Audit Committees – NYSE American
Posted by Securities Attorney Laura Anthony | January 29, 2021 Tags:

Like Nasdaq, I’ve written several times about the NYSE American listing requirements including the general listing requirements (see HERE) and annual compliance guidelines (see HERE).  As an aside, although the Nasdaq recently enacted significant changes to its initial listing standards, the NYSE American has not done the same and no such changes are currently anticipated.  I suspect that the NYSE American will see a large uptick in new company applicants as a result.

I recently drilled down on audit committee requirements and director independence standards for Nasdaq and in this and the next blog, I will do the same for the NYSE American.  As required by SEC Rule 10A-3, all exchange listed companies are required to have an audit committee consisting of independent directors.  NYSE American Company Guide Rule 803 delineates the requirements independent directors and audit committees.  Rule 803 complies with SEC Rule 10A-3 related to audit committees for companies listed on a national securities exchange.

SEC Rule 10A-3

SEC Rule 10A-3 requires that each national securities exchange have initial listing and ongoing qualification rules requiring each listed company to have an audit committee comprised of independent directors.  Although the NYSE American rule details its independence requirements, the SEC rule requires that at a minimum an independent director cannot directly or indirectly accept any consulting, advisory or other compensation or be affiliated with the company or any of its subsidiaries.  The prohibition against compensation does not include a reasonable compensation for serving as a director.

Like the NYSE American rules, the SEC allows for different independence standards for foreign private issuers (FPI) following their home country rules and even allows for affiliation as long as the person is not an executive officer of the FPI.

The audit committee of each listed company, in its capacity as a committee of the board of directors, must be directly responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged for auditing and audit-related services.  Furthermore, the SEC requires that an executive officer of a listed company promptly notify the national exchange if he or she becomes aware of any material noncompliance with the audit committee requirements by that listed company.

Although charter requirements are detailed in the NYSE American rule, the SEC rule requires that the audit committee establish certain processes and procedures for handling complaints regarding accounting, internal financial controls and auditing matters, including for the confidential submission by employees.  The SEC rule also requires that an audit committee be given the power, authority and funding to engage independent counsel and other advisors to carry out its tasks.  Funding must also be provided to hire audit firms and pay administrative expenses.

The SEC allows for a phase-in for compliance when a company is completing an initial public offering.  In particular, all but one director may be dependent for 90 days following the IPO and a minority of the audit committee may be dependent for one year from effectiveness of the registration statement.  The SEC rule also contains general exemptions from the audit committee requirements including: (i) for consolidated subsidiaries that are listed on another exchange with similar audit committee requirements; (ii) FPI’s that follow home country rules and have a similar committee to an audit committee and satisfy certain additional conditions; and (iii) related to the listing of certain options, futures, asset-backed issuers, investment trusts, a passive trust or foreign governments.  Specific disclosure is required when an exemption is being relied upon including an assessment of whether, and if so, how, such reliance would materially adversely affect the ability of the audit committee to act independently and to satisfy the other requirements of Rule 10A-3.

The SEC rule specifically requires that an exchange must give a listed company the opportunity to cure a defect in the audit committee requirements prior to delisting.  Moreover, the SEC rule provides that if an independent director on the audit committee loses independence as a result of factors outside of their control, that person may remain on the audit committee until the next annual shareholders meeting or one year from the date of the occurrence that caused the board member to no longer be independent.

NYSE American Rule 803

Audit Committee Composition

One of the corporate-governance-related listing requirements is that a company have an audit committee consisting solely of independent directors (for more information on independence qualifications, see HERE) who also satisfy the requirements of SEC Rule 10A-3 and who can read and understand fundamental financial statements including a balance sheet, income statement and cash flow statement. One member of the audit committee must have employment experience in finance or accounting, an accounting certification or other experience that results in the individual’s financial sophistication, including but not limited to being or having been a CEO, CFO or other senior officer with financial oversight.

The audit committee must have at least three members; however, a smaller reporting company is only required to have two members on its audit committee.  For the current definition of a smaller reporting company, see HERE.  Nasdaq does not have this carve-out for smaller reporting companies, though it does have it for compensation committees.

None of the committee members can have participated in the preparation of the financial statements of the company or any of its current subsidiaries for the prior three years.  An individual will be considered to have participated in the preparation of the company’s financial statements if the individual has played any role in compiling or reviewing those financial statements, including a supervisory role. An interim officer who signed or certified the company’s financial statements will be deemed to have participated in the preparation of the company’s financial statements and, therefore, could not serve on the audit committee for three years.

The eligibility requirements to serve on the audit committee apply to all committee members whether or not such member is afforded non-voting status or other limitations on their participation with the committee.  Lawyers that work at a law firm employed by the company cannot serve on the audit committee.

The NYSE American has a limited exception to the independence requirements where a director meets the independence standards in SEC Rule 10A-3 but not the more detailed requirements of the NYSE American company guide, is not currently an executive officer, employee or family member of an executive officer and exceptional circumstances makes the appointment of the person in the best interests of the company and its shareholders.  Specific disclosures are required in the company’s next proxy statement or annual 10-K when relying on this exception including the nature of the relationship that makes the person non-independent and the reasons for the board’s determination.  A committee member appointed under this exception may not serve for more than two years and cannot be chair of the audit committee.

Audit Committee Charter

NYSE American Company Guide Rule 803 requires that each company must certify that it has adopted a formal written committee charter and that the audit committee will review and reassess the charter on an annual basis.  The certification is submitted one time and a copy of the actual charter does not need to be provided to the NYSE American.  However, Item 407(d)(1) of Regulation S-K requires that companies report whether a current copy of its audit committee charter is available on its website and provide the website address.  If the charter is not on the website, companies should include the charter as an appendix to its proxy statement at least once every three years or in any year in which the charter has been materially amended.

The charter must specify: (i) the scope of the audit committee’s responsibilities and how it carries out those responsibilities including structure, processes and membership requirements; (ii) the audit committee’s responsibility to ensure that it receives written statements from the outside auditor regarding relationships between the auditor and the company and actively taking steps for ensuring the independence of the auditor; (iii) the committee’s purpose of overseeing the accounting and financial reporting processes of the company and the audits of the financial statements of the company; and (iv) the specific audit committee responsibilities and authority.

