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TOPIC: Footnote 32 Shells

Footnote 32 Shells 7 years 8 months ago #1508

[Re: Footnote 32 Shells]
Really very great and informative article
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Footnote 32 Shells 9 years 8 months ago #1327

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[Footnote 32 Shells Pose Threat]
Footnote 32 Shells Pose Threat by Reg Crowder

A little-noticed footnote tucked away in a two-year-old Securities and Exchange Commission rule may be a "ticking time bomb" capable of destroying some of the companies that have gone public by reverse merging into trading shell companies.

Boiled down to its essence, the problem arises when the SEC discovers that what was really a shell company went public some time in the past by masquerading as an operating business or a start-up.

Securities lawyers and reverse merger players say they don't know exactly when or how this time bomb will go off. But they believe the SEC staff has been giving them -- for some time -- subtle indications that it is just waiting for the perfect case that will enable the SEC to drop the hammer on "Footnote 32 shells."

"When that happens, even for a company that innocently merged into a trading shell that falls under Footnote 32, it's "game over" for the company," said securities lawyer Jim Moloney, a former SEC staff attorney who is now a partner in the Orange County, Calif. office of Gibson Dunn & Crutcher. His six years with the SEC included three years as special counsel in the Office of Mergers & Acquisitions.

Moloney said the Footnote 32 trap could easily go unnoticed by the SEC for years. He said the passage of time offers absolutely no protection for the unsuspecting company that has reverse merged into what turns out to be a Footnote 32 shell. The filing of every new SEC form increases the chance of the SEC staff comparing the most recent action with earlier filings that describe precisely how the company became public Maloney said.

"At the very least, this is rescission event, he said. "Every single person who purchased stock after the improper going-public event is entitled to rescind their purchase. The company is required to pay back the money and disgorge any profit gained as a result of the stock sale." After that, it gets worse. Moloney said the SEC has a variety of additional tools available to deal with a company caught in a Footnote 32 shell, including seeking criminal prosecution.

So, exactly what is the Footnote 32 and what makes it so dangerous?

Footnote 32 was included in the SEC rule-making in June 2005 that tied up several regulatory loose ends for the reverse merger business. The provision that stands out is the requirement for the filing of a complete disclosure document four days after a company completes a reverse merger into a shell.

The entire final rule, including commentary and footnotes, was published in the Federal Register on July 21, 2005. Footnote 32 isn't terribly long or difficult to follow, but worth viewing in its entirety:

"We have become aware of a practice in which the promoter of a company and/or affiliates of the promoter appear to place assets or operations within an entity with the intent of causing that entity to fall outside of the definition of blank check companies in Securities Act Rule 419. The promoter will then seek a business combination transaction for the company, with the assets or operations being returned to the promoter or affiliate upon the completion of that business combination transaction.

"It is likely that similar schemes will be undertaken with the intention of evading the definition of shell company that we are adopting today. In our view, when promoters (or their affiliates) of a company that would otherwise be a shell company place assets or operations in that company and those assets or operations are returned to the promoter or to its affiliates (or an agreement is made to return those assets or operations to the promoter or its affiliates) before, upon completion of, or shortly after a business combination transaction by that company, those assets or operations would be considered 'nominal' for purposes of the definition of shell company."

Although nominal is commonly defined by laymen as existing in name only, the SEC refused to define the word in the regulation. It said establishing a quantitative threshold would make sidestepping the intent of its regulations and the misuse of shell companies easier. In other words, if the SEC were to set a dollar value test, the scammers would come in with one dollar more.

Thus, the rule doesn't say exactly what will trigger an SEC challenge to a company's claim that it is outside the Rule 419 definition of a blank check company. But it does put the reverse merger industry on notice that it is on the lookout for schemes that have the intention to evade being defined as a shell company.

Securities lawyer David N. Feldman, with Feldman Weinstein & Smith, said dishonest shell promoters try to get around Rule 419, which lays down the procedures for IPOs by blank check companies, because the rule is highly restrictive.

"Those who comply with Rule 419 are at a disadvantage because, under this rule, the stock issued in an IPO of a shell cannot trade, and promoters believe it is important for their shell's tock to trade," Feldman said. On the other hand, he said, operating businesses and start-up ventures are example from Rule 419. From the shell buyer's perspective, Feldman said he personally doesn't agree that a trading shell is worth a lot more than a non-trading shell. But many buyers of trading shells see things differently. The words "trading shell" are magic n the marketplace today. And that is what drives promoters to continue offering Footnote 32 shells to unsuspecting buyers, even in the face of the SEC's not-so-subtle warning.

