Shell companies in the past have been abused by promoters as a method to pump and dump penny stocks and reap illicit profits. As a result, the Securities and Exchange Commission (the “SEC”) has issued various regulations under the Securities Act of 1934. These provisions prohibit the use of short form registration of securities on Form S-8 generally used for registering securities for officers, directors, employees and consultants until after 60 days from the date the company ceases to be a shell company. In addition, expanded reporting on Form 8-K, commonly referred to a “Super 8-K”, for reverse mergers (or “back-door registrations”) involving a private operating company and a shell company in the US. The term shell company means a registrant, other than an asset-backed issuer as defined in Item 1101(b) of Regulation AB, that has:
1. No or nominal operations; and
i. No or nominal assets;
ii. Assets consisting solely of cash and cash equivalents; or
iii. Assets consisting of any amount of cash and cash equivalents and nominal other assets.
How is nominal measured? The SEC purposely did not define nominal since they wish to retain some level of judgment to managements and the SEC staff. Often times, it is not easy to determine whether a company with assets is a shell company or deemed an operating company.
A company with a business plan and qualified management team, which has not commenced operations, may be deemed to be a shell company until operations and assets become significant. Additionally, a company which has exited a business, and temporarily has no significant operations or revenue generating assets, would likely fall into classification as a shell company until operating assets are acquired. A company with a royalty stream from licensing may be considered a shell company if revenues and operating activities are nominal, even though investing activities in new products may be significant.
The facts and circumstances need to be addressed with each company that gives the appearance of a shell company, and the related impact on use of Form S-8 and reporting requirements of Form 8-K for US domiciled companies.
dbbmckennon is a registered firm of the Public Company Accounting Oversight Board, performing financial statement audits for public companies, and providing consultations to management teams involving complex accounting and reporting matters before the SEC.