Audit Committee Responsibilities and Authority

The audit committee is responsible for items delineated in SEC Rule 10A-3 and in particular related to: (i) registered public accounting firms, (ii) complaints relating to accounting, internal accounting controls or auditing matters, (iii) authority to engage advisers, and (iv) funding as determined by the audit committee.

The audit committee is required to meet on at least a quarterly basis.  Nasdaq does not specify meeting requirements.

Cure Periods

All noncompliance with audit committee requirements requires prompt notification to the NYSE American.

Consistent with SEC Rule 10A-3, if a member of the audit committee loses independent status for reasons outside the member’s reasonable control, the audit committee member may remain on the audit committee until the earlier of its next annual shareholders meeting or one year from the occurrence of the event that caused the failure to comply with this requirement. A company relying on this provision must provide notice to the NYSE American immediately upon learning of the event or circumstance that caused the noncompliance.

If noncompliance is a result of a vacancy arising on the audit committee, the company will have until the earlier of the next annual shareholders meeting or one year from the occurrence of the event that caused the failure to comply with this requirement – provided, however, that if the annual shareholders meeting occurs no later than 180 days following the event that caused the vacancy, the company shall instead have 180 days from such event to regain compliance.  For a smaller reporting company, if the annual shareholders meeting occurs no later than 75 days following the event that caused the failure to comply with the audit composition requirement, a smaller reporting company shall instead have 75 days from such event to regain compliance.  Nasdaq does not have a different compliance cure period for smaller reporting companies.


If a company has a class of equity securities listed on another exchange with SEC Rule 10A-3 audit committee requirements, they may list securities of a consolidated subsidiary on the NYSE American without having a separate audit committee for that subsidiary.

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NYSE Continues To Struggle With Direct Listing Rule Changes
Posted by Securities Attorney Laura Anthony | September 18, 2020 Tags: ,

Late last year, around the same time that the SEC approved Nasdaq rule changes related to direct listings on the Nasdaq Global Market and Nasdaq Capital Market (see HERE), the SEC rejected proposed amendments by the NYSE big board which would allow a company to issue new shares and directly raise capital in conjunction with a direct listing process.  Nasdaq had previously updated its direct listing rules for listing on the Market Global Select Market (see HERE).

The NYSE did not give up and in August of this year, after two more proposed amendments, the SEC finally approved new NYSE direct listing rules that allow companies to sell newly issued primary shares on its own behalf into the opening trade in a direct listing process.  However, after receiving a notice of intent to petition to prevent the rule change, the SEC has stayed the approval until further notice.  Still pushing forward, on September 4, the NYSE filed a motion with the SEC requesting that the stay be lifted and allowing the rule change to proceed.  The NYSE argued that the objection to the rule change lacks merit and that the arguments raised were already fully vetted in the lengthy rule approval process.

Shortly after the August rule change approval, software unicorn Palantir Technologies filed an S-1 with the SEC to go public via direct listing on the NYSE.  Although Palantir does not intend to sell securities under the new rule, but rather only filed for re-sale of existing shareholders’ equities, the much anticipated public transaction continues to be delayed.  However, it is likely that the delay is not related to the stalled rule change, but rather normal market conditions.

Not wanting the NYSE to have a competitive edge, Nasdaq has filed a similar proposal with the SEC to allow for companies to sell shares directly in conjunction with direct listings onto the Exchange.  I suspect that a ruling on that request will be delayed until the NYSE issue has been resolved.

Direct Listings in General

Traditionally, in a direct listing process, a company completes one or more private offerings of its securities, thus raising money up front, and then files a registration statement with the SEC to register the shares purchased by the private investors.  Although a company can use a placement agent/broker-dealer to assist in the private offering, it is not necessary.  A company would also not necessarily need a banker in the resale direct listing process.  A benefit to the company is that it has received funds much earlier, rather than after a registration statement has cleared the SEC.  For more on direct listings, including a summary of the easier process on OTC Markets, see HERE.

Most private offerings are conducted under Rule 506 of Regulation D and are limited to accredited investors only or very few unaccredited investors.  As a reminder, Rule 506(b) allows offers and sales to an unlimited number of accredited investors and up to 35 unaccredited investors—provided, however, that if any unaccredited investors are included in the offering, certain delineated disclosures, including an audited balance sheet and financial statements, are provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering. Rule 506(c) requires that all sales be strictly made to accredited investors and adds a burden of verifying such accredited status to the issuing company.  Rule 506(c) allows for general solicitation and advertising of the offering.  For more on Rule 506, see HERE.

Early investors take a greater risk because there is no established secondary market or clear exit from the investment.  Even where an investment is made in close proximity to an intended going public transaction, due to the higher risk, the private offering investors generally are able to buy shares at a lower valuation than the intended IPO price.  The pre-IPO discount varies but can be as much as 20% to 30%.

Accordingly, in a direct listing process, accredited investors are generally the only investors that can participate in the pre-IPO discounted offering round.  Main Street investors will not be able to participate until the company is public and trading.  Although this raises debate in the marketplace – a debate which has resulted in increased offering options for non-accredited investors such as Regulation A – the fact remains that the early investors take on greater risk and, as such, need to be able to financially withstand that risk.  For more on the accredited investor definition including the SEC’s recent amendments, see HERE.

The private offering, or private offerings, can occur over time.  Prior to a public offering, most companies have completed multiple rounds of private offerings, starting with seed investors and usually through at least a series A and B round.  Furthermore, most companies have offered options or direct equity participation to its officers, directors and employees in its early stages.  In a direct listing, a company can register all these shareholdings for resale in the initial public market.

In a direct listing there is a chance for an initial dip in trading price, as without an IPO and accompanying underwriters, there will be no price stabilization agreements.  Usually price stabilization and after-market support is achieved by using an overallotment or greenshoe option.  An overallotment option – often referred to as a greenshoe option because of the first company that used it, Green Shoe Manufacturing – is where an underwriter is able to sell additional securities if demand warrants same, thus having a covered short position.  A covered short position is one in which a seller sells securities it does not yet own, but does have access to.

