Corporate Finance Advisory
SEC Amends Rules for Shell Companies
By Marcus J. Williams and Paul B. Bifford
[September 2005]
The SEC recently adopted rules relating to Form 8-K and Form S-8 filings by reporting shell companies. The new rules are designed to increase the amount of disclosure and to deter fraud and abuse in the securities markets through the use of shell companies that are registered under the Exchange Act but have substantially no operations or assets. Since the rules include amendments to the cover pages of quarterly and annual reports requiring companies to indicate whether they are shell companies, the new rules affect all reporting companies. Other than the addition of new Item 5.06 of Form 8-K (which becomes effective on Nov. 7, 2005), the new rules became effective on Aug. 22, 2005.
The SEC has defined a “shell company” as a company, other than an asset-backed issuer, that is registered under the Exchange Act but has no or nominal operations and either no or nominal assets or assets consisting of any amount of cash and cash equivalents and nominal other assets. The SEC refused to define “nominal” or to provide a quantitative threshold in order to avoid aiding in the circumvention of the new rules. In addition, in cases where assets or operations are placed in a company under an agreement to return them to a promoter before or shortly after a business combination, these assets or operations will be deemed “nominal” for purposes of the definition. A subset of shell companies is exempt from the new Form 8-K requirements and provided some relief under the new Form S-8 rules. The subset, defined as “business combination related shell companies,” is companies formed by operating companies solely for the purpose of either changing the operating companies’ domicile within the United States or completing a business combination transaction among operating companies.
Amendments to Form 8-K
The amendments to Form 8-K require the surviving entity in a transaction where a shell company ceases to be a shell company to make a more detailed filing than previously required. In most cases, this will occur when a shell company acquires or is acquired by an operating company, but it could also occur when a shell company acquires more than nominal assets (other than cash or cash equivalents). Note that these disclosure requirements are in addition to the qualitative and quantitative market listing requirements that govern changes of control of companies listed on a national securities exchange or Nasdaq.
Items 2.01 and 9.01
These items had previously applied to transactions in which a shell company acquired a private operating company. As amended, Item 2.01 of Form 8-K also requires that the former shell company include, within four business days after completing the acquisition, the same detailed information, including financial information, as would be required to register a class of securities on Form 10 or Form 10-SB under the Exchange Act, which is similar to the information about the registrant and the securities required to register securities in an initial public offering. If the information has previously been included in an effective Securities Act registration statement or Exchange Act filing, the registrant can identify the filing, rather than repeat the disclosure.
Item 9.01 of Form 8-K had required that companies file audited financial statements for the acquired company and any pro forma information required not later than 75 days after completion of an acquisition reported under Item 2.01. Under the news rules, former shell companies will be required to file this information with the initial report within four business days. In response to comments about the timeframe, the SEC stated its view that shell companies and their counsel control the timing of transactions and thus that transactions should not be completed until the registrant can timely provide investors with adequate information to make informed investment decisions.
Item 5.01
Item 5.01 of Form 8-K applies to transactions in which a private operating company acquires a reporting shell company resulting in a change in control of the shell (whether or not the operating company’s shareholders before the transaction control the surviving entity afterward). Existing SEC interpretations had permitted the acquiring company to file a Form 8-K with certain information and succeed to the rights and obligations of the reporting shell without having to file a registration statement on Form 10 or Form 10-SB. The new rules specifically permit this succession in connection with a change in control required to be reported under Item 5.01; however, amended Item 5.01 requires disclosure of the same Form 10 or Form 10-SB information with respect to the surviving entity as is required under amended Item 2.01.
New Item 5.06
In order for investors and regulators to easily identify Form 8-K filings regarding shell company transactions and more completely understand the terms of those transactions, Item 5.06 of Form 8-K will require the former shell company or the surviving entity to disclose the material terms of the transaction pursuant to which the shell ceased to be a shell company.
Prohibition on Use of Form S-8
The new rules prohibit all shell companies from using Form S-8 to register securities for offer and sale under employee benefit plans. The SEC saw little legitimate basis for the use since shell companies do not operate businesses and rarely have employees and cited a history of abuse of Form S-8 by reporting shell companies. Shell companies will instead have to use forms such as Form S-1 or Form SB-2 or offer and sell securities pursuant to an available Securities Act exemption.
A reporting company is eligible to use Form S-8 60 days after it ceases to be a shell company and files the information required by Form 10 or Form 10-SB. A business-combination-related shell company is permitted to use the Form immediately after it ceases to be a shell company and files the Form 10 or Form 10-SB information. The latter requirement would seem to be slightly at odds with the exemption of these shell companies from all of the new Form 8-K requirements, but perhaps the SEC will deem the requirement to be satisfied by a reference in the Form S-8 to a prior filing by the operating company that formed the shell or will clarify the matter with an interpretation or further rulemaking.
Amendments to Form 20-F
A foreign private issuer that completes a transaction that causes it to cease to be a shell company is required to report on Form 20-F, within four business days of the completion of the transaction, the material terms of the transaction and the same information that would be required in a registration statement on the Form to register a class of securities subject to the reporting requirements of the Exchange Act. Exchange Act Rule 12b-25 will not be available to provide an extension of the due date, and issuers are not required to include the CEO/CFO certifications with the Form 20-F filing. Foreign private issuers that are business-combination-related shell companies are likewise excluded from these Form 20-F requirements, and the cover page of Form 20-F has similarly been amended to include a box that the registrant must mark to indicate whether it is a shell company.
Foreign private issuer shell companies are also ineligible to use Form S-8 until 60 days after ceasing to be a shell company and filing the Form 20-F information described above. A foreign private issuer that has elected to report as a domestic issuer or that enters into a transaction with a domestic operating company causing it to lose its foreign private issuer status as well as to cease to be a shell company is required to comply with the Form 8-K, rather than Form 20-F, requirements.
Marcus J. Williams is a partner in the Corporate Finance practice group of Davis Wright Tremaine LLP. The information presented in this bulletin is a general description of newly adopted rules and should not be construed as legal advice with respect to a specific circumstance or issuer. Should you have specific questions about the regulations described in this release, please consult with qualified securities counsel.
You may reach Davis Wright Tremaine’s securities attorneys in the following offices:
Other DWT Contacts:
Keith G. Baldwin, Bellevue, (425) 646-6133, keithbaldwin@dwt.com
Kevin F. Saer, New York, (212) 603-6403, kevinsaer@dwt.com
David C. Baca, Portland, (503) 778-5306, davidbaca@dwt.com
This Corporate Finance Law Advisory is a publication of the Business Transactions/Corporate Finance Group of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of developments in business, corporate finance and securities laws. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.
Copyright © 2005, Davis Wright Tremaine LLP
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