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Necessity of Background Searches on Officers and Directors as Part of Due Diligence Prior to a Reverse Merger or IPO

If you are a private company looking to go public on the OTCBB, securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel. Ms. Anthony counsels private and small public companies nationwide regarding reverse mergers, corporate transactions and all aspects of securities law.

Many private companies go public either through a reverse merger with a public shell or initial public offering (IPO) process. A reverse merger allows a private company to go public by purchasing a controlling percentage of shares of a public shell company and merging the private company into the shell. An initial public offering is where the private company files a registration statement with the Securities and Exchange Commission and once the registration statement is effective proceeds to sell stock either directly (a DPO) or more commonly through an underwriter.

It is very important that management of public shells and underwriters conduct a background check on the private company’s officers and directors prior to embarking on any transaction that will result in a private company becoming public. While a reverse merger saves on the costs associated with going public, private companies must be weary of the intentions of the officers and directors associated with the takeover.

Within four days of completing a reverse merger of with a shell public company, the company must file a form 8-K which contains all the information that is required in a Form 10 registration statement. Such information includes Regulation S-K Items 401 and 404. This same information must be included in a registration statement filed to conduct an IPO.

Regulation S-K Item 401 requires public companies to provide detailed information regarding its directors, executive officers, significant employees, promoters and control persons, including, but not limited to, the following:

  • Name, age and positions with the company
  • Family relationships among directors, executive officers, significant employees, promoters and control persons
  • Detailed background, business experience and employment for the last five years
  • Directorships in other public companies;
  • Involvement in any of the following legal proceedings in the past five years:
    1. Any personal or corporate bankruptcy proceedings;
    2. A conviction in a criminal proceeding or being named the subject of a pending criminal proceeding;
    3. Being subject to an order, judgment or decree permanently or temporarily enjoining or permanently or temporarily barring the person from acting as a broker, associated person; investment adviser, underwriter, dealer, affiliated person, director or employee in any way related to the securities or banking business; engagement in any securities related activities or violating any state or federal securities laws;
    4. Being found by a court to have violated any state or federal securities or commodities laws;

Regulation S-K Item 404 requires public companies to provide detailed information regarding transaction by and among related persons including transactions by and among the company and any of its directors, executive officers, significant employees, promoters and control persons. Moreover, Item 404 requires detailed information regarding how such transactions were reviewed, approved and ratified.

Clearly it is important for all parties to know well in advance the disclosures that will be required regarding its directors, executive officers, significant employees, promoters and control persons. Moreover, it is important for both public shell companies and underwriters to conduct independent background checks as individuals may not always be forthcoming regarding disclosures such as prior securities law issues and criminal convictions.

It is generally the responsibility of corporate legal counsel to conduct, or assist in completing, these background searches. The foundation of the due diligence process, and the success of the potential reverse merger or IPO itself, depends upon the meticulousness and accuracy of these various background checks.

Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!

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