A typical overallotment option is 15% of the offering.  In essence, the underwriter can sell additional securities into the market and then buy them from the company at the registered price, exercising its overallotment option.  This helps stabilize an offering price in two ways.  First, if the offering is a big success, more orders can be filled.  Second, if the offering price drops and the underwriter has oversold the offering, it can cover its short position by buying directly into the market, which buying helps stabilize the price (buying pressure tends to increase and stabilize a price, whereas selling pressure tends to decrease a price).

The new NYSE rule (and Nasdaq proposal) will change the direct listing process to allow a company to sell shares directly into the trading market and thus complete a capital raise at the same time as its going public transaction.  In essence, this direct listing hybrid is an IPO without an underwriter.

Direct Listing with Company Share Sales

A company that seeks to list on the NYSE must meet all of the minimum initial listing requirements, including specified financial, liquidity and corporate governance criteria, a minimum of 400 round lot shareholders, 1.1 million publicly held outstanding shares and a $4.00 share price. Direct listings are subject to all initial listing requirements applicable to equity securities and as such, in a direct listing process, the rules must specify how the exchange will calculate compliance with the initial listing standards including related to the price of a security, including the bid price, market capitalization, the market value of listed securities and the market value of publicly held shares.

In order to qualify for the NYSE big board in a direct listing process, a company must have a minimum of $100 million aggregate market value of publicly held shares.  In contrast, in an IPO, a company is only required to have a market value of publicly held shares of $40 million.  The reason for the much higher standard in a direct listing process is a concern related to the liquidity and market support in an opening auction process without attached underwriters.

As indicated, the NYSE rule change allows a company to sell shares directly into the market, without an underwriter, as part of a direct listing process.  In order to accomplish this, the NYSE created a new process dubbed an Issuer Direct Offering (IDO).  To get the process across the finish line, the last amendment (i) deleted a provision that would provide additional time for companies completing a direct listing to meet the initial listing distribution standards; (ii) added specific provisions related to the concurrent selling security holder and IDO process; (iii) added provisions related to participation in the direct listing auction when completing an IDO; and (iv) removed references to direct listing auctions in the rule related to Exchange-Facilitated Auctions.

The material aspects of the final NYSE rule change (i) modifies the provisions relating to direct listings to permit a primary offering in connection with a direct listing and to specify how a direct listing qualifies for initial listing if it includes both sales of securities by the company and possible sales by selling shareholders; (ii) modifies the definition of “direct listing”; and (iii) adds a definition of “Issuer Direct Offering (IDO)” and describes how it participates in a direct listing auction.

To clarify the difference between an IDO and selling security holder process, the NYSE has defined a shareholder-resale process as a “Selling Shareholder Direct Floor Listing.”  A pure Selling Shareholder Direct Floor Listing occurs where a company is listing without a related underwritten offering upon effectiveness of a registration statement registering only the resale of shares sold by the company in earlier private placements.

The Selling Shareholder Direct Floor Listing process retains the existing standards for direct listing and how the NYSE determines company eligibility including the market value of publicly held shares.  In particular, a company can meet the $100 million market value of publicly held shares requirement using the lesser of (i) an independent third-party valuation; and (ii) the most recent trading price of the company’s common stock in a trading system for unregistered securities that is operated by a national securities exchange or a registered broker-dealer (“Private Placement Market”).  In order to satisfy the $100 million valuation, the NYSE requires that the independent valuation comes in at a market value of at least $250 million.  In addition, the NYSE will only consider the Private Placement Market price if the equity trades on a consistent basis with a sustained history of several months, in excess of the market value requirement.  Shares held by directors, officers or 10% or greater shareholders are excluded from the calculation.

An IDO listing is one in which a company that has not previously had its common equity securities registered under the Exchange Act, lists its common equity securities on the NYSE at the time of effectiveness of a registration statement pursuant to which the company would sell shares itself in the opening auction on the first day of trading on the Exchange in addition to, or instead of, facilitating sales by selling shareholders.  This process is being called a “Primary Direct Floor Listing.”  In a Primary Direct Floor Listing, a company can meet the $100 million market value of publicly held shares listing requirement if it sells at least $100 million in market value of shares in the NYSE’s opening auction on the first day of trading.  Alternatively, where a company will sell less than $100 million of shares in the opening auction, the NYSE will determine that the company has met its market value of publicly held shares requirement if the aggregate market value of the shares the company will sell in the opening auction on the first day of trading and the shares that are publicly held immediately prior to the listing is at least $250 million.  In that case the market value is calculated using a price per share equal to the lowest price of the price range established by the company in its registration statement.

In order to facilitate the direct sales by the company, the NYSE has created a new type of buy-sell order called an “Issuer Direct Offering Order (IDO Order)” which would be a limit order to sell that is to be traded only in a Direct Listing Auction for a Primary Direct Floor Listing.  An IDO Order is subject to the following: (i) only one IDO Order may be entered on behalf of the company and only by one member organization; (ii) the limit price of the IDO Order must be equal to the lowest price of the price range in the effective registration statement; (iii) the IDO Order must be for the quantity of shares offered by the company as disclosed in the effective registration statement prospectus; (iv) an IDO Order may not be cancelled or modified; and (v) an IDO Order must be executed in full in the Direct Listing Auction.

A designated market maker effectuates the Direct Listing Auction manually and is responsible for setting the price (which involves many factors including working with the valuation financial advisor and the price set in the registration statement).  The Direct Listing Auction and thus Primary Direct Floor Listing would not be completed if (i) the price is below the minimum or above the highest price in the range in the effective registration statement or (ii) there is not enough interest to fill both the IDO Order and all better priced sell orders in full.  In other words, a Primary Direct Floor Listing can fail at the finish line.  To provide a little help in this regard, the NYSE has provided that an IDO Order that is equal to the auction price, will receive priority over other buy (sell) orders.

