News

Going Public Using a Shell Company


By James Beck - August 14, 2017

GOING PUBLIC USING A SHELL COMPANY
Owners of privately held companies that desire greater access to capital markets or increase liquidity for their stock should consider entering into a “reverse merger” transaction with a publicly traded shell company.  For purposes of this discussion, we only consider shell companies that have an established shareholder base and file reports with the SEC on a periodic basis, but have no significant assets or business operations.
The advantage of a reverse merger with a shell company is that it allows the private company to become public more quickly and usually at less expense than completing an initial public offering (either through an underwriter or on a self-underwritten basis).  There is also no certainty of success for an initial public offering.
The disadvantages to shell company transactions include the fact that owners must give up a portion of their equity interest (usually 10 to 20 percent) and incur expenses for conducting due diligence on the shell company, negotiating and completing the merger and in some cases pay cash to shell company insiders.  In addition, SEC rules impose restrictions on the trading of the stock of the post-merger company for one year.  There is also a one year waiting period before a post-merger company can become listed on an exchange (such as Nasdaq).
The SEC also requires that, within four business days of the closing of the reverse merger, the company file a “jumbo” Form 8-K with complete disclosures regarding the transaction and the change of control, including all information required in a Form 10, such as disclosures regarding the company’s business, material agreements, risk factors, directors and officers, MD&A, and two years of audited financial statements.
Becoming a public company via a reverse merger likely offers a company many benefits, including access to capital and a higher profile. However, care must be taken in structuring and implementing these types of transactions in order to obtain the benefits. A private company that is considering going public through such a structure must carefully weigh the advantages and disadvantages and take steps to reduce the risks
Please contact us to discuss the possibility of a shell company transaction for your company if you are considering a reverse merger.
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Control Person Liability under the Colorado Securities Act

What Investors should know

By Russell Bean - July 25, 2017

The Colorado Court of Appeals recently issued an opinion analyzing control person liability under the Colorado Securities Act.  Under the Colorado Securities Act, a control person is jointly and severally liable for violations of the Act by the primary wrongdoer unless the control person can show it acted in good faith and did not induce the acts constituting the violation.  In Houston v. Southeast Investments N.C., Inc. (2017 COA 66), issued on May 18, 2017, the Court held that an investor must demonstrate (1) that a primary violation of the securities law occurred and (2) that the broker-dealer is a controlling person, in order to invoke the control person rule.  However, the Court recognized an exception to the general rule that a broker-dealer is a controlling person of its registered representative where (1) the plaintiff did not reasonably rely on the representative’s relationship with the broker-dealer in making their investment, (2) the plaintiff invested in markets other than those promoted by the broker-dealer, (3) the representative did not rely on its relationship with the broker-dealer to access the securities market in order to sell the subject securities to the plaintiff, and (4) the broker-dealer did not know of, or have a financial interest in the plaintiff’s business with the representative.
            The exception would be an issue where a registered representative is engaging in a securities transaction away from his firm (“selling away”) or is engaging in an outside business activity.  In Houston, the plaintiff gave her retirement savings to Mr. Hornick to invest.  In turn, Mr. Hornick worked at 1st Consumer Financial Services (“CFS”) with Mr. Sorenson.  Mr. Sorenson was a registered representative for Southeast Investments, but he had failed to disclose CFS to Southeast, and Mr. Hornick was not registered with Southeast.  When the plaintiff lost her retirement savings, she brought an action against Southeast as a control person of Sorenson.  The Court determined that Southeast was not a control person of Sorenson with regard to his outside activity at CFS or the securities transaction between Hornick and the plaintiff.
            In response to the plaintiff’s argument that Southeast failed in its obligation to properly supervise Mr. Sorenson, the Court stated that the adequacy Southeast’s supervision would only be an issue if Southeast asserted it affirmative defense of good faith.  Since Southeast did not control Mr. Sorenson’s activities in this instance, it did not need to assert its affirmative defense.
            The Court’s decision is in keeping with federal law regarding control person liability.
            For investors seeking to impose control person liability, make sure (1) that your representative is licensed with his broker-dealer by checking https://brokercheck.finra.org/, (2) that the products your representative is offering to you have been approved by his broker-dealer, and (3) that your funds only go to the broker-dealer and not to the representative or a third party directly.
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Control Person Liability Under the Colorado Securities Act


