Required paperwork for purchasing or selling a business

The documents you need to buy or sell a business depend on the structure (discussed here) and complexity of the deal as well as its specific terms. However, in virtually all cases, there will be a principal agreement governing the transaction. This will be a merger agreement for a merger, a stock purchase agreement for a stock purchase and, you guessed it, an asset purchase agreement for an asset purchase. These documents may have slightly different names at times. For example, a merger agreement may be called an agreement and plan of merger or a stock purchase agreement may be referred to as a securities purchase agreement or a purchase and sale agreement. Contracts for transactions involving the sale of stock and assets may simply be called purchase agreements. By and large, these slight variances in nomenclature don’t reflect any substantive distinctions.

Below, I’ll describe the purpose of each of these principal transaction agreements. After that, I’ll also very briefly introduce you to several other common mergers and acquisitions (M&A) transaction documents, including:

Confidentiality Agreements
Letters of Intent
Exclusivity Agreements
Disclosure Schedules
HSR Filings
Third Party Consents
Legal Opinions
Stock Certificates
Bills of Sale
Assignment and Assumption Agreements
Escrow Agreements and
Transition Services Agreements.

There are dozens of other documents I could mention, including various Securities and Exchange Commission (SEC) filings for public deals, other federal and state regulatory filings, board resolutions, proxy statements, closing certificates, non-competition agreements, shareholder representative agreements, financial adviser engagement letters, fairness opinions, exchange agent agreements, employment agreements, compensation plans, real estate documents, lien releases, financing documentation and more, but I’ll save those for later posts. I’ll also spend more time discussing each of the following documents in subsequent posts.

Principal Transaction Agreements

Merger Agreements

Merger agreements provide that one company will merge with and into another company by operation of law, thereby effecting a change in control over one of the companies. They are the primary transaction agreement governing mergers and are frequently employed in public M&A deals. Among other things, these agreements typically:

address the cancellation of the target company’s shares and their conversion into the right to receive the purchase price from the buyer,
include mechanics for the tendering of cancelled shares and the payment of the purchase price to target company shareholders,
require the filing of one or more certificates of merger (or equivalent documents) with the state or states whose law governs the constituent companies,
provide for appraisal (dissenters’) rights,
contain representations and warranties from each party to the other as to its ability to consummate the transaction and, in the case of the target, its businesses,
contain covenants (i.e., binding promises) requiring the parties to make any necessary regulatory filings, obtain third party consents, secure permits, solicit shareholder approval and cooperate prior to and (except in public deals) after closing,
allow the parties to terminate the agreement under specified circumstances, such as the occurrence of an event that has a material adverse effect on the target company,
include conditions to closing and
in private M&A deals, provide for the parties to indemnify each other for losses resulting from breaches of the agreement.

In public transactions, merger agreements also contain deal protections (no-shops, break-up fees and other devices intended to make termination of the agreement less likely) and securities law compliance provisions. Want to buy a merger agreement?

Stock Purchase Agreements

Like merger agreements, stock purchase agreements, or SPAs, are the primary transaction documents governing a deal. However, SPAs take the place of merger agreements in stock purchase transactions where ownership of stock changes hands. No merger occurs. Among other things, SPAs typically:

provide for the transfer of stock, including, when applicable, physical delivery of stock certificates to the buyer, in return for payment of the purchase price, and
contain representations and warranties from each party to the other as to its ability to consummate the transaction and, in the case of the sellers, the target company’s businesses and the shares being transferred.

Otherwise, SPAs are very similar to merger agreements. Note, though, that they are almost never used in connection with an acquisition of 100% of a public company’s stock. Want to buy a stock purchase agreement?

Asset Purchase Agreements

Asset purchase agreements, or APAs, are the primary transaction documents governing sales of assets. However, rather than provide for a merger or transfer of shares, they establish the terms and conditions by which assets and liabilities will be conveyed by a seller to a buyer. APAs are very similar to stock purchase agreements, except for:

specific enumeration of the assets and liabilities being transferred,
providing for use of necessary legal instruments to transfer ownership, such as bills of sale (for personal property), assignment and assumption agreements (for contracts and permits), intellectual property assignments, real property transfer documents and so on,
some differences in representations and warranties of the seller, such as a representation that the acquired assets are sufficient to run the acquired business, and
provisions governing the treatment of assets that are used in both the business of the seller and the acquired business (shared assets).

Want to buy an asset purchase agreement?