The NYSE has also added provisions regarding the interaction with a company’s valuation or other financial advisors and the designated market maker to ensure compliance with all federal securities laws and regulations, including Regulation M.  To provide an additional level of investor protection, and to satisfy the SEC, the NYSE retained FINRA to monitor compliance with Regulation M and other anti-manipulation provisions of the federal securities laws and NYSE rules. Finally, the NYSE made several changes to align definitions and rule cross-references with the new provisions and direct listing process.

In passing the rule, the SEC noted that after its several modifications, they were satisfied that the final rule helped ensure that the listed companies would have a sufficient public float, investor base, and trading interest to provide the depth and liquidity necessary to promote fair and orderly markets.

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NYSE, Nasdaq And OTC Markets Offer Relief For Listed Companies Due To COVID-19
Posted by Securities Attorney Laura Anthony | April 24, 2020 Tags:

In addition to the SEC, the various trading markets, including the Nasdaq, NYSE and OTC Markets are providing relief to trading companies that are facing unprecedented challenges as a result of the worldwide COVID-19 crisis.


The NYSE has taken a more formal approach to relief for listed companies.  On March 20, 2020 and again on April 6, 2020 the NYSE filed a notice and immediate effectiveness of proposed rule changes to provide relief from the continued listing market cap requirements and certain shareholder approval requirements.

Recognizing the extremely high level of market volatility as a result of the COVID-19 crisis, the NYSE has temporarily suspended until June 30, 2020 its continued listing requirement that companies must maintain an average global market capitalization over a consecutive 30-trading-day period of at least $15 million.  Likewise, the NYSE is suspending the requirement that a listed company maintain a minimum trading price of $1.00 or more over a consecutive 30-trading-day period, through June 30, 2020.

The NYSE intends to waive certain shareholder approval requirements for continued listing on the NYSE through June 30, 2020.  In particular, in light of the fact that many listed companies will have urgent liquidity needs in the coming months due to lost revenues and maturing debt obligations, the NYSE is proposing to ease shareholder approval requirements to allow capital raises.  The big board amendments align the requirements more closely with the NYSE American requirements.

The NYSE big board rules prohibit issuances to related parties if the number of shares of common stock to be issued, or if the number of shares of common stock into which the securities may be convertible or exercisable, exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance subject to a limited exception if the issuances are above a minimum price and no more than 5% of the outstanding common stock.  For a review of the NYSE American rule for affiliate issuances, see HERE.  The NYSE also requires shareholder approval for private issuances below the minimum price for any transactions relating to 20% or more the outstanding common stock or voting power.  For a review of the 20% rule for the NYSE American, see HERE.

Realizing that existing large shareholders and affiliates are often the only willing providers of capital when a company is undergoing difficult times, the rule change allows for the issuance of securities to affiliates that exceed the 1% or 5% limits if completed prior to June 30, 3030 where the securities are sold for cash that meets the minimum price and if the transaction is reviewed and approved by the company’s audit committee or a comparable committee comprised solely of independent directors.  The waiver cannot be relied upon if the proceeds would be used for an acquisition of stock or assets of another company in which the affiliate has a direct or indirect interest.  Furthermore, the waiver does not extend to shareholder approval requirements triggered by the transaction under other rules such as the equity compensation rule or change of control rule. The substantially similar NYSE American rules can be reviewed HERE – equity compensation, and HERE – change of control.

The NYSE has also waived the 20% rule for private placements completed through and including June 30, 2020 where a bona fide financing is made to a single purchaser for cash meeting the minimum price requirement.  Again, the waiver does not extend to shareholder approval requirements triggered by the transaction under other rules such as the equity compensation rule or change of control rule.


The Nasdaq has taken a less formal approach on some of its requirements and a formal rule amendment on others.  Although Nasdaq has not suspended its listing requirements, it will give due weight to the realities surrounding the worldwide crisis in both considering listing standards compliance and requests for financial viability waivers, such as under Rule 5635.

Generally, companies newly deficient with the bid price, market value of listed securities, or market value of public float requirements have at least 180 days to regain compliance and may be eligible for additional time. Nasdaq has enacted a temporary rule change such that companies that fall out of compliance with these listing standards related to price through and including June 30, 2020 will have additional time to regain compliance.  That is, the non-compliance period will be tolled through June 30, 2020 and not counted in the 180 day period.  Companies will still receive notification of non-compliance and will still need to file the appropriate Form 8-K.  Companies that no longer satisfy the applicable equity requirement can submit a plan to Nasdaq Listing Qualifications describing how they intend to regain compliance and, under the Listing Rules, Listing Qualifications’ staff can allow them up to six months plus the tolling period, to come back into compliance with the requirement.

The information memorandum confirms that listed companies that avail themselves of the 45-day extension for Exchange Act filings (see HERE) will not be considered deficient under Nasdaq Rule 5250(c) which requires all listed companies to timely file all required SEC periodic financial reports.  Companies that are unable to file a periodic report by the relevant due date, but that are not eligible for the relief granted by the SEC, can submit a plan to Nasdaq Listing Qualifications describing how they intend to regain compliance and, under the Listing Rules, Listing Qualifications’ staff can allow them up to six months to file.

As discussed in my blog related to SEC COVID-19 relief (see HERE), the SEC has granted relief where a company is required to comply with Exchange Act Sections 14(a) or 14(c) requiring the furnishing of proxy or information statements to shareholders, and mail delivery is not possible due to the coronavirus and the company has made a good-faith effort to deliver such materials.  Nasdaq likewise will not consider a company in non-compliance with Rule 5250(d) requiring companies to make available their annual, quarterly and interim reports to shareholders or Rule 5620(b) requiring companies to solicit proxies and provide proxy statements for all meetings of shareholders when relying on the SEC relief. Nasdaq confirms that it permits virtual shareholder meetings as long as it is permissible under the relevant state law and shareholders have the opportunity to ask questions of management.

The Nasdaq shareholder approval rules generally require companies to obtain approval from shareholders prior to issuing securities in connection with: (i) certain acquisitions of the stock or assets of another company (see HERE); (ii) equity-based compensation of officers, directors, employees or consultants (see HERE); (iii) a change of control (see HERE); and (iv) certain private placements at a price less than the minimum price as defined in Listing Rule 5635(d) (see HERE.

