Brian A. Lebrecht, founder and President of The Lebrecht Group, APLC, will be among the presenters at a seminar on May 16, 2013 by the National Business Institute entitled Accounting 101 for Attorneys.  Specific topic will be Complying with Ethical Standards.

NASDAQ has special rules for companies that went public via a reverse merger.

 By: Brian A. Lebrecht, Esq.

NASDAQ Markets Overview

NASDAQ has three different U.S. markets, the NASDAQ Global Select Market, the NASDAQ Global Market, and the NASDAQ Capital Market.  Each of the three markets is designed to accommodate companies of a different size, from largest to smallest in the order presented.  Each market has its own distinct set of initial listing requirements, and its own set of continued listing requirements.  The initial listing requirements are more stringent than the continued listing requirements; I suspect this reflects NASDAQ’s desire to vet out companies with a marginal track record, while being more lenient once the company receives the NASDAQ listing.

The listing requirements for each market are set forth in the Marketplace Rules, beginning in Section 5000.  NASDAQ publishes a summary of these rules, titled Initial Listing Guide and Continued Listing Guide.  NASDAQ has also organized its FAQ’s into a variety of topics, including Initial Listing and Continue Listing.

NASDAQ Capital Market Initial Listing Requirements

Many times a reverse merger company doesn’t use an underwriter when it goes public, and because it is likely still developing its business, the NASDAQ Capital Market is probably the best fit.  Before discussing the special requirements for reverse merger companies, it is helpful to discuss the general initial listing requirements for all companies.

The financial and liquidity requirements for an initial listing on the NASDAQ Capital Market are summarized as follows (companies must meet all of the criteria under at least one of the three standards below):

* Companies qualifying solely under the Market Value Standard must meet the $50 million Market Value of Listed Securities and the applicable bid price requirement for 90 consecutive trading days before applying.

** To qualify under the closing price alternative, a company must have: (i) average annual revenues of $6 million for three years, or (ii) net tangible assets of $5 million, or (iii) net tangible assets of $2 million and a 3 year operating history, in addition to satisfying the other financial and liquidity requirements listed above.

In addition to the financial and liquidity requirements, a company applying for an initial listing, regardless of which NASDAQ market it is applying to, must meet the following corporate governance requirements:

Initial Listing Requirements for Reverse Merger Companies

Section 5110(c) of the Marketplace Rules covers reverse merger companies applying for an initial listing.  This section states:

(c)        Reverse Mergers

(1)        A Company that is formed by a Reverse Merger (a “Reverse Merger Company”) shall be eligible to submit an application for initial listing only if the combined entity has, immediately preceding the filing of the initial listing application:

(A)       traded for at least one year in the U.S. over-the-counter market, on another national securities exchange, or on a regulated foreign exchange, following the filing with the Commission or Other Regulatory Authority of all required information about the transaction, including audited financial statements for the combined entity; and

(B)       maintained a closing price of $4 per share or higher for a sustained period of time, but in no event for less than 30 of the most recent 60 trading days.

(2)        In addition to satisfying all of Nasdaq’s other initial listing requirements, a Reverse Merger Company will only be approved for listing if, at the time of approval, it has:

(A)       timely filed all required periodic financial reports with the Commission or Other Regulatory Authority (Forms 10-Q, 10-K or 20-F) for the prior year, including at least one annual report. The annual report must contain audited financial statements for a full fiscal year commencing after filing the information described in paragraph (1)(A) above; and

(B)       maintained a closing price of $4 per share or higher for a sustained period of time, but in no event for less than 30 of the most recent 60 trading days prior to approval.

(3)        A Reverse Merger Company will not be subject to the requirements of this Rule 5110(c) if, in connection with its listing, it completes a firm commitment underwritten public offering where the gross proceeds to the Reverse Merger Company will be at least $40 million. In addition, a Reverse Merger Company will no longer be subject to the requirements of this Rule 5110(c) once it has satisfied the one-year trading requirement contained in paragraph (1)(A) above and has filed at least four annual reports with the Commission or Other Regulatory Authority containing all required audited financial statements for a full fiscal year commencing after filing the information described in that paragraph. In either case described in this paragraph (3), the Reverse Merger Company must satisfy all applicable requirements for initial listing, including the minimum price requirement and the requirement contained in Rule 5210(e) that the Company not be delinquent in its filing obligation with the Commission or Other Regulatory Authority.