Documents Signed Before Principal Transaction Agreements

Confidentiality Agreements

M&A confidentiality agreements are usually entered into at commencement of discussions between the parties to ensure the fact that discussions are occurring, the terms being discussed and information about the parties’ respective businesses will be maintained in confidence. I’ve written a lengthy post about confidentiality agreements in M&A deals here. Want to buy a confidentiality agreement?

Letters of Intent

Letters of intent, or LOIs, are short, largely non-binding documents signed by the parties to prospective M&A transactions that lay out the general framework for the transaction, including the target, the purchase price (or a purchase price range), transaction structure, contingencies (e.g., whether there’s a buyer financing contingency), covenants and the terms of any indemnification.

Although LOIs are intended to be non-binding, they are employed by M&A parties as a tool to simplify the negotiation process by crystallizing the most material issues early in their interaction. By investing a bit of extra effort in hammering out an LOI at the commencement of discussions, parties can reduce the risk that they will needlessly expend even more resources through a full-scale due diligence, negotiation and definitive document drafting process only to discover that there is no deal to be had.

Exclusivity Agreements

Exclusivity agreements are very short (1-2 page) agreements through which a seller agrees not to begin or continue attempting to sell the target company to a third party for a period of time (typically, 15-60 days). They are generally sought by buyers who do not wish to compete or continue competing with third parties for a deal. As one might expect, sellers agree to exclusivity reluctantly, as doing so may reduce their ability to maximize value from the transaction by inducing competing bids. However, without exclusivity, many buyers will refuse to invest the time and resources in conducting fulsome due diligence and negotiating an LOI or definitive transaction agreements. Want to buy an exclusivity agreement?

Documents Effective Upon Signing Principal Transaction Agreement

Disclosure Schedules

Disclosure schedules, sometimes called disclosure letters, aren’t separate agreements or other independently operative instruments. Rather, they are attachments to, and made a part of, the deal’s principal transaction agreement (merger agreement, SPA or APA). Their primary purpose is to provide disclosure about one of the parties to the transaction and to qualify or limit representations and warranties, and they are frequently quite lengthy, sometimes even exceeding 100 pages.

A given deal may have two disclosure schedules, one for the buyer and one for the seller or target. However, a seller or target disclosure schedule is far more common than one for the buyer. Buyer disclosure schedules are usually only needed in deals where the seller requires a significant amount of information about the buyer, such as, for example, when the purchase price is paid with buyer stock.

The disclosure provided by disclosure schedules is usually tied to specific representations and warranties contained in the principal transaction agreement. For example, a representation relating to material contracts of the target company may include a reference to a list of such contracts in the seller disclosure schedule. Alternatively, the information contained in the disclosure schedule may qualify or limit the scope of corresponding representations and warranties. For example, a representation may provide that there are no existing legal proceedings involving the target, except as set forth in the seller disclosure schedule.

Documents Needed Between Signing and Closing

HSR Filings

The Hart-Scott-Rodino Antitrust Improvements Act of 1976 requires parties to M&A transactions that meet certain criteria to file a Premerger Notification and Report Form, commonly called an HSR filing, with the Federal Trade Commission (FTC) before they may consummate the transaction. These filings are designed to provide information to the FTC and U.S. Department of Justice (DOJ) for the purpose of determining whether the proposed transaction may have an anti-competitive effect on any relevant markets. If the FTC and DOJ have no concerns, then the parties may close the transaction 30 days after making the HSR filing (or earlier of the authorities grant early termination of the waiting period).

Third Party Consents

Many target companies are subject to agreements with third parties that restrict their ability to consummate a deal. These may include leases, loan agreements, customer contracts and more. Whether they may impede the transaction depends on the specific terms of the agreement, the law governing the agreement and the structure of the transaction. For example, while a direct assignment of a contract may be prohibited, which would interfere with an asset sale transaction, a merger or change in control (i.e., a sale of stock) of the target may not be so restricted.

When contractual restrictions cannot be avoided through creative deal structuring, M&A parties must obtain written consents from third parties who have rights that would be triggered by a deal. These consents are simple instruments that must be tailored to the specific terms of the subject agreement, and they are rarely controversial in form. However, securing the required consents may at times prove difficult and time-consuming, as some counterparties may use their leverage to extract value from the requesting party.

