United States: SEC Approves New Rules To Toughen Listing Standards For Reverse Merger Companies

On November 8, 2011, the SEC approved new rules proposed by the NASDAQ Stock Market ("NASDAQ"), New York Stock Exchange ("NYSE") and NYSE Amex that toughen the initial listing requirements for reverse merger companies.¹ Reverse merger or reverse takeover companies (RTOs) typically refer to private operating companies, many of which operate primarily outside the United States, that have become public by combining with an existing U.S. public reporting shell company through a reverse merger or similar process.

Reverse merger companies based overseas have recently been the subject of increased public scrutiny and regulatory focus because of a number of accounting fraud allegations and other irregularities associated with these companies.² In recent months, the SEC and U.S. exchanges have suspended or halted trading in more than 35 companies, at least 25 of which are reverse merger companies with primary operations outside of the U.S., based on a lack of current and accurate information about the companies and their finances.

Under the new rules, NASDAQ, NYSE and NYSE Amex will impose additional listing requirements for companies that seek to become public through a reverse merger. Under the new rules, a reverse merger company would be eligible to apply for an initial listing on the applicable exchange only if it meets certain "seasoning period", filing and minimum stock price requirements as follows:

Seasoning Period. The reverse merger company must have traded for at least one year in the U.S. over-the-counter market, on another national securities exchange or on a regulated foreign exchange following the reverse merger, and filed all disclosures and financial information required by the SEC in connection with the reverse merger transaction.

Filings. The reverse merger company must have timely filed all required reports since the reverse merger transaction, including the filing of at least one annual report containing all required audited financial statements for a full fiscal year commencing after the date of the company's initial SEC filing relating to the reverse merger transaction.

Minimum Stock Price. In the case of listings on NASDAQ and NYSE, the reverse merger company must have maintained a closing stock price of $4 or higher for a sustained period of time, but in any event for at least 30 of the most recent 60 trading days prior to each of the date of the initial listing application and the date of listing. In the case of NYSE Amex, the stock price minimum is $2 or $3 depending on the type of listing.

A reverse merger company must also comply with all other applicable initial listing requirements, which include, among other things, corporate governance requirements and distribution, stock price and market value requirements.

In addition to the above requirements, NASDAQ, NYSE and NYSE Amex have the discretion to impose more stringent standards on the reverse merger company based upon certain factors, including, among others, an inactive trading market, a low number of publicly traded shares or if the company has disclosed a material weakness in its internal controls.

The new rules provide an exemption from these new requirements if the reverse merger company is listing in connection with a firm commitment underwritten public offering that meets certain offering size requirements. Also, the new minimum stock price requirement generally does not apply if the reverse merger company has satisfied the "seasoning period" requirement and has filed at least four annual reports with the SEC that each contain all required audited financial statements for a full fiscal year commencing after making all required filings in connection with the reverse merger transaction.

The new rules aim to protect investors by requiring a pre-listing "seasoning period" during which the reverse merger company would have produced and filed required financial and other information. The "seasoning period" is intended to give time for regulatory and market scrutiny of the company, as well as time for auditors to detect any potential irregularities and to address any internal control weaknesses. The minimum price requirement is intended to make it more difficult for a reverse merger company to employ a quick manipulative scheme in the securities of the company by requiring a minimum price to be sustained for a meaningful period of time.

Footnotes

1 See Release Nos. 34-65708, 34-65709, and 34-65710.

2 See SEC Investor Bulletin: Reverse Mergers (Jun. 9, 2011); PCAOB Research Note No. 2011-P1, Activity Summary and Audit Implications for Reverse Mergers Involving Companies from the China Region: January 1, 2007 through March 31, 2010 (Mar. 14, 2011); PCAOB Staff Audit Practice Alert No. 8: Audit Risks in Certain Emerging Markets (Oct. 3, 2011).

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