This company concluded that the conversion option embedded in their convertible notes issued in December 2012 is an embedded derivative. I disagree.
Some history. The company did a reverse merger into a public shell back in May/June 2012. They did some small private securities sales since, and then closed the big one in December 2012. Their trading volume was on average fairly meager except for a few spikes here and there. The biggest spikes were in January 2013. Without doing a detailed calculation, I struggle to understand how they concluded that a daily average of about 50,000 shares can easily absorb the stock issuable upon conversion of a note…some 800,000 shares ($200,000 note convertible at $.25).
Without a contract method for net settlement (there isn’t one), they would need to meet the net settlement condition by having the issued shares easily absorbed by the market without negatively affecting price. Just don’t see how they got there. The price protection provisions would definitely fail Step 2 of the test to determine of the feature is indexed to the company’s own stock. So if it is in fact a derivative, then they figured out that it can’t be classified in equity correctly.
BUT, it doesn’t appear to be a derivative from where I’m sitting. If not, that would lead them to potential beneficial conversion feature accounting since the notes were issued with detachable warrants that would absorb a good chunk of the issuance proceeds.