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A Net Too Wide – SEC Seasoning Rules and Their Applicability to Newly Public Companies

03.27.12

According to published reports, 25% of all securities fraud class action lawsuits filed during the first half of 2011 involved Chinese companies that have gone public through reverse mergers.  A 2011 report by Cornerstone Research stated that 12 securities class action complaints were filed in 2010 against Chinese companies listed on U.S. stock exchanges, representing 42.9% of all class action filings against foreign issuers listed in the U.S.  Commentators assert that one factor fueling this trend is the fact that many Chinese issuers have gone public through reverse mergers with listed U.S. shell companies – a process which, in some cases, results in a significant lack of disclosure associated with the newly public business.

Due in part to increasing allegations of fraud by foreign reverse merger companies, in late 2011, the SEC approved new rules imposing additional requirements on companies intending to list their shares on one of the three major U.S. stock exchanges.  These rules, including applicable exceptions, are described in our prior posts found here and here.  However, it remains to be seen whether these rules will actually help to remedy many of the disclosure issues associated with foreign issuers going public through reverse mergers.

OUR TAKE:  The problem with these seemingly heavy-handed new rules is that they fail to directly address the lack of financial disclosure sometimes associated with foreign issuer reverse mergers.  For example, by requiring reverse merger companies to undergo one year of trading in a systemically under-regulated environment like the OTC Bulletin Board, the SEC may be simply imposing a bureaucratic holding pattern rather than creating targeted, meaningful regulation.

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