January 19, 2024

Developments in Reverse Merger Transactions: “Shell Company” Definition and New Constraints on Resales of Securities Acquired in Rule 145 Transactions

The Staff of the Division of Corporation Finance at the Securities and Exchange Commission (SEC) has recently begun issuing comment letters in the life sciences reverse merger (RM) context that involve a broadened interpretation of the definition of “shell company" for the purposes of applicable SEC rules. This broader reading of the rules by the Staff effectively treats a “fallen angel” biotech public company in a traditional RM as a “shell company” if (i) the primary purpose of the RM is to provide cash and a stock exchange listing to the private company and (ii) the RM is accounted for as a reverse recapitalization. This new interpretation, together with a new Staff position relating to resales of securities issued in Rule 145 transactions, have significant implications to the economics and liquidity of investors whose companies engage in RM transactions.

Why Does This Matter?

The Staff’s approach in recent transactions represents a shift from historical practice where two operating companies merged and the private target stepped into the shoes of the public company. While this shift may reduce the attractiveness of the public company to potential merger partners, it also affects the liquidity analysis for certain stockholders and the private company. Additionally, as this new interpretation of the “shell company” definition has been largely communicated through comment letters on post-merger filings, it has created risk for investors who acquired securities in a RM without knowledge that the resale of such securities would be subject to the Rule 145(d) resale requirements and, in particular, those set forth in Rule 144(i) applicable to former shell companies.

What is a “Shell Company” in a Life Sciences RM Under the Staff’s Interpretation?

In a number of recent RM transactions and in connection with subsequent resale registration statement filings, the Staff has determined that the public company was a “shell company” for purposes of Rule 12b-2 because (i) it held itself out to potential merger partners as an opportunity to acquire cash and a stock exchange listing and (ii) the parties accounted for the transaction as a reverse recapitalization.

  • The Staff has articulated the following primary considerations: Does the combined company intend to continue any operations of the public company? Does the combined company intend to retain any of the public company’s employees for a meaningful period of time following the closing? Did the pre-closing public company stockholders receive a contingent value right (CVR) entitling them to the value of legacy assets of the public company to be sold following the closing of the RM? 
  • The Staff did not provide specific guidance as to what would constitute more than “nominal other assets” to avoid being characterized as a shell company under its broadened interpretation of the Rule 12b-2 definition.  
  • The Staff indicated that accounting for a RM as a reverse recapitalization (as opposed to a reverse asset acquisition) is a strong indication that the public company should be viewed as a “shell company.”

What Are Some High Level Implications?

If the public company is considered a “shell company” at the time of the RM, some practical limitations on the combined company and investors include:

  • Delayed Form S-3 Eligibility: the post-merger combined company will not be Form S-3 eligible until 12 full calendar months after closing of the RM (e.g., similar to an IPO, the combined company needs “seasoning” through 12 calendar months of SEC reporting).
  • Delayed Filing of Form S-8: the post-merger combined company will need to wait at least 60 calendar days post-closing of the RM to file a Form S-8 for any equity plans or awards.
  • “Ineligible Issuer” Status: the post-merger combined company will be an ineligible issuer for three years following the closing of the RM (e.g., no free writing prospectus, no WKSI status despite public float, etc.). 
  • No Incorporation by Reference: although Form S-1 is available for offerings (including for a resale shelf registration statement), the post-merger combined company will be ineligible to use incorporation by reference until Form S-3 becomes available (e.g., manual updates will be required to keep a resale shelf prospectus current).
  • Closing 8-K: the public company will need to consider whether to file a more fulsome closing Form 8-K under Item 2.01(f) of Form 8-K.
  • No Rule 145(c) Securities on the Form S-1 Resale Shelf: investors who were affiliates of the private company and receive securities of the public company in the RM (i.e., Rule 145(c) securities) will be statutory underwriters with respect to resales of those securities and, as such, the Staff has indicated that such securities may not be included in the Form S-1 resale shelf and instead may be sold only in a fixed price offering in which such investors are named as underwriters in the prospectus.  
  • Rule 144(i)(2) Compliance: applies to all public resales of Rule 145(c) securities per Rule 145(d), as well as “restricted” or “control” securities of the issuer per Rule 144 (e.g., holders of restricted securities and any affiliates of the public company are also affected).

Companies considering (or party to) a RM, as well as their investors and advisors, should take notice of the shift in the Staff’s positions, and the potential implications on both raising capital by the combined company and potential liquidity constraints post-RM for investors in either of the pre-RM companies or the combined company.

If you have any questions, please feel free to reach out to Marianne Sarrazin, Jim Matarese, Dave Lynn, Andrew Goodman, Kingsley Taft, or Jocelyn Arel.


This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.