Securities Act Release No. 4982

Securities Exchange Act Release No. 8638

July 2, 1969

Application of the Securities Act of 1933 and the Securities Exchange Act of 1934 to Spin Offs of Securities and Trading in the Securities of Inactive or Shell Companies.

The Securities and Exchange Commission today made publicly known its concern with the methods being employed by a growing number of companies and persons to effect distributions to the public of unregistered securities in possible violation of the registration requirements of the Securities Act of 1933 and of the antifraud and anti-manipulative provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. The methods employed can take and in fact have taken a variety of patterns.

I.

Frequently, the pattern involves the issuance by a company, with little, if any, business activity, of its shares to a publicly owned company in exchange for what may or may not be nominal consideration. The publicly-owned company subsequently spins off the shares to its shareholders with the result that active trading in the shares begins with no information on the issuer being available to the investing public. Despite this lack of information, moreover, the shares frequently trade in an active market at increasingly higher prices. Under such a pattern, when the shares are issued to the publicly-owned or acquiring company, a sale takes place within the meaning of the Securities Act and if the shares are then distributed to the shareholders of the acquiring company, that company may be an underwriter within the meaning of Section 2(11) of the Act as a person "who purchased from an issuer with a view to . . . the distribution of any security" or as a person who "has a direct or indirect participation in any such undertaking."

While the distribution of the shares to the acquiring company's shareholders may not, in itself, constitute a distribution for the purposes of the Act, the entire process, including the redistribution in the trading market which can be anticipated and which may indeed be a principal purpose of the spin off, can have that consequence. It is accordingly the Commission's position that the shares which are distributed in certain spin offs involve the participation of a statutory underwriter and are thus, in those transactions, subject to the registration requirements of the Act and subsequent transactions in the shares by dealers, unless otherwise exempt, would be subject to the provisions of Section 5 requiring the delivery of a prospectus during the forty or ninety day period set forth in Section 4(3).

The theory has been advanced that since a sale is not involved in the distribution of the shares in a spin off that registration is not required and that even if it is required, no purpose would be served by filing a registration statement and requiring the delivery of a prospectus since the persons receiving the shares are not called upon to make an investment judgment.

 This reasoning fails, however, to take into account that there is a sale by the issuer and the distribution thereafter does not cease at the point of receipt by the initial distributees of the shares but continues into the trading market involving sales to the investing public at large. Moreover, it ignores what appears to be primarily the purpose of the spin off in numerous circumstances which is to create quickly, and without the disclosure required by registration, a trading market in the shares of the issuer. Devices of this kind, contravene the purpose, as well as the specific provisions, of the Act which, in the words of the statutory preamble, are "to provide full and fair disclosure of the character of the securities sold in interstate and foreign commerce and through the mails, and to prevent frauds in the sale thereof."  In the circumstances of a spin off, when the shares are thereafter traded in the absence of information about the issuer, the potential for fraud and deceit is manifest.

This release does not attempt to deal with any problems attributable to more conventional spin offs, which do not involve a process of purchase of securities by a publicly-owned company followed by their spin off and redistribution in the trading markets.

II.

Another pattern has come to the Commission's attention in which certain promoters have acquired corporations which have ceased active operations, or which have little or no assets ("shell corporations"), and which have a substantial number of shares outstanding, generally in the hands of the public. Thereafter the promoters have engaged in activities to quickly increase the market value of their shareholdings. For example, in some cases promoters have initiated a program of acquisitions, transferring assets of dubious value to the "shell corporations" in exchange for substantial amounts of newly issued shares. This activity is frequently accompanied by publicity containing exaggerated or misleading statements and designed to stimulate interest of public investors in the company's shares in violation of the antifraud provisions of the Securities Exchange Act of 1934. Thereafter the market prices of these securities have risen sharply under circumstances which bear no relationship to the underlying financial condition and business activities of the company. In some of these cases the promoters or other corporate insiders, take advantage of the market activity and the price rise which they have generated, have sold their shares at the inflated prices to the public in violation of the registration and anti-fraud provisions of the Federal securities laws. Similar activities have also been noted in a number of cases involving shares which a publicly held company has spun off to its shareholders.

III.

The activities discussed above generally can only be successfully accomplished through the efforts of brokers and dealers. Accordingly, brokers and dealers are cautioned to be particularly mindful of their obligations under the registration and anti-fraud provisions of the Federal securities laws with respect to effecting transactions in such securities. In this connection, where a broker or dealer receives an order to sell securities of a little-known, inactive issuer, or one with respect to which there is no current information available except possibly unfounded rumors, care must be taken to obtain sufficient information about the issuer and the person desirous of effecting the trade in order to be reasonably assured that the proposed transaction complies with the applicable requirements. Moreover, before a broker or dealer induces or solicits a transaction he should make diligent inquiry concerning the issuer, in order to form a reasonable basis for his recommendation, and fully inform his customers of the information so obtained, or in the absence of any information, of that fact.

In the foregoing connection the Commission also calls attention to its release dated February 2, 1962 on the subject "Distribution by Broker-dealers of Unregistered Securities" (Securities Act Release No. 4445, Securities Exchange Act Release No. 6721).