Companies Going Public Through Reverse Mergers

By Cydney Posner

Consistent with the heightened scrutiny proposed by Nasdaq (see the email below) for companies going public through reverse mergers, the SEC has just posted an Investor Bulletin warning potential investors about the risks of investing in these companies.

The Bulletin contends that "[m]any companies either fail or struggle to remain viable following a reverse merger. Also, as with other kinds of investments, there have been instances of fraud and other abuses involving reverse merger companies. In light of these considerations, individual investors should take into account their own financial situation, consult their financial adviser, and perform thorough research before making any investment decisions concerning these types of companies.

"Another consideration is that some of the foreign companies that access the U.S. markets through the reverse merger process have been using small U.S. auditing firms, some of which may not have the resources to meet its auditing obligations when all or substantially all of the private company's operations are in another country. As a result, such auditing firms might not identify circumstances where these companies may not be complying with the relevant accounting standards. This can result in increased risks for investors."

The Bulletin also includes examples of risk factor disclosures applicable to reverse merger companies and identifies a substantial number of recent enforcement actions targeting reverse merger companies.

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