Section (c)(1)(A) requires that the company’s common stock has traded for a full year after the filing of information with the SEC about the reverse merger, including audited financial statements for the combined entity.  In most cases, this is the so-called “Super 8-K”, but in some instances, depending on where the issuer is in the reporting cycle, audited financial statements of the combined entity might not be filed until later.

Section (c)(1)(B) requires that the stock’s closing price be at least $4.00 for at least 30 of the last 60 days.  Note that this is more stringent than the guidelines set forth in the financial and liquidity requirements table above, which allows a closing price of either $2 or $3 per share.

Section (c)(2)(A) requires that the company meet all three conditions: 1) be current in its SEC filings, 2) has filed at least one annual report and 3) that the annual report contains audited financial statements covering at least one full year that commences after the Super 8-K was filed.  In many cases, this requirement will mean that the issuer must wait nearly two years before it is eligible to trade on NASDAQ.

Section (c)(2)(B) requires that the stock price is at least $4 per share at the time of approval, in addition to the requirement of (c)(1)(B), which is at the time of application.

Section (c)(3) provides some relief from these special requirements if the issuer completed a firm-commitment underwriting that resulted in gross proceeds of at least $40 million.

Conclusion

A company that goes public via a reverse merger is subject to a higher set of listing standards than issuers that go public through other methods.  In particular, it is possible that the issuer, and its shareholders, may have to wait longer than anticipated, in some cases nearly two years, before listing.

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The Lebrecht Group, APLC provides comprehensive advice on a variety of corporate and securities law matters.  Please contact us if you have any questions.

Brian A. Lebrecht, Esq. is the President and Founder of The Lebrecht Group, APLC, located in Orange County, California and Salt Lake City, Utah.  He can be reached at (949) 635-1240 or (801) 983-4948 or via e-mail at blebrecht@thelebrechtgroup.com with questions or comments. 

Follow Brian on Twitter at @secattorney, and The Lebrecht Group, APLC on Facebook at www.facebook.com/lebrechtgroup.  Please visit our website at www.thelebrechtgroup.com for future updates and other information.

The new chair of the SEC, Mary Jo White, testified before Congress this week and asked to have the SEC’s budget increased by 26%, to $1.67 billion.  A few of the highlights:

- she reiterated her commitment to completing the rule making under Dodd Frank and the JOBS Act.

- she wants to add 676 new staff positions.

- she claims the increase will be budget-neutral because it will be offset by an increase in collections fees.

- Corporation Finance will get 25 new staff members, “to hire additional attorneys and accountants to continue to enhance the Division’s reviews of large companies, review draft registration statements . . . prepare and finalize the remaining rules and projects to implement the Dodd-Frank Act and the JOBS Act . . .”

- Enforcement will get 131 new staff members, for “expertise in the securities industry and new product areas [and for additional] trial attorneys, and forensic accountants, as well as staff for the Office of Market Intelligence, the Office of the Whistleblower, and the SEC’s collections and distribution functions.”

- also mentioned was an upcoming overhaul of Edgar.

I recently visited three different investment banks in three days.  The purpose of the meetings was to (a) present an offering for a mutual client, (b) update each other about existing clients that we share, and (c) talk about the capital markets for small- and mid-sized public companies.  I’m pleased to see that the boutique investment banks are once again interested in smaller companies and smaller deals, including smaller IPO’s, which haven’t existed for a while.  Despite all the concerns about the burden of regulation, entrepreneurial banks are figuring out how to make a profit and fill a void.  There is a feeling that investment capital is continuing to loosen up for small cap issuers and that deal flow pipelines are starting to fill.  Good news for everyone.  To those who hosted me, thank you for the hospitality.

