Over the past three years companies subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (“Exchange Act”), without current business operations, and trading on the NASDAQ over the counter bulletin board (“OTCBB”) shells have become the vehicle of choice for private companies seeking to go public through a reverse merger.
Bulletin Board Shells have replaced non reporting pink sheet traded shells in popularity due to increasing industry pressure for public companies to maintain total disclosure of their financial condition as well as their operations. Whereas companies that trade on the pink sheets have little or no reporting requirements, Bulletin Board Shells must maintain detailed periodic, quarterly and annual filings with the SEC. In addition, Bulletin Board Shells are generally subject to the proxy rules of the Exchange Act requiring certain SEC filings and shareholder voting for amendments to the articles of incorporation, including reverse splits.
The importance of a reporting company may be self evident in that a potential merger or acquisition candidate can learn of outstanding liabilities, pending or threatened lawsuits, disputes with auditors and other obvious concerns. However, in addition to these obvious benefits, using a Bulletin Board Shell as a reverse merger vehicle as opposed to a non-reporting entity has other benefits.
Specifically, if an entity intends to become reporting in the future, they can be assured that historical records are available to meet SEC requirements for the filing of a registration statement. Moreover, a reporting Bulletin Board Shell is less susceptible to market manipulation, the concealment of beneficial ownership of key shareholders and other potentially fraudulent and unethical activities.
The other important feature that lends value to trading OTCBB or Bulletin Board Shells is the fact that it they are compliant with SEC Rule 15c2-11, making the companies “piggy back” qualified for market makers. SEC 15c2-11 requires a market maker to have on file certain due diligence information regarding a company prior to quoting that company’s securities. The market maker submits such information to the Financial Industry Regulation Authority (FINRA) for review and approval prior to beginning quotation of such securities.
Following approval of the 15c2-11 application, and the consistent quotation of a company’s securities, additional market makers may “piggy back” on the approved and completed 15c2-11. In short, a Market Maker may quote the share price of the Bulletin Board Shell while relying on the due diligence of other market makers.
OTCBB Due Diligence
Although highly technical, the due diligence process can be completed quickly and thoroughly by knowing where to look at what to look for.
- All articles and amendments are ordered from the Company’s state of domicile and are reviewed for procedural correctness.
- DTC (the Depository Trust Company) is contacted to confirm the Company is in a transferable status.
- Using several proprietary online search services, the firm conducts comprehensive debt and litigation searches to identify any miscellaneous debts as well as pending or past litigation.
- A tax search is run with the IRS to confirm the Company does not have any outstanding Federal or Employment Taxes owed.
- A complete copy of the Company’s shareholder records are ordered from the transfer agent and examined from an audit perspective; all issuance are strictly examined.
- When appropriate, the former transfer agent is contacted to ensure that the shareholder records were transferred directly, without interruption, from the former transfer agent to the current transfer agent. This ensures the integrity of the shareholder records and eliminates the possibility that the records were altered by the previous issuer.
- A NOBO (Non-Objecting Beneficial Owner) List is retrieved and examined.
- Background searches are run on the Company’s Officers and Directors, as well as on the Company itself, to locate any SEC, NASD, or state regulatory violations.
- In the event of a previous bankruptcy, the bankruptcy file is retrieved from the appropriate court of jurisdiction and the disposition of the bankruptcy is reviewed
Where Do OTCBB Shells Come From?
Bulletin Board Shells generally derive from a failed public company business. A company may have traded on the bullet board when operating and subsequently suffered a failure of the operating business leaving behind a shell. Moreover, NASDAQ exchange traded and AMEX Companies experience operational difficulties on a regular basis. Some fail to succeed in an ever competitive market, while others simply cannot adapt to what has become a global economy.
When this occurs, these companies may no longer be able to meet the listing requirements of their respective exchanges such as trading price or market capitalization. The Company then “falls off” to the OTCBB or Bulletin Board over the counter market. When the operating business ceases entirely it leaves behind a Bulletin Board shell Company. It also leaves behind a prime opportunity for up-and-coming private companies to take their place in the public market via a reverse merger.
The OTCBB Shell Company has no operations and no or nominal assets and liabilities, but the shareholders remain. In the process of an operating business failing and leaving behind a Bulletin Board Shell, many issues must be addressed in order to ensure that the successor business or merger candidate does not end up assuming the liabilities and responsibilities of the former operating business. In most cases these issues can be rectified. For example, prior liabilities may be written off if the statute of limitations has passed, or the debt may be settled.
The process of diagnosing potential issues with a Bulletin Board Shell is known as Due Diligence.
