than the $600-800,000 charged for a controlling interest in a trading shell. The AMEX has made clear that a major attraction for them to accept the WRASP is by starting with a virgin shell.

The deals Rick has started with are Chinese, debunking another myth that Chinese companies strongly prefer a shell that is already trading. Just as in the mid-1990s SPACs started as a straightforward way to create a clean trading shell with cash, the WRASP may indeed provide another innovative, clean and legitimate alternative to a traditional IPO for a company ready to trade on a major exchange.

I hope Rick's next stop is the Nasdaq! Hey anything is possible since the New York Stock Exchange has announced that they are proposing to change their rules to permit SPACs to list there.