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Reverse Mergers in Crypto: Separating Facts from Fraud

Whenever a market’s fervor heats up, there is the inevitability that issuers will use the hype to ride the wave in the public markets. Cryptocurrency and ICOs are currently witnessing this in a very real way. KODAK is a great example of this with the company’s recent ICO announcement of KODAKCoin. Greater still are the multitude of companies in cryptocurrency that have used alternative public offerings as a means to go public. The current level of interest in public shells and reverse mergers for cryptocurrency and blockchain-related firms mirrors the volume seen in the late 1990’s just prior to the dotcom bubble. That is one of the reasons the inventory for quality public shells has been lower than it has in a decade. It is also the main reasons many such deals have come under recent fire from the SEC. Anything currently related to cryptocurrency and/or cannabis—buyer beware.

In many cases, thinly-traded microcap stocks are nothing more than startups with light assets and businesses inside of them. In fact, microcap stocks themselves could rightly be considered the initial coin offerings (ICOs) of yesteryear. In the 1980’s reverse mergers took on a bad rapport as many were plagued with ill-prepared data and investor-harming pump-and-dump schemes.

A reverse merger is a uniquely structured alternative to taking a company public. In the case of microcap stocks it typically involves an Over the Counter (OTC) shell or thinly-traded stock that already holds DTC eligibility. A consortium backed by the private company typically will take over the public entity and “reverse merge” the private company into the public vehicle. This process is much less expensive than a typical Initial Public Offering (IPO) and even faster than a Direct Public Offering (DPO). Unfortunately, companies that use this method for going public are notorious for various schemes used to ride public sentiment waves in hot industries.

This is one of the many reasons small public companies have been seeing so much recent backlash from regulators. Specific companies have received SEC backlash for nefarious dealings in the following ways:

  • Public companies simply changing their names to reflect the fact that they are now in blockchain in order to ride the hype of the industry’s wave. As an example, Long Island Iced Tea Corp’s stock more than tripled when it changed to Long Blockchain.
  • Cherubim Interests, PDX Partners and Victura Construction Group all recently had trading halted by the SEC. Alarming evidence included smoke-and-mirror-like press releases touting blockchain asset purchases and promises of initial coin offerings. Several have done so with very delinquent reported filings with the SEC.
  • Riot Blockchain—which incidentally was previously a biotech startup—saw a massive stock selloff during a botched reverse merger transition.
  • Overstock has even received scrutiny of its shift more toward blockchain with the release of TZero—a secondary trading platform for blockchain securities which has raised millions. Overstock’s stock spiked and fell—some blame the volatility to the tie between the two companies.

While some of those listed on the over-the-counter exchange truly provide strong ties and business plans directed at taking blockchain to the next level, investors are advised to perform substantial due diligence when considering investing in such companies.

Things like issuer third party due diligence reports, management background checks and financial audits are all critical. Companies with more significant revenue and traction, including those with traction in blockchain and cryptocurrency should also be a strong consideration.

The short is that where there is money to be made, there is money to be lost. The markets are not always a zero-sum game, but in the case of non-existent business models, this can easily be the case.