“Going Dark” – There is a Right Way and a Wrong Way

March 08, 2012

Louis Taubman

In the previous article in this series we discussed the increased costs for Chinese companies to remain public in the U.S. For many Chinese companies who became public in the U.S. the costs outweigh the benefits and management has decided they no longer wish to be a public company. Some of these companies have the capital necessary to repurchase their stock from the public shareholders and “go private.” However, many companies lack the funds to effect a more costly going private transaction and may simply wish to reduce their costs by ceasing to be publicly reporting, although not repurchasing any shares from the public shareholders. This cessation of reporting has been referred to as “going dark” and there is a right way and a wrong way to do it.

Most of the expenses of being a public company arise from the requirement that the company report its financial results on Form 10-K annually and Form 10-Q quarterly. In order to qualify for reporting purposes, a company’s annual financial statements must be audited by a qualified independent accounting firm and its quarterly financial statements must be reviewed by such a firm. Additional costs include paying for legal review of the forms and the costs of having the forms formatted for filing with the SEC on its EDGAR filing system. Potential additional costs may arise from the requirement that a company’s CEO and CFO certify the accuracy of the financial statements, in that regulators or class action law firms may seek to hold these officers liable for any alleged misstatements or omissions contained in the financial statements.

For these reasons, many Chinese companies have decided to simply cease filing the forms required by U.S. law. However, once a company has its stock registered under the U.S. Securities and Exchange Act of 1934 (the “Exchange Act”), it cannot simply cease reporting without negative consequences such as possible SEC enforcement action against the Company and increased difficulty in regaining compliance in the future should it so desire. Most Chinese companies that went public through an RTO, because they reverse merged into a public reporting shell company, have their stock registered under the Exchange Act. However, if a company has either (a) less than 300 shareholders or (b) less than 500 shareholders and its net assets for each of the last three fiscal years was less than $10 mm USD, then it may legally cease reporting by filing a Form 15 with the SEC. The Form 15 is a one page form that is simple and inexpensive to file but your company must meet the requirements set forth above to qualify to use the form. Also, the SEC will usually only accept the Form 15 if the company has already filed all of the forms that it was already required to file before it decided to go dark so it is important to stay current in filing your company’s Form 10Ks and Qs up until you decide to cease reporting.

It is important to note a few additional items in connection with ceasing to report (going dark). First, going dark is different than going private because the company is not buying back shares from its public shareholders. Second, until the company actually goes private, it will still have responsibility to its remaining shareholders under the law of the state in the U.S. in which the company is incorporated (e.g. Delaware or Nevada), which include maintaining a board of directors and having annual meetings of its shareholders. Also, once the company goes dark (whether legally or illegally) its shares will no longer qualify to be listed on Nasdaq, NYSE-AMEX or even the OTCBB, OTCQB or OTCQX. Rather, it will only qualify to trade on the OTC Pink Sheets. This will negatively impact the company’s ability to attract outside investment and diminish the liquidity in its stock. However, if the foregoing issues are acceptable to management and it lacks the financial means to buy back its stock in a going private transaction, filing a Form 15 is a legal, effective, simple and inexpensive way to reduce the costs of remaining a public company in the U.S. In our next article we will discuss the more complicated and expensive process of “going private.”