The SEC Reverse Merger Investor Bulletin: Balanced?

The SEC Reverse Merger Investor Bulletin: Balanced?


I have finally had the chance to actually sit and read the SEC's vaunted "Investor Bulletin" on reverse mergers that came out last month. In recent years these bulletins have been seen more often. One warning folks about the retail foreign exchange market. Another on life settlements. A third explaining how say-on-pay works. Yet another on target date funds, and one on after hours trading. The headlines blared that the SEC was warning investors that reverse mergers are risky. One of my lawyer competitors says on his website that it confirms his long standing advice on reverse mergers.

Well, when you actually read the thing, it's a more balanced look at our little RM world than I expected, and points out some things that one would think should have been obvious to most investors. First they explain reverse mergers and why people do it, pointing out the advantages of cost and time saving, access to capital, liquidity and greater value as an acquisition target. They make clear that while an 8-K is filed, there is no registration as with an IPO. They explain trading on the OTCBB and OTC Markets. The bulletin then describes some risks. Many of these companies fail. There has been fraud in some of these companies. Perform thorough research, they say, before you invest. They also point out that there can be enhanced risk when a foreign company goes public here and uses a small US auditing firm that may not have the resources to do everything necessary to protect investors. They then list some scary risk factors that we sometimes put in SEC filings for these companies, and list six recent enforcement actions concerning reverse merged companies.

In the end, the big advice: do your research before buying a stock, be wary of companies that are not reporting with the SEC, and don't rely on blogs and social networking sites to get your information. All good advice that is hard to disagree with.

What do they not point out?

  • That about 200 companies go public this way each year, and you are seeing a small handful of problems relatively speaking.
  • That there are historical illegalities associated with the traditional IPO market, so that is not a panacea and it is fraught with cost, delay, and tremendous risk of success.
  • That these tend to be smaller companies that are at an earlier stage and therefore automatically more likely to fail. That doesn't mean they can't benefit from a public trading stock and shouldn't be allowed to do so. The investor's risk is balanced with a much greater potential upside. It's the basics of investing in any small cap company, not just those that did reverse mergers.
  • That many of these companies do not see a single share of stock trade after the reverse merger until there is a fully underwritten, due diligenced and SEC-approved registration process, providing the same level of protection to public investors as an IPO.

So I would have preferred if some of these points were made, but overall it is hard to argue with the SEC's advice that probably could be given in any small and microcap situation regardless of how the company went public. For some reason this "niche hunt" (ooo good new catch phrase, feel free to use it) has focused on the humble RM. I remain as always hopeful that whatever actions the SEC may take in this area remain focused on both investor protection and minimizing impediments to capital formation for companies any one of which could be the next Microsoft or cancer cure.

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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