Tim Keating, founder and president of Keating Investments, said shell buyers today will pay $600,000 to $1 million for a trading shell that would have sold for $200,000 just a few years ago. He said the pieces of trading shells have been driver sky high by the acceptance of the combined reverse merger and PIPE, commonly known as an APO, as well as the seemingly insatiable demand from private Chinese companies eager to go public in the U.S.

The cost of creating a legitimate trading shell is somewhere in the vicinity of $100,000, while a bogus trading shell might be launched with as little as $50,000, Keating said. That's not exactly chopped liver in itself. But the really big payoff for the promoter is on the back-end of the deal. The seller of a Footnote 32 trading shell could easily get $550,000 for the controlling stake in the shell.

"This $500,000 windfall is money for nothing," Keating said. "Who can blame the private company that is attracted to the 'failed' Internet consulting business that only had three months of operations, no revenue, no employees, no real business, etc.? Why wait six months to a year to get a ticker symbol when a 'clean' Footnote 32 shell has a symbol that is available today?"

Keating answered his own question: "I am confident that the SEC will continue to closely review and monitor all reverse mergers," he said. "Among other things, I believe the commission will be on the lookout for 'serial business creators whose companies coincidentally all happen to become shells. It will only take one strong enforcement action to act as a major deterrent to this kind of bogus shell creation activity."

Asked directly what it intendeds to do about abusive Footnote 32 shells, an SEC spokesperson would only say that no enforcement or regulatory actions were currently underway.

Nimish Patel, a partner in the Richardson & Patel law firm, said it is customary for the SEC to be closed-mouthed about an issue while it is getting ready to make an example of an offending company.

The filing of a Form 8-K announcing a reverse merger a short time after a company's going public event is one dead giveaway that the company is going to run afoul of Footnote 32, he said.

"Say a company is doing a reverse merger and just a few months ago they went public," Patel said. "Before, they were eager to start a company and now they want to get rid of it as a shell. You've got to ask what's going on. The SEC staff is going to see that, too. I think the SEC staff is waiting until they have enough data points to know they have the perfect case. And then they'll starting writing letters. And then they'll start making examples of companies. And they'll start putting out press releases about Footnote 32 shells."

Meanwhile, what can legitimate companies do to avoid becoming entangled in bogus trading shells? Securities lawyer Feldman has put together a list of seven telltale signs of a Footnote 32 shell:

A start-up or very early stage company is doing an IPO or other going public event and allowing shareholders to resell their stock in the public market.

The filing is completed less than one year after the company is started.

The IPO is seeking to raise very few dollars (maybe $100,000) and usually ends up raising much less.

Management of the company has little or no experience in the supposed business they are creating -- or have experience in securities, corporate consulting or other specialties closely associated with Wall Street.

The company claims to be based in Utah, Nevada or Canada.

The company intends to engage in a business relation to oil, gas or mineral rights, or owns rights in entertainment projects that have no been developed.

The officers, directors, large shareholders or consultants have launched small companies of the sort described above many times before.

Feldman said he advises his clients to avoid, at all costs, getting involved with any company that has the slightest change of being identified by the SEC as a Footnote 32 shell. "For an innocent, unsuspecting company, a Footnote 32 shell is a ticking time bomb just waiting to go off," he said.

A quick look at trading shells now being marketed for use in reverse mergers confirms that the industry retains much of its carnival atmosphere. That includes the marketing of supposedly "trading shells" that have absolutely no operations or assets.

In what might be a new twist, a trading shell was recently offered on eBay online auction and shopping website with an asking price of $150,000. The eBay listing described the company as a public trading shell with no assets or operations -- yet ready to list on the Bulletin Board.

Internet marketers of shells routinely offer potential buyers no more information about themselves than their web address, e-mail address and a telephone number that is difficult or impossible to trace. The shell promoter using eBay took the process one step further, using the eBay system to conceal all of his contact information and make the offering under an alias, "Analoxide." The only option available to a purchaser willing to ask for more information was to send questions through the eBay messaging system.

"Analoxide" described the shell as a public shell trading on the Pink Sheets. However, the promoter did not include the company's name or trading symbol. "I normally broker diamonds and precious metals along with fine jewelry but am known in the tight knit shell community for being able to raise money for public companies that previously reversed into the company they are currently running." the promoter's pitch said.

The promoter said that in the past two years he has acted as a consultant for a shell company that raised over $3.5 million. He said the trading shell offered for sale on eBay had no operations, no assets and no debts. The promoter added: "The shell is
504 qualified and all you need is a [Form] 15c2-11 on file to jump to the OTCBB!"

