Persons seriously considering, on an informed basis, going public through a reverse merger with a public shell company likely understand that the transaction will not create liquidity for shareholders of the public company within at least a year after the merger. What those persons may not appreciate, however, is the restriction on shareholder liquidity that will continue for years after the merger.
Frequently, the public company in a reverse merger is or was a “shell company,” as defined in Rule 144(i)(1) and Rule 405 under the Securities Act of 1933, as amended . The shares held by the public company’s shareholders after the merger may be publicly resold only in accordance with a resale registration statement filed with the Securities and Exchange Commission – which is unusual – or under Rule 144, the principal exemption from registration for resales of securities under the Securities Act. Rule 144 is first available to permit public resales of the public company’s shares only one year after the public company has filed Form 10 information with the SEC, if the public company has ceased to be a shell company and has filed all required periodic SEC reports during the year. (“Form 10 information” is the information required of a company filing a registration of securities on Form 10 under the Securities Exchange Act of 1934, as amended, which is typically included in a Form 8-K, often referred to as a “Super 8-K,” filed by the public company promptly after the merger.)
Unfortunately for the public company’s shareholders, however, the availability of Rule 144 for resales of shares issued while the company is a shell company or thereafter may be restricted even after the expiration of that one-year period. Rule 144(i)(2) provides that the Rule 144 exemption is available to a shareholder of any public company that was a shell company only if the company is current on all of its periodic reports required to be filed with the SEC during the 12 months before the date of the shareholder’s resale. This condition to the availability of Rule 144 must be satisfied regardless of the time that has elapsed since the public company ceased to be a shell company and regardless of when the shares were issued. In its Securities Act Rules Compliance and Disclosure Interpretations, Question 137.01, the SEC has made it clear that this condition must be satisfied even regarding shares issued by the public company long after it ceases to be a shell company. If this condition is not satisfied at the time a shareholder wishes to sell (because, for example, the company did not timely file a Form 10-Q), Rule 144 will not be available; and in the absence of a resale registration covering the sale, the shareholder would be able only to privately resell his shares – with the likely decreased value and the procedural limitations that such a resale would involve.
As a few practitioners and commentators have pointed out since the amendments to Rule 144 became effective in 2008, the limited availability of Rule 144 for shareholders of a former shell company may be unfair under certain circumstances. Also, the condition to the availability of Rule 144 provided in Rule 144(i)(2) does not apply to shares of a public companies that was not a shell company. The SEC is apparently so focused on making a reverse merger into a public shell company unattractive, however, that it has not yet proposed any amendment to Rule 144 to address that unfairness or discrepancy.
OUR TAKE: Even if a reverse merger into a public shell company is otherwise attractive, persons considering such a transaction should be informed of the risk of restricted liquidity for shareholders that will continue long after the transaction.