Regulation FD and Section 13(a) of the Exchange Act prohibit public companies, or persons acting on their behalf, from selectively disclosing material, nonpublic information to certain securities professionals, or shareholders where it is reasonably foreseeable that they will trade on that information, before it is made available to the general public.  The Commission’s 2008 Guidance explained that for purposes of complying with Regulation FD, a company makes public disclosure when it distributes information “through a recognized channel of distribution.”

As explained in the 2008 Guidance, “whether a company’s web site is a recognized channel of distribution will depend on the steps that the company has taken to alert the market to its web site and its disclosure practices, as well as the use by investors and the market of the company’s web site.”  The guidance offered a non-exhaustive list of factors to be considered in evaluating whether a corporate web site constitutes a recognized channel of distribution.  The central focus of this inquiry is whether the company has made investors, the market, and the media aware of the channels of distribution it expects to use, so these parties know where to look for disclosures of material information about the company or what they need to do to be in a position to receive this information.

In July 2012, the CEO of Nexflix, Inc. used his personal Facebook page congratulate one of his employees for achieving a milestone in terms of monthly viewed content.  The post contained the specific number of hours, which was a metric reported in the Company’s press releases and SEC filings.  The SEC launched an investigation into whether Regulation FD had been violated.

The SEC published the results of its investigation, and in doing so, provided some guidance for the use of social medial channels and Regulation FD compliance, essentially the same as company web sites:

“We seek to remind issuers that disclosures to persons enumerated in Regulation FD, even if made through evolving social media channels, must still be analyzed for compliance with Regulation FD.  Moreover, we emphasize that the Commission’s 2008 Guidance, though largely focused on the use of web sites, is equally applicable to current and evolving social media channels of corporate communication.  The 2008 Guidance explained that issuers must take steps sufficient to alert investors and the market to the channels it will use for the dissemination of material, nonpublic information.”

Most clients are familiar with the idea that general solicitation is not allowed under most offering exemptions, including Rule 506 of Regulation D.  Most clients are also aware that one of the proposed rule changes brought about by the JOBS Act is to eliminate the ban on general solicitation in 506 offerings.  As of the date of this writing, the SEC has not finalized its rules for implementing that ban.  You can review my blog posting on this topic here.

But what is general solicitation anyway?

The SEC has made it clear that any general notice of a securities offering directed to persons not known to the issuer will be considered advertising, and is not allowed.   But a notice of a securities offering to a person with whom the issuer has a “preexisting relationship” will not be considered advertising.  The relationship does not need to be formal or contractual one, and it does not need to be a business relationship.  However, in order to avoid general solicitation, the relationship must be sufficient to enable the issuer or its agent to be currently aware of the financial circumstances or sophistication of the contacted party.  So, for example, contacting a list of the issuer’s customers, while a preexisting relationship (and thus not advertising), is not allowed because that customer relationship doesn’t give the issuer insight into the financial circumstances of sophistication of the customer (and is thus solicitation).

While the discussion above covers issuers reaching out to potential investors, issuers are not prevented from talking to potential investors who come to them unsolicited.  This includes customers or others who approach the issuer, and referrals from other potential investors who have been properly contacted.  But the issuer cannot ask for the referrals, they must come unsolicited.

For now, the ban on general solicitation still exists and must be addressed carefully by the issuer and its legal counsel.  To check the status of the JOBS Act ‘s elimination of the ban on general solicitation, go here.

As part of restructuring a business, we are often called upon to dissolve an entity, including often one or more subsidiaries of a parent company.  I recently presented on Dissolving a Business during a continuing education seminar entitled Representing Small Businesses.  I have adapted my presentation for this article.

By: Brian A. Lebrecht, Esq.

Dissolution of a business entity is a very formal, structured and statutorily guided process.  It is also almost exclusively a state law matter, and so procedures from the state of incorporation must be followed.

Most states have published guidance and statutes that walk the company through exactly how to handle a dissolution, including notification of creditors.  Utah has very detailed guidance at Title 16, Chapter 10a of the Utah Revised Business Corporation Act, and references in this article are to applicable Utah statutes.