By Russell Bean - July 25, 2017

The Colorado Court of Appeals recently issued an opinion analyzing control person liability under the Colorado Securities Act.  Under the Colorado Securities Act, a control person is jointly and severally liable for violations of the Act by the primary wrongdoer unless the control person can show it acted in good faith and did not induce the acts constituting the violation.  In Houston v. Southeast Investments N.C., Inc. (2017 COA 66), issued on May 18, 2017, the Court held that an investor must demonstrate (1) that a primary violation of the securities law occurred and (2) that the broker-dealer is a controlling person, in order to invoke the control person rule.  However, the Court recognized an exception to the general rule that a broker-dealer is a controlling person of its registered representative where (1) the plaintiff did not reasonably rely on the representative’s relationship with the broker-dealer in making their investment, (2) the plaintiff invested in markets other than those promoted by the broker-dealer, (3) the representative did not rely on its relationship with the broker-dealer to access the securities market in order to sell the subject securities to the plaintiff, and (4) the broker-dealer did not know of, or have a financial interest in the plaintiff’s business with the representative.
            The exception would be an issue where a registered representative is engaging in a securities transaction away from his firm (“selling away”) or is engaging in an outside business activity.  In Houston, the plaintiff gave her retirement savings to Mr. Hornick to invest.  In turn, Mr. Hornick worked at 1st Consumer Financial Services (“CFS”) with Mr. Sorenson.  Mr. Sorenson was a registered representative for Southeast Investments, but he had failed to disclose CFS to Southeast, and Mr. Hornick was not registered with Southeast.  When the plaintiff lost her retirement savings, she brought an action against Southeast as a control person of Sorenson.  The Court determined that Southeast was not a control person of Sorenson with regard to his outside activity at CFS or the securities transaction between Hornick and the plaintiff.
            In response to the plaintiff’s argument that Southeast failed in its obligation to properly supervise Mr. Sorenson, the Court stated that the adequacy Southeast’s supervision would only be an issue if Southeast asserted it affirmative defense of good faith.  Since Southeast did not control Mr. Sorenson’s activities in this instance, it did not need to assert its affirmative defense.
            The Court’s decision is in keeping with federal law regarding control person liability.
            For broker-dealers whose compliance procedures already prohibit outside business activities or securities transactions, this exception provides a significant defense when registered representatives engage in conduct away from their firm
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T+2 Goes Into Effect on September 5, 2017


By Russell Bean - July 24, 2017

In March, the SEC approved a rule change reducing the settlement cycle from T+3 to T+2.  Whereas your Monday trade settles on Thursday right now, it will settle on Wednesday when the rule goes into effect on September 5, 2017.  The change is being made to improve capital efficiencies and reduce the risk of counterparty default.  The change applies to stocks, bonds, exchange traded funds, certain mutual funds, and limited partnerships that trade on exchanges.
While this change is not as drastic as when the cycle was reduced to 3 days from 5, it will mean that brokers and investors will want to make sure funds or securities are available for settlement before the trade is entered.  Investors will actually own the security that they are purchasing one day earlier than under T+3 for dividend and interest purposes.
The industry is already discussing the concept of T+1, and we might see that sooner rather than later if T+2 goes well.
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Supreme Court Limits the Period of Disgorgement


June 5, 2017

The Supreme Court, in a 9-0 decision, ruled that the SEC’s claims for disgorgement are subject to a five-year statute of limitations, thus preventing the SEC from seeking disgorgement for wrongdoing occurring prior to the five year limit.  In doing so, the Supreme Court ruled that disgorgement is a penalty, rather than equitable relief intended to put the defendant back into the position he was before the wrongdoing.  Kokesh v. SEC, slip opinion, June 5, 2017.  This decision reinforces the Supreme Court’s decision in 2013 that claims for civil monetary penalties were subject to a five year statute of limitations.