Analysis of Section 404(b) of the Sarbanes-Oxley Act of 2002 for Non-Accelerated Filers
On October 13, 2009, the Securities and Exchange Commission (SEC) officially extended the date for non-accelerated filers to comply with Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX) until their fiscal years ending on or after June 15, 2010. Since the adoption of the rules implementing Section 404(b) on June 5, 2003, the time period for compliance by non-accelerated filers has been extended several times. It is widely believed that this extension, for six additional months, will be the last. Companies other than non-accelerated filers are already subject to Section 404 compliance. Although “non-accelerated” filers are not specifically defined, such filers include small business entities.
Among other things, Section 404(b) of SOX requires companies to include in their annual reports filed with the SEC, an accompanying auditor’s attestation report, on the effectiveness of the Company’s internal control over financial reporting. In other words, reporting companies must employ their auditor to audit and attest upon their financial internal control process,
Potential Impact of Rule SEC Release #34-60515 Regarding Proposal to Extend Regulation NMS Coverage to OTC Securities
FINRA, in August of 2009, filed Release No. 34-60515 with the SEC. FINRA proposes to extend certain NMS protections to quoting and trading in the OTC market for equity securities.
In summary:
- Restrictions on sub-penny quoting;
- Prohibitions on locked or crossed markets;
- Implementation of caps on access fees;
- Requirements of transparency of customer limit orders.
FINRA’s goals, part of broadly anticipated changes in financial systems, are proposed as part of efforts to both modernize and achieve higher “quality” in the OTC marketplace.
1. Sub-Penny Quote Restrictions
FINRA addresses both issues of modernization and higher quality by proposing to restrict sub-penny quoting in conjunction with removing the requirement that ATS’s include non-subscriber access fees within its quote. Restricting sub-penny quoting may help prevent the practice of “stepping ahead” of displayed limit orders by trivial amounts.
The proposal will most effect small businesses whose securities trade for under $1.00. Under FINRA’s proposal, market participants will be able to quote in increments ranging
Examination of Rule 144 and Potential Interpretations
The SEC revised Rule 144, effective February 15, 2008. Section 144 rules are used to ascertain if a company falls into an exemption from registration, because of non-underwriter status. But if securities, or the transaction, are registered as required, 144 doesn’t apply. The revisions aimed to reduce previous limits on resale of restricted securities by reporting companies. Unfortunately, a certain amount of ambiguity has also crept in.
The Rule had clearly required a one-year holding period. But included in the new Rule 144(i) is the following: (paraphrased) “if a company has ever been a shell company[1], past or present, then the company must be current on its periodic SEC filings for twelve months following the time it ceases to be a shell, before 144 is available.”
For non-affiliates of non-reporting companies, the one year holding period requirement remains.
Rule 144 thus allows non-affiliates of a reporting company to resell restricted securities after a six-month holding period,
OTCBB Reporting Requirements Enable Successful Reverse Mergers
Companies subject to the reporting requirements of the Securities Exchange Act of 1934 (amended to the “Exchange Act”), without current business operations, and trading on the NASDAQ Over the Counter Bulletin Board (“OTCBB”), commonly known as Bulletin Board Shells, have become the vehicle of choice for private companies seeking to go public through a reverse merger.
Although the domestic economy has slowed, reverse mergers still flourish, and Chinese-based companies in particular have taken the lead in reverse mergers with Bulletin Board Shells. As old sectors slow, new sectors such as biofuels, health supplements, and agricultural science have risen to lead the charge into the public arena.
SEC Reporting Requirements Make Due Diligence Practical
Bulletin Board Shells have become the vehicle of choice for private companies seeking public status. This is due in part to increasing industry pressure for public companies to maintain total disclosure of their financial condition and operations.
Bulletin Board Shells and OTCBB Companies must prepare and file
Market Makers Rely on Due Diligence in Reverse Mergers
Following approval of the 15c2-11 application by FINRA, and the consistent quotation of a company’s securities, market makers may “piggy back” on the approved and completed 15c2-11. In short, a market maker may quote the share price of the Bulletin Board Shell while relying on the due diligence of other market makers and the company’s current SEC filings.
Although highly technical, the due diligence process can be completed quickly and thoroughly by an experienced securities attorney; the key is knowing where to look and what to look for. For example:
- All articles and amendments are ordered from the company’s state of domicile and reviewed for procedural correctness and historical understanding.
- DTC (the Depository Trust Company) is contacted to confirm the company is in a transferable status.
- In addition to financial statement review, using several proprietary online search services, the firm conducts comprehensive debt and litigation searches to identify any miscellaneous debts as well as pending or past litigation.
- A tax
Reverse Mergers Hinge on Due Diligence and Cleaning Up Public Shells
When a publicly traded company “goes dark” and becomes delinquent in its filing requirements, it generally becomes a public shell and is no longer quoted on the Over the Counter Bulletin Board Exchange (OTCBB). However, with the assistance of an experienced securities attorney, the shell company can be restored so that a merger candidate can be introduced.
Some of the specific details that constitute the clean-up process include:
- Reinstating the Company’s corporate charter and paying franchise taxes to the Company’s state of domicile, if necessary
- Working with a PCOAB (Public Company Oversight Accounting Board) auditor to update all necessary financial statements and audits
- Holding a shareholder meeting for purposes of electing directors and amending articles of incorporation and bylaws as necessary
- Updating the Company’s articles of incorporation and bylaws to ensure they suit the needs of the successor Company
- Conducting reverse splits of the Company’s outstanding shares of common stock in order to decrease the size of the outstanding common