Formalizing the Decision to Dissolve

For corporations, in most jurisdictions, the decision to dissolve the corporation must be approved by both the Board of Directors and the Shareholders of the company.  (Utah 15-10a-1402).

Filing Required Documents with Local, State and Federal Agencies

Articles of Dissolution are prepared and filed with the Secretary of State.

A dissolved corporation actually stays in existence, but only for the purpose of winding up and liquidating its business and affairs.  (Utah 16-10a-1405).

A corporation can revoke its dissolution within 120 days after the effective date of the dissolution.

Notifying any and all Creditors

At any time after the effective date of the dissolution, the corporation can dispose of known claims by giving written notice as follows (UT 16-10a-1406):

(a)        describe the information that must be included in a claim;

(b)        provide an address to which written notice of any claim must be given to the corporation;

(c)        state the deadline, which may not be fewer than 120 days after the effective date of the notice, by which the dissolved corporation must receive the claim; and

(d)       state that unless sooner barred by any other state statute limiting actions, the claim will be barred if not received by the deadline.

There is also a process whereby claims can be disposed of by publication.

Distributing Assets Efficiently

All the assets of the corporation should be accumulated, liquidated, and the proceeds therefrom distributed to (1) the corporate creditors, and then to (2) corporate shareholders.

Filing IRS Forms and Reporting Requirements

Dissolving corporations should file a Form 966 with the IRS within 30 days after the plan of dissolution is adopted.  A corporation then typically files a “final” tax return at the end of the applicable year in which it dissolved.

Sample Letter to Creditors – No Distribution

 

[Date]

 Via U.S. First Class Mail

 

«Company»

«Address»

«City», «State» «Zip»

Re:      Dissolution and Winding Up of [insert name]

Dear Sir or Madam:

You are receiving this letter because you are a creditor of [insert name] (the “Company”).  The Company ceased operations on December 31, 2008, and filed a Certificate of Dissolution with the Nevada Secretary of State on December 3, 2012.  This letter serves as notice of the dissolution of the Company.

Under normal circumstances, the Company would liquidate its assets and distribute them pro rata to its creditors.  However, the Company does not have any assets to distribute.  As a result, it is not necessary to send or file a claim to it or file a claim against the Company for amounts you are owed.  Unfortunately, there will be no distributions.

Thank you for your time and attention to this matter.

Sincerely,

 

 

Sample Letter to Creditors – Pro-Rata Distribution of Assets

[Date]

Via U.S. First Class Mail

«Company»

«Address»

«City», «State» «Zip»

Re:      Dissolution and Winding Up of [insert name]

Dear Sir or Madam:

You are receiving this letter because you are a creditor of [insert name] (the “Company”).  The Company ceased operations on December 31, 2008, and filed a Certificate of Dissolution with the Nevada Secretary of State on December 3, 2012.  This letter serves as notice of the dissolution of the Company.

Over the next 60 days, under the direction of its Board of Directors, the Company will be liquidating its assets and distributing them in accordance with the applicable corporate statute.  We anticipate that the total assets will be less than the total amount owed to all Company creditors, and thus you will be receiving a pro-rata amount of your claim.  In order to verify and lodge your claim, please submit to us, in writing, the amount of your claim, a copy of the contract under which the claim is made, and the two most recent invoices no later than [date].  You will receive your pro-rata payment, along with an accounting of the Company’s assets and liabilities, within thirty (30) days thereafter.

Thank you for your time and attention to this matter.

Sincerely,

 

Useful Links

California Certificate of Election to Wind Up and Dissolve

California LLC Certificate of Dissolution

Utah Corporation Articles of Dissolution

Utah LLC Articles of Dissolution

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The Lebrecht Group, APLC provides comprehensive advice on a variety of corporate and securities law matters.  Please contact us if you have any questions.

Brian A. Lebrecht, Esq. is the President and Founder of The Lebrecht Group, APLC, located in Irvine, California and Salt Lake City, Utah.  He can be reached at (949) 635-1240 or via e-mail at blebrecht@thelebrechtgroup.com with questions or comments.  Please visit our website at www.thelebrechtgroup.com for future updates and other information.

