Humble Thoughts on Nasdaq Seasoning Proposal

 At thesaurus.com, words like "color" and "enliven" are synonyms to the word "seasoning." Unfortunately I don't believe Nasdaq's extreme overreaction to a real, but relatively controlled issue, does either to the world of reverse mergers or the markets in general. Please see prior posts for a description of their proposal to require post-reverse merged companies to trade over-the-counter for 6 months before applying to Nasdaq for uplisting, unless the uplist is through a firm commitment public underwriting. Here is my reaction to the idea.

First, some perspective. Dozens and dozens of firm commitment public underwritings in the late 1990s led to over $2 billion in fines and much more in class action settlements because of illegal activities in the initial public offering market during the frothy Internet days. And frankly, quite a number of Chinese companies facing issues today also went through full due diligence and underwritten public offerings just like an IPO.  I don't see Congress or regulators trying to eliminate or marginalize the IPO or secondary public offering market (although I think some commentators in the Wall Street Journal think so, read: Sarbanes). That said, there is indeed some fraud in all corners of Wall Street, including taking companies public, whether through IPO or other means. But respectfully I don't see 6 months of seasoning as the solution.

If a fraudster is doing his or her thing, trading over-the-counter for a few months has very little chance of "outing" the bad guy. In fact, so many complain about problems that arise in the over-the-counter markets that it is the very reason they seek uplisting, or avoiding the OTC completely. The platforms are not the issue - I have respect for Cromwell Coulson of OTC Markets who is working hard to up the transparency and reliability of companies trading there. So relegating post-RM companies to be forced to trade OTC just furthers the risk that some feel is there for problems that are much less likely to appear if the company moves directly to a higher exchange.

Nasdaq says they made the proposal in part because they believe that some promoters have bad regulatory histories or have done deals that are "disproportionately beneficial" to them. I don't understand this. Is Nasdaq suggesting they do not have the ability to background check the promoters of a deal unless it has "seasoned" on the OTC for 6 months? That respectfully just does not make sense. They also say they are "aware" of cases where promoters tried to manipulate stock prices to qualify for Nasdaq, that the SEC recently brought an (ie one) enforcement case based on an alleged bad audit and the PCAOB has identified issues with post-RM companies. So this major change should be implemented because of a few anecdotal cases, apparently not even successful, of potential price manipulation, one enforcement case and a concern raised by PCAOB? As to price manipulation, the same risk attaches if the companies are sent to the OTC.

Nasdaq also believes banishment to OTC will mean financial results will be more reliable by requiring two public filings prior to applying to Nasdaq. That auditors will review two quarterly financials.  Again, I really think this is, to say the least, strained logic. To come to Nasdaq anytime a company must have at least two years of audited financial statements. But two quarters reviewing public filings will change everything? I'm sorry but I am just not buying it.

So what is the solution to fraud in taking companies public? Ah this is the $4.00 per share question. I know that the answer is not hitting an annoying but relatively small flea with a Thor-sized hammer (current popular movie reference).  Nasdaq makes a circumstantial case at best with no studies or real evidence of more than anecdotal cases of abuse. In exchange, they will discourage many companies from considering entering the public markets to improve their chances for growth and capital formation if their opportunity to uplist is delayed. Is this worth it? In my opinion no. The SEC is conducting a wide-ranging investigation into Chinese companies that went public. How about we at least wait to see where that goes before the massive finger-pointing begins.

For additional insights on reverse mergers, SPACs, other alternatives to traditional initial public offerings, the small and microcap markets and the economy, visit the Reverse Merger and SPAC Blog  by David N. Feldman, Esq., Partner of Richardson & Patel LLP.

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