Securities Law Blog

Publicly traded companies making strategic pivots from their current primary business focus may be unintentionally becoming “shell companies” if they dispose or monetize their legacy business assets before, upon completion of, or shortly after their pivot. The NYSE is also considering suspensions for companies changing their primary business focus after listing.

It seems more and more public companies are transitioning or pivoting organically to focus on a new business. In many cases, they are hiring an investment bank to run a process seeking acquisition candidates to pivot their business. It is important that companies be reminded that when disposing or monetizing their legacy business assets before, upon completion of, or shortly after a pivot, they may be unintentionally becoming a “shell company,” subjecting them to various securities law restrictions including eligibility to register securities on Form S-3. Further, the New York Stock Exchange has proposed a new rule permitting the exchange to suspend and delist a company that pivots to a business line “substantially different” than its original plan at the time of its listing.

The SEC’s July 2005 Release No. 33-8587, “Use of Form S-8, Form 8-K, and Form 20-F by Shell Companies” (note 32), as updated in the SEC’s March 2022 Release No. 33–11048, “Special Purpose Acquisition Companies, Shell Companies, and Projections” (note 239), reflects the SEC’s view that a company with no operations and with assets consisting of cash and nominal other assets that pivots to an entirely new primary business and contemporaneously disposes its previous business assets or operations to its former shareholders or promoters may be deemed to be a “shell company,” as defined in Rule 405 under the Securities Act of 1933 or Rule 12b-2 under the Securities Exchange Act of 1934.

The New York Stock Exchange recently proposed a new rule under which it would have the discretion to suspend and delist companies that change their primary business focus. See the SEC’s April 19, 2024 Release No. 34-99992, File No. SR-NYSE-2024-21. In determining whether there has been a change in primary business focus from a company’s original operations, the exchange will look at contemporaneous changes to the company’s management, board of directors, voting power, ownership and financial structure, as these other changes typically demonstrate the “totality” of a change in primary business focus. The SEC’s test for shell company status similarly weighs these factors, such as the termination of prior business employees and executives in conjunction with a pivot.

Generally, the SEC does not view a natural evolution of a company’s business as a shell pivot. For example, a pivot from a DVD-by-mail service to a streaming video service in the case of Netflix, from an online bookstore to an “everything” company in the case of Amazon, and for so many other tech companies transforming from offering traditional on-premises apps to cloud-based software as a service. However, in the biotechnology area, it cannot be assumed that a pivot from developing therapeutics for one disease to another unrelated medical condition would be viewed as a natural evolution of a company’s business, especially if the pivot is accompanied by a change in control and discontinuance of legacy clinical programs.

There are several negative consequences of becoming a shell company due to a poorly planned pivot. They include (i) the need for a “super” Form 8-K when the company ceases to be a shell company (typically involving a reverse merger) to provide extensive information regarding the company’s business, operations and risks equivalent to that of a Form S-1 for a traditional IPO, (ii) ineligibility to use Form S-3 until 12 calendar months after the company ceases being a shell company, (iii) ineligibility to incorporate by reference on Form S-1 for three years from when it ceases to be a shell company, (iv) prohibition on the use of Form S-8 as a shell company, and (v) unavailability of Rule 144 for the resale of restricted and control securities until one year from the time the company ceases to be a shell company and files Form 10 information with the SEC, during which time the issuer must remain current in its filing obligations. Additionally, shell companies are sometimes associated with fraudulent or illicit activities and receive greater regulatory scrutiny.  

Some speculate that the pivot trend is predictable – there has been a significant slowdown in new issues for companies with innovative, high-growth business models seeking to access the public equity markets through an initial public offering, while at the same time there are many existing public companies with outdated business models looking for strategic alternatives to preserve and maximize investment value for its legacy shareholders.