Interesting New Method of Shell Creation - But be Careful

As you all know as faithful blogees, I have been trying to find every legitimate way to create a shell that does not involve deception, failing to disclose real intent and so on. Until now, I had thought the only way to do that was by inheriting the now-dormant public vehicle that was a real operating public company at some point in the past, whose stock often continues to trade, or setting up a Form 10 shell which is fully SEC reporting but is not permitted to have its stock trade until a merger and subsequent registration of shares.

The ingenuity of our industry never ceases to amaze. There is a new development which was enhanced by the SEC’s now famous footnote 172 to its Rule 144 rulemaking last year. Part of that footnote is less famous. It basically clarifies something that was not clear before. If you own stock that was issued when the company was a real operating business, even if it becomes a shell company later, the shareholder still can sell under Rule 144 while it is a shell. As a result we are starting to see players find a dormant company that was never public, and presumably has sufficient shareholders to qualify for trading. They take over this company and file Form 10 on its behalf, admitting it is a shell, “checking the shell box,” and confirming its intent to find a business to acquire. Since it is a shell you cannot file a Form S-1 to register shares for trading without all the burdensome restrictions of good old Rule 419. But Form 10 works. The key with a Form 10 approach is that holders have to have the ability to sell without registration for it to work. But with the new footnote, even if it is a shell, those holders who bought when it was operating can sell without being registered even while it is a shell.

The good news is that this does indeed work and is not misleading in any way. The company admits it’s a shell and doesn’t try to “pretend” to be a real operating business in order to develop a trading market. The shareholders can begin to sell immediately if they have held their shares at least six months. The bad news is that I understand the SEC staff believes that the tradability of the shares in question under Rule 144 ceases once the shell ceases again to be a shell, and cannot be sold again until one year has passed from the reverse merger and release of the “super” Form 8-K. In other words, all shareholders’ ability to sell under Rule 144 is suspended during that one year. Thus, these shareholders have the small window when the shell is a shell in order to use the 144 exemption to sell, then must wait like all other holders.

Note: this is not clear in the text of the foonote, and I have only unofficial and informal guidance. So if you follow this informal advice, you indeed create a shell and get a ticker symbol for this former operating business, and trading can commence. But for any holder who does not sell during the time it is a shell, they become restricted again. If no holders have sold, this means there is zero float post-merger for one year unless shares are registered. But arguably this is still better than a Form 10 shell, because the company can retain its ticker symbol obtained while a shell, even though no one can yet trade for a period. A number of critics of Form 10 claim that the lack of a ticker symbol post-merger is risky, though most disagree and know that any legitimate company meeting the criteria for the OTC Bulletin Board will obtain a ticker reasonably quickly. But perception is everything, and in the market having that ticker arguably will enhance the value of the vehicle.

If all holders sell under Rule 144 while the company is a shell, subsequent holders are not bound by 144 and can publicly sell into the marketplace. So the key if you are creating one of these: hope that all your shareholders make that initial sale under 144 so that a trading market can continue post-merger. Definitely interesting though.

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