Documents Delivered At or Effective After Closing

Legal Opinions

Occasionally, a seller’s attorneys may be called upon to render a written legal opinion for the buyer to be delivered at closing. These opinions are intended to provide additional assurance to the buyer that certain legal matters are as they have been described by the seller in its representations and warranties. A typical opinion might cover the following matters:

the target was duly formed,
the target is in good standing in relevant states,
the target’s capital structure (i.e., shares outstanding),
the transaction and transaction agreements will not violate the target’s charter and other organizational documents or material contracts,
there is no litigation pending or threatened against the target and
any issuance of stock or other securities in the transaction complies with federal and state securities laws.

While commonplace in the past, buyers only rarely request seller legal opinions today on account of the legal fees that must be incurred to obtain them as well as the buyer’s ability to confirm independently many or all of the matters that would be addressed by the opinion.

Stock Certificates

Stock certificates are the physical embodiment of an ownership interest in a corporation. If the target is a limited liability company or partnership, equivalent membership, unit or partnership certificates may exist. These must be signed by the seller or sellers and delivered to the buyer at closing of a stock purchase transaction. In merger transactions, they are deemed cancelled and converted into the right to receive the merger consideration upon delivery to the buyer or paying agent.

Bills of Sale

Bills of sale are short instruments that actually transfer ownership of personal property from the seller to the buyer. They are only used in asset purchase transactions because personal property transfers to the buyer automatically in a stock purchase or merger. They are typically attached as exhibits to APAs, and the seller agrees to deliver a duly executed bill of sale to the buyer at closing.

In very simple asset sales, parties may forego an APA and instead prepare a long-form bill of sale that includes basic representations and warranties and, possibly, covenants. Want to buy a bill of sale?

Assignment and Assumption Agreements

Assignment and assumption agreements are analogous to bills of sale, except they effect the transfer of contracts, permits and similar assets by the seller to the buyer in an asset purchase transaction. It’s important to note that the word “assumption” in the title of these instruments refers to the buyer’s assumption of liabilities associated with the assigned assets.

As with bills of sale, it is possible, though uncommon, for parties to simple M&A transactions to rely solely on a long-form assignment and assumption agreement containing representations and warranties rather than a full APA. Want to buy an assignment and assumption agreement?

Escrow Agreements

In private M&A transactions, sellers usually agree to indemnify (i.e., hold harmless and protect) buyers and their affiliates and representatives from any losses they incur as a result of breaches of the seller’s representations, warranties and covenants contained in the principal transaction agreement. Should such an indemnification obligation arise post-closing, the buyer or other indemnified party would become an unsecured creditor of the seller or sellers, and it may be difficult for the indemnified party to collect on this debt.

To mitigate this risk, buyers frequently demand, and sellers usually agree, that a portion of the purchase price will be deposited with a trustworthy third party agent to hold for a period of time after closing for the purpose of remitting funds to indemnified parties if they become entitled to recover damages from the seller or sellers. These escrow arrangements are governed by escrow agreements signed by the parties to the M&A transaction as well as the third party escrow agent. Aside from establishing the mechanics for distributing the funds, escrow agreements also set forth the terms of the escrow agent’s engagement, including its rights, obligations and fees. Want to buy an escrow agreement?

Transition Services Agreements

Many M&A transactions involve the sale of only part of the operations of a larger enterprise. Thus, the extraction of the target business may be disruptive to that business, as it loses enterprise-wide services and support it had previously enjoyed. This may include, among other things, the loss of IT and telecommunications services, finance and accounting services, participation in employee benefits plans, legal and compliance support, equipment maintenance, logistics support, supply chain management and access to favorable vendor pricing and other terms.

Gayatri GuptaJanuary 16, 2024

Nasdaq Compliance

The Nasdaq Stock Market features three tiers of listed companies, namely: (1) The Nasdaq Global Select Market, (2) The Nasdaq Global Market, and (3) The Nasdaq Capital Market. These tiers are characterized by progressively stringent listing requirements, with the Nasdaq Global Select Market setting the highest standards for initial listings and the Nasdaq Capital Market serving as the entry-level tier, particularly suitable for most small-cap issuers.

To list securities on Nasdaq, a company must fulfill minimum listing requirements, encompassing defined criteria related to financial performance, liquidity, and corporate governance. Nasdaq retains extensive discretion in the listing process and reserves the right to reject an application, even if the technical prerequisites are satisfied, if it deems such denial essential to safeguard the interests of investors and the public.

After securing a listing on Nasdaq, a company is obligated to adhere to ongoing listing standards. To initiate the listing process, a company seeking inclusion on Nasdaq must diligently complete and submit a comprehensive listing application to Nasdaq. This application should include specific documents and information as outlined by Nasdaq's requirements.

