The shell company: going public with a Pandora's box.

• Author: Lehman, Jeanine Marie

Beware the offer to take your firm public by mating with a shell company.

From a legal standpoint, you may be buying yourself a headache.

With Black Monday more than three years past and the market still suffering the aftershocks of the junk-bond debacle, companies large and small are capital hungry. Facing severe contraction in the capital markets, including a poor environment for initial public offerings, financial officers are seeking alternatives.

Accompanying these trends are catchy ads that promise a creative financing panacea. The ads promise that you can avoid the rigors of an SEC filing, roll up partnerships, consolidate debt, and, yes, go public just by buying a public shell. These shells, typically Utah or Nevada corporations, are marketed to legitimate corporations as merger candidates. Too often, through this creative financing, the buyer ends up with a company that is not public and feloniously sells securities-risking investor and regulatory litigation. The post-merger shell companies are liability minefields for larger corporations that may acquire them.

Many people harbor the misconception that stock in a public company may be freely bought and sold without compliance with Federal and state securities laws. The purveyors of the shells prey on that misconception. Often, they deliver shells that are not even public companies in the jurisdictions in which they are sold. They succeed in their deception due to consumer ignorance.

The shell-company deal

The shell-company promoter begins by packaging his product-a blank-check, blind-pool offering. Warning companies about accepting such offerings, the North American Securities Administrators Association (NASAA) and the Council of Better Business Bureaus (BBB) noted in their April 1987 joint Investor Alert that "blank-check offerings do not identify any proposed intent whatsoever. They are literally `blank checks' that the promoter can use at his whim."

In the initial blank-check offering, investors are brought into the offering to establish shareholder base or float." Often they buy into the shell company hoping that the share price will rise after merger with an operating company.

In the U.S. securities industry, a public company is often thought to be synonymous with a reporting company. A reporting company is subject to and complies with the reporting requirements of the Securities Exchange Act of 1934; it generally has shares outstanding in public hands and the concomitant availability of a secondary trading exemption. These companies file annual and quarterly financial reports (10-Ks and 10-Qs) with the Securities and Exchange Commission, and that information is open to the public.

The typical route for a company to go public is to file a registration statement and prospectus with the SEC and with the states that have jurisdiction over the transaction. This, of course, registers the sale of the stock. To provide companies access on a limited basis to capital markets, the SEC has provided exemptions from the requirements for filing a registration statement and prospectus if compliance with certain rules is present. One of those rules is Rule 504 of SEC Regulation D. Some of the shells being sold as "public companies" established their shareholder float through Rule 504 offerings. However, by definition, Rule 504 is available only to companies that are not SEC reporting companies. Therefore, businesses that are considering the shell route to go public should beware of...