Reverse Mergers - trading OTCBB Shells - the Dark side

It doesn't take much surfing around the Internet to find lots of material from promoters hawking trading OTCBB shells. The promotional descriptions invariably talk about how clean, or even pristine the shell company is. But I remain a devout skeptic.

It is virtually impossible to list a new shell, other than a SPAC, on the OTC Bulletin Board. So virtually every company that is being touted as a clean OTCBB shell is a public company that has already failed in at least one business. On balance, I think it would generally be fair to say that all the talk about clean OTCBB shells is about as reliable as a used car dealer's pitch about a shiny low-mileage beauty sitting on his lot.

In 28 years of representing entrepreneurs, the one immutable constant has been that when a company is experiencing operating or financial difficulties, its management team starts talking louder to support a sagging stock price and working harder to bring in badly needed capital. For a public company, these are very high risk behaviors because:

• Section 12 of the Securities Act makes it illegal for a company to sell stock by means of any written or oral communication that includes an untrue statement of material fact or fails to state a material fact that is necessary to make the other statements made by the company not misleading;
  
• Rule 10b-5 under the Exchange Act makes it illegal for anybody, in connection with the purchase or sale of a security, to (a) employ a device, scheme or artifice to defraud; (b) make any untrue statement of a material fact or to fail to state a material fact  that is necessary to make the other statements that were made not misleading; or (c) engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person; and
  
• The securities or "Blue Sky" laws of most states have similar provisions for investor protection
  

If a company violates Section 12, Rule 10b-5 or a wide variety of state securities laws, the measure of damages is usually the amount of money the investor lost as a result of the false or misleading statement.

Human nature being what it is, few entrepreneurs can stand idly by and watch their businesses fail without engaging in some conduct that will give rise to substantial carry-over liabilities under the securities laws. If you enter into a reverse merger with a public company that has undisclosed securities act liabilities, all of your assets and your business itself will be fully exposed to those claims.

For a company that is contemplating a merger with an OTCBB shell, the process of obtaining a reasonable level of comfort that there are no contingent Section 12, Rule 10b-5 or state securities law liabilities can be overwhelming. When we are asked to advise a private company that wants to combine with an OTCBB shell, our response is always the same:

"We cannot give you any comfort or assurance that there are no contingent securities law liabilities."

Since our clients are never happy with that answer, we fastidiously avoid reverse mergers with any shell that has sold any securities or been actively traded at any time within the last three years. In practice, we prefer shells that (a) have been through a full Chapter 11 reorganization, and (b) have not been actively traded for several years.

It is relatively easy to clean up the balance sheet of a failed public company; and if you're only interested in a balance sheet review, I suppose there are lots of clean OTCBB shells out there. 

As a practicing lawyer, the only way I can tell a client that an OTCBB shell is clean is by reviewing the docket in its Chapter 11 case and making sure that no trades have occurred for several years.

Undisclosed securities liabilities are not the only potential problem one typically encounters with trading OTCBB shells, but they're the ones that can cost you your company.