An exception is available for companies in financial distress where the delay in securing stockholder approval would seriously jeopardize the financial viability of the company. To request a financial viability exception, the company must complete a written request including a letter addressing how a delay resulting from seeking shareholder approval would seriously jeopardize its financial viability and how the proposed transaction would benefit the company. The standard is usually difficult to meet; however, Nasdaq has indicated that it will consider the consider the impact of disruptions caused by COVID-19 in its review of any pending or new requests for a financial viability exception.  In addition, reliance by the company on a financial viability exception must expressly be approved by the company’s audit committee and the company must obtain Nasdaq’s approval to rely upon the financial viability exception prior to proceeding with the transaction. Under the rule, companies must also provide notice to shareholders at least ten days prior to issuing securities in the exempted transaction.

OTC Markets

OTC Markets Group has provided blanket relief for OTCQB and OTCQX companies with certain deficiencies until June 30, 2020.  Until that date, no new compliance deficiency notices will be sent related to bid price, market cap, or market value of public float. Also, any OTCQX or OTCQB company that has already received a compliance notice related to bid price, market cap, or market value of public float with a cure period expiring between March and June will automatically receive an extension until June 30, 2020 to cure their deficiency.

OTC Markets has also extended the implementation date for compliance with the OTCQB rules requiring at least 50 beneficial shareholders and minimum float of 10% or $2 million in market value of public float, respectively, until June 30, 2020.  The extension applies only to companies already traded on OTCQB as of May 20, 2018.  All other companies were subject to these requirements effective May 20, 2018.

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NYSE American Board Independence Standards
Posted by Securities Attorney Laura Anthony | January 19, 2020 Tags: ,

NYSE American Company Guide Rule 803 delineates the requirements independent directors and audit committees.  NYSE American Company Guide Rule 802 requires that a majority of the board of directors of a listed company be “independent.”  Rule 803 requires that all members of the audit committee be independent and defines independence and Rules 804 and 805 require that all directors on the nominating and compensation committees, if a company has such committees, be independent.

Under NYSE American Company Guide Rule 803, an “independent director” means a person other than an executive officer or employee of a company.  The board of directors must make an affirmative finding that a director does not have a relationship which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director for that director to qualify as independent.  However, the NYSE American rules specify certain relationships that would disqualify a person from being considered independent.  Stock ownership is not on the list and is not enough, without more, to preclude independence.

Company Guide Rule 803 specifies that the following people cannot be considered independent:

(i) a director who is, or at any time during the past three years was, employed by the company, provided however, interim employment of less than one year would not be a disqualifier as long as such employment had since terminated.  In addition, employment by an entity that was later acquired by the company would not disqualify a director from being independent provided the former officer was not employed by the company after the acquisition;

(ii) a director who accepted or who has a family member who accepted any compensation from the company in excess of $120,000 during any period of twelve consecutive months within the three years preceding the determination of independence, other than: (a) compensation for board or board committee service; (b) compensation paid to a family member who is an employee but not an executive of the company; (c) benefits under a tax-qualified retirement plan, or non-discretionary compensation; or (d) compensation received while acting as an interim officer as long as such employment lasted for less than a year and has since terminated.  Options received for services should be valued using a commonly accepted option pricing formula, such as the Black-Scholes or binomial model at the time of grant.  The option value is considered a payment upon grant even if the option does not immediately vest or if there are conditions to vesting or exercise.  This prohibition is meant to capture any compensation that directly benefits the director or family member and as such would include political contributions to a campaign by either.  However, it is not meant to capture ordinary course business transactions such as interest on an arm’s-length loan;

(iii) a director who is a family member of an individual who is, or at any time during the past three years was, employed by the company as an executive officer;

(iv) a director who is, or has a family member who is, a partner in (other than limited partner), or a controlling shareholder or an executive officer of, any organization to which the company made, or from which the company received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient’s consolidated gross revenues for that year, or $200,000, whichever is more, other than the following: (a) payments arising solely from investments in the company’s securities; or (b) payments under non-discretionary charitable contribution matching programs;

(v) a director of the company who is, or has a family member who is, employed as an executive officer of another entity where at any time during the past three years any of the executive officers of the company serve on the compensation committee of such other entity; or

(vi) a director who is, or has a family member who is, a current partner of the company’s outside auditor, or was a partner or employee of the company’s outside auditor who worked on the company’s audit at any time during any of the past three years.

Reference to the “company” includes parents and subsidiaries or any other entities that the company consolidates financial statements with, including variable interest entities.  “Executive officer” refers to any person covered by SEC Rule 16a-1(f) and in particular the company’s president, principal financial officer, principal accounting officer, any vice-present in charge of a principal business unit, division or function or any officer or person who performs a policymaking function, which can include officers of a parent or subsidiary.

For purposes of Rule 803, “family member” means a person’s spouse, parents, children and siblings, mothers-in-law and fathers-in-law, sons-in-law and daughters-in-law, brothers-in-law and sisters-in-law, and anyone (other than domestic employees) who shares such person’s home.  This definition differs from the  – see HERE.

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The 20% Rule – Private Placements
Posted by Securities Attorney Laura Anthony | May 15, 2019

Nasdaq and the NYSE American both have rules requiring listed companies to receive shareholder approval prior to issuing twenty percent (20%) or more of the outstanding securities in a transaction other than a public offering at a price less than the Minimum Price, as defined in the rule. Nasdaq Rule 5635 sets forth the circumstances under which shareholder approval is required prior to an issuance of securities in connection with: (i) the acquisition of the stock or assets of another company (see HERE); (ii) equity-based compensation of officers, directors, employees or consultants (see HERE); (iii) a change of control (see HERE); and (iv) transactions other than public offerings. NYSE American Company Guide Sections 711, 712 a 713 have substantially similar provisions.

