The SEC Warns About Reverse Mergers
The U.S. Securities and Exchange Commission (www.sec.gov/investor/alerts/reversemergers.pdf.issued a bulletin about reverse mergers in early June. The bulletin provided information about reverse mergers and advice on how investors can protect themselves. It can be read at
The bulletin follows regulatory actions against several Chinese companies that have used reversed mergers to access the U.S. security markets. These companies have included, but are not limited to, Heli Electronics Corp., China Changjiang Mining & New Energy Co and RINO International Corp. . These companies have been accused of engaging in financial fraud. Several other Chinese companies that have used the reverse merger process are also alleged to have published misleading financial reports.
A reverse merger allows a private company to get its stock traded on public exchanges without going through the initial public offering (process, a step that is more costly but far more thorough. This is accomplished by having a shell company—a company that is publicly traded but has few or no operations—acquire a privately held company. The public shell company survives after the merger, but control of it is ceded to the shareholders of the private company. The end result is that the private company obtains a listing on an exchange or the over-the-counter ( market by simply merging with a company that already had a publicly traded stock.
Though proponents would argue that the reverse merger process is cheaper and faster, critics would point to the regulatory loopholes that it can exploit. A company pursuing an IPO has to file detailed registration documents with the SEC. A company that goes public via a reverse merger is exempt from filing such documents. Rather, the acquiring shell company merely has to file an 8-K form with the SEC, which is simply an announcement of major events. Furthermore, the post-merger company may be able to avoid another regulatory filing, Form 211, if its stock was continuously traded on the OTC markets prior to the merger. These loopholes significantly increase the risk of investing in a reverse-merger stock.
Source: SEC Investor Bulletin: Reverse Mergers, June 9, 2011.