Listing of companies with blank checks: market fraud and regulatory response

Blank Check Company (Blank Check Company) is a unique type of company in the U.S. securities market. This type of company will help another company complete an IPO through mergers and acquisitions as its sole business. It was born in the practice of the U.S. securities market at the end of the last century. The predecessor of SPAC.

The Regulatory Tolerance of the regulatory authorities has allowed market fraud by companies with impure blank checks. In order to protect the rights and interests of investors and restore market order, the US Securities and Exchange Commission (SEC) issued new regulations to deal with it. While eliminating fraudulent listings of blank check companies, it also restrained the development of blank check companies with legitimate purposes.

1、 Overview of the listing of blank cheque companies and market fraud

The 1980s was a period of rapid development in the U.S. securities market, and it was also a period of widespread securities fraud and corruption. As of 1989, fraud in the Penny Stock market had reached an "epidemic degree." Allegations of market fraud have increased by more than 260% since the beginning of the 20th century.

Loose controls have also provided the ground for unorthodox trading tools. Blank Check Offering is a typical representative among them. Blank Check Offering refers to a company's reverse takeover of blank check companies in order to raise funds. Complete the listing behavior of the initial public offering.

Blank check companies have no operating income and hard assets, and have very few employees. Before the Blank Check Regulation Act was promulgated, they were not subject to regulations, were not within the scope of SEC supervision, and were not even registered or traded on stock exchanges. They manipulated low prices. The price of company securities in the stock market is often a typical fraudulent method for the stock promoters to seek illegal benefits.

In the 1980s, securities fraud by blank check companies emerged in an endless stream. Unscrupulous and illegal securities transactions caused individual investors to suffer billions of dollars in huge losses. Faced with the increase in fraud in the securities market, the Securities and Exchange Commission had no enforcement and review powers. The increase seems to have become an "incompetent institution terribly defeated by the bad guys in the market."

In this context, the issuance of blank checks has been identified by the SEC as a fraud tool in the low-price stock market. There are regulatory gaps between it and the Congress, the North American Association of Securities Administrators (NASAA), the National Association of Securities Dealers (NASD) and the states. The historic cooperation of cheque listing fraud also began.

2、 Case analysis of fraud by blank cheque company: Onnix Financial Group case

The biggest blank check listing fraud in the last century was handled by Arnold Charlie Kimmes and Michael Wright. Between 1984 and 1987, they created more than 70 blank check companies. Wright is responsible for handling the daily affairs of the blank check company, nominally arranging lawyers and accountants to prepare the necessary documents to be submitted to the SEC, and sending company documents including company resolutions and board meeting minutes to nominated executives.

Kimmes is responsible for tracking securities trading and laundering proceeds. It usually actually holds stocks and warrants and monitors the flow of millions of stocks and warrants through various nominal holders and economic dealer trading accounts. When it receives When the dividends of trading proceeds are distributed, these proceeds will be cleared up through the Swiss Bank.

The Onnix Financial Group (Onnix Financial Group, Inc. hereinafter referred to as Onnix) is one of the classic cases of Arnold Charlie Kimmes and Michael Wright using blank check companies to commit fraud. Onnix was incorporated in Florida in September 1985 and submitted a registration statement to the SEC. In December of the same year, it successfully issued 1.25 million sets of products. Each set of products consisted of 10 common stocks and 40 equity stocks. These products Soon they were all sold to investors in seven countries, including the United States.

In the summer of 1986, Onnix split each stock into two shares, obtaining a total of 25 million shares of common stock and 100 million shares of warrants. Six months later, in January 1987, all those who purchased Onnix products in the IPO Investors unanimously decided to exercise their warrants and sell all their shares, and an institutional investor named Blinder Robinson, headquartered in Denver, readily purchased all 125 million shares of Onnix.

This is a very unusual securities trading activity. After two and a half years of investigation by the SEC, they found that Onnix's directors, senior managers, and shareholders are nominees for Kimmes and Wright, and most IPO purchasers are also Both are agents of Kimmes and Wright, and they deposit all the purchased Onnix products into the accounts of Kimmes and Wright. This allows Kimmes and Wright to achieve actual control of Onnix before and after the IPO.

