LETTER PERTAINING TO THE SALE OF STOCK WHILE A COMPANY IS A SHELL In a letter written by Mr. Ken Worm, the Assistant Director of the OTC Compliance Unit of the Securities and Exchange Commission (SEC) and Mr. Richard K. Wolff, Chief Office of Small Business of the SEC, the outlined the opinion of the SEC pertaining to stock that shareholders can sell under Rule 144 of shell companies. The letter is usually called the “Worm/Wulff Letter” and has been used since to define the SECs stand on shell companies. The entire letter is below:
----------------------------------- 2000 SEC No-Act. LEXIS 42, * 2000 SEC No-Act. LEXIS 42 Securities Act of 1933 -- Section 2(a)(11) -- Rule 144 January 21, 2000 CORE TERMS: issuer, Securities Act, blank check, scenario, dealer, registration, gifted, free-trading, shareholder, broker, underwriter, recipients, selling, gift, exemption, affiliate, investor, entity, nominal, resale, staff, sophisticated, transferred, disclose, promoters, shell, business plan, free trading, market maker, small number [*1] NASD Regulation, Inc. TOTAL NUMBER OF LETTERS: 2 SEC-REPLY-1: SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 January 21, 2000 Mr. Ken Worm Assistant Director OTC Compliance Unit
NASD Regulation, Inc. 9513 Key West Avenue Rockville, MD 20850 Re: NASD Regulation, Inc. Incoming letter dated November 1, 1999
Dear Mr. Worm: You have raised a question regarding the "free trading" status n1 of securities initially issued by so-called blank check companies in a number of factual scenarios. n1 Because the Securities Act of 1933 establishes the requirement to register securities for sale, subject to a series of exemptions, the concept of freely tradable securities is not a technically accurate one. In common parlance, the term is used to describe securities subject to the exemption provided by section 4(1) when it is available because no issuer, underwriter or dealer is engaged in the transaction.
A blank check company is a development stage company that has no specific business plan or purpose or has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person.
In 1990, the U. S. Congress found that offerings by these kinds of [*2] issuers were common vehicles for fraud and manipulation in the market for penny stocks which undermines investor confidence and inhibits legitimate capital formation by small, issuers and other companies. n2 The Commission has adopted several rules, as Congress directed, to deter fraud in connection with registered offerings by blank check companies. n3 The Commission has also excluded blank check companies from eligibility for several exemptions from Securities Act registration requirements. n4 n2 Securities Enforcement Remedies and Penny Stock Reform Act of 1990, S. 647, Pub. L. 101-429. See H. R. Rep. No. 101-617; 101 Cong., 2d Sess. at 23. n3 Rule 419 under the Securities Act of 1933 and Rule 15g-8 under the Securities Exchange Act of 1934. n4 See. e.g., Rule 504 under Regulation D and Regulation A.
Each of your scenarios suggests the availability of Rule 144 or Section 4(1) of the Securities Act following the lapse of some period of time following the issuance of shares in the blank check company regardless of whether a merger has occurred. In a number of cases, promoters of these issuers appear to be in the business of creating blank check companies, then [*3] gifting or selling the securities of the companies without registration, either directly or through intermediaries.
Section 4(1) exempts transactions not involving issuers, underwriters or dealers. The availability of the exemption depends upon the facts and circumstances of each particular situation, which the staff generally is not in a position to determine.
Nonetheless, transactions in blank check company securities by their promoters or affiliates, especially where they control or controlled the "float" of the "freely tradable" securities, are not the kind of ordinary trading transactions between individual investors of securities already issued that Section 4(1) was designed to exempt. n5 n5 SEC v. Cavanagh, 1 F. Supp. 2d 337 (S.D.N.Y 1998). Furthermore, as the Commission has indicated, purchasers who are mere conduits for a wider distribution of the securities are "underwriters." When they do sell, these purchasers assume the risk of possible violation of the registration requirements of the Securities Act and consequent civil liabilities. Persons engaged in the business of buying and selling securities who function in this capacity are [*4] subject to careful scrutiny. n6 n6 Release No. 33-4552 (Nov. 6, 1962).
It is our view that, both before and after the business combination or transaction with an operating entity or other person, the promoters or affiliates of blank check companies, as well as their transferees, are "underwriters" of the securities issued.
Accordingly, we are also of the view that the securities involved can only be resold through registration under the Securities Act. n7 Similarly, Rule 144 would not be available for resale transactions in this situation, regardless of technical compliance with that rule, because these resale transactions appear to be designed to distribute or redistribute securities to the public without compliance with the registration requirements of the Securities Act. n8 n7 This view is analogous to the one the Commission has expressed with respect to business combinations under Rule 145 where affiliates of parties to the transaction are viewed to be "underwriters." Further, the nature of these types of resale transactions are closely analogous to shares from an unsold allotment held by professional underwriters. Generally, these securities are only resaleable through registration. Shares purchased by non-affiliates in a registered transaction such as one offered in compliance with Rule 419, however, would not be subject to this restriction. n8 Release No. 33-5223 (Jan. 11, 1972).