The promoter responded to an inquiry from RMR through the eBay messaging system, identifying himself only as Scott. "I do not want to provide my contact info or more specific information on myself, due to wanting to stay off the SEC radar," he said. "...If you have ever had the experience of sitting in the Washington, D.C. headquarters of the SEC then you would know that being grilled by up to six agents plus a Justice Department investigator is about as much fun as drinking your own blood. It's extremely costly , too, since SEC attorneys are some of the most expensive ones/

Responding to one of RMRs questions, Scott said he was confident the shell would survive any SEC review under Footnote 32 with no problems. "I did not create the shell six months ago or anything like that," he said. "I bought it a couple of years ago to put a business into. I got involved with another company that was listed on the OTC at the time and never got around to doing anything with it." He said he also has another shell company available for sale and possesses all the relevant records for "all the reverse mergers since the shell was created in the early '90s."

Scott answered RMR's inquiry from an email address associated with Gemrush.com, an online marketer of jewelry, precious stones and precious metals. The domain registration record for Gemrush.com lists the registrant contact, technical contact and administrative contact as Stealth Enterprises Inc. and Scott Gold of Lake Villa, Ill.

Despite Scott's confidence that his trading shell with no assets or operations would have no difficulty getting the SEC's blessings, that's not how it always goes when a company starts making filings with the SEC in preparation for raising money. As it turns out the SEC is, in fact, quietly watching for shell companies masquerading as operating companies and they are catching them.

Nevada corporation Knickerbocker Capital Corp., which has its home office in California, learned that lesson after it took the position that it was a going concern in its Jan. 3, 2006, Form 10-SB filing. On the same form it showed no operations or assets of any consequence. The filing also raised the possibility of selling Knickerbocker shares under a SEC Rule 144 exemption.

The SEC staff responded that Knickerbocker Capital Corp. was really a blank check company and that the Rule 144 exemption to registration was not available to it. The Jan. 11, 2006 SEC letter said that a blank check's shares must be registered under the Securities Act of 1933 before they may be sold.

Knickerbocker's president Dempsey K. Mork argued in a response to the SEC staff that the company at one time had operations.

"Knickerbocker completed an S-18 registered offering of its common stock on April 7, 1988, raising $300,000," Mork said. "On June 10, 19888 Knickerbocker acquired a concrete formula and rights to produce and sell a concrete product by acquiring the stock of the owning corporation. Knickerbocker issued common stock to the owners of this corporation and the developer of the formula."

The SEC staff didn't buy it. Knickerbocker gave in and declared its shell status on a subsequent Form 10-KSB. At the SEC's insistence, the company's later filings disclosed the fact that all but 24,090 of Knickerbocker's two million outstanding shares were prohibited from being sold until they are registered.

Nevertheless, today Knickerbocker Capital Corp. is being marketed on the website Publicshellmergers.com as a "fully reporting public shell company" trading on the Bulletin board under the symbol KNIK. As it turns out, Knickerbocker hasn't filed anything with the SEC since it submitted a Form 10-QSB back in August 2006. The company's prior SEC filings clearly state that Knickerbocker has not had a public market or listing anywhere since 2005.

Mork did not respond to RMR's request for an explanation. Identical requests submitted to Publicshellmergers.com were not answered.

www.feldmanweinstein.com/inthenews_article.cfm?NewsID=36
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Footnote 32 Shells 9 years 8 months ago #1326

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[SEC Footnote 32]
We have become aware of a practice in which a promoter of a company and/or affiliates of the promoter appear to place assets or operations within an entity with the intent of causing that entity to fall outside of the definition of “blank check company” in Securities Act Rule 419. The promoter will then seek a business combination transaction for the company, with the assets or operations being returned to the promoter or affiliate upon the completion of that business combination transaction. It is likely that similar schemes will be undertaken with the intention of evading the definition of shell company that we are adopting today. In our view, where promoters (or their affiliates) of a company that would otherwise be a shell company place assets or operations in that company and those assets or operations are returned to the promoter or its affiliates (or an agreement is made to return those assets or operations to the promoter or its affiliates) before, upon completion of, or shortly after a business combination transaction by that company, those assets or operations would be considered “nominal” for purposes of the definition of shell company.

www.sec.gov/rules/final/33-8587.pdf
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Footnote 32 Shells 9 years 8 months ago #1325

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[Footnote 32 Shells]
A Footnote 32 Shell Stock is a type of Shell Stock that is created to bypass the SEC’s Rule 419 that places restrictions on public offerings of Shell Stocks.

For more information, see the Glossary of Shell Stock Terms.
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