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Public Shell Companies

 

• Shell Company
• Blank Check Company

• no or nominal operations and
• either
  • no or nominal assets or
  • assets consisting solely of any amount of cash and cash equivalents and nominal other assets.

• has no specific business plan or purpose or
• has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies, other entity, or person.

• OTCBB Reporting/Trading Shell

• This Shell files reports with the SEC under the 1934 “Filing Reports” Act.
• This Shell trades on the Over-the-Counter Bulletin Board.

• Pink Sheet Non-Reporting/Trading Shell

• This Shell does not file reports with the SEC under the 1934 “Filing Reports” Act, although some Pink Sheet Shells at one time were OTCBB Shells that ceased filing reports with the SEC.

• This Shell trades on the Pink Sheets.
  
  

  • Make sure you read the true story at the end of this section.

• Form 10 Virgin Non-Reporting/Non-Trading Shell

• This Shell does file reports with the SEC under the 1934 “Filing Reports” Act.

• This Shell does not trade either on the OTCBB or the Pink Sheets.

• Special Purpose Acquisition Companies [SPAC’s]

• Generally the SEC does not allow manufactured Public Shells to trade under Rule 419. However, if the Public Shell has over $5,000,000 in net assets and a stock price in excess of the $5.00 limit under Penny Stock Rules, this type of Public Shell can trade.

• Legally

• A Form 10, SEC reporting/non-trading virgin shell is specifically created to be a shell company. These shells cannot trade. The benefits of these shells are sometimes misrepresented, although they can be used for valid purposed.

• A SPAC is a legitimately created, trading Public Shell.

• Illegally

• Because Form 10 shells cannot legally trade, and because SPAC’s must have a high trading price and significant assets, some shells are manufactured by forming a company that allegedly has a valid business plan, but really doesn’t. The goes public and attempts to implement that plan but not surprisingly, as that was the intent. the business fails, the company becomes a public shell, i.e. the shell of its former business. But this shell is trading. The SEC calls these “Footnote 32 Shells.”

• The SEC doesn’t allow you to register stock in a shell company under the 1933 “Selling Stock” Act. Thus, you cannot obtain free trading stock by filing with the SEC.

• The SEC, under Rule 144, does not allow stock in a shell company sold in a private offering without registration to be free trading.

• You probably can’t raise $5,000,000 and have a stock price above $5.00 per share.  If you could, you would be creating what is called a SPAC or Special Purpose Acquisition Company, which is the sole exception to bullet point 1 above in which the SEC will actually let you file a 1933 Act Registration Statement and get free trading stock.

REVERSE MERGER DUE DILIGENCE

Due diligence is a key element in any reverse merger transaction. If there are problems with the shell in the reverse merger, you shouldn’t do the deal. However, the basic difficulty in reverse mergers is that you can never really know what happened in the shell’s past. There may be skeletons hidden so deep in the closet and so far off the record that you can never find them—no matter how long and hard you look.

To get the most complete story of a shell company in a reverse merger, you often have to use unorthodox methods before beginning traditional corporation finance due diligence.

In the first phase of due diligence for a reverse merger, I focus primarily on intangible factors unrelated to the shell itself. I’m examining the players involved on the shell side of transaction and their past reverse merger track record. My theory is that if I am satisfied with the background of the people involved with the reverse merger, it is much less likely that there will be any unpleasant surprises further down the road. I only move forward with my due diligence of the shell company itself, if I am satisfied with the players.

Step 1. Know who you’re dealing with

If you have been in the reverse merger business for some time, you will know or have heard of most of the reputable attorneys and accountants in the business. It’s generally a positive sign if professionals I know and trust from past experience are on the other side of the shell transaction. I’ll call them and get the real scoop on this particular shell and the promoters and principals involved.

Of course, there are transactions where I don’t know the shell’s professionals. In this case, I call attorneys and accountants that I do know to get a lead. If no one knows anyone on the other side of the transaction, that’s not a positive sign, but I continue on by running their names through Google and EDGAR to see if anything shows up one way or another.

Step 2. Hire an investigator

If I am still concerned, or my client requests, I spend the money and have an independent search firm do a background, litigation and liability check on the shell promoters and principals and their reverse merger history. I also have the search firm simultaneously run a litigation and liability check on the shell itself.

When you are paying hundreds of thousands of dollars for a shell, the cost of a formal search firm investigation is minor compared to the potential benefit of information that might be discovered.

