Reverse Mergers & Form 10 Shells

Form 10 Shells are often sold for reverse merger transactions.  A Form 10 shell is a company with no or nominal operational activity that are “Public Companies” meaning they are obligated to file reports with the Securities and Exchange Commission as a result of filing a Form 10 registration statement. Form 10 shells are rarely a good solution or cost effective method for a private company to obtain public company status. Form 10 Shells do not have a ticker symbol despite having costly SEC reporting obligations. Unlike Form S-1 registration statements, a Form 10 registration does not create “free trading” shares. 

A private company using a Form 10 Shell to go public will have to commit time and money to: (i) due diligence and completion of a reverse merger into the Form 10 Shell; (ii) notification to and approval of the reverse merger by FINRA pursuant to Rule 6490; (iii) additional disclosures, including the filing of Form 10 information in a “Super 8-K,” the need for which is triggered by the reverse merger; (iv) locating a sponsoring market maker to file a Form 211 and respond to FINRA’s comments; and (v) apply for electronic trading eligibility from Depository Trust Company (“DTC”).

Types of SEC Registration Statements

All issuers qualify to file a Form S-1 registration statement  under the Securities Act and Form S-1 is the most commonly used registration statement form.  All companies qualify to register securities on Form S-1. Once a S-1 is deemed effective, a sponsoring market maker must file a Form 211 on the issuer’s behalf with the Financial Industry Regulatory Authority (“FINRA”) in order for it to obtain a ticker symbol.

The SEC provides various forms of registration statements for registering securities offerings which vary based upon the characteristics of the issuer and of the particular type of offering.  Unlkike a Securities Act registration statement, a Form 10 registration statement registers an entire class of securities under the Securities Exchange Act of 1934 (the “1934 Act”). A Securities Act registration registers only a certain number of a particular class of securities.

Unlike a registration statement on Form S-1, a Form 10 also does not affect the tradability of securities. After a Form 10 registration statement becomes effective, restricted securities remain restricted and unrestricted securities remain unrestricted.

The Problem with Form 10 Shells

Purchasing a Form 10 Shell does not help a private company go public; it makes the going public process more costly, time consuming and difficult. Form 10 Shells are often touted as an alternative to a going public transaction involving Form S-1.  Often a Form 10 Shell is subject to the SEC’s reporting requirements but its securities are not publicly traded.  As such, the purchaser of the shell may incur the expenses of SEC reporting yet derive no benefit in connection with a going public transaction until steps have been taken to qualify it for trading including the filing of a registration statement under the Securities Act. As a result, the costs of reverse mergers into Form 10 Shells almost always exceed the time and expenses of filing a registration statement under the Securities Act.

When is Form 10 Registration Required?

The 1934 Act’s Section 12(g)(1) requires any company with total assets exceeding $10,000,000 and a class of equity security held of record by five hundred or more persons to register under the Exchange Act. The measurement date for these thresholds is the last day of a company’s fiscal year. It then has 120 days from that date to register.

Any issuer may voluntarily file a Form 10 registration statement under Exchange Act Section 12(g) regardless of its assets, number of shareholders or revenues.

A Form 10 requires that the issuer disclose much of the same information required by Form S-1. This information includes, among other things, a detailed description of its business, properties, risk factors, transactions with management, legal proceedings, and executive compensation, as well as audited financial statements.

Upon filing a Form 10, the SEC may render comments to the disclosures. Regardless of whether such comments have been answered satisfactorily, a Form 10 registration statement automatically becomes effective sixty (60) days after its initial filing. Effectiveness causes the issuer to become subject to the SEC’s periodic reporting requirements.

Periodic Reporting After A Form 10 Registration Statement

Once a company has a security registered under the 1934 Act or the 1933 Act, it is required to file annual, quarterly, and current reports with the SEC. An issuer with securities registered under the 1934 Act must additionally comply with SEC proxy rules; and its directors, officers, and holders of ten percent or more of its outstanding securities must also make insider filings related to their benefitical ownership. The issuer’s securities become subject to the short-swing profit rules under Section 16 of the 1934 Act.

Getting a Ticker and Trading After A Form 10

Even though an issuer that files a Form 10 registration statement becomes subject to the reporting requirements of the 1934 Act, that does not make the company public or qualify the company for a ticker assignment from FINRA. An issuer must still satisfy other regulatory requirements and criteria to obtain a ticker and be quoted on OTCMarkets’ Pink Sheets, OTCQB, OTCQX tiers, or list on a securities exchange such as NASDAQ, the AMEX or the NYSE.

Generally, FINRA requires that the issuer have at least 35 shareholders who hold either registered shares or, with respect to Pink Sheet listed issuers, shares that have been held by non-affiliate investors for twelve months. The majority of the 35 holders must have paid cash consideration for their shares. Additionally, these shares in the aggregate should represent at least 10% of the issuer’s outstanding securities and are often referred to as the “float.” The float must also be somewhat evenly distributed without significant concentration in one or a few shareholders.  Under FINRA rules, only a sponsoring market maker can file a Form 211 (“211”).

The Solution

By undertaking a Direct Public Offering, the issuer avoids many of the expenses and risks associated with reverse merger transactions, including incomplete and sloppy records, pending lawsuits and other possible liabilities including securities violations. After a reverse merger with a Form 10 Shell, the private company is forever labeled as a shell or reverse merger issuer, which makes it much more difficult to raise capital because Rule 144 is unavailable for its investor’s resales. Issuers who go public through direct public offerings avoid the shell company and reverse merger stigma. Another advantage is that issuers who go public directly have lower costs and the added credibility associated with providing transparency by filing an S-1 registration statement with the SEC.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers Brenda Hamilton, Securities Attorney 101 Plaza Real South, Suite 202 North Boca Raton, Florida 33432 Telephone: (561) 416-8956 Facsimile: (561) 416-2855 www.SecuritiesLawyer101.com