Typically, the application process spans a duration of four to six weeks. Once the application is submitted, a Nasdaq analyst is designated as the primary liaison with the company. Within two to three weeks of submission, the company can expect to receive an initial comment letter. The comment and review process persists until a decision is reached on the approval or denial of the application. Similar to filing with the SEC, a meticulously prepared Nasdaq application tends to attract fewer comments and facilitates a more streamlined process. Generally, the company's securities counsel assumes a leading role, serving as the primary contact for preparing the application and engaging in communication with Nasdaq.

Similarly to the SEC review process, Nasdaq conducts a thorough examination of publicly accessible information pertaining to a company. This encompasses, but is not limited to, SEC filings, the company's website, management communications and speeches, as well as press releases. The iterative nature of the review process typically doesn't necessitate a formal protocol, and communication is commonly facilitated through email correspondence and phone calls.

Listing Criteria For Nasdaq
For a company to list its securities on Nasdaq, it must satisfy the following criteria:

Specific Initial Requirements:
- Quantitative Standards: Meeting defined thresholds for both quantitative and qualitative factors.
- Qualitative Standards: Fulfilling certain qualitative benchmarks.
Continuing Requirements:
- Quantitative Criteria: Adhering to ongoing quantitative benchmarks.
- Qualitative Criteria: Maintaining specified qualitative standards.

The initial quantitative thresholds are typically set at a higher level than those required for continued listing. This distinction aims to ensure that companies achieve a sufficient level of maturity before being listed. Additionally, Nasdaq imposes rigorous corporate governance standards that listed companies must adhere to throughout their tenure on the exchange.

Before formally submitting a comprehensive listing application, a company has the option to pursue a preliminary listing eligibility review. In this stage, the Listing Qualifications Staff conducts a thorough examination of the company's public filings to assess its compliance with numerical listing requirements. Additionally, the team evaluates the company's adherence to corporate governance requirements outlined in the Marketplace Rules ("Rules"). This preliminary review provides valuable insights into the company's eligibility for listing on Nasdaq before committing to the full application process.

Upon completion of the preliminary review, the Listing Qualifications Staff will make an assessment regarding whether the company meets the numerical listing criteria. Additionally, any corporate governance or regulatory concerns raised during this phase will be considered to determine their impact on the listing approval. It's important to note that while the preliminary review provides insights, final approval necessitates the submission of a formal listing application. This application undergoes a thorough examination by the NASDAQ Listing Qualifications Staff. Furthermore, the final approval process involves satisfactory compliance with specific qualitative reviews. This includes an examination of the regulatory history of the company's officers, directors, and significant shareholders. Meeting these criteria is integral to obtaining the final approval for listing on Nasdaq.

Financial And Liquidity Requirements

    Requirements

    Equity Standard
    Market Value of Listed Standard
    Net Income Standard

    Listing Rules

    5505(a)
and
5505(b)(1)
    5505(a)
and
5505(b)(2)
    5505(a)
and
5505(b)(3)
    
    Stockholders Equity

    	$5 million
    	$4 million
    	$4 million
    
    The market value of publicly held shares

    $15 million
    $15 million
    $
      5 million
    
    Operating History

    	Two years
    N/A
    N/A
    
    The market value of listed securities

    N/A
    $50 million
    N/A
    
    Net income from continuing operations (in the latest fiscal
a year or in two of the last three
fiscal years)

    N/A
    N/A
    $750,000
    
    Publicly held shares

    	1 million
    	1 million
    	1 million
    
    Bid Price

    	$4
    	$4
    	$4)
    
    Closing Price

    	$3
    	$2
    	$43
    
    Corporate Governance

    Yes
    Yes
    Yes
    
    Total Shareholders

    300
    300
    300

Corporate Governance Requirements

Across all three tiers of the Nasdaq Stock Market, corporate governance requirements remain largely consistent. The categories encompassing corporate governance standards include:

Distribution of Annual or Interim Reports
Independent Directors
Audit Committee
Compensation Committee
Nomination of Directors
Code of Conduct
Annual Meetings
Solicitation of Proxies
Quorum
Conflict of Interest
Shareholder Approval
Voting Rights

These governance elements play a crucial role in ensuring transparency, accountability, and ethical conduct within listed companies, irrespective of the specific tier within the Nasdaq Stock Market.

