The Securities and Exchange Commission has approved new rules that will make it more difficult for foreign companies to go public on the three major U.S. exchanges through a reverse merger with a U.S. shell company.

In part, the new rules are a reaction to the problems encountered with Chinese companies that went public on the U.S. exchanges in recent years and then were found to have accounting problems. The Public Company Accounting Oversight Board has been seeking access to inspect auditing firms in China that audit the books of such companies, but has so far not yet reached an agreement with Chinese financial regulators (see PCAOB Warns on Chinese Audits).

Currently, reverse merger companies, like other operating companies, can pay to be listed on an exchange, where investors can purchase and sell shares of the company. In some cases, regulators and auditors have greater difficulty obtaining reliable information from reverse merger companies, particularly those based overseas, the SEC pointed out Wednesday in announcing the new rules. Reverse mergers permit private companies, including those located outside the U.S., to access U.S. investors and markets by merging with an existing public shell company.

The SEC began an initiative last year to determine whether certain companies with foreign operations—including those that resuklted from reverse mergers—were accurately reporting their financial results, and to assess the quality of the audits being done by the auditors of these companies.

In recent months, the SEC and U.S. exchanges have suspended or halted trading in more than 35 companies based abroad, citing a lack of current and accurate information about organizations and their finances. These included a number of companies that were formed by reverse mergers. In June, the SEC issued an investor bulletin warning investors about companies that engage in reverse mergers.

“Placing heightened requirements on reverse merger companies before they can become listed on an exchange will provide greater protections for investors,” said SEC Chair Mary L. Schapiro in a statement.
Under the new rules, Nasdaq, NYSE, and NYSE Amex will impose more stringent listing requirements for companies that become public through a reverse merger. Specifically, the new rules would prohibit a reverse merger company from applying to list until the company has completed a one-year “seasoning period” by trading in the U.S. over-the-counter market or on another regulated U.S. or foreign exchange following the reverse merger, and filed all required reports with the SEC, including audited financial statements.

The company also must maintain the requisite minimum share price for a sustained period, and for at least 30 of the 60 trading days, immediately prior to its listing application and the exchange’s decision to list, according to the new rules.

Under the rules, the reverse merger company generally would be exempt from these special requirements if it is listing in connection with a substantial firm commitment underwritten public offering, or the reverse merger occurred long ago so that at least four annual reports with audited financial information have been filed with the SEC.

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