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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Disclaimer: This is not legal or investment advice of any kind. Seek competent advice from qualified attorneys and investment professionals. Your situation may vary. The more you know about finance and business, the more you can profit