image description

SEC Sounds Alarm on Reverse Mergers

by Yoko Goto
Eyes On Wall Street |

On June 9, the U.S. Securities and Exchange Commission issued a bulletin warning investors about companies that enter U.S. markets through so-called "reverse mergers"-and explaining how they can be detected.

In a reverse merger, a private company merges with an existing public shell company to become listed on a U.S. exchange and gain access to capital markets-a process that avoids the regulatory scrutiny given to IPOs.

The bulletin points out that the lack of transparency in reverse merger companies poses grave risks to investors. However, it can be very difficult to determine whether a public company has undergone this process.

To assist investors, the SEC identifies risk factor disclosures in SEC filings that may serve as red flags signaling a reverse merger.For example, the SEC urges that investors look out for words or phrases such as "lack of public company experience," "lack of history of compliance with U.S. securities laws and accounting rules," "inability to comply with federal securities laws" or "inability to attract the attention of major brokerage firms."

The risks involved in reverse mergers are more than theoretical. The SEC and U.S. exchanges have recently cracked down on many companies that became public through this process. Trading in more than a dozen such companies has been suspended due to a lack of current, accurate information about these firms and their finances. In addition, several reverse merger companies have recently seen their securities registrations revoked because of failures to make required periodic filings.