Nasdaq Proposes New Rules for Reverse Mergers
posted by The Traveller on Sunday, April 24, 2011

In a filing with the Securites and Exchange Commission last week, the NASDAQ Stock Market proposed additional requirements for Reverse Merger companies that want to apply for a Nasdaq listing. According to the filing, the purpose of this rule change is to enhance investor protection, as this group of companies has "raised regulatory concerns."

A previously unlisted private company that becomes a public company by merging with a public shell must file a Form 8-K with the SEC, within four days of completing this reverse merger. This filing must contain audited financial statements and most of the information that is usually provided in a Form 10. I am using SinoCoking (SCOK) as an example for this procedure: The operating business of this coal company merged into a shell company named ", Inc." (AAC) on February 5, 2010. The Form 8-K was filed three days later, and the new entity was quoted on the Over-the-Counter Bulletin Board under the new ticker "SCOK" on February 8, 2010. SinoCoking amended this 8-K filing on March 5, 2010 to include the required audited financial statements.

Nasdaq proposes now "to prohibit a company going public via a reverse merger from applying to list until six months after the combined entity submits audited financial statements to the SEC." In SinoCoking's case that would have meant that the company was not allowed to apply for a Nasdaq listing earlier than September 5, 2010. But Nasdaq was very eager to approve SCOK for an initial listing. The stock started trading on the NASDAQ Stock Market on February 18, 2010, or more than two weeks before the company even filed its first audited financials with the SEC.

The second proposed rule change calls for a company to maintain a bid price of $4 per share or higher on at least 30 of the 60 trading days immediately preceding the filing of the initial listing application, while trading in the over-the-counter market, on another national securities exchange, or on a listed foreign market. SinoCoking was trading on the OTC market for just eight sessions before it was allowed to move up to the big board.

An additional requirement for a reverse merger uplisting to NASDAQ should be the "timely filing" of at least two required periodic financial reports with the SEC for domestic issuers (10-Q or 10-K), or in the case of a Foreign Private Issuer, one or more reports including financial statements for a period not less than six months (6-K or 20-F). SinoCoking filed its second such report (10-K) on September 29, 2009, which - had the proposed new rules been already in place then - would have marked the day the company were allowed to apply for a Nasdaq listing. That is, if we interpret the requirement for "timely filing" only loosely. SCOK has submitted a Form NT-10, "Notification of inability to timely file Form 10-K or 10-Q", for three of the four reporting periods since it became a public company. With a strict interpretation of this rule, the company would still not be allowed to apply for a Nasdaq listing today, more than 14 months after the reverse merger completed.

Nasdaq elaborates in its SEC filing what prompted the proposed rule changes:
  • extraordinary level of public attention to reverse merger companies
  • financial press and short sellers raised allegations of widespread fraudulent behavior
  • certain individuals who aggressively promote these transactions have significant regulatory histories
  • RTO promoters have engaged in transactions that are disproportionately beneficial to them at the expense of public shareholders
  • PCAOB identified issues with the audits of these companies
  • the SEC recently took an enforcement action based on a firm's audit of a reverse merger company
  • promoters manipulate prices higher to satisfy Nasdaq's initial listing bid price requirement
  • companies have gifted stock to artificially satisfy the 300 round lot public holder requirement

Nasdaq believes the additional listing requirements would help "to discourage inappropriate behavior on the part of companies, promoters and others." Heightened review procedures for reverse merger applicants had already been adopted over the past year, but new rules would result in "significant investor protection benefits." We have seen only two reverse merger uplistings since September 2010, NFEC and KEYP (currently halted), and the only Chinese small cap stock that has been approved to move from the OTC market to Nasdaq this year is Asia Pacific Wire & Cable (AWRCF), but this is not a reverse merger company.

Nasdaq sees the following investor protection benefits:
  • FINRA will have more time to view trading patterns and uncover potentially manipulative trading
  • a more bona fide shareholder base
  • assure that the $4 bid price was not satisfied through a quick manipulative scheme
  • improve the reliability of the reported financial results
  • auditors and the company's audit committee will have reviewed several quarters, at least, of the public company's operating results
  • new internal controls, adopted at the time of the merger, will have been in place for a while

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At April 25, 2011 5:09 pm , Anonymous Anonymous said...

Nothing about mismatched filings in different countries?

I was also expecting something like: "Consolidated financial statements submitted to governmental and regulatory bodies, including those inside and outside the US, should report similar financial results, with any differences explained in said reports by reference to differing accounting rules, such as differing rates of depreciation and the like."

The notion that firms can still report $1 million of revenue in China and $100 million of revenue in the US is absurd.

At April 26, 2011 9:12 pm , Anonymous Anonymous said...

You are right that is absurd, but that is the job of the auditors over the several quarters of reporting, not within the capabilities of the exchange to monitor and confirm.

At November 15, 2011 9:12 am , Anonymous forex affiliate said...

This is a good move to discourage improper applications. Although legitimate mergers may have a hard time with the new policy.

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