Reverse Mergers - revised resale rules

The SEC has just revised Rule 144, the regulation that provides a safe harbor exemption for the public resale of stock that was purchased in a private placement transaction. The rule change became effective on the 15th of this month. Today's entry will provide an overview of the rule change. This discussion is general in nature, does not constitute legal advice to any person, and does not apply to directors, officers and other corporate insiders who can be classified as "affiliates."  If you own restricted stock that you want to sell, you should consult your own attorney before taking any action.

The SEC's goal in adopting the rule change was to make it easier for investors to sell restricted stock, while maintaining the bulk of the current restrictions for affiliates. While the changes are beneficial for most investors, they have complicated the analytical matrix and made it far more difficult for an average investor to understand what the changes mean to him.

The Old Rule 144

Most investors understood what the old Rule 144 required. If the issuer was registered under the Exchange Act and current in its reporting, and you were not an affiliate:

• During the first year of ownership you were not allowed to sell any stock;
  
• During the second year of ownership you were allowed to sell up to 1% of the company's outstanding stock in any rolling 90-day period; and
  
• After two years of ownership, the restrictive legends could be removed and your stock could be deposited in a brokerage account.
  

The old Rule 144 also included manner of sale restrictions and required the seller to report sale transactions on Form 144.

New Rule 144 - Reporting Issuers That Have Never Been Shells

The new Rule 144 is most beneficial for investors that hold stock issued by companies that have never been shell companies, are registered under the Exchange Act and are current in their SEC reports. If those three requirements are satisfied and you are not an affiliate of the issuer:

• During the first six months of ownership you can't sell any stock;
  
• After six months you can engage in unlimited public resales; and
  
• After one year restrictive legends can be removed and your stock can be deposited in a brokerage account.
  

New Rule 144 - Nonreporting Issuers That Have Never Been Shells

The new Rule 144 also provides rules for the resale of stock issued by companies that have never been shell companies and are not registered under the Exchange Act. If you are not an affiliate of a non-reporting issuer:

• During the first year of ownership you can't sell any stock; and
  
• After one year you can engage in unlimited public resales.
  

New Rule 144 - Current and Former Shell Companies

While the new Rule 144 is beneficial for the stockholders of issuers that have never been shell companies, it imposes harsh restrictions on the shareholders of current and former shell companies. The basic rule is that stockholders of issuers that are now or have ever been shell companies cannot rely on the safe harbor unless:

• The issuer is no longer a shell company;
  
• The issuer has registered under the Exchange Act;
  
• The issuer is current in its Exchange Act reporting; and
  
• At least one year has elapsed since the issuer filed Form 10 type information with the SEC reflecting its status as an operating entity.
  

We view the shell company limitations of the new Rule 144 as a potential minefield for investors and their lawyers, and will be curious to see how the SEC's staff interprets those limitations in the future. 

Until the staff's interpretive position is clarified, we will advise our clients to regard non-reporting shells and companies that have merged with non-reporting shells as toxic waste. We will also advise that the risks of a reverse merger with a reporting shell are far greater than they were before the rule change.