Form 10 Shell Danger

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Form 10 Shell Danger

There are many people who create "Form 10 shells" and sell them to people as reverse merger vehicles to go public with a reverse merger.  These are sometimes called "blank check" shells or "virgin shells."

A Form 10 shell is created a company with limited assets and no business, files a Form 10 with the SEC to register the company.   Form 10 registers a company with the SEC under the Securities and Exchange Act of 1934, but does not allow the company to issue any trading securities publicly.  Free trading stock is accomplished by a registration under the Securities Act of 1933, a different statute than the Securities and Exchange Act of 1934.

The game plan of the Form 10 shell is apparently to get the company registered with the SEC so that subsequent filings to register the stock proceed more rapidly.

The procedure is that a Form 10 shell merchant creates a new company, gives it enough money to withstand the initial expenses of an audit and filing, gets an audit that qualifies under SEC rules and files Form 10 with the SEC. The SEC may or may not comment on the filing. Once the filing has been accepted the Form 10 shell merchant seeks a merger partner, an operating company, for a reverse merger.

Note that up to this point, there are no securities in the public market and the stock of the company does not trade. There is no market maker and no trading volume. The stock is not listed anywhere.

The Form 10 shell company may have a limited number of shareholders, say 50-100, but the shares of these minority shareholders are not registered and do not trade. The Form 10 shell has no business except to find a reverse merger.

When a reverse merger is done, the combined companies file a "Super 8-K"  with the SEC. The company must also find a market maker to file a Form 211 with FINRA.
There are various issues with Form 10 shells and in some circumstances they may have their uses.

We focus here on one problem that seems to be entirely overlooked.

The Form 10 shell is controlled by its promoters, who are usually the officers, directors and control shareholders. These promoters may own 80% or so of the outstanding stock. They are the control persons and affiliates.
The minority shareholders are often friends and associates of the promoters. As a factual matter, these minority shareholders are often under the control of the promoters. The minority shareholders will listen to what the promoters ask them to do.

Because the company and the minority shareholders are under common control, the minority shareholders may be deemed to be affiliates. As affiliates, their stock is restricted and not free trading.

Thus, any Form 10 shell merchant, or any other shell merchant, who sells "99%" of the shell may be saying that the minority shareholders are selling free trading stock, when in fact it may be restricted.

SEC v. Kern, 425 F.2d 143 (2nd  Cir. 2005) holds that the stock held by minority shareholders of a shell was restricted because those minority shareholders are under the "common control" of the promoters of the shell (page 149 and page 150). The Court amalgamated the minority stock in that shell with the control stock because the SEC rules amalgamate stock under common control. The Court said "Indeed, this transaction -- attempting to garner large quantities of closely held companies' stock in anticipation of a public distribution -- is exactly the type of transaction for which the Act was intended to require disclosure."

As the defendants in Kern learned, buying up the stock in a Form 10 shell can be a very expensive thing to do if not done in compliance with the rules. This can be an issue with other shells  as well.

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SEC Rule 144 Trap for the Unwary

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 SEC Rule 144  Trap for the Unwary

The doctrine of "Acting in Concert" can be a trap for the unwary under SEC Rule 144.

SEC Rule 144 is the primary tool for making sales in the public market of securities acquired from a public company or its affiliates in a transaction that did not involve a public offering.

If you bought stock in a public company in a private transaction, you may sell into the public market if you meet certain conditions.

Rule 144 has different requirements for affiliates and non-affiliates. Generally, affiliates are persons that directly, or indirectly control or are controlled by the issuer.

For non-affiliates, these limitations generally involve adequate current public information on the company and an adequate holding period after the securities are acquired and fully paid for.

For affiliates there are also restrictions on the manner of sale, volume limitations and a notice requirement.

We focus here  on the volume limitations.

Rule 144(3)(e )(vi) provides that "When two or more affiliates or other persons agree to act in concert for the purpose of selling securities of an issuer, all securities of the same class sold for the account of all such persons during any three-month period shall be aggregated for the purpose of determining the limitation on the amount of securities sold; . . . ."

In other words, when two or more persons agree to act in concert to sell securities, all securities sold by them during any three-month period are aggregated for the volume limitations.

We find that affiliates may overlook the fact that their sales will be aggregated with sales of others with whom they are "acting in concert"

There are many fact situations where people would be acting in concert.  For example, two persons coordinating the timing of sales of their securities might be deemed to be acting in concert.  More subtly, if both sellers' accounts were run by the same investment advisor, these sellers might be deemed to be acting in concert.

If an affiliate of an issuer is the general partner of limited partnerships which hold or held restricted securities of the issuer the affiliate may be aggregated with the partnerships and their partners.

Further aggregation may also be required if the affiliate is "acting in concert" with other persons under Rule 144(e)(3)(vi)

We therefore warn you to be aware of this provision of Rule 144 and act accordingly.

Violating Rule 144 is selling restricted stock as free trading stock and the penalties are severe.

Non-affiliates can be aggregated with other holders so they control enough stock to be affiliates.

Seek competent legal counsel to make sure you are in compliance.

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Disclaimer: This is not legal or investment advice of any kind. Consult qualified securities attorneys. Your situation may vary.