The new rules were announced on Wednesday November 9 and will apply to all three major US listing markets: Nasdaq, NYSE, and NYSE Amex.
Private businesses based outside of the US who want to avoid the costs or scrutiny associated with a new public offering process, can choose to merge with an already listed shell company a corporation that is not operationally active and does not hold important assets.
The move, which was proposed by the stock exchanges, comes as a response to concerns that companies were using this method of entry into the markets to avoid proper accounting oversight. Many of the US listed firms being targeted by the SEC in its latest directive are based in China.
The agency had issued a warning to investors earlier this year urging them to be skeptical of investing in companies listed through reverse merges, mentioning that such listings were not subject to as much scrutiny as an initial public offering. The SEC increased its focus on this matter in the beginning of 2010, as dozens of China-based firms reported auditor resignations or accounting irregularities.
Under the new directions, a reverse merger company would be prohibited from applying to list until it completes a one-year easoning period by trading in the US over-the-counter market or on another American or foreign regulated exchange after the merger.
During that phase, it would also be required to provide the SEC with all requested paperwork and reports, including official audited financial statements.
Additionally, the company shares would have to be maintained at a minimum stock price over a sustained period of time, and for at least 30 of the 60 trading days immediately prior to its submission of the listing application and the exchange decision to list, as reported by the SEC.
The Commission and US exchanges have in recent months suspended or halted trading in more than 35 firms based abroad, mainly due to lack of sufficient and up to date information on the companies, their operations and their finances. A number of those entities were formed through reverse mergers.
Such a company, however, could be exempt from these special requirements in two cases. If it affirms its commitment at the time of the listing with a considerable underwritten public offering, or if the merger between the shell company and the foreign one occurred on a much earlier date, allowing for at least four annual company reports with audited financial information to have been filed with the agency.
The drawback from the regulatory update, and what some investors now fear, is that it could affect the capital formation efforts of some of the smaller companies. Adding that perhaps scrutiny would have been better levied on the companies themselves instead of the reverse merger structure as a whole.
