Rule 144 vs Shell Companies

In February 2008, the Securities and Exchange Commission (the “SEC”) amended Rule 144 of the Securities Act of 1933 (“Rule 144”). Hidden behind the significant changes, such as the shorter holding period, is an important impact to shareholders of shell companies regarding whether they could use the Rule 144 resale exemption.

Under the amended Rule 144(i), Rule 144 is not available for the resale of securities issued by a shell company unless:

(A) the company is no longer a shell company as defined by Rule 144(i)(1);

(B) the company has filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act of 1934(the “Exchange Act”), as applicable, during the preceding 12 months (or for such shorter period that the issuer was required to file such reports and materials), other than Form 8-K reports; and

(C) the company has filed current “Form 10 information” with the SEC reflecting its status as an entity that is no longer an issuer described in paragraph (i)(1)(i), and at lease one year has elapsed from the date that the issuer filed “Form 10 information” with the SEC.

How will the new Rule 144(i) affect public companies which finish their public process by merger with a shell company, such as some of our clients? From our legal practice, even though those companies are no longer shell companies, they still need to face two main issues.

I. Longer holding period before resale.
Under Rule 144(i), the resale exemption is available only after one year of the filing of “Form 10 information” with the SEC. For example, XYZ Company finished a reverse merger in January 1, 2009 and ceased to be a shell company. In January 2, 2009 XYZ Company filed with SEC the super 8-K with Form 10 information. When can the shareholders of XYZ Company start to resale under Rule 144? The answer is January 2, 2010, one year after the 8-K filing, even though they might satisfy the 6 months holding period requirements under Rule 144(d).

II. Higher risk for the shareholders of former shell companies.
Under Rule 144(i), the former shell companies must file with SEC all reports required by the Exchange Act during the preceding 12 months of the resale. For Instance, XYZ Company is supposed to file its Form 10-K on March 31, 2010. However, XYZ Company doesn’t make the filing. On April 1, a shareholder of XYZ Company wants to have the restricted legend removal and gets a clean certificate of her shares. Can she do so? The answer is no. She has to wait 12 months after XYZ Company makes the Form 10-K filing, before she could rely on Rule 144 for resale. The same risk bears with shareholders having the legend removed but not to sale the shares on time. The practical method to solve the issue is to sale the shares immediately after the legend removal, to avoid the potential risk that the companies can not meet the Exchange Act requirements.

The new Rule 144(i) will not only affect the shareholders of shell companies, but also will have far reaching impact even to shareholders receiving their shares after the company ceases to be a shell company. So far, the SEC has not taken any action to deal with the results of Rule 144(i). In the Compliance and Disclosure Interpretations (“C&DIs”) issued August 14, 2009, the staff at the SEC’s Division of Corporate Finance answered the following question of Rule 144(i).

Section 137. Rule 144(i) — Unavailability to Securities of Issuers with No or Nominal Operations and No or Nominal Non-Cash Assets

Question 137.01

Question: If an issuer had previously been a shell company but is an operating company at the time that it issues securities, is the Rule 144 safe harbor available for the resale of such securities if all of the conditions in Rule 144(i)(2) are not satisfied at the time of the proposed sale?

Answer: No. Rule 144(i)(1) states that the Rule 144 safe harbor is not available for the resale of securities “initially issued” by a shell company (other than a business combination related shell company) or an issuer that has “at any time previously” been a shell company (other than a business combination related shell company). Consequently, the Rule 144 safe harbor is not available for the resale of such securities unless and until all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale. [Jan. 26, 2009]

Written by Claire Libing Wu | Download v-card

View LinkedIn Profile for Claire Libing: Claire Libing Wu is a member of Guzov Ofsink’s corporate, securities and Asia practices. Her experience includes private placements and public offerings of securities, mergers and acquisitions, debt and equity financing, and other securities law matters. She assists Chinese clients in a wide range of industries with the process of obtaining financing and going public in the U.S., including completing reverse merger, making timely filings with SEC and listing on NASDAQ.