Companies seeking listing on Nasdaq must adhere to specific corporate governance standards, including the following:

Compensation Committee with Independent Directors:
- The company is required to establish a compensation committee comprised of independent directors.
- The committee must consist of at least two members.
- Rule 5605(d)(2)(A) introduces an additional independence test for compensation committee members.
Responsibility for Executive Compensation:
- The compensation committee is tasked with determining or recommending to the entire board the compensation of the chief executive officer (CEO) and all other executive officers.

These standards are designed to ensure a level of independence and scrutiny in the decision-making processes related to executive compensation within the company.

The Application And Documents

The Nasdaq application package encompasses several key components:

Symbol Reservation Form:
- Used to request the reservation of a specific trading symbol for the company.
Listing Application:
- Requires supplemental documents and details about the company's financials, operations, and other pertinent information.
Listing Agreement:
- A formal agreement outlining the terms and conditions of the listing on Nasdaq.
Corporate Governance Certification:
- A certification affirming the company's commitment to meeting Nasdaq's corporate governance standards.
Initial Application Fee:
- Payable via check or wire transfer, this fee is a prerequisite for initiating the listing process.
Logo Submission Form:
- Used for submitting the company's logo for use in Nasdaq's materials.

These application forms are completed through the Nasdaq website listing center, utilizing the online platform to facilitate the submission of supplemental and supporting documents. It is advisable to thoroughly review all required paperwork in advance, ensuring that the necessary information is readily available before initiating the application process.

Symbol Reservation Form

The symbol reservation form is a concise, one-page electronic form where applicants input information for Nasdaq's consideration. Nasdaq symbols, limited to 1-5 characters, adhere to guidelines established by the Intermarket Symbols Reservation Authority (ISRA). The ISRA system is designed to organize symbols efficiently, prevent duplication, and reduce programming and operational complexities. The ISRA operates within the framework of the NMS Symbology Plan, a plan utilized by Nasdaq.

Key details about the symbol reservation process:

Symbol Choices:
- The form allows applicants to propose three symbol choices in order of preference.
- While Nasdaq generally honors the first choice if available, it retains the authority to assign, rescind, or reassign a trading symbol at its discretion.
ISRA and Nasdaq Authority:
- The ISRA and Nasdaq have overarching authority in managing the assignment of symbols.
Additional Information:
- The form captures essential details about the issuer and the planned public offering.
- Information may include the name of the attorney, lead underwriter (if applicable), CEO and CFO names, yearly revenues, company website, and the sector in which the company operates.

Completion of this symbol reservation form initiates the process of securing a trading symbol on Nasdaq, and it's essential to provide accurate and comprehensive information to facilitate this stage of the listing application.

The Application

The Nasdaq listing application process is comprehensive and varies based on the circumstances surrounding the listing sought. There are twelve distinct listing applications catering to different situations, including changes of control, switches from other exchanges or markets, spin-offs, and initial public offerings (IPOs). Each application, spanning approximately seven pages, collects detailed information about the company, covering areas such as address, contact and billing details, securities attorney and auditor information, transfer agent particulars, and the company's officers and directors. Specific information on the company's securities, including type, par value, and cusip number, is also required.

Furthermore, the application mandates disclosure of legal proceedings involving the company, its officers or directors, or significant shareholders over the past ten years. This encompasses inquiries, investigations, lawsuits, litigation, arbitrations, and other legal and administrative proceedings. Documents supporting the backup and final disposition of these matters must be provided.

Regarding private offerings within the prior six months, including bridge financings, shelf registrations, and Regulation S offerings, the company is required to disclose such activities. Additionally, the application delves into the company's background, posing questions to ensure compliance with seasoning rules.

While Nasdaq retains the right to request relevant supporting documents, specific documents are mandatory based on the application type. For an uplisting from an existing U.S. market, the application must include letters from three market makers confirming their commitment to making a market in the subject securities. Other required documents include a listing agreement, a logo submission form, a corporate governance certification form, regulatory correspondence over the past 12 months, and shareholder confirmation documents. Nasdaq often seeks confirmation from the company's transfer agent regarding the eligibility of the security for the direct registration program (DRS).

During the review of an up listing application, Nasdaq may request additional information, such as a Broadridge share range analysis and NOBO list, a certified shareholder list, details about mitigating any going concerns or opinions, income statement and/or balance sheet projections for the next 12 months, and confirmation of Sarbanes Oxley Section 302 and 906 certifications by the company, among other inquiries related to compliance and financial matters.