In view of the objectives and policies underlying the Act, the rule shall not be available to any individual or entity with respect to any transaction which, although in technical compliance with the provisions of the rule, is part of a plan by such individual or entity to distribute or redistribute securities to the public. In such case, registration is required. [*5]
Each of your scenarios illustrates what we believe to be a scheme to evade the registration requirements of the Securities Act. Consequently, it is our view that the resale of the shares in scenarios 1 through 7 would require registration.
In addition, with regard to scenario 6, we are of the view that Rule 701 is not available for issuances to companies or entities, but only to individuals. In view of the business of a blank check company which generally has few or no employees, it seems unlikely that reliance upon this exemption would be appropriate. It is our view that Rule 701 would generally not be available to blank check companies for issuing shares to their consultants or advisors.
Moreover, we have been advised by staff of the Division of Market Regulation that Rules 101 and 102 of Regulation M n9 impose restrictions on issuers, selling shareholders and distribution participants when they effect transactions in securities that are part of a distribution. Generally, a distribution exists when a sufficient magnitude of shares is being sold and special selling efforts are employed to sell these shares. If a distribution exists, the persons involved in the distribution are prohibited [*6] from bidding for or purchasing the securities in distribution. The rule covers persons selling securities, their affiliates, and others participating in the distribution. Persons selling in the manner described in your letter should carefully analyze the facts surrounding the sales to determine whether the security being sold is in distribution for purposes of Regulation M. This analysis should specifically consider the actions taken by any persons assisting with the transactions. In particular, selling through a market maker into an illiquid market raises heightened concerns regarding compliance with Regulation M. n10 n9 17 CFR 242.101 - 102. n10 See Release No. 34-38067 (Dec. 20, 1996).
Because these positions are based upon representations made in your letter, any different facts or conditions might require a different conclusion.
Sincerely, Richard K. Wulff, Chief Office of Small Business INQUIRY-1: NASD REGULATION 9513 Key West Avenue, Rockville, MD 20850 November 1, 1999 Richard K. Wulff Assistant Director Office of Small Business Division of Corporation Finance 450 5th Street, N.W. Washington, D.C. 20549
Re: Tradeability of Securities Distributed by Means Other [*7] than Public Offerings
Dear Mr. Wulff:
The purpose of this letter is to request the guidance of the Division of Corporation Finance ("Division") as to whether certain specific factual scenarios present potential violations of Section 5 of the Securities Act of 1933 ("Securities Act"). The Market Regulation Department's OTC Compliance Unit ("Unit") reviews Form 211 filings submitted by potential market makers to determine whether they are in compliance with SEC 15c2-11 and NASD Rule 6740 before they are cleared to initiate or resume quotation of a non-Nasdaq security in any quotation medium.
During the course of these reviews, the staff has been presented with certain factual scenarios that, based on the nature of the initial security distribution of blank check shell company issuers, either the initial distribution or the redistribution of the shares in the aftermarket may constitute violations of Section 5 of the Securities Act. Set forth below are various scenarios that the Unit has encountered, or feels that it may encounter, while reviewing Form 211 filings. The staff requests that the Division provide its opinion on the following scenarios with respect to potential violations [*8] of the securities rules:
1. As a gift the issuer transferred a nominal amount of its shares (less than 10% of the total float) to between 20 and 50 individuals under Section 4(2) of the Securities Act. After the gift recipients have held their shares for two years, a broker/dealer submits a Form 211 citing the gifted shares as the only free-trading securities. The application does not disclose whether the recipients are sophisticated investors, although the individual who controls the issuer frequently has gifted shares of other companies to the same individuals on other occasions.
2. The issuer transferred a significant amount of its shares to one individual under Section 4(2) of the Securities Act. Then that individual in turn gifts a nominal amount of the shares to between 20 and 50 individuals. After the gift recipients have held their shares for two years, a broker/dealer submits a Form 211 citing the gifted shares as the only free-trading securities. The application does not disclose whether the recipients are sophisticated investors, although the individual who gifted the shares frequently has gifted shares of other companies to the same individuals on other occasions. [*9]
3. The issuer transferred a significant amount of its shares to one individual under Section 4(2) of the Securities Act. That individual holds the shares for two years and then in turn gifts a nominal amount of the shares to between 20 and 50 individuals. After the gift recipients have held their shares a few months, a broker/dealer submits a Form 211 citing the gifted shares as the only free-trading securities. The application does not disclose whether the recipients are sophisticated investors, although the individual who gifted the shares frequently has gifted shares of other companies to the same individuals on other occasions.
4. A small number of shareholders (less than ten) hold all of the free-trading shares. A broker/dealer submits a Form 211 indicating that the concentration of ownership in the hands of so few shareholders will not result in an ongoing distribution because it expects the market for the security to develop slowly.