And Kimmes and Wright signed an agreement with Blinder Robinson. The agreement stipulates that Kimmes and Wright provide Blinder Robinson with all of Onnix's existing securities. In return, Blinder Robinson will pay $2.6 million in addition to the price. Pay 50% of profit. Subsequently, Blinder Robinson sold its shares at a price of US$0.325 to US$0.475 per share, with a total sales of more than US$5.8 million and a profit of approximately US$3.1 million, equivalent to 120% of its original investment return.

In the end, all participants in the Onnix case were charged by the SEC on the grounds that “selling unregistered securities, failing to keep books and records, participating in securities fraud activities, unreasonable price increases, conducting unauthorized transactions, and unsupervised employees”. Meyer Blinder, CEO of Blinder Robinson, was sentenced to 46 months in prison, fined $100,000 and banned from entering the securities industry for life. Kimmes and Wright both confessed to their securities frauds, and were punished with lenient punishment for accusing Blinder and sentenced to two years in prison.

3、 Regulatory response to the listing of blank check companies and analysis of their market impact

Regarding the listing fraud of blank check companies, regulators believe that "sunlight is the best disinfectant, and lights are the best police." Rule 419 formulated by the SEC takes investor protection as the primary goal and imposes strict restrictions on blank check companies as follows: First, strictly restrict trading accounts. Except for paying underwriters’ commissions, underwriting fees, distributor allowances, and 10% of the registrant’s cash, all income from the IPO process must be deposited into an escrow account until the acquisition is approved. And the escrow account must meet one of the following two conditions:

(1) The depository institution to which the account belongs is insured.

(2) A separate bank account, and the net assets of the broker or dealer acting as the trustee shall not be less than USD 25,000.

Second, ensure information disclosure. When the target company is determined to be the acquired company, the company registration statement needs to be revised after it becomes effective. The revision includes the financial statements and previous financial information of the registrant and the target company that are required by law to be disclosed. And when the acquisition agreement enters the execution stage, a separate amendment to the registration statement after it becomes effective must be submitted. The seller must send the revised prospectus to the buyer, and the buyer should notify the registrant within 20 to 45 working days after the revision takes effect if they wish to continue to invest under this condition.

Third, give investors the right to decide and cancel. Mergers and acquisitions need to be approved by 80% of investors. If more than 20% of investors give a veto and do not want to continue the investment, they can exercise the right of cancellation, and the seller shall refund the investment cost, interest generated during this period, and Other uncertain costs incurred in the process.

Fourth, standardize the target business investment. Rule 419 requires that more than 80% of the issuance benefit must be invested in the target business.

Fifth, limit the maximum investment period. The target company and the SPAC must complete the merger within 18 months. After this period, the company shall return the funds raised in full to the investors.

Rule 419 had a direct and significant impact on the US low-priced stock market. The creation of this clause eliminated almost all blank check companies from the US securities industry.

On the positive side, Rule 419 prevents blank check companies from continuing to commit fraud in the low-priced stock market. First of all, 90% of the raised funds must be kept in the prescribed account regulations and the existence of an 18-month refund period to ensure the safety of the raised funds. Secondly, the existence of information disclosure clauses and investment cancellation mechanisms make it impossible for the company's management to hijack the company to exercise a bid-up plan, making it impossible to secretly profit. It gives the regulators more room for supervision and gives investors more investment options.

But Rule 419 also has certain negative effects and limitations. It is mainly manifested in the following two points: First, it makes it difficult to achieve the legitimate purpose of blank check listing. Because the investor's right to withdraw is exercised after the company announces the merger, this is a critical period for business development.

Investors have the right to withdraw their investments in accordance with the law, which makes it difficult for the management to have an accurate grasp of the company’s financial status before the refund ends. The uncertainty of funds makes it difficult for merger negotiations and other business negotiations. Second, the scope of Rule 419 is limited, and it is restricted to the low-priced stock market. In other securities markets, companies can still achieve their listing goals through reverse acquisition of blank check companies, and there is still the possibility of market fraud.