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The Reverse Merger Report

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“There are two things that I tell companies they absolutely cannot do. They are inherent in a lot of reverse mergers, depending on who did the deal. And that’s email blasts and fax blasts – it’s the absolute red flag to the SEC.”
Devon Blaine
The Blaine Group

Investor Relations Offers Benefits, Poses Risk
by Paul Springer

As once-favored methods like email blasts, mass faxes, paid-for research, and hyperbolic press releases fall deeper into disrepute, current IR success stories are more likely to involve targeted appeals, search engine savvy, and careful, long-term planning.

Many IR professionals feel the mass appeal is on its way out. “You have to be targeted,” said Justin Davis, manag­ing partner of Greenwood Village, Colo.-based Cirrus Financial Communications. “But more importantly, you have to be executing pull-based marketing as opposed to push.”

On the dark side, issuers’ reliance on old school methods like email or other shotgun approaches may be more harmful than helpful. In the case of Rocket City Enterprises, for instance, a torrent of amped-up press releases and paid research of dubious quality did little to stop a 99% drop in share price since the company’s reverse merger onto the Pink Sheets in 2007. The company’s original CEO, Jeff Roman, was fired in March of this year.

Rocket City’s IR firm, Jeff Bishop’s BlueWave Advisors, commissioned equity research through Bishop’s Beacon Equity Research and failed to disclose the relationship clearly.

All reverse merged companies face some of the same tricky issues. They all need to make decisions about how aggressively to tell their story, how useful paid research can be, and how to handle equity compensation of IR professionals.

Good things can happen for a new company when these questions get answered with cogent planning that is not based on expectations of immediate fame and glory. One success story is ShengdaTech, a China-based specialty chemical maker that formed by reverse merger in March 2006. The company’s share prices suffered at the outset, when shell shareholders sold off, but CCG’s Coulson said his firm continued to work with a long-term plan.

“We went out with them and did a pretty broad-based, non-deal road show,” Coulson said. “We helped them to get ready to move to an advanced exchange, they filed their app to Nasdaq, they got accepted, and this spring they did a $115 million convertible offering.”

ShengdaTech stock recently traded around $9.25, up about 85% from where it started out in 2006.

Not every story plays out like Sheng­daTech’s, and companies and their IR consultants need to be extremely cautious to avoid less desirable results.

Thanks to increasing investor education and the SEC’s crackdown on spamming, a breathlessly issued prediction of rising stock prices is becoming dangerous to both the issuer and the IR company.

“There are two things that I tell companies they absolutely cannot do,” said Devon Blaine, principal of The Blaine Group, based in Beverly Hills, Calif. “They are inherent in a lot of reverse mergers, depending on who did the deal. And that’s email blasts and fax blasts — it’s the absolute red flag to the SEC.”

Emails and faxes do not work, said Andrew Barwicki of New York-based Barwicki Investor Relations, who said that when they’re employed, it’s usually a pump-and-dump scheme.

A jump in share price following a merger can prompt shell shareholders to stampede and sell off. But this legitimate selling may not be a catastrophe if it doesn’t get out of hand. “You have some immediate selling that causes problems if it’s not managed correctly,” said Cirrus’ Davis. “But on the flip side, it creates some of that initial turnover that looks like vol­ume — it’s an active market with some liquidity.”

Pump-and-dump scenarios were more common before the SEC made it difficult for companies to use Form S-8 to issue freely tradable stock to consultants. But IR professionals still receive equity compensation, though usually in the form of options, warrants, or restricted stock. Such equity ownership motivates the IR firm but could lead to conflicts of interest when an IR firm manipulates the price of stock to capitalize on its equity.

Some would say that adhering to honest communication eliminates the potential for conflict. “As long as you’re providing factual information, there’s no conflict of interest,” Barwicki said. “Accepting stock is fine, but you can’t pump up the company or make false statements. You still have to make legitimate, honest statements.”

Others are concerned with the differing kinds of incentives offered by stock as opposed to options or warrants. “Free trading or restricted [stock], that’s just a free ride,” said George Tsiolis of Agoracom, an IR firm catering to small cap companies.

“No matter what happens, I’m going to have shares, so even if the company does nothing, if I can keep it at neutral for a year, I can cash in those shares.” Tsiolis said stock options provide a better incentive since they are usually priced so that they can only be exer­cised if the stock goes up.

Davis believes restricted stock insulates the IR firm from potential conflict. His firm includes voluntary lockups in its agreements so that it can’t touch any underlying stock it receives until it’s done working with a company. “It handicaps us to a degree because some of the unethical guys will take a portion of the shares they received and start creating some volume on their own, which will spur some more volume,” he said.

The wild card in illegal promotional stock use gets played when an anonymous third party — not the issuer or IR firm — pays for and disseminates research. Unknown parties with a position in the company’s stock try to pump up prices by releasing dubious projections about the company’s future.

Such may have been the case earlier this year when Immunosyn, a La Jolla, Calif.-based biopharmaceutical developer, had to issue a press release disavowing a privately commissioned research report stating that Immunosyn’s stock had an “implied value” of $32. After the report hit newswires on Jan. 16, the company’s stock rose 26% during the day to $2.90 on seven times the previous day’s volume.

Devon Blaine, who handles Immunosyn’s investor relations, said the newswires were quick to withdraw releases on the report, but getting archived releases off the internet was a frustrating and time-consuming process. “It became a multi-month job. That’s a basic nightmare situation,” Blaine said. The maker of the report, Venice, Calif.,-based Proteus Equity Research, did not return calls.

But small and micro cap companies with no institutional research coverage often do commission paid research. Doing so requires considerable caution to mitigate the impression that the paid-for research is blatantly biased towards the company that pays.

A.J. Cervantes, with China America Financial Communications Group, said paid research is a good way for companies to make factual information readily available to potential investors, but that the analysis needs to be orchestrated carefully.

Cervantes isn’t opposed to paid research, but it must have three elements, he said. It needs to be created by a qualified chartered financial analyst; there can be no stock anywhere in the transaction; and it has to be paid for in full up front.

Some market participants take a dimmer view of paid research. “We’re very disappointed with the results,” said Cirrus’ Davis. The only people looking at paid research are retail investors with little money to play with, he said. The investors that most companies are looking to entice would never take advice from paid research.

“Until you’ve got a ThinkEquity Partners, for example, to cover, why bother?” he said.

Disclosing the paid nature of this type of research is important to distinguish it from institutional coverage that was not originated by the company. Failure to disclose properly looks bad. Such was the case for Rocket City Enterprises. Jeff Bishop’s IR firm, BlueWave Advisors, commissioned Rocket City research through Bishop’s Beacon Equity Partners.

BlueWave identified itself as Rocket City’s IR firm in press releases touting the Beacon report, but BlueWave did not indicate that it paid for the research. The research itself did bore some disclaimer statements, but nothing to indicate that it had been paid for by Rocket City’s IR firm.

The ultimate challenge for IR firms and their clients may be deciding how far to go in telling the company’s story. IR firms need to focus on facts and avoid predictions, said Davis. But they still have to get investors’ attention.

“At the end of the day we’re here to educate, we’re not here to sell,” Davis said. “There’s obviously a fine line. You want to educate in a way that’s exciting and engaging, but we’re not here to trump up a story, and you really have to walk that line.”

Contact The Blaine Group