Nasdaq and the NYSE recently amended their rules related to issuances in a private placement to provide greater flexibility and certainty for companies to determine when a shareholder vote is necessary to approve a transaction that would result in the issuance of 20% or more of the outstanding common stock or 20% or more of outstanding voting power in a PIPE or similar private placement financing transaction. The amendments simplified the prior multi-part language and changed the pricing test trigger to create a new “Minimum Price.” For my blog on the Nasdaq amendment, see HERE. Although the NYSE American has not yet amended its rule to conform with the changes, I expect it will be forthcoming. In this blog, I will drill down further on the rule and its interpretive guidance.

As I’ve mentioned in each of the blogs in this series, many other Exchange Rules interplay with the 20% Rules; for example, the Exchanges generally require a Listing of Additional Securities (LAS) form submittal at least 15 days prior to the issuance of securities in the same transactions that require shareholder approval. Companies need to carefully comply with each of the rules that may interplay with a transaction or proposed transaction.

Nasdaq Rule 5635(d)

Nasdaq Rule 5635(d) requires shareholder approval prior to a 20% issuance of securities at a price that is less than the Minimum Price in a transaction other than a public offering. A 20% issuance is a transaction, other than a public offering, involving the sale, issuance or potential issuance by the company of common stock (or securities convertible into or exercisable for common stock), which alone or together with sales by officers, directors or substantial shareholders of the company, equals 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance. “Minimum Price” means a price that is the lower of: (i) the closing price (as reflected on immediately preceding the signing of the binding agreement; or (ii) the average closing price of the common stock (as reflected on for the five trading days immediately preceding the signing of the binding agreement.

The September 2018 rule amendment creating a new “Minimum Price” standard provides more flexibility by adding the option of choosing between the closing bid price and the five-day average closing price. For example, in a declining market, the five-day average closing price will be above the current market price, which could make it difficult for companies to close transactions because investors could buy shares at a lower price in the market. Likewise, in a rising market, the five-day average could result in a below-market transaction triggering shareholder approval requirements.

NYSE American Company Guide Section 713

The NYSE American Company Guide Section 732 requires shareholder approval prior to the listing of additional shares in connection with a transaction, other than a public offering, involving: (i) the sale, issuance, or potential issuance by the company of common stock (or securities convertible into common stock) at a price less than the greater of book or market value which together with sales by officers, directors or principal shareholders of the company equals 20% or more of presently outstanding common stock; or (ii) the sale, issuance, or potential issuance by the issuer of common stock (or securities convertible into common stock) equal to 20% or more of presently outstanding stock for less than the greater of book or market value of the stock.

Interpretation and Guidance

Public Offering

Although the rules do not require shareholder approval for a transaction involving “a public offering,” the Exchanges do not automatically consider all registered offerings as public offerings.

Generally, all firm commitment underwritten securities offerings registered with the SEC will be considered public offerings. Likewise, any other securities offering which is registered with the SEC and which is publicly disclosed and distributed in the same general manner and extent as a firm commitment underwritten securities offering will be considered a public offering for purposes of the 20% Rule. In other instances, when analyzing whether a registered offering is a “public offering,” the Exchanges will consider: (a) the type of offering (including whether underwritten, on a best efforts basis with a placement agent, or self-directed by the company); (b) the manner in which the offering is marketed (including the number of investors and breadth of marketing effort); (c) the extent of distribution of the offering (including the number of investors and prior relationship with the company); (d) the offering price (at market or a discount); and (e) the extent to which the company controls the offering and its distribution.

A registered direct offering will not be assumed to be public and will be reviewed using the same factors listed above. Likewise, a Rule 144A offering will be considered on its facts and circumstances, though generally share caps are used in these transactions to avoid an issue.  On the other hand, a confidentially marketed public offering (CMPO) is a firm commitment underwritten offering and, as such, will be considered a public offering.

                Substantial Shareholder

A substantial shareholder is defined in the negative and requires the company to consider the power that a particular shareholder asserts over the company.  Nasdaq specifically provides that someone that owns less than 5% of the shares of the outstanding common stock or voting power would not be considered a substantial shareholder for purposes of the Rules.

                Shares to be Issued in a Transaction; Shares Outstanding; Votes to Approve

In determining the number of shares to be issued in a transaction, the maximum potential shares that could be issued, regardless of contingencies, should be included. The maximum potential issuance includes all securities initially issued or potentially issuable or potentially exercisable or convertible into shares of common stock as a result of the transaction. The percentage to be issued is calculated by dividing the maximum potential issuance by the number of shares of common stock issued and outstanding prior to the transaction.

In determining the number of shares outstanding immediately prior to a transaction, only shares that are actually outstanding should be counted.  Shares reserved for issuance upon conversion of securities or exercise of options or warrants are not considered outstanding for the purpose of the 20% Rule. Where a company has multiple classes of common stock, all classes are counted in the amount outstanding, even if one or more classes do not trade on the Exchange.

Voting power outstanding as used in the Rule refers to the aggregate number of votes which may be cast by holders of those securities outstanding which entitle the holders to vote generally on all matters submitted to the company’s security holders for a vote.

Where shareholder approval is required under the 20% Rule, approval can be had by a majority of the votes cast on the proposal. The proxy for approval of a transaction under the 20% Rule should provide specific details on the proposed financing transaction.

Convertible Securities; Warrants; Anti-Dilution Provisions

Convertible securities and warrants can either convert at a fixed or variable rate. If the securities are convertible at a fixed price, Nasdaq will determine whether the issuance is below the Minimum Price, and for the NYSE American at a price less than the greater of book or market value, if the conversion or exercise price is less than the applicable threshold price at the time the parties enter into a binding agreement with respect to the issuance.

Variable rate conversions are generally tied to the market price of the underlying common stock and accordingly, the number of securities that could be issued upon conversion will float with the price of the common stock. That is, the lower the price of a company’s common stock, the more shares that could be issued and conversely, the higher the price, the fewer shares that could be issued. Variable priced convertible securities tend to cause a downward pressure on the price of common stock, resulting in additional dilution and even more common stock issued in each subsequent conversion round. This chain of convert, sell, price reduction, and convert into more securities, sell, further price reduction and resulting dilution is sometimes referred to as a “death spiral.”

