Companies that obtained their listings on U.S. exchanges by way of a reverse merger with a publicly traded shell have been the focus of a great deal of scrutiny and even litigation in recent months, particularly with regard to Chinese reverse merger companies, as discussed here.
Reverse merger companies are also now the focus of regulatory attention. The following guest post from Anjali C. Das (pictured to the left), a Partner in the Chicago office of Wilson Elser Moskowitz Edelman & Dicker, discusses recent regulatory actions from the SEC and the U.S. stock exchanges with respect to reverse mergers. Anjali’s practice focuses on professional liability insurance coverage. She represents the interests of domestic and foreign primary and excess insurers in connection with a variety of shareholder claims and class actions against directors and officers, financial institutions, investment banks, insurance companies, and ERISA plan fiduciarieues.
Many thanks to Anjali for her willingness to publish her article here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Here is Anjali’s guest post.
For the past year, Chinese reverse merger companies have been the target of numerous shareholder suits, government investigations, and scathing analyst reports for alleged financial and accounting fraud. In some instances, the companies are purported to be a complete sham. In response to Congressional inquiries and public outcry by investors who claim they were duped, the United States Securities and Exchange Commission ("SEC") launched an investigation last year of foreign (non-U.S. based) reverse merger companies ("RMCs") and their auditors. The SEC has since suspended or halted trading of dozens of RMCs due to untimely, incomplete, or inaccurate financial information from these companies. This past summer, the SEC issued a bulletin (here) cautioning investors of the potential pitfalls of investing in RMCs, citing instances of fraud and inadequate audits.
Until now, it has been relatively easy for foreign private companies to access U.S. capital markets by merging with an existing public shell company through a so-called "reverse merger." For instance, a private company located overseas in China might merge into a public shell company listed on a U.S. exchange, whereby the bulk of the company’s control and operating activities remain in China. As some U.S. investors have discovered, this may pose logistical and other hurdles in terms of obtaining accurate information about the company’s financial and business activities.
On November 9, 2011, in an effort to stem the tide of fraud and investor abuse, the SEC unveiled new rules (here) approved and adopted by each of the three major U.S. stock exchanges which impose more stringent listing requirements for RMCs.
NASDAQ’s new rules (here) prohibit an RMC from applying to list unless and until it meets each of the following requirements: (1) the company has previously traded in a U.S. over-the-counter market, on another national securities exchange, or on a foreign exchange for at least one year following the reverse merger (also known as the one-year "seasoning period"); (2) prior to listing, the company must timely file all required periodic financial reports for the prior year with the SEC, including an annual report which contains audited financial statements and information about the reverse merger transaction; and (3) the company must maintain a minimum closing share price of $4 for a "sustained period" — at least 30 of the most recent 60 trading days as of the date of the listing application as well as the date of listing.
NASDAQ’s rules identify two exceptions from these new listing requirements for RMCs. First, an RMC that completes a firm commitment underwritten public offering at or around the time of listing with gross proceeds to the company of at least $40 million is not subject to the new listing requirements. The second exception applies to an RMC that has filed with the SEC at least four annual reports containing audited financial statements following the filing of all required information about the reverse merger transaction, in addition to fulfilling the one-year trading requirement.
The SEC approved similar new listing requirements for the New York Stock Exchange and the NYSE Amex (here and here). In approving these new rules, the SEC expressed its belief that these enhanced listing requirements were specifically designed to curb the potential for accounting fraud and manipulation associated with RMCs by increasing the transparency of their trading history and financial statements. While it is too early to tell just how effective these new listing requirements will be in preventing future fraud on U.S. investors, the rules underscores regulators’ commitment to fighting these abuses by RMCs. Meanwhile, the SEC’s continues to maintain an aggressive stance against purported fraud by China-domiciled issuers and charged Longtop Financial Technologies on November 10 with failing to file timely and accurate financial statements (here).
Olympus Garners Securities Class Action Lawsuit After All: In a recent post, I speculated that the reason there had not yet been a securities class action lawsuit filed against Olympus Corp. in the wake of its high-profile accounting scandal is that most of its shareholders acquired their shares on the Tokyo stock exchange and therefore — under the "transaction" standard enunciated by the U.S. Supreme Court in the Morrison case — cannot assert a claim under the U.S. securities laws
I also noted that, according to news reports, about one percent of its public float trades in the U.S. on the pink sheets in the form of American Depositary Receipts. Well, either the ADRs represent greater value than i understood when I wrote my blog post or some plaintiffs lawyers are going after some fairly small potential recoveeries.
According to their November 14, 2011 press release (here), a plaintiffs’ firm has filed a securities class action in the Eastern District of Pennsylvania against Olympus and certain of its directors and officers The complaint purports to be filed only on behalf of "purchasers of Olympus American Depository Receipts (pinksheets:OCPNY) (pinksheets:OCPNF) between November 7, 2006 and November 7, 2011, inclusive."
The plaintiffs did not include the Olympus shareholders that had purchased their shares on the Tokyo exchange, in an obvious effort to avoid Morrison problems. The Morrison effect on this case is that it is a much smaller scale case than would have been filed pre-Morrison.
Meanwhile, a November 15, 2011 artice in The Asian Lawyer entited "What Will be the Legal Fallout for Olympus Corp." (here) discusses the various legal and cultural reasons why a significant litigation recovery or even regulatory fine involving Olympus Corp. is unlikely in Japan.
LexisNexis Top Insurance Law Blogs of 2011: On November 11, 2011, the LexisNexis Insurance Law Community announced the top Insurance Law Blogs of 2011. The D&O Diary is honored to be listed among the 2011 designees. The LexisNexis press release also lists all of the other designees, with links to their sites. Congradulations to all of the designees, and thanks to the LexisNexis Insurance Law Community for the selection. And thanks to all of the readers out there who keep this blog alive.