The Lebrecht Group, APLC is pleased to welcome Edward H. Weaver back to the firm.  Ed was with TLG from March 2005 through September 2009, when he left to pursue various other professional and personal interests.  Ed has most recently been a partner at Baird Lamb, PLLC, practicing in the areas of corporate governance and compliance, entity formation, mergers and acquisitions, and finance.  Ed has a JD/MBA from the University of San Diego, and a BS in economics and Spanish from the University of Utah.

“Ed is an exceptional transactional and securities lawyer.  We were fortunate to have him at TLG during the first phase of his career, and since then he has exploded as a transactional lawyer.  A lawyer’s career development is always enhanced by variety and experience, and Ed is coming back to us with a wealth of both,” said Brian A. Lebrecht, President of The Lebrecht Group.  “Many of our clients remember Ed, and I encourage everyone to reach out and welcome him back.”

Ed’s practice at TLG will focus heavily on public company reporting and ’34 Act disclosure.  He will also be the firm’s expert on Section 16 beneficial ownership reporting.  Ed’s expertise will be available to all the firm’s clients.

Brian A. Lebrecht, TLG’s founder and President, recently sat down to Q&A with Ed:

Tell us about your professional development over the last 3 years?

The last three years have been eye-opening.  Before the recession, my experience as an attorney primarily involved helping businesses grow and succeed.  Then the recession changed the legal landscape for transactional attorneys like me.  Lawsuits, dissolutions, and distressed asset sales replaced business formations, financing transactions and IPOs.  To make practicing law more enjoyable again, I partnered with two other attorneys to focus on advising start-up technology companies.  The economic environment was still challenging, but it was great fun helping to breathe a little life into these promising new companies.

Like me, you pursued a joint JD and MBA while in law school.  You also have a degree in economics.  How has that business background helped you in your law practice?

I have always tried to absorb as much business knowledge and experience as possible so I can see transactions through my clients’ eyes.  Lawyers are trained to be analytical, cynical and risk averse.  Entrepreneurs and managers are usually optimistic and pragmatic, respectively.  I believe I can provide better service if I understand their world and their mindset.  They work hard to create value, generate deals and develop business relationships and they want an attorney who understands the nuanced process of protecting legal interests without frustrating business objectives.

I know you have lived in Washington, D.C., New York and San Diego, why did you come back to Utah?

First and foremost, I came back to Utah for a girl.  That was the best decision I’ve ever made because she is now my wife.  I also came back for professional reasons.  I believe Utah has a fertile environment for entrepreneurs and businesses. Utah’s low corporate tax rate, favorable regulatory climate and young, educated workforce have attracted many national and international companies, including Microsoft, Oracle, Twitter, and Adobe. That trend will continue and I believe Utah will be an exciting place to work for the foreseeable future.

What recreational activities do you enjoy?

I spend most of my free time with my wife, three-year-old daughter and one-year-old son.  I also enjoy tennis, golf, skiing and hiking along the Wasatch Range.

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      The Lebrecht Group, APLC provides comprehensive advice on a variety of corporate and securities law matters.  Please contact us if you have any questions.

      Brian A. Lebrecht, Esq. is the President and Founder of The Lebrecht Group, APLC, located in Irvine, California and Salt Lake City, Utah.  He can be reached at (949) 635-1240 or via e-mail at blebrecht@thelebrechtgroup.com with questions or comments. 

      Edward H. Weaver, Esq. can be reached at (801) 983-4948 or via email at eweaver@thelebrechtgroup.com.

      Please visit our website at www.thelebrechtgroup.com for future updates and other information.

There is much to be read about the SEC’s delay in drafting and ultimately implementing the crowdfunding rules.  Public comments to the SEC can be found here.  Some are predicting that it will be 2014, at the earliest, before we see implementation.

While we are waiting, I started thinking about the risks of crowdfunding to the investors.  This firm usually represents issuers, and so I have already spent considerable time thinking about and advising clients on the risk to issuers.  Some of my thoughts can be found here, here, and here.  But what about the investors?

