What do I think about this? I have mixed feelings. The bad part? Whenever the SEC takes action with a message that reverse mergers and shells are dangerous, risky and rife with fraud, it hurts all the legitimate players trying to use this technique properly and for good. The same thing happened when the seasoning requirements were imposed in November. In most cases I consider these actions to be overreactions, as I did with seasoning.

However, in this case, I understand more why the SEC acted. Where fraud does exist in the reverse merger world, much of it seems to be tied to the non-reporting shells that provide no information to investors. Pretty much every bad story I hear about a reverse merger gone bad starts (other than the Chinese deals, which are their own category) with promises made by a sponsor of a shell with no public information. And from their report it seems that in these cases the SEC did try to get information from the companies and gave them a chance.

So do I mourn the reduction in shell supply by probably 379 when the loss is in shells that are the least transparent and most likely to be involved in fraud? Not really. Do I wish there could be more support from the regulators for legitimate players trying to help small companies grow, go public and access capital? Yes I do.

“On April 5, 2012, the Jumpstart Our Business Startups (JOBS) Act was signed into law. The Act requires the Commission to adopt rules to implement a new exemption that will allow crowdfunding. Until then, we are reminding issuers that any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws.”

Got the message gang?

If you have any interest in IPO alternatives and getting companies public, this is a must-attend event as there really is no other gathering like it around. I will be on a panel talking about reverse merger seasoning, but there will be a detailed discussion of the JOBS Act and other great panels.

Hope to see you there!!!!

• The SEC dubbed the plan “Operation Shell-Expel.”
• The head of SEC Enforcement said shells are like guns are to bank robbers, a tool for bad guys.
• They say shell operators pay as much as $750,000 for control of a shell but we haven’t seen one go for that much since 2008. Best prices now are around $350,000, and not for the non-reporting shells they suspended, which go for more like $100,000 to $150,000 currently.
• In order to trade again each shell will have to apparently have its market maker file a new Form 211 which needs to be approved by FINRA and contain information including the company’s most recent balance sheet, profit and loss statement and retained earnings statement.
• Some “unsolicited” trading may be permitted while waiting for the new Form 211 after the 10-day suspension.

None of the trading suspensions affect Form 10 shells or shells which are current in their SEC reporting. Commentary coming.

The SEC says it took the action regarding these shells “before they could be hijacked by fraudsters and used to harm investors through reverse mergers or pump-and-dump schemes,” according to the release.

I will be analyzing the release, and the 73-page suspension order and will give you more information thereafter. At least on first blush there is no suspension of shell companies that are SEC reporting and current in their filings. But here is the first major shot across the bow by Chris Ehrman’s Microcap Fraud Working Group in the SEC’s Division of Enforcement. More to come.

Our law says the PCAOB has to be able to inspect firms that audit US public companies. They’ve had trouble being able to do so in a number of countries, including most notably the PRC. The Chinese government contends its privacy laws prohibit such inspections by foreigners. So while it wasn’t clear in the article, it appears the PRC government does not believe it a violation to permit the PCAOB to watch the inspection but not to conduct its own.

Doty also said he hopes this will lead to joint inspections which US law requires. A positive step though. There was a real risk this could have led to a standoff and the PCAOB cutting off the right for Chinese auditing firms to audit US public companies. It looks like that’s been put off now.

But others do a share exchange, which on its face seems ultimately simpler. All the shareholders of the private company agree to exchange their shares for shares of the public shell. The same result occurs: private company becomes wholly owned sub of the shell and shareholders of the private company control the stock of the former shell. No need for a merger, Delaware filings and costs and delays, etc. So why not do this every time?

There are a number of reasons. First, sometimes there are many shareholders in a private company, I’ve handled deals with 80 or even hundreds of shareholders. In a share exchange every single shareholder has to agree to exchange their shares. If you are worried about getting signatures back from many people, the merger is simpler. Why? Because the merger requires only a majority vote of the shareholders, not an agreement from every shareholder. And any shareholder voting against the merger has so-called “dissenters rights” to go to Delaware and try to claim the value of their shares is greater than the value of the deal. In my decades of practice I have never seen these rights be exercised in the small and mid-market deals I have been involved with.

Another reason companies choose merger over share exchange is, even if the number of holders is small, there is a concern that a small shareholder can try to exploit their power to demand something in return for their signature. Or there may be a worry that a shareholder might be somewhat dissident and simply refuse to exchange. They may not be angry enough to sue or claim dissenters’ rights, but they might be angry enough to try to sabotage the company’s efforts to go public. The merger approach solves this.

Last, deals involving foreign private companies are generally easier to do as a share exchange. Statutory mergers between Delaware companies and offshore companies are technically possible but can get complicated in the offshore venue. Share exchanges generally are much simpler in foreign countries.

To me the default setting should be share exchange unless there is a reason not to.

Don’t have much more info than that, hope we’ll hear more soon. But good news for them!

First, there is no time deadline for the SEC to write regulations to implement the Regulation A changes, so I strongly urge the SEC to expedite these changes for the benefit of the marketplace. I know both Dodd-Frank and the JOBS Act will keep them very busy, but this is a major change that can have a big impact.

The big decision in Reg A rulemaking will be the definition of “qualified purchaser.” The key to the changes to Reg A being successful will be its proposed exemption from state securities review so long as the offering is limited to qualified purchasers, a term to be defined by the SEC. Back in 2001 the SEC proposed to define the term to be the same as accredited investor under Regulation D. That rule was never adopted. Personally I think we can go farther for this purpose. Remember that every investor in a Reg A offering will receive an offering circular carefully reviewed and approved by the SEC. It will now be required to include audited financial statements. People are pretty darn protected when investing in a post-JOBS Act Reg A offering.

So what should it take in this context to relieve the states of any right to review the offering? I would argue nothing different than what relieves them in a public offering of stock on the Nasdaq, which is a fully reviewed SEC disclosure document. But clearly the bill is suggesting that not just anyone should be “qualified.” I would suggest you define it as anyone accredited, but for this purpose you change the $200,000 minimum income requirement to $100,000 and the minimum net worth test from $1 million to $500,000. I think an experienced teacher making $125,000 is capable of reviewing a full disclosure document and making an informed investment decision. But that’s just me.

OK more later.

The law directs the SEC to end the ban on general solicitation in Regulation D 506 offerings so long as all investors are accredited. Two issues there. First, how do we confirm the accredited status of investors? Second, what about a combination Regulation D/Regulation S offering where Reg S prohibits “directed selling efforts” which might be deemed the same as general solicitation?

As to accredited status, I believe current practice should be sufficient. That is, each investor completes a separate questionnaire which confirms with a “check the box” approach how the investor is accredited and is individually signed by that person. If the SEC is concerned about fraud, one could add a provision right above the signature line asking the investor to acknowledge that they confirm, under penalty of perjury, that all information contained in the questionnaire is true.

The Reg S problem, in my opinion, should be solved with a change to Reg S to confirm that anything that would have been deemed general solicitation or advertising in a Reg D offering does not constitute directed selling efforts in a combination Reg D/Reg S offering so long as all ultimate investors are accredited.

OK more to come.