News

New Rules Posted Regarding Shell Companies

News Brief
July 15, 2005

By: Cydney Posner

The SEC has now posted its new rules regarding the use by reporting shell companies of Forms S-8, 8-K and 20-F. The rule amendments prohibit the use of Form S-8 by shell companies and require a shell company that ceases to be a shell company to disclose the same type of information that would be required to register a class of securities under the Exchange Act. These rules will take effect 30 days after publication in the Federal Register, except that new Item 5.06 of Form 8-K will take effect on November 7, 2005.

Rule 405 and Rule 12b-2 will now define a "shell company" as a company, other than an asset-backed issuer, with:

  • no or nominal operations; and
  • either:
    • no or nominal assets;
    • assets consisting solely of cash and cash equivalents; or
    • assets consisting of any amount of cash and cash equivalents and nominal other assets.
A subset of shell companies, "business combination related shell companies," will be subject to limited exceptions to these rules. A "business combination related shell company" is a shell company formed by an entity that is not a shell company solely for the purpose of:

  • changing that entity’s domicile solely within the United States; or
  • completing a business combination transaction among one or more entities other than the shell company, none of which is a shell company. As defined in Rule 165(f), the term "business combination transaction" is any transaction specified in Rule 145(a) or an exchange offer.
The SEC adopted the prohibition on use of Form S-8 by reporting shell companies out of concern that these companies, which do not operate businesses and rarely have employees, may inappropriately use the form to circumvent the registration and prospectus delivery requirements of the Securities Act. The prohibition on use of Form S-8 continues until 60 days after the shell company ceases being a shell company and files information equivalent to that required for registration of a class of securities on Form 10, There is an exception to this prohibition for a business combination-related shell company, which may use Form S-8 immediately after it ceases being a shell company and files the required information.

In addition, there have been several amendments to Form 8-K requiring shell companies to report more detailed information in the event of "reverse mergers" and other similar transactions. In a "reverse merger," the private business merges into the shell company, with the shell company surviving and the former shareholders of the private business controlling the surviving entity. In another common type of transaction, a "back door registration," the shell company merges into the formerly private company, with the formerly private company surviving and the shareholders of the shell company becoming shareholders of the surviving entity.

In these transactions, the reporting company will be required to file current reports on Form 8-K to report both the entry into a material non-ordinary course agreement (Item 1.01) with respect to the transaction and the completion of the transaction under either or both of Item 2.01 (Completion of Acquisition or Disposition of Assets) and Item 5.01 (Changes in Control of Registrant) by the surviving entity. These two items have been amended to require the inclusion of the information that would be required if the shell company were filing a general form for registration of securities on Form 10 or Form 10-SB, with that information reflecting the surviving entity and its securities upon consummation of the transaction. However, if any disclosure required has been "previously reported," as that term is defined in Rule 12b-2, the company may identify the filing in which that disclosure was included instead of including that disclosure in the report. Audited financial statements and pro forma financial information would be required to be filed under Item 9.01 for transactions reportable under Item 2.01.

The SEC has also added new Item 5.06 to Form 8-K to require shell companies (other than business combination-related shell companies) to report transactions that cause them to cease being shell companies The report is required to be filed within four business days after completion of the transaction. Further, the extension of time that otherwise may be permitted to file financial statements and pro forma financial information reflecting the new financial profile of the company following completion of a significant acquisition is eliminated for shell companies. There are similar reporting requirements for foreign private issuers on Form 20-F.

Finally, the SEC has added a check box to Form 10-Q, Form 10-QSB, Form 10-K, Form 10-KSB and Form 20-F to allow market participants and regulators to identify shell companies more easily.

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