Companies subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (“Exchange Act”), without current business operations (a “shell”), and which are trading on the over the counter market (“OTCQB, OTCQX and OTCBB”) have become the vehicle of choice for private companies seeking to go public through a reverse merger.
OTCQB, OTCQX and OTCBB shells have replaced non reporting pink sheet traded shells in popularity for many reasons including issues with due diligence, DTC eligibility and the unavailability of Rule 144 for non reporting pink sheet shells.
The importance of a reporting company may be self evident in that a potential merger or acquisition candidate can learn of outstanding liabilities, pending or threatened lawsuits, disputes with auditors and other matters by simply reviewing publicly available filings on the SEC EDGAR database. However, in addition to this obvious benefit, using a fully reporting SEC compliant shell as a reverse merger vehicle as opposed to a non-reporting entity has other benefits. Specifically, a company can be assured that historical records are available to meet SEC requirements for the filing of a new registration statement. In addition, FINRA and DTC both require historical records on all past issuances, which are often not available by non-reporting entities. Moreover, a reporting shell is less susceptible to market manipulation, the concealment of beneficial ownership of key shareholders and other potentially fraudulent and unethical activities.
OTCQB, OTCQX and OTCBB Due Diligence
Due diligence generally includes (but is not limited to):
- All articles and amendments are ordered from the Company’s state of domicile and are reviewed.
- DTC (the Depository Trust Company) is contacted to confirm the Company is in eligible status and not subject to a current chill;
The entire transfer agent file is reviewed to ensure that there are appropriate records for all share issuances and that all freely tradeable shares are rightfully so;
- The firm conducts comprehensive debt and litigation searches to identify any miscellaneous debts as well as pending or past litigation.
- A tax search is run with the IRS to confirm the Company does not have any outstanding Federal or employment taxes owed.
- When appropriate, the former transfer agent is contacted to ensure that the shareholder records were transferred directly, without interruption, from the former transfer agent to the current transfer agent. This ensures the integrity of the shareholder records and eliminates the possibility that the records were altered by the previous issuer.
- A NOBO (Non-Objecting Beneficial Owner) List is retrieved and examined.
- Background searches are run on the Company’s Officers and Directors, as well as on the Company itself, to locate any SEC, FINRA, or state regulatory violations.
- In the event of a previous bankruptcy, the bankruptcy file is retrieved from the appropriate court of jurisdiction and the disposition of the bankruptcy is reviewed
Where Do OTCQB, OTCQX and OTCBB Shells Come From?
OTCQB, OTCQX and OTCBB Shells generally derive from a failed public company business. A company may have traded on the bullet board when operating and subsequently suffered a failure of the operating business leaving behind a shell. When this occurs, these companies may no longer be able to meet the listing requirements of their respective exchanges such as trading price or market capitalization. The Company then “falls off” to the OTCQB, OTCQX or OTCBB over the counter market. When the operating business ceases entirely it leaves behind a shell Company.
The OTCQB, OTCQX and OTCBB Shell Company has no operations and no or nominal assets and liabilities, but the shareholders remain. In the process of an operating business failing and leaving behind a OTCQB, OTCQX or OTCBB Shell, many issues must be addressed in order to ensure that the successor business or merger candidate does not end up assuming the liabilities and responsibilities of the former operating business. In most cases these issues can be rectified. For example, prior liabilities may be written off if the statute of limitations has passed, or the debt may be settled.
The process of diagnosing potential issues with a OTCQB, OTCQX and OTCBB Shell is known as Due Diligence.
Cleaning Up OTCQB, OTCQX and OTCBB Shells
Cleaning up OTCQB, OTCQX and OTCBB Shells is primarily a legal function. Some of the specific details that constitute the process include:
- Reinstating the Company’s corporate charter and paying franchise taxes to the Company’s state of domicile
- Working with a PCOAB (Public Company Oversight Accounting Board) auditor to update all necessary financial statements and audits
- Updating the Company’s articles of incorporation and bylaws to ensure they suit the needs of the Company as a merger candidate
- Conducting reverse splits of the Company’s outstanding shares of common stock in order to decrease the size of the outstanding common stock and increase the stock price.
- Updating the Company’s SEC filings
- Answering any outstanding SEC comments that were never satisfied by the Company’s former Officers and Directors
- Installing a qualified Board of Directors and/or a skilled management team
- Updating the Company’s corporate minute books and drafting any necessary board resolutions depending on the circumstance
- The preparation and distribution of shareholder proxies and certain notices should a shareholder meeting be necessary
- Updating compliance procedures by drafting corporate compliance standards and implementing a code of ethics.
- Educating the board of directors regarding the legal responsibilities of being control persons of a public company, including the duty of loyalty, conflict of interest and self dealing obligations, prohibitions against short-swing profits and reporting requirements under sections 13 and 16 of the Securities Exchange Act.