Soon it may just be a little harder to go public through a reverse merger transaction. The SEC published proposed rule changes from both the New York Stock Exchange (PDF) and NYSE Amex (PDF) on Aug. 4, 2011 that, if approved, may make you reconsider the reverse-merger route and probably makes the shell-company industry wince.
Both the NYSE and NYSE Amex in late July 2011 filings proposed additional listing requirements for companies completing a reverse merger with a shell company. As outlined in the NYSE rule change proposal (PDF), a reverse-merger company would not be eligible for listing unless it could meet the following requirements immediately before filing its initial listing application:
- the Company’s securities had “traded for at least one year in the U.S. over-the-counter market, on another national securities exchange or on a regulated foreign exchange following consummation of the reverse merger”;
- the Company filed specified information with the SEC on Form 8-K (for domestic issuers) or Form 20-F (for foreign private issuers), including all required audited financial statements;
- the Company maintained “on both an absolute and average basis for a sustained period a minimum closing stock price of at least $4” (per the NYSE’s initial listing standards and maintains that stock price through the listing process; and
- the Company timely filed with the SEC all required reports since the reverse merger, including at least one annual report that included audited financial statements for a full fiscal-year period beginning on the date the company filed the required Form 8-K or Form 20-F.
The proposed additional listing requirements on NYSE Amex (PDF) mirror the NYSE’s proposal. Both exchanges propose having discretion to “impose more stringent requirements.” Examples for exercising this discretion included an inactive trading market or material weaknesses in internal controls that have not been corrected. There are also some limited exceptions to the additional requirements.
The NASDAQ Stock Market proposed similar rule changes in an April 2011 filing, which was subsequently withdrawn and replaced by a May 2011 filing (PDF). The SEC published the proposed NASDAQ rule change in June 2011 (PDF), but has not yet acted on it. NASDAQ’s proposed additional listing requirements do not appear to be as strenuous as those proposed by NYSE and NYSE Amex. For example, the trading requirement would be for six months rather than a full year.
For each of the exchanges, the concern is the absence of registration requirements under the Securities Act of 1933 and the related lack of detailed operational and financial disclosure and the scrutiny of the SEC review process. The Wall Street Journal also linked the concern to questionable accounting practices of Chinese companies, many of which have used reverse-merger transactions to go public in the United States, as an example of the perceived problem. (We have previously discussed these accounting concerns and efforts to address them in posts in February, June and July 2011.)
The SEC has previously shown its own concern about reverse mergers by imposing additional regulatory burdens on shell companies, including limitations in Rule 144 and special disclosure obligations in Form 8-K (PDF). More recently, the SEC published an Investor Bulletin on Reverse Mergers (PDF) in June 2011 as a public warning about the risks.
OUR TAKE: This is not the first time that risks associated with reverse mergers have been highlighted. The exchanges believe that the additional listing requirements will provide more transparency and reduce the level of risk to investors. There will still be companies considering reverse mergers as a speedy way to become public, and still more firms and individuals trying to sell that idea. The additional listing requirements, if approved, should serve a roadblock to these transactions and deter those that are not sound—or realize that a quick exchange listing is no longer a possibility.