- SEC Proposes Rule Prohibiting the Use of Form S-8 and Imposing Form 8-K Reporting Requirements on Shell Companies
- May 4, 2004
- Law Firm: Blank Rome LLP - Philadelphia Office
On April 15, 2004, the Securities and Exchange Commission proposed rule and form amendments intended to curb abuses involving "shell companies" (i.e. companies with no or nominal operations and assets). If the proposals are adopted, these companies will no longer be eligible to use Form S-8, a short-form registration statement for securities issued under employee benefit plans to employees, consultants and advisors. In addition, a shell company that enters into a transaction that causes it to cease being a shell company will be required to file a report on Form 8-K containing comprehensive disclosure concerning the company as it exists following the transaction similar to that required when registering a class of securities under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Comments on these proposals must be submitted to the SEC by June 7, 2004. The full text of the SEC's proposals is available at http://www.sec.gov/rules/proposed/33-8407.htm.
Proposed Definition of "Shell Company"
The SEC proposes to define a "shell company" as a registrant with no or nominal operations and with:
- no or nominal assets; or
- assets consisting solely of cash and cash equivalents.
Practice Point: The definition of shell company would include shell companies used to change corporate domicile or shell companies formed to effect mergers and acquisitions commonly referred to as "merger subs." Accordingly, the proposals would apply to these types of entities, with one variation in the Form S-8 proposal, as discussed below.
Proposed Form S-8 Changes
The proposal would prohibit the use of Form S-8 by shell companies. Form S-8 is a short-form registration statement available to register securities to be offered under employee benefit plans to the issuer's employees, consultants or advisors. It becomes effective automatically and is not subject to prior review by the SEC staff. Currently, the form may not be used to raise capital or to compensate consultants or advisors for providing services in connection with the offer or sale of securities in a capital-raising transaction or services that promote or maintain a market in the issuer's securities.
The SEC believes that because shell companies do not operate businesses and rarely have employees, there is no legitimate basis for shell companies to use Form S-8. The SEC believes that to the extent a shell company has employees, their activities usually involve capital-raising and similar activities. The SEC does not believe that a shell company's employees should be able to be compensated for these activities with securities registered on Form S-8 any more than its consultants or advisors.
As indicated above, the proposed amendments to Form S-8 would prohibit the use of the form by a shell company. A company that ceases to be a shell company would become eligible to use Form S-8 to register securities 60 calendar days after it has filed information equivalent to what it would be required to file if it were registering a class of securities on Form 10 or Form 10-SB under the Exchange Act.
The amendments would not prevent a shell company from registering offers and sales of securities under employee benefit plans on other forms or offering them pursuant to an exemption from registration. In addition, the Form S-8 amendments provide an exception for a shell company in existence solely for the purpose of changing the corporate domicile of another entity. Such a shell company would be able to use Form S-8 immediately upon ceasing to be a shell company rather than having to wait the 60-day period after it has filed the specified information with the SEC.
Proposed Form 8-K Changes
The proposed amendments to Form 8-K would require a shell company to make a detailed filing on Form 8-K upon completion of an acquisition or a change-in-control transaction that causes it to cease being a shell company. These transactions often take one of the two following forms:
- a "reverse merger," in which a private business merges into the shell company, with the shell company surviving and the former shareholders of the private business controlling the surviving company; or
- a "back-door registration," in which the shell company merges into a formerly private company, with the formerly private company surviving and the shareholders of the shell company becoming shareholders of the surviving company.
Under current Form 8-K requirements1, the completion of each of these transactions is reportable under either or both of Item 2.01 of Form 8-K as the acquisition of assets and Item 5.01 as a change-in-control transaction. The existing requirements, however, are not tailored for shell company conversion transactions and do not address the fact that these transactions introduce a reporting company with a new operating business to the marketplace for the first time.
If the proposals are adopted, a shell company that completes an acquisition or change-in-control transaction that causes it to cease being a shell company would be required to file a report on Form 8-K including the information required to be included in an Exchange Act registration statement on Form 10 or Form 10-SB. This includes comprehensive disclosure of, among other things, the company's business, management, executive compensation, security ownership, market for its common stock, as well as audited financial statements and management's discussion and analysis of financial condition and results of operations. The Form 8-K would be due within four business days after completion of the transaction.
In addition, the proposal would, for these shell conversion transactions, close the 71-day window for inclusion of financial statements of acquired businesses generally applicable to reports on Form 8-K. Thus, required financial information would have to be included in the initial filing of the Form 8-K rather than in an amendment to the form. The SEC believes that the market should have prompt access to financial information concerning the operating business that constitutes all or substantially all of the company's operations and assets and that in a shell company conversion transaction, management of the operating business typically is in control of the transaction and has the power to control the preparation of the required financial statements. Therefore, the SEC noted that obtaining audited financial statements for the operating business does not present the difficulties that caused the agency to provide the 71-day window for typical business combinations involving reporting companies.
As indicated above, the definition of shell company includes shell companies used to change corporate domicile and shell companies that are "merger subs." The SEC does not envision an unreasonable burden in applying the proposals to these entities. A change in corporate domicile typically is not reportable as an acquisition of assets or a change-in-control, the only types of transactions to which the Form 8-K proposal is applicable. In addition, the SEC believes that merger subs typically do not survive business combinations as reporting companies and, where they do, the merger sub should have previously filed Form 10 information with the SEC and should not have difficulty complying with the Form 8-K requirement.
In addition to amending the asset acquisition and change-in-control items of Form 8-K, the proposals would revise the definition of "succession" in the Exchange Act rules to include a change-in-control of a shell company. This would cause the private company involved in a "back-door registration" as described above to succeed to the reporting obligation of the public shell company and thus be required to report the transaction on Form 8-K.
Foreign Private Issuers
The proposal applies to foreign private issuers, with certain differences. One difference is that a foreign private issuer shell company would not be eligible to use Form S-8 until 60 days after it files the information that it would be required to file if it were registering a class of securities under the Exchange Act on Form 20-F, rather than on Form 10 or Form 10-SB.
In addition, for purposes of the proposed Form 8-K requirement, the SEC noted that foreign private issuers generally are not required to file current reports on Form 8-K. The SEC believes that foreign private issuer shell companies should have the same disclosure requirements as those proposed for domestic shell companies, and is considering the appropriate form on which they should file in the event they do not lose their foreign private issuer status following completion of the transaction.
1References to Form 8-K requirements in SEC's proposing release (and thus this Corporate Alert) take into account changes to that form that have been approved by the SEC and take effect on August 23, 2004, suggesting that the shell company proposals are not expected to take effect until after that date.