Cleaning Up OTCBB Shells
Cleaning up Bulletin Board Shells is primarily a legal function. Some of the specific details that constitute the process include;
- Reinstating the Company’s corporate charter and paying franchise taxes to the Company’s state of domicile
- Working with a PCOAB (Public Company Oversight Accounting Board) auditor to update all necessary financial statements and audits
- Updating the Company’s articles of incorporation and bylaws to ensure they suit the needs of the successor Company
- Conducting reverse splits of the Company’s outstanding shares of common stock in order to decrease the size of the outstanding common stock and increase the stock price.
- Updating the Company’s SEC filings and/or drafting and filing a Registration Statement
- Answering any outstanding SEC comments that were never satisfied by the Company’s former Officers and Directors
- Installing a qualified Board of Directors and/or a skilled management team
- Updating the Company’s corporate minute books and drafting any necessary board resolutions depending on the circumstance
- The preparation and distribution of shareholder proxies and certain notices should a shareholder meeting be necessary to satisfy disclosure requirements and ensure the furtherance of the successor Company
- Updating compliance procedures by drafting corporate compliance standards and implementing a code of ethics.
- Educating the board of directors regarding the legal responsibilities of being control persons of a public company, including the duty of loyalty, conflict of interest and self dealing obligations, prohibitions against short-swing profits and reporting requirements under sections 13 and 16 of the Securities Exchange Act.
- Drafting or updating an applicable business plan.
OTCBB Clarification
The OTCBB or Bulletin Board is not an “Exchange” as defined by the Securities Exchange Act of 1934, as amended, but rather is a centralized quotation system that is regulated by the Financial Industry Regulation Authority (FINRA). Accordingly, OTCBB Shells are not bound by the additional rules and regulations of a particular exchange such as the independence of directors; the requirement to maintain a separate audit committee; and the requirements to hold annual meetings while satisfying proxy requirements.
All companies whose stock is traded on the OTCBB or Bulletin Board must maintain their current reporting status with the Securities and Exchange Commission (SEC), including current audited financial statements.
Other than being current in SEC reporting obligations, there are no actual listing requirements associated with Bulletin Board Shells; for example the Bulletin Board does not set thresholds regarding number of shareholders; assets; market capitalization and share price. The fundamental difference between a Bulletin Board and lower tier shell, such as a Pink Sheet Shell, is the reporting requirements. A Bulletin Board Shell is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended including but not limited to the filing of annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
The 15C-211
The Over the Counter Bulletin Board (OTCBB) and Pink Sheets are quotation mediums for subscribing members. It is not a listing service for Issuer’s such as a national exchange (for example the NASDAQ Stock Market, AMEX, NYSE, etc.). Accordingly, Issuer’s do not apply for listing. Rather a Market Maker applies to the NASD for the right to quote a particular security and make a market for a particular security on the Over the Counter Bulletin Board (OTCBB). The application is referred to as a 15c2-11 application as Securities Exchange Commission Rule 15c2-11 sets forth the information requirements and need for such application.
The basis of a 15C2-11 application is intended to ensure that a market maker has adequate information and has completed adequate due diligence on an Issuer before it quotes their securities. In addition, Rule 15C2-11 requires that a market maker make such information available to the public, upon request, where such market maker makes a market in a security.
The information requirements do not apply to a market maker that quotes an issuer’s securities based on an exemption to the 15C2-11 application requirements. One such common exemption is where another market maker has completed the 15C2-11 application process and quotes a security for 30 consecutive days. Such issuer’s securities are considered “piggyback qualified” and as such, a new market maker wising to quote the securities, may “piggyback” on a previously filed 15C2-11 application.
The 15C2-11 application process is similar to a registration process, in that the Issuer provides disclosure information to a market maker who in turns files such information with the NASD who in turn comments on the information and asks additional questions. When the NASD is satisfied that the market maker has adequate disclosure (as provided by the Issuer) and that the Issuer has answered all questions the market maker may have (which have usually been posed by the NASD), the NASD will clear the 15C2-11 application and the Issuer’s securities can be quoted and traded.
The same 15C2-11 application is used to apply to quote securities on both the Pink Sheets and the Bulletin Board and absent an exemption, to move a quotation from the Pink Sheets to the Bulletin Board.
Although the market maker submits the application, it is based on information provided by the Issuer and accordingly, it is incumbent upon the Issuer to put together sufficient information and disclosure and to respond to comments. An Issuer needs qualified securities counsel to assist in this process.
The acquisition of a Bulletin Board Shell is succeeded by a reverse merger of the private entity into the dormant OTCBB Shell. For the inexperienced, the process is complex, and success hinges on retaining experienced securities legal counsel.
