In order to meet differing capital requirements,ents, the US securities market is split between the stock exchanges and the over-the-counter trading market. The former predominantly serve the capital-raising needs of large US or even global companies, while the latter offers fund-raising services for companies that are in the early stage of development and are unable to satisfy the requirements for a listing on a main board.
Established in 1990, the Over-The-Counter Bulletin Board (OTCBB) is an electronic online quotation and trading system and an over-the-counter trading market regulated by the National Association of Securities Dealers. After 20 years of development, the OTCBB has established a dominant position in the US market outside the main boards. The securities of more than 3,300 enterprises are currently traded on the OTCBB, and among these, 535 are from China (including Hong Kong and Taiwan).
Although the OTCBB and Nasdaq are both over-the-counter trading markets, there are distinct differences between the two. Firstly, the OTCBB does not have strict listing conditions and standards, being equivalent to a junior second board. As long as a small or medium-sized company has sound financial statements it may, after its financial statements and submission documents have been reviewed and signed off by an accountant and a lawyer, directly find a market maker to seek listing. Conversely, for a share to receive approval to list on Nasdaq, it must satisfy stringent financial requirements. Secondly, the OTCBB does not offer an automatic trading system, but still uses the telephone instruction method, with quotations and trading reports entered by market makers via a computer network. At present, the OTCBB has approximately 400 market makers providing various types of market-making services to companies.
The OTCBB listing procedure is relatively simple. To list on the OTCBB, a company need only: 1) have a market maker make a market recommendation after the review and signing of its financial statements and submission documents by an accountant and a lawyer; and 2) fill out a Form 211 for a stock that has been reviewed by the Securities and Exchange Commission and is qualified for trading on OTCBB. Having taken these steps, it may be quoted within three business days of registration. The company must submit two copies of the necessary issuer information to Nasdaq’s OTC market legal department within three days before publicly quoting on the OTCBB.
Although the OTCBB listing procedure is relatively simple, it nevertheless requires the expenditure of a great deal of time and financial resources. PRC enterprises are also required to satisfy the conditions and procedures of PRC laws relating to offshore listings. Pursuant to the Offshore Share Offerings and Listings by Joint Stock Limited Companies Special Regulations issued by the State Council in 1994 and the Issues Relevant to Applications by Enterprises to List Offshore Notice issued by the China Securities Regulatory Commission, the main approval authority for domestic enterprises applying to list offshore is the China Securities Regulatory Commission. When applying to list offshore, a domestic enterprise must satisfy the following main conditions: 1) the purpose of the proceeds must comply with state industrial policy, policy on the use of foreign investment and state regulations on investments in and proposals for fixed assets; 2) it must have net assets of not less than RMB400 million, after-tax profits in the previous year of not less than RMB60 million, growth potential and, calculated based on a reasonable anticipated price to earnings ratio, projected proceeds of not less than US$50 million; 3) it must have a compliant corporate governance structure and relatively sound internal control systems, relatively stable senior management and a relatively advanced management level; and 4) it must have a reliable source of foreign exchange complying with relevant state regulations on exchange control for the payment of bonuses and dividends after listing. Additionally, a domestic company is required to obtain a document from the provincial level people’s government in the place where it is located, or gain the consent of the relevant authority of the State Council to its offshore listing, and it must obtain an analytical and recommendation report from an offshore investment bank in respect of its offering and listing.
With a view to circumventing the foregoing conditions and procedures, the great majority of domestic enterprises realize an OTCBB listing through a reverse takeover. Numerous so-called clean “shell companies” that have almost no assets or liabilities and are free of legal disputes exist on the OTCBB. A domestic enterprise can inject domestic assets or equity into such a shell company by way of a capital arrangement and appropriate contractual provisions, list and raise capital on the OTCBB in the name of the shell company, submit 8K/A, 10KSB, 10QSB and 14F forms in accordance with SEC requirements and carry out relevant information disclosures. By realizing a back-door listing through a reverse takeover, the domestic enterprise is not only eligible for tax breaks, but is able to circumvent the PRC government’s stringent approval rules and regulations for overseas listings by companies. In contrast to IPOs, not only are the costs of a back-door listing lower, but the time required is also considerably reduced. The completion of a typical reverse takeover of an OTCBB-listed shell company requires only about four to six months.
Once a company has successfully listed on the OTCBB, it is subject to two new obligations. The first of these is maintaining its OTCBB quotation obligation. Each OTCBB issuing company is required to have at least one market maker entering quotes for it and maintaining trading on the OTCBB. If the company has no market maker entering quotes for it, it will be removed by the OTCBB. Second, there a requirement of full disclosure of trading information. The company must punctually submit quarterly reports and audited annual reports to the SEC.
In recent years, the OTCBB has become a springboard for small and medium-sized enterprises wishing to list on Nasdaq. The principal conditions for an enterprise to transfer from the OTCBB to Nasdaq are as follows: 1) having net assets of at least US$5 million or after-tax profits exceeding US$750,000 or a market value of at least US$50 million; 2) having at least one million tradable shares; 3) having a minimum share price of US$4; 4) having more than 300 shareholders; and 5) having at least three market makers. After satisfying these conditions, the enterprise only needs to expend a few months’ time to complete the relevant application work before it can transfer from the OTCBB to Nasdaq.
Since the eruption of the financial crisis, the eyes of American capital markets have, as never before, been on PRC companies that have maintained stable and rapid growth. For small and medium-sized PRC companies wishing to list in the US, riding on the back of the OTCBB market is without a doubt the most effective option. Even if it has successfully listed on the OTCBB, a company can further carry out an asset and equity restructuring with a quality domestic company, and then use the China concept to transfer to an American main board. In the past six years, more than 30 PRC enterprises have transferred from the OTCBB to such main boards as Nasdaq and the New York Stock Exchange. In 2009 alone, 12 PRC enterprises successfully made the jump.
Listing on the OTCBB by way of a takeover and restructuring then transferring to Nasdaq has become an effective route for PRC enterprises wishing to tap the international capital markets.
Xiao Jinquan is a senior partner and head of global strategy at Dacheng Law Offices. He specializes in mergers and acquisitions and is devoted to promoting Sino-US economic co-operation. For enquiries relating to US capital markets, please contact him on +8610 13910161818, or by email at jinquan.xiao@dachengnet.com