The Listing Agreement

The Listing Agreement is a concise document, spanning two pages, serving as a formal affirmation of the company's commitment to adhere to all rules and regulations set forth by the Nasdaq Stock Market. It includes provisions for indemnifying and holding Nasdaq harmless from liability. Notable points in the agreement include:

Compliance Assurance:
- The company explicitly agrees to comply with all rules and regulations stipulated by the Nasdaq Stock Market.
Indemnification Clause:
- The company indemnifies Nasdaq, meaning it undertakes to compensate or reimburse Nasdaq for any losses or damages incurred. This includes harm resulting from third-party trademark infringement claims related to the company's symbol and logo, as well as Nasdaq's use of the same.
Disclaimer of Warranty and Liability:
- The agreement contains a disclaimer of warranty and liability against Nasdaq for trading issues, with the exception of those resulting from gross negligence or willful misconduct.

This agreement establishes a clear framework for the relationship between the listed company and Nasdaq, emphasizing the company's commitment to regulatory compliance while providing indemnification for certain specified matters and delineating the scope of Nasdaq's liability.

Corporate Governance Certification Form

The corporate governance certification form certifies compliance with the governance requirements related to an audit committee, director nomination process, compensation committee, board composition, executive sessions, quorum, and codes of conduct. Where an exemption applies, the form requires specification of the exemption terms. The document specifies the different rules and exceptions in a check-the-box format.

Logo Submission Form

The logo submission form contains the guidelines for the logo and affirms Nasdaq’s rights to use the same. Nasdaq uses company logos in its marketing materials, on the MarketSite Video Wall and Tower, and websites.

Fees

Entry fees are based upon the aggregate number of shares to be listed at the time of initial listing, regardless of class, with a maximum cap of $75,000. Fees are assessed on the entry date in The Nasdaq Capital Market, except for $5,000, representing a non-refundable application fee. This fee must be submitted with the company’s application.

Nasdaq does not charge application or entry fees for any securities transferred from a national securities exchange.

Benefits Of Trading On An Exchange

There are many benefits to trading on an exchange instead of the OTC Markets. The most significant benefits to a business are the ability to attract analyst coverage and institutional investors and the corresponding increase in liquidity that comes with both. Stocks that trade on Nasdaq tend to have a lower bid/offer spread — again encouraging trading volume and liquidity. Exchange-traded securities are exempt from the penny stock definition, allowing more market maker and broker-dealer participation. As further explained below, a broker-dealer cannot recommend a penny stock transaction to its retail clients. Therefore, no analysts, financial advisors, or institutional investors make recommendations for purchases of penny stocks.

As an aside, this is one of the reasons that OTC Markets created the OTCQX market tier, which does not list penny stocks. It is also why the small-cap industry is pushing for a supported valid venture exchange (for further reading.

In today’s world, depositing stock and/or trade-in non-exchange traded securities is increasingly difficult. Despite the congressional efforts and SEC rulemaking in support of small-cap capital formation (for example, the JOBS Act, including the emerging growth company regulations, new Regulation A+ and Title III Crowdfunding and the new FAST Act), through enforcement and investigative proceedings, both the SEC and FINRA continue to apply pressure on broker-dealers, clearing firms and transfer agents to reduce the secondary trading and free flow of penny stocks. For more information on difficulties in depositing stocks.

Further On Penny Stocks

NASDAQ and NYSE MKT traded securities are exempted from the definition of a “penny stock” due to the initial and ongoing listing standards. Penny stock rules focus on broker-dealers’ activity in effectuating trades in penny stocks. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the “Penny Stock Act”) prohibits broker-dealers from effecting transactions in penny stocks unless they comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The rules promulgated thereunder, particularly Exchange Act rules 15g-1 through 15g-100 (the “penny stock rules”).

Section 15(h) of the Exchange Act provides that no broker or dealer may effectuate a customer’s purchase or sale of any penny stock unless such broker or dealer.

Approves the customer for the specific penny stock transaction and receives a written agreement to the transaction from the customer.
Furnishes the customer a risk disclosure document describing the risks of investing in penny stocks.
Discloses to the customer the current market quotation, if any, for the penny stock, including the bid and ask prices and the number of shares that apply to such bid and ask prices.
Discloses to the customer the amount of compensation the firm and its broker will receive for the trade.

In addition, after executing the sale, a broker-dealer must send its customer monthly account statements showing the market value of each penny stock held in the customer’s account.

Moreover, brokers and dealers subject to the penny stock rules are subject to additional disclosure requirements outlined in Rules 15g-2 through 15g-9. For my information on penny stocks and the rules affecting broker-dealer activity.

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