19 Nov Have you heard of backdoor listings?
On October 30, 2014, Véronique Bruneau-Bayard, managing director of Labrador Conseil, represented France at a conference organized by the Organization for Economic Co-Operation and Development (OECD) and the Indonesian Financial Services Authority on the issue of transparency in backdoor listings. Bruneau-Bayard, a specialist in corporate governance, issues attended the conference and explains what this practice means, and the specific transparency requirements relating to it. Coincidentally, this type of transactions is not known in France.
We have researched this issue extensively and have not found any information on French backdoor listings. The name itself does not sound very transparent so what is it about and why do we not know about it?
A backdoor listing, or reverse merger as they are known in the U.S., is a strategy whereby companies desiring to go public but are prevented from doing so through traditional listing methods such as inadequate governance bodies, lack of operations, difficulties in attracting investors, etc. By purchasing an already listed company it allows the acquiring company to become a public entity and bypass the listing process. The practice is well established in the U.S., Australia, Hong Kong and Sweden.
Indonesia most likely organized this discussion with the OECD because it is expecting a “wave” of backdoor listings. The aim was therefore to determine the regime governing these operations in terms of financial transparency and governance. Such transactions do not really exist in France. One of the reasons for this could be the existence of Alternext, which allows a company to go public with less stringent listing requirements than those of Euronext.
It would seem likely that backdoor listings could be used fraudulently.
Yes indeed. In particular, there was a wave of Chinese companies who used this process to go public in the United States at the end of the 1990s and start of the 2000s. For example, let’s take one of these companies, China MediaExpress. China MediaExpress was delisted two years after its introduction to the U.S. market following the discovery of a certain number of fraudulent practices. The company stated in its annual report that it had $57 million in cash but in fact it only had $141,000. The statutory auditors, an international firm, refused to cooperate with the Securities and Exchange Commission (SEC) invoking the principle of territoriality and refused to disclose documents that were located in China. Finally, the SEC signed an agreement with the Chinese regulator that allowed the SEC to pursue its investigations and thus put pressure on Chinese companies.
What needs to be monitored to ensure that a backdoor listing is correct?
It is important to understand that in this type of transaction the acquiring company may change its corporate purpose completely. Therefore, as a shareholder, if you invested in a construction company all of a sudden you may find yourself holding shares in a company that now specializes in cosmetics as a result of a backdoor listing! It is thus particularly important to ensure that shareholders’ rights are as transparent as possible, giving them as much information on the planned operation.
The feedback during the conference highlighted the need for an exhaustive due diligence report by an independent expert and the need to engage statutory auditors in ensuring the authenticity of the company’s accounts. The audit committee, more generally the directors -particularly the independent directors, should be heavily involved in the due diligence process. This is not an ordinary transaction rather an opportunistic one and thus particular vigilance is required. The role of the financial markets authority, regardless of the country, is clearly essential.