New Exchange Rules to Address Abuses in IPO Market Involving Reverse Mergers

On November 8, 2011, the SEC approved new rules that add requirements for initial listings that are accomplished through a reverse merger with a publicly traded shell company. Those that feel the new rules will have little impact base their view on the fact that American exchanges had already informally adopted to the new trading requirements. Others feel the new rules will hamper small businesses and their ability to legitimately raise capital.

Excerpt:

On November 8, 2011, the U.S. Securities and Exchange Commission ("SEC") approved new rules that had been proposed by the three major U.S. stock exchanges, NASDAQ, the New York Stock Exchange ("NYSE") and NYSE Amex, that add requirements for initial listings that are accomplished through a reverse merger or a similar transaction ("Reverse Merger Companies") with a publicly traded shell company. The new rules prohibit a Reverse Merger Company from listing its shares on all three major U.S. stock exchanges until three basic conditions are met. First the company must trade in the U.S. over-the-counter market or on another regulated U.S. or foreign exchange for at least one year following the reverse merger. Second, the reverse merger company must timely file all required reports with the SEC for at least one year. Third, the company must have maintained the requisite minimum share price in the over-the-counter market for a sustained period, and also for at least 30 of the 60 trading days immediately prior to submitting its listing application and the exchange's decision to approve the application for listing. Certain exceptions to these new stringent requirements apply, including for transactions over a certain dollar threshold. The new rules were adopted after U.S. exchanges suspended or halted trading in more than 35 companies based overseas, many of which were formed through reverser mergers with shell companies, due to a lack of current and accurate information about the firms and their finances.

Background to the New Rules.

In the last several years foreign companies (including many Chinese companies) have sought to access U.S. capital markets by merging with U.S. companies that are publicly traded on an American exchange. A typical scenario how this is accomplished is as follows: a business is acquired by a U.S. shell company that is worthless except that it is publicly traded. The American board then resigns; the foreign board takes over, changes the company's name, and issues new stock to hedge funds and other new investors, raising millions of dollars in fresh capital. Companies also may purchase a defunct American-listed company, merge with it and then adopt its ticker symbol. As reported by Bloomberg, many Chinese companies were attracted to reverse mergers because it is faster and less onerous than a traditional Initial Public Offering ("IPO"). Getting listed on an American exchange through a reverse merger can take as little as a few months.

The three major U.S. exchanges requested additional listing requirements because there were allegations that many of the Reverse Merger Companies were engaging in fraudulent actions and their financial statements were unreliable. Moreover, it was alleged that promoters intended to manipulate the prices of Reverse Merger Companies securities higher to help meet NASDAQ's initial listing bid price requirement and that these companies had gifted stock to artificially satisfy NASDAQ's public holder listing requirement." [footnotes omitted]

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