The 20% Rule requires that the company consider the largest number of shares that could be issued in a transaction when determining whether shareholder approval is required.  Where a transaction involves variable priced convertible securities, and no floor on such conversion price is included or cap on the total number of shares that could be issued, the Exchanges will presume that the potential issuance will exceed 20% and that shareholder approval will be required.

The calculation of whether an issuance is above 20% and below the threshold Minimum Price where warrants are involved can be complicated.  Where warrants are involved, Nasdaq will require shareholder approval if the issuance of common stock is less than the 20% threshold and such stock is issued below the Minimum Price if the exercise of the warrants would result in greater than a 20% issuance.  However, the warrants do not need to be included in the calculation if the exercise price is above the Minimum Price and the warrants are not exercisable for at least six months.  If the common stock portion of an offering that includes warrants exceeds the 20% threshold, Nasdaq will value the warrants at $0.125, regardless of whether the exercise price exceeds the market value. This is referred to as the “1/8th Test.” In this case, shareholder approval will be required even if the warrants are not exercisable for six months.

However, Nasdaq has indicated that convertible bonds with flexible settlement provisions (i.e., cash or stock at the company’s option) will be treated the same way as physically settled bonds under the rule. If the conversion price of the bonds equals or exceeds the Minimum Price, shareholder approval will not be required. Contrarily, Nasdaq will treat a convertible security with a flexible settlement provision as if it will be settled in securities for purposes of the 20% Rule.

Moreover, the Exchanges generally view variable priced transactions without floors or share caps as disreputable and potentially raising public interest concerns. Nasdaq specifically addresses these transactions, and the potential public interest concern, in its rules. In addition to the demonstrable business purpose of the transaction, other factors that Nasdaq staff will consider in determining whether a transaction raises public interest concerns include: (1) the amount raised in the transaction relative to the company’s existing capital structure; (2) the dilutive effect of the transaction on the existing holders of common stock; (3) the risk undertaken by the variable priced security investor; (4) the relationship between the variable priced security investor and the company; (5) whether the transaction was preceded by other similar transactions; and (6) whether the transaction is consistent with the just and equitable principles of trade.

Nasdaq will closely examine any transaction that includes warrants that are exercisable for little or no consideration (i.e., “penny warrants”) and may object to a transaction involving penny warrants even if shareholder approval would not otherwise be required.  Warrants with a cashless exercise feature are also not favored by the Exchanges and will be closely reviewed.  Nasdaq guidance indicates it will review the following factors related to warrants with cashless exercise features: (i) the business purpose of the transaction; (ii) the amount to be raised (if the acquisition includes a capital raise); (iii) the existing capital structure; (iv) the potential dilutive effect on existing shareholders; (v) the risk undertaken by the new investors; (vi) the relationship between the company and the investors; (vii) whether the transaction was preceded by similar transactions; (viii) whether the transaction is “just and equitable”; and (ix) whether the warrant has provisions limiting potential dilution.  In practice, many warrants include dilutive share caps and have cashless features that only kick in if there is no effective registration statement in place for the underlying common stock.

Any contractual provisions that could result in lowering the transaction price to below the Minimum Price, including anti-dilution provisions, most favored nations, true-up and similar provisions will be viewed as a discounted issuance. Likewise, a provision that allows a company to voluntarily reduce the conversion or exercise price to a price that could be below the Minimum Price, will be treated as a discounted issuance.


Both Nasdaq and the NYSE American may aggregate financing transactions that occur within close proximity of each other in determining whether the 20% Rule applies. Nasdaq considers the following factors when considering aggregation: (i) timing of the issuances; (ii) facts surrounding the subsequent transactions (e.g., planned at time of first transaction); (iii) commonality of investors; (iv) existence of contingencies between the transactions; (v) commonalities as to use of proceeds; and (vi) timing of board approvals. Moreover, transactions that are more than six months apart are generally not aggregated. Although the NYSE American does not provide such specific guidance, in practice, their analysis is substantially similar.

Two-Step Transactions and Share Caps

As obtaining shareholder approval can be a lengthy process, companies sometimes bifurcate transactions into two steps and use share caps as part of a transaction structure. A company may limit the first part of a transaction to 19.9% of the outstanding securities and then, if and when shareholder approval is obtained, issue additional securities. Companies may also structure transactions such that issuances related to a private offering, including through convertible securities, are capped at no more than 19.9% of total outstanding.

In order for a cap to satisfy the rules, it must be clear that no more than the threshold amount (19.9%) of securities outstanding immediately prior to the transaction, can be issued in relation to that transaction, under any circumstances, without shareholder approval. In a two-step transaction where shareholder approval is deferred, shares that are issued or issuable under the cap must not be entitled to vote to approve the remainder of the transaction.  In addition, a cap must apply for the life of the transaction, unless shareholder approval is obtained. For example, caps that no longer apply if a company is not listed on Nasdaq are not permissible under the Rule.  If shareholder approval is not obtained, then the investor will not be able to acquire 20% or more of the common stock or voting power outstanding before the transaction. Where convertible securities were issued, the shareholder would continue to hold the balance of the original security in its unconverted form.

Moreover, where a two-step transaction is utilized, the transaction terms cannot change as a result of obtaining, or not obtaining, shareholder approval. For example, a transaction may not provide for a sweetener or penalty. The Exchanges believe that the presence of alternative outcomes have a coercive effect on the shareholder vote and thus deprive the shareholders of their ability to freely determine whether the transaction should be approved. Nasdaq provides specific examples of a defective share cap, such as where a company issues a convertible preferred stock or debt instrument that provides for conversions of up to 20% of the total shares outstanding with any further conversions subject to shareholder approval. However, the terms of the instrument provide that if shareholders reject the transaction, the coupon or conversion ratio will increase or the company will be penalized by a specified monetary payment, including a rescission of the transaction. Likewise, a transaction may provide for improved terms if shareholder approval is obtained. The NYSE American similarly provides that share caps cannot be used in a way that could be coercive in a shareholder vote.

Reverse Acquisitions

reverse acquisition or reverse merger is one in which the acquisition results in a change of control of the public company such that the target company shareholders control the public company following the closing of the transaction. In addition to the 20% Rule, a change of control would require shareholder approval under the Change of Control Rule and the Acquisition Rule will likely apply as well. A company must re-submit an initial listing application in connection with a transaction where the target and new control entity was a non-Exchange listed entity prior to the transaction.