Diversification.  Crowdfunded deals will likely be ultra risky.  A high quality venture capitalist knows that 3 out of 10 of his deals fail, and crowdfunded deals will probably fail at a higher average.  Alternatively, and especially if you believe in the risk/reward analysis, some of the crowdfunded deals will be hugely successful.  As with any investment strategy, the key is to invest in a variety of crowdfunded deals in order to spread the risk.  If you have a set amount of money set aside for crowdfunded investments, I would spread that over at least 10 different companies.

Information flow.  Crowdfunded companies will be private, not public, and won’t file information with the SEC.  This means investors will be at the mercy of the company in terms of what, if any, periodic information is disseminated to investors.  Also, since crowdfunded companies will likely have a large number of investors, one-on-one communication is unlikely.  And ultimately, unless you group together to exert influence, a small investor isn’t going to have a lot of leverage.  The squeeky wheel is likely to get the grease.

Enforcement of corporate formalities.  Similar to the flow of information, if an issuer isn’t following the rules, such as holding shareholder meetings, etc., a small investor is not going to have a lot of influence over management.  If you invested $1,000, are you going to hire a lawyer to sue the company and force it to hold a shareholders’ meeting?  Company’s that don’t want to follow formalities know the answer to that question.

Confusion over crowdfunding will continue.  There is a lot of confusion now, and you should expect it to continue, and increase, once crowdfunding starts.  The SEC will continue to adopt rules.  States will all have their own regulations.  And you can bet that the plaintiff’s lawyers will get involved early, and courts will be deciding cases and (gulp) shaping the law in this area.

As with any investment strategy, the key is to do your homework, diversify, and trust your instincts.  And most of all, have some fun, its going to be a wild ride, and it is a unique opportunity to get in on the ground floor of a variety of cutting edge companies.

As a general rule, SEC filers must file each required periodic report (i.e. 10-Q and 10-K) separately, and if there is an amendment to something disclosed in a report (such as financial statements), then they must file each amended periodic report separately.

Likewise, a filer that is delinquent with more than one filing generally has to file each delinquent filing separately.  We sometimes represent clients who, for a variety of reasons, are delinquent in a year or more of required filings, and we help them put together a package of several 10-Q’s and/or 10-K’s, all to be filed simultaneously, in order to get them current again.

We are often asked by clients if they can combine several periods together into one report.  The SEC, in the Division of Corporation Finance Financial Reporting Manual (available here), Section 1320.4, does outline a process whereby a delinquent filer can request permission to do so.  Section 1320.4 reads as follows:

1320.4             Delinquent Filers Not Operating Under the Bankruptcy Laws

a.         A delinquent filer may request an accommodation to file a comprehensive annual report on Form 10-K by writing to CF-OCA.  If before the request, however, the filer had been notified in writing about its delinquency, CF-OCA generally will deny the accommodation request.

b.         If granted, the accommodation would allow the filing of a comprehensive Form 10-K to include all audited financial statements and other material information that would have been available had the registrant filed timely and complete reports.  This comprehensive report also will be required to include unaudited quarterly financial statements in a level of detail consistent with S-X 10-01(a) and (b) for at least the same quarters required by S-K 302(a)(1) as well as a discussion of operating results, trends, and liquidity for each interim and annual period.

c.         The granting of this reporting accommodation would not constitute a waiver of the registrant’s duty under the Exchange Act to file all delinquent reports nor would it foreclose enforcement action as to the registrant’s filing delinquencies.

d.         The mere filing of a comprehensive annual report would not result in the registrant being considered “current” for purposes of Regulation S, Rule 144, or Form S-8 registration statements.  Also, the registrant would not be eligible for Form S-3 level disclosures until it establishes a sufficient history of making timely filings.  Registrants having questions on this matter should contact OCC

Note in subsection d, that a filer who is granted permission to file a comprehensive annual report will NOT be considered “current” under Rule 144 until, presumably, it “establishes a sufficient history of making timely filings (drawing the analogy from S-3 eligibility).  Specific guidance as to what constitutes a sufficient history will have to come from OCC (Office of Chief Counsel).