Investors Beware - Reverse Mergers Stink

What's happening, I think, is parallel to the way reputable companies -- well, make that read "established" companies like Citigroup (C) and E*Trade Financial(ETFC) -- have been giving serious thought to shafting their shareholders with reverse splits. As with reverse splits, reverse mergers are no longer as disgraceful as they were years ago, back when they were common among the "chop house" stock fraud machines of the 1990s.

Stock promoters in those days would form shell companies with clean records, and then back in the companies that they wanted to hype to the public at inflated prices. The shells themselves had no business, and were not marketable. So the stock promoters would find companies with a "story" and reverse-merge them into the shells. The practice drew so little attention from regulators that an reputed mafia captain had no problem putting his name on four publicly held shells back in the day.

Reverse mergers, like reverse splits, aren't consistently terrible for shareholders. Just the way reverse splits can keep a stock from being delisted from an exchange, a reverse merger reduces the costs involved in clearing an IPO with federal and state regulators, and also prevents the IPO from being buffeted by the harsh winds of a declining stock market. The technique has lately been used as a method of bringing bankrupt companies back into the glorious ranks of public trading.

A reverse merger combined the bankrupt US Airways with America West, with the US Airways(LCC) name surviving. This is also how Frederick's of Hollywood(FOH), the gaudy-lingerie manufacturer, became publicly traded after its 2003 bankruptcy. In 2006, Fredericks reverse-merged with Movie Star, an apparel manufacturer that traded on the American Stock Exchange.

So, getting back to Swisher -- I'm sure it's a fine company. I'm sure that CoolBrands will rise up again in glory, just as it did when kids everywhere were chowing down on Eskimo Pies. Which is why I don't think it would have been such a terrible imposition if the company had been brought public in a simple, straightforward IPO that would have given greater protection of investor rights than a reverse merger.

Reverse mergers aren't on the regulatory radar screen any more than reverse splits, and that's a pity. The dangers are just too serious to be believed.

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