At a wedding reception in White Plains, N.Y., last weekend, a fellow guest stepped up to Tom Tenenbaum and asked the securities lawyer if he knew anything about 'reverse mergers.'

'He had been approached to invest in one and wanted to know more about how they worked,' says Mr. Tenenbaum, who runs a practice in Denver. 'It reminded me of tax shelters a few years back, when they were so popular that people would talk about them at parties.'

Party talk aside, reverse mergers -- in which a private company buys all or most of the stock of an already publicly traded firm -- are on the scene. Small firms find them a low-cost, quick and fuss-free way to instantly become a public company, often without the paperwork required for a conventional initial public offering of shares. Moreover, the market for traditional IPOs from such microcap companies has all but dried up.

NYSE Deal an Exception

The biggest reverse merger deal this year is probably the New York Stock Exchange's proposed acquisition of electronic-trading firm Archipelago Holdings Inc., which is publicly traded. But the bulk of reverse mergers, involve much smaller private businesses acquiring companies with few or no operating assets, also known as shell companies, that are quoted on over-the-counter markets like the Bulletin Board and the Pink Sheets.

Excluding deals with Pink Sheet companies, there have been 55 reverse mergers so far this year compared with 89 for all of 2004, according to the Reverse Merger Report, a trade publication. This year's deals include private China-based businesses, fledgling biotechnology companies and software companies.

Compare that to the IPO market, which has seen 83 issues this year -- well off the 251 of 2004, according to Thomson Financial.

Fueling the boomlet in reverse mergers is a growing pool of hedge funds and other investors keen to buy discounted stakes in the new public entities.

In the past, such deals occasionally have had an unsavory air. In some of the most egregious cases, unscrupulous promoters would use a shell company to bring public a company with no real business, talking up the company's potential then selling their own stock once the deal was complete. Once investors realized they had bought into a business that essentially didn't exist, it was too late: They were holding worthless stock.

SEC Cracking Down

But regulators are acting to curb such 'pump and dump' schemes. The Securities and Exchange Commission is scheduled to vote today to tighten rules governing shell companies as part of a final batch of regulatory measures backed by outgoing Chairman William Donaldson. The new rules are expected to compel shell companies to provide detailed disclosures about their new businesses shortly after they merge with private operating companies, among other strictures.

In a conventional IPO, the company must hire an underwriting bank that examines the company's business and financial merits, acting as a gatekeeper between the company and its potential investors. In a reverse merger, there's no such gatekeeper, although the two parties generally perform 'due diligence' on each other.

'There are pitfalls with reverse mergers, but they have become a lot more legitimate and popular,' says David Feldman, managing partner of New York law firm Feldman Weinstein LLP. 'More firms are turning to them because they realize that an IPO is not always the best way to raise funds.'

Microcap companies often find it difficult to find brokers, who often shun such deals as unprofitable. In addition, a conventional IPO can take much longer.

Many companies that aspire to list on a bigger exchange find a reverse merger a good 'stepping stone' toward that goal, adds Tim Halter, chairman and chief executive of the Halter Financial Group, a Texas-based reverse-merger consultant. Soon after the reverse merger is completed, they can raise funds through a stock sale to fund growth.

Some of the companies executing a reverse merger do so in conjunction with what's known by bankers as a PIPE, or private investment in public equity, transaction. PIPE investors buy registered or soon-to-be registered shares in public companies directly, usually at a discount to the market price. By tapping the PIPE market immediately after a reverse merger, companies get to raise funds as soon as they go public, just like they would in an IPO.

'The firms I'm looking to invest in typically have rapid growth and need money quickly to finance that growth,' says Barry Kitt, manager of the Pinnacle Fund, a $130 million hedge fund that invests in microcap companies. 'An IPO can take up to a year to complete, and with a hot IPO I probably won't be able to get much of it. But if I'm aligned with the investment bankers of a reverse-merger deal I can usually buy as many shares as I want.'