The attorneys of the Burningham Law Group have a collective 90 years of experience in mergers and acquisitions, specializing in “reverse mergers.” We have been instrumental in the completion of well over 200 mergers or acquisitions involving publicly-held companies and have served as consulting attorneys to lawyers across the United States that have been involved in similar securities transactions. In addition, we have prepared and/or reviewed thousands of legal opinion letters relating to the resale of “restricted securities” under Securities and Exchange Commission (the “SEC”) Rule 144 and Section 4(a)(1) of the Securities Act of 1933, as amended (the “Securities Act”), among other available registration exemptions under the Securities Act, on behalf of clients, transfer agents and broker-dealers. Our participation in completing over 200 reverse mergers and our due diligence in preparing and reviewing these opinion letters has provided us with substantial insight and expertise in identifying issues that are paramount to successfully completing a reverse merger.
Reverse merger transactions are a fast and efficient method of “going public” that avoids the high cost and the time consuming process of registration. However, when used by unscrupulous promoters, they can be a method of avoiding the registration process as part of a scheme to unlawfully distribute unregistered securities for the benefit of promoters, founders and controlling persons. Therefore, a clear understanding of the Securities Act and the general rules and regulations promulgated thereunder by the SEC are the first and most important steps in engaging in a reverse merger.
A reverse merger is like any other merger or reorganization, with one very distinct characteristic – the transfer or sale of “free trading” shares is often involved. These shares may be already outstanding; or are to be issued, bought or sold as part of the transaction; or are shares currently held by the stockholders of the publicly-held company whose “successor” existence continues following the closing of the transaction. Each transaction is unique and the correct legal advice depends upon the facts and circumstances of each. Although there is no one way to complete a reverse merger, it is very important to keep in mind that the Securities Act was enacted “to provide full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails, and to prevent frauds in the sales thereof, and for other purposes.” These purposes must be weighed in each and every transaction, and the following observations should be helpful.
Norman S. Johnson, Esq., who served as an SEC Commissioner from 1996 to 2000 and who had a long and distinguished legal career as a securities lawyer prior to his death in 2002, always advised that when representing someone in connection with a merger, it boils down to “What’s the deal and who are the players?” That advice is even more important in a reverse merger.
What Is the Deal?
It is important for you and your attorneys to know every facet of the proposed reverse merger transaction, especially any plans that may involve the issuance, sale or transfer of “free trading” securities. Your attorneys can provide guidance only if they are well informed. During the course of our due diligence process, we often discover matters that we were not advised of and are able to timely resolve these issues for the benefit of the issuer of these securities and the parties involved.
Who Are the Players?
It is also important to take the name and address of every person involved in the reverse merger transaction. This includes the principals and principal stockholders of any party, as well as principals, promoters, founders, advisors and lawyers. We customarily run the names of these persons through the SEC website and Pacer U.S. Case Index (or another similar website) to search for adverse legal proceedings or conduct background checks on them through a reputable firm. If we have further questions, we have requested written representations from the parties’ lawyers, accountants or business associates about any “bad boy” proceedings. We also have each such person fill out a questionnaire that sets forth at a minimum his or her principal occupation and whether he or she has been subject to any “bad boy” actions. If anything adverse comes up in our due diligence review the scope of our inquiry broadens and is more detailed.
Know the Law
You will need a working knowledge of applicable securities and corporate law and the specific legal issues attendant to reverse merger transactions. Keeping abreast of current legal and administrative actions is also very important. These types of proceedings clearly describe the unlawful activities of some practitioners and stock promoters and will help you to better understand the applicable law. Our lawyers stay well-informed of recent developments in this area of law and can help avoid potential issues before they become problems.
Every resale of securities needs to be registered or exempt from registration under the Securities Act and applicable state laws. Technical compliance with the letter of the law means little when the parties’ actions work as a “public distribution” of unregistered securities. Our lawyers have a thorough understanding of statutory and rule-based resale exemptions, including Section 4(a)(1) of the Securities Act and Rule 144 promulgated thereunder. We have prepared (and have reviewed for clients, broker-dealers and transfer agents) thousands of opinion letters expressing reliance on these exemptions. In addition, we routinely draft agreements that are designed to ensure that stockholders conduct resales of securities in accordance with these securities laws and regulations. Allowing someone to purchase shares in the publicly-held merger candidate without imposing resale restrictions risks violation of the securities laws and can put your own reputation at risk. Our extensive knowledge of the issues and our custom-drafted resale agreements substantially limit this type of exposure.
Every Reverse Merger Transaction is Different
What will work in one situation may not work in another. Our best advice is to keep in mind the questions outlined by the SEC in its Preliminary Note to Rule 144: (i) ensure there is adequate current information about the issuer; (ii) ensure that resales by persons involved do not result in an unlawful distribution of securities; (iii) ensure that all resales are effected in “routine trading transactions” and are covered by clear and concise written terms and conditions; (iv) require additional holding periods and resale conditions as appropriate, regardless of whether Rule 144 or other holding periods have been previously satisfied; and (v) consider the potential impact of the particular transactions on the trading market for the publicly-held company’s securities following the closing of the transaction. Our attorneys have seen all of these issues at one time or another and can provide reasonable solutions that will protect the parties long after the completion of the reverse merger.
Always Assume the Worst
We represent clients in a fair, open, competent and diligent manner but always assume the worst possible outcome, regardless of the good intentions of the parties. Although it seems counterintuitive, this is a very positive stance! Would you be worried if the SEC or some other regulatory agency asked to see your attorneys’ files on the reverse merger and asked to discuss the transaction with you? Are you concerned about any of the advice that you may have been given in connection with the transaction or the related legal opinions? The amount of due diligence that you and your attorneys conducted or did not conduct? We maintain all files and all communications to protect our clients because we want to ensure that anyone looking at them will see that the reverse merger and all related transactions were lawfully completed and provided for current and future compliance with applicable securities laws, rules and regulations. It is important to have this information available to prove that all aspects of the reverse merger were done strictly within the guidelines of applicable law and not in a manner that, although technically correct, may violate the spirit of the law.
This partial summary of issues related to reverse mergers was excerpted from a presentation at the 27th Annual Securities Law Workshop/Securities Law Section/Utah Bar Association on “Shell Reorganization/Merger Transactions” presented by Leonard W. Burningham, Esq. in 2005. Look for future posts by us on the subject of reverse mergers from that presentation, updated to current practices.