Court Holds Promoter of Reverse Mergers Violated Section 5
August 25, 2008
In SEC v. M&A West, Inc., the Ninth Circuit Court of Appeals affirmed a grant of summary judgment by the district court in favor of the SEC, holding that the promoter of three reverse mergers violated Section 5 of the Securities Act of 1933 (Act) when he sold stock acquired as compensation in the deals. Each of the reverse mergers involved the merger of a public shell company into a private company, with the surviving corporation being a publicly-traded company. The defendant arranged the reverse mergers and was compensated in part with shares in the newly-merged company, which shares were subject to lock-up agreements. The defendant later sold his shares but no registration statement was filed for the shares.
The district court granted the SEC’s motion in part for partial summary judgment finding that the defendant violated Section 5 when he sold unregistered shares to the public. The Appeals Court affirmed the district court’s grant of summary judgment with respect to the Section 5 violation. The Appeals Court held that the defendant did not qualify for the exemption to the registration requirement for securities under Section 4(1) of the Act because the defendant was an underwriter. The Appeals Court looked to Rule 144 which identifies certain conditions by which a person will be deemed to not be an underwriter. Rule 144 allows a person who is not at the time of the sale, and has not been during the past three months, an affiliate of the issuer to sell restricted securities without complying with certain requirements after they have held the securities for two years. The Appeals Court found that the defendant did not hold the shares for two years nor could the defendant take advantage of tacking on the time of a prior holder because the prior holder was an affiliate of the issuer at the time of the transfer.
Rule 144 has been amended since this case went to court and now excludes from its safe harbor shares of companies with no or nominal operations and assets. The revisions may preclude transactions such as the one in this case.
SEC v. M&A West Inc., 2008 WL 3307217 (9th Cir. August 12, 2008)
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