Step 3. Muckrake a shell promoter’s past reverse merger deals

In this step, I put together a list of deals that a shell’s promoters and principals have been involved in over the past several years to look for any questionable signs. The first thing I review is trading history surrounding the reverse mergers. A spike in trading activity just before a merger announcement is a negative sign, as is lots of trading activity and downward pressure after a deal is closed.

I also pay attention to any press releases distributed near to the time of a reverse merger—who distributed them and how accurate were they? I also identify the principals of the private companies that merged with these prior shells. I’ll call and ask them what they thought of the transactions and the shell promoters and principals after the reverse mergers had closed and all the dust had settled.

Step 4. Follow the money

I always want to know how the person that brought me the deal found this shell. Are there any intermediaries or finders involved in any way? If so, are they getting any form of compensation if we acquire or do a reverse merger with the shell? The Securities and Exchange Commission’s position on this issue is quite clear. Any intermediaries or finders who are getting any form of compensation in a shell reverse merger transaction are violating federal securities laws if they are not registered broker/dealers. (See SEC Releases 34-43708 43713, Dec. 12, 2000.)

Step 5.  Examine the financials

Financial statements are an important source of information on a reporting shell company. The lack of audited financial statements can kill a deal, and not just because they’re not worth the paper they’re printed on. If the shell is non-reporting or trading only on the Pink Sheets, the inability to secure an audit will doom any attempt to move the post-merger company up to the OTC Bulletin Board and beyond. If I want to move forward with this type of shell and eventually trade on the OTC Bulletin Board, I consult with a Public Company Accounting Oversight Board (PCAOB) member accounting firm and confirm that they can deliver the required audits to get the company reporting after the deal closes.

Then, after all these steps, you can go on to typical due diligence which you do in a non-reverse merger transaction as well.

• Review SEC filings.
• Ask about the applicability of Rule 144 to your shares and those of your shareholders after the reverse merger.
• Review all issuances and transfers of unregistered securities.
• Focus on and review corporate organization, corporate contracts, commitments and obligations, and tax issues.
• Determine what SEC filings are required for a reverse merger.

And for all those people who may be considering a reverse merger without simultaneous funding and the involvement of a FINRA broker/dealer, here’s a little story for you:

The SEC has filed a lawsuit alleging securities fraud by Prime Time Group (now known as Hunt Gold Corp.) and three former officers, for allegedly sending out false press releases about company acquisitions. One of the former executives named in the suit is identified as a South Florida resident – Johnny Ray Arnold of Fort Lauderdale.

In a press release, the SEC said it temporarily suspended trading in the securities of Hunt Gold Corp. on June 15, because of questions raised about the accuracy and adequacy of publicly disseminated information concerning, among other things, Hunt Gold’s gold mining exploration business. Hunt Gold President Michael Saner of Johannesburg, South Africa, said in a phone interview that his company had acquired Prime Time around 18 months ago through a reverse merger. Hunt Gold has announced several acquisitions of gold mines in recent months, but Saner said those were legitimate.

“These allegations have nothing to do with the incumbent board whatsoever. But the allegations have basically destroyed the company now,” Saner said.

The complaint, filed in Miami federal court, alleges that between February 2006 and November 2007, Prime Time, Arnold and two other officers – Dallas L. Robinson and Troy K. Metz, both Canadians – distributed false and misleading press releases concerning, among other things, Prime Time’s acquisition and ownership interest in a Puerto Rico convenience store franchise, agreements the company claimed to have with other wireless businesses, and its purported acquisitions of other companies.

The complaint also alleges that Prime Time, Arnold, and Mattera made false statements to the company’s transfer agent in connection with a fraudulent scheme involving the issuance of bogus promissory notes. The scheme allegedly allowed Mattera to obtain millions of unlegended shares of Prime Time stock, most of which he later sold in the open market in November 2007. (Legends are information, such as restrictions, often found on the back of share documents.) The complaint further alleges that Prime Time, Arnold, and Mattera violated the securities registration provisions by engaging in unregistered distributions of Prime Time stock. For instance, the suit alleges that Prime Time, Arnold, and Mattera engaged in an improper “gypsy swap” transaction in which Mattera agreed to transfer his unlegended shares to various stock promoters on behalf of Prime Time. In return, Mattera received restricted stock from the company. The SEC said the scheme was designed to circumvent the securities registration requirements because Prime Time could not legally issue unrestricted shares to the stock promoters without filing a registration statement.

The suit seeks permanent injunctions and civil penalties against all the defendants, disgorgement plus prejudgment interest against Mattera, and penny stock bars against Arnold, Robinson, Metz, and Mattera.

Caveat Emptor!  

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