5. A small number of shareholders (less than ten) control nearly all (more than 90%) of the free trading shares in the issuer. The remaining nominal amount of free trading shares (less than 10%) are widely dispersed among a larger number of [*10] shareholders (50 or more individuals). A broker/dealer submits a Form 211 indicating that the concentration of ownership in the hands of so few shareholders will not result in an ongoing distribution because it expects the market for the security to develop slowly and considers the number of total shareholders to be determinative.
6. An issuer controlled by one individual issued shares to another company controlled by the same individual pursuant to SEC Rule 701. The issuer filed a Form 10 with the SEC that became effective by default. The second company then sells all its shares in the issuer through a brokerage firm. A second broker/dealer submits a Form 211 indicating that the shares sold through the first broker/dealer are all free-trading securities.
7. A reporting shell company merged with a private company and the former controlling shareholder of the reporting shell company sold his shares to numerous individuals more than three months after he ceased to be an affiliate of the postmerger company. A market maker submits a Form 211 citing the post-merger shares sold by the former control person as the only free-trading shares. Thank you for your attention to this matter. [*11] We look forward to receiving the Division's guidance on whether any of these scenarios are of regulatory concern to the Division. If you have any questions, please do not hesitate to contact me at (301) 978- 2097.
Sincerely, Ken Worm Assistant Director OTC Compliance Unit
SECURITIES ACT OF 1933 and the SECURITIES EXCHANGE ACT OF 1934 The Securities Act of 1933, passed back in 1933 and sometimes called the “33 Act” or “Securities Act”. The Securities Act was enacted after the stock market crash of 1929. It was the first major federal legislation to regulate the offer and sale of securities in the United States. The Act required that any offer or sale of securities in interstate commerce be registered with the SEC under the ACT. The Securities Exchange Act of 1934 established the Securities and Exchange Commission (SEC) and is a law governing the secondary trading of securities (stocks, bonds and debentures) in the United States.
It is important to know that securities rules and regulations change constantly through the years. Any actions that a company might contemplate or have that involves anything that might pertain to the Securities Acts should be handled by an experienced attorney that deals with SEC matters every day. Only an experience attorney can stay on top of the changing rules and regulations. It is also important to understand that in addition to the Exchange Acts, every state has the own “Blue Sky” laws which govern the sale of securities in that particular state.
Securities Exchange Act of 1934 – description - Wikipedia STATUTE OF LIMITATIONS - “Statutes of Limitations” is a limitation of time placed on debts by each state. The type of debt incurred may be of several different kinds. It could be oral agreements, written contracts, promissory notes or open accounts. Each state has their own laws pertaining to their Statute of Limitations. For example, Colorado has a 6 year limitation on oral agreements, a 6 year limitation on written contracts, promissory notes and open accounts. While Arizona has only 3 year limitation on oral agreements, 6 year limitation on written contracts, 5 year limitation on promissory notes and a 3 year limitation on open accounts.
The Statute of Limitation of each state simply places a time limitation that a supposed creditor may take action to recover a debt. If they have not taken any action in that specific period of time, and the Statute of Limitations has expired, it would be very difficult for the creditor or note holder to collect on the debt. This is usually not the case if the debtor has filed and received a judgment against the person or company owing the debt. While each state may vary, judgments can be good for as long as 20 years and perhaps indefinitely. If a judgment is granted, it means that could hold a debt over your head for a significant period of your life or perhaps the rest of your life.
STANDARD INDUSTRIAL CLASSIFICATION SYSTEM (SIC CODE) AND NAICS CODES The Standard Industrial Classification (SIC) Code indicates a company’s particular type of business. For example, if a company is the metal mining business, the SIC code assigned to that particular business is SIC 1000.
The SIC code is a United States government system four-digit number system used for classifying industries.
The SIC code is gradually being replaced by the North American Industry Classification System (NAICS) The NAICS system uses six-digit codes to identify an industry.
This classification is used in different types of filings with the SEC and IRS so it may be very important for a company to know exactly what their SIC code is.
EMPLOYEE OR INDEPENDENT CONTRACTOR? - It is very critical that business owners determine whether any individuals that are providing services to the company are considered employees or independent contractors. Before you can determine how to treat payments that the company makes to individuals for services, the company must first know the business relationship that exists between the company and the person performing the services.
The person performing the services may be: (1) an employee or (2) an independent contractor In general, the company must withhold income taxes, withhold Social Security taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on independent contractors. Facts that provide evidence of the degree of control and independence of the person performing services could fall into three categories
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker performs his or her job.
2. Financial: Are the business aspects of the workers job controlled by the company? The would include how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.
3. Type of Relationship: Are there written contracts or employee benefits (i.e. pension plan, insurance, vacation pay, etc)? Will the relationship continue and is the work performed a key aspect of the business of the company?
You must weigh all of these factors in determining whether a worker is, in fact, or is an independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. The problem is that there is no firm set of factors that makes the worker an employee or independent contractor, and no one factor stands alone in making the determination. Also, factors that may be relevant in one situation may not be relevant in another. It is important to look at the entire relationship and consider the degree or extent of just how much right the comp0any has to direct and control the worker, and finally to document each of the factors that is used in coming up with the determination. .