Over recent years, many companies have pursued paths for going public as an alternative to a traditional IPO, including, for example, through a reverse merger, and or a SPAC transaction. In the following guest post, Sarah Abrams, Head of Claims Baleen Specialty, a division of Bowhead Specialty, takes a look at these alternatives, and considers what these kinds of transactions may mean in terms of potential D&O liability exposure. I would like to thank Sarah for allowing me to publish her article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Sarah’s article.
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Tron, a China-based cryptocurrency platform, recently went public through a reverse merger with SRM Entertainment Inc. (SRM), a Nasdaq-listed manufacturer of custom toys and souvenirs. Much of the press surrounding the Tron and SRM merger stems from Tron founder Justin Sun’s prior fraud charges and various connections to President Trump. However, spotlighting the less complex process to take a company public may make Tron a reverse merger influencer. In addition, the SEC’s March announcement to expand confidentiality over regulatory filings and lumpier traditional IPO activity during the first half of 2025 may add to the transaction’s appeal.
D&O underwriters should recall, however, the early 2010s wave of Chinese reverse mergers that resulted in a slew of securities class actions and regulations. Several Chinese companies obtained a U.S. listing through mergers with public shell companies. These transactions ultimately resulted in dozens of U.S. securities lawsuits. In many cases, the underlying operating companies were not the business enterprises they were represented to be. There were scandals. There are lessons as well, lessons with important D&O insurance underwriting implications.
However, given the current SEC relaxation of certain filing requirements for reverse mergers and Tron’s media exposure, reverse mergers may again increase in popularity. If this happens, will there be increased risk for D&O underwriters of companies involved in the deal? To determine whether this type of transaction may impact executive risk exposure, the following discusses what a reverse merger is, that it is not a SPAC, as well as the historical regulatory inquiries and securities litigation against reverse mergers.
First, what is a reverse merger? A reverse merger is an alternative to an initial public offering (IPO) or direct public offering (DPO). The reverse merger transaction allows a privately held company to go public by acquiring a controlling interest in, and merging with, a public operating or public shell company. The SEC defines a “shell company” as a publicly traded company with (1) no or nominal operations and (2) either no or nominal assets or assets consisting solely of any amount of cash and cash equivalents.
In a reverse merger transaction, the private operating company shareholders exchange their shares of the private company for either new or existing shares of the “shell” public company. At the end of the transaction, the shareholders of the private operating company own a majority of the public company, and the private operating company has gone public by acquiring a controlling interest in a public company and having the public company assume operations of the operating entity.
Because the public company is already registered with the Securities and Exchange Commission (SEC) before the merger, the go-forward registration process is relatively straightforward and less expensive. That does not mean, however, that there will be less shareholder scrutiny over the transaction and representations made by both the private and public companies ahead of a reverse merger. It is important to recall that, in 2011, numerous Chinese reverse merger companies became the target of shareholder suits, government investigations, and scathing analyst reports for alleged financial and accounting fraud.
Thus, D&O underwriters on both the shell public company program and the private company merging to go public may want to acknowledge that the ease of access to US capital markets through a reverse merger may itself raise red flags. In addition, awareness of the current Nasdaq and SEC enforcement rules impacting reverse mergers may be critical for D&O carriers offering regulatory coverage. Similarly, D&O underwriters should be aware of the public statements by company leadership and company directives, which may be used as purported proof of fraud or misrepresentation in a future securities claim.
Take, for example, Tron and SRM’s reverse merger, in which SRM raised $100 million via private placement to acquire Tron’s native TRX tokens and establish a treasury. Specifically, SRM issued 100,000 shares of preferred stock convertible to 200 million common shares worth 50 cents each. The offering is linked to warrants that carry the right to acquire an additional 220 million shares at 50 cents each, meaning the total investment could reach $210 million. SRM used the proceeds of the capital infusion to complete Tron’s merger into SRM through the acquisition of Tron’s tokens. SRM rebranded as Tron Inc. and Tron made its official public debut on July 24 as trading of its shares began on the Nasdaq.
Justin Sun, founder of Tron, has previously been charged with fraud by the SEC for manipulating the market for Tron’s TRX token. A court filing in February showed that Sun and the SEC were exploring a resolution to the civil fraud case, as part of the Trump administration’s unwinding of the prior administration’s crypto enforcement actions. That filing came after Sun purchased tokens issued by the Trump family’s crypto bank World Liberty Financial for $75 million. SRM has now rebranded as Tron Inc., with Sun joining as an advisor. Shares of SRM went up 460% after the announcement, lifting the company’s market cap to about $140 million.
Should Tron shares plummet as a result of any actions or statements made by Sun, loss causation damages asserted in a future securities class action may be significant. Loss for D&O insurers may be substantial should such a case survive the motion to dismiss stage. One such previous securities case involving a reverse merger, and which survived the motion to dismiss stage, was the 2011 securities class action, Henning v. Orient Paper, Inc. Orient Paper, a Chinese company, entered the U.S. public markets through a reverse merger and shareholders successfully alleged that it made false statements regarding related-party transactions, issued inflated financials for 2008 and 2009 (over 2,700%), and used a disbarred and unlicensed auditor.
Orient Paper was not the only reverse merger securities case from that time involving purported egregious fraud and, even though is has been over a decade since the SEC had to suspend or halt trading of dozens of reverse merger companies due to untimely, incomplete, or inaccurate financial information, the market still experienced SPAC mania, fallout, and comeback in the meantime. That experience with SPACs may also be informative to underwriters
SPACs, Special Purpose Acquisition Companies, are “blank check” companies created by raising funds to acquire a private “target” company and take it public. Differently, a reverse merger involves a private company merging with a public company. In a SPAC merger, the target company is identified before the merger happens, but in a reverse merger, the private company is often already in control of the public shell company. So, is a company that has gone public by reverse merger a better D&O underwriting risk than a SPACd public company?
The 2019 transaction involving Social Capital Hedosophia Holdings Corp. (IPOA) and Virgin Galactic Holdings, Inc. (SPCE) may provide some context as to whether a SPAC or reverse merger is more likely to attract securities claims. IPOA was a SPAC that completed a reverse merger with Virgin Galactic, a privately held spaceflight company. Virgin Galactic became a subsidiary of IPOA and, after the merger, a publicly traded company under the ticker SPCE. Investors who bought into IPOA’s IPO post-merger held shares of Virgin Galactic. And, as D&O Diary readers may also recall, post reverse merger, a securities class action lawsuit was brought against Virgin Galactic Holdings relating to its accounting of warrants issued by the SPAC.
While warrant accounting is a significant issue in a SPAC transaction, a reverse merger without a SPAC is direct, and the securities issued are generally accounted for following standard accounting principles to ensure an accurate reflection of the company’s financial position. This may initially appear more favorable for D&O insurers considering reverse merger companies; in theory, a more accurate picture of the financial health of the company is publicly provided to its investors.
While D&O insurers may be as optimistic 15 years later about public companies exiting a reverse merger as Jason Sun is about the future of Tron, Inc., we have seen regulatory and litigation fallout from reverse mergers before. While this is a different time, with a different administration, securities fraud risks stemming from reverse mergers remain the same. Understanding the transaction as well as case scenarios may help keep all parties to the deal grounded in risk reality.
The views expressed on this article are exclusively those of the author, and all of the content in this article has been created solely in the author’s individual capacity. This article is not affiliated with her company, colleagues, or clients. The information contained in this article is provided for informational purposes only, and should not be construed as legal advice on any subject matter.