In determining whether a change of control has occurred, the Exchange will consider all relevant factors including, but not limited to, changes in the management, board of directors, voting power, ownership, nature of the business, relative size of the entities, and financial structure of the company.


The Exchanges have a “financial viability” exception to the 20% Rule. Although rarely granted, to qualify for the financial viability exception, a listed company must apply in writing and demonstrate that: (i) the delay in securing stockholder approval would seriously jeopardize the financial viability of the company; and (ii) reliance on the exception has been expressly approved by the company’s audit committee or comparable board committee comprised of all independent, disinterested directors. A determination will be rendered by the Exchange very quickly, such as in a matter of days.

Nasdaq guidance suggests an in-depth letter focusing on how a delay resulting from seeking shareholder approval would seriously jeopardize its financial viability and how the transaction would benefit the company. The letter should also describe the proposed transaction in detail and should include the identity of the investors. Nasdaq provides a list of examples of information that should be discussed in the letter, including: (i) the facts and circumstances that led to the company’s predicament; (ii) how long the company will be able to meet its current obligations, such as payroll, lease payments, and debt service, if it does not complete the proposed transaction; (iii) the company’s current and projected cash position and burn rate; (iv) other alternatives; (v) why a step transaction will not work; (vi) would the company file for bankruptcy without the transaction; (vii) the impact to operations while waiting for shareholder approval; (viii) why the company didn’t enter into a transaction sooner; (ix) demonstrate that the transaction will rescue the company; (x) demonstrate that the company will continue to meet Nasdaq’s listing requirements; and (xi) explain changes in voting power.

A company that gets approval for this exception must send a mailing to all shareholders at least 10 days prior to the issuance of securities under the exception. The letter must disclose the terms of the transaction, including number of shares to be issued and consideration received, that the company is relying on the financial viability exception and that the audit committee (or other committee) has approved the reliance on the exception. The company must also file an 8-K and issue a press release with the same information also no later than 10 days before the issuance.

Furthermore, shareholder approval is not required if the issuance is part of a court-approved reorganization under the federal bankruptcy laws or comparable foreign laws.

Also, a foreign private issuer that has elected to follow its home country rules will be exempt from the 20% Rule if it notifies Nasdaq, provides an opinion from local counsel that shareholder approval would not be required, and discloses its practices in its annual report on Form 20-F.

Consequences for Violation

Consequences for the violation of the 20% Rule or Acquisition Rule can be severe, including delisting from the Exchange.  Companies that are delisted from an Exchange as a result of a violation of these rules are rarely ever re-listed.

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Multiple Classes of Stock and the Public Company
Posted by Securities Attorney Laura Anthony | May 29, 2018 Tags: , , , , , , ,

In March 2017, Snap Inc. completed its IPO, selling only non-voting Class A common shares to the investing public and beginning an ongoing discussion of the viability and morality of multiple classes of stock in the public company setting. No other company has gone public with non-voting stock on a U.S. exchange. Although Facebook and Alphabet have dual-class stock structures, shareholders still have voting rights, even though insiders hold substantial control with super-voting preferred stock.

Snap’s stock price was $10.79 on May 7, 2018, well below is IPO opening price of $17.00. Certainly the decline has a lot to do with the company’s floundering app, Snapchat, which famously lost $1.3 billion in value when reality star Kylie Jenner tweeted that she no longer used the app, but the negativity associated with the share structure has made it difficult to attract institutional investors, especially those with a history of activism. Although there was a net increase of $8.8 million in institutional ownership in the company for the quarter ending March 2018, the approximate 20% total institutional ownership is below average for the Internet software/services industry and the increase in the quarter resulted from purchases by 2 institutions where 8 others decreased their holdings.

Moreover, many institutions, including pension funds, have holdings in Snap because they buy index funds, including ETFs, and Snap is in the S&P 500. The Council of Institutional Investors has even sent Snap a letter urging it to reconsider its share structure.

The discussion has gained regulatory attention as well. On February 15, 2018, SEC Commissioner Robert J. Jackson Jr. gave a speech entitled “Perpetual Dual-Class Stock: The Case Against Corporate Royalty” in which he talked about the detriments of closely held perpetual control stock in a public company.

Days prior to Commissioner Jackson’s speech, Commissioner Kara Stein gave a speech at Stanford University about the role of corporate shareholders. Commissioner Stein posits that the relationship between a company and its shareholders should be mutual, including in areas involving cyber threats, board composition, shareholder activism and dual-class capital structures. Stein sees dual-class structures as purposefully disenfranchising shareholders and being inherently undemocratic.

Perhaps feeling the pressure, on May 2, 2018, Zynga founder Mark Pincus announced he will convert his super-voting preferred stock into common stock, eliminating the company’s dual-class structure. As a result of the conversion, Pincus’ voting power was reduced from 70% to 10%. His prior 10% economic stake remains unchanged.

SEC Commissioner Robert J. Jackson Jr.’s Speech: Perpetual Dual-Class Stock: The Case Against Corporate Royalty

On February 15, 2018, SEC Commissioner Robert J. Jackson Jr., gave a speech entitled “Perpetual Dual-Class Stock: The Case Against Corporate Royalty” at the University of California, Berkley campus.  Commissioner Jackson began the substantive portion of his speech with a summary background of a dual-class stock structure. I’ve supplemented his explanation with additional information.

Dual-class voting typically involves two more or more classes of stock, with one class having significantly more voting power than the others. The higher voting shares are often called “super-voting.” Typically, in a dual-class structure, the equity issued to the public is common equity with one vote per share and equity issued to insiders would be super-voting preferred stock. A company may also have other classes of preferred stock with various rights issued to different investors. Snap’s issuance of non-voting common stock to the public takes this structure one step further.

Historically, the NYSE did not allow companies to go public with dual-class voting structures. However, the takeover battles in the 1980s resulted in a change in the rules to allow for insider and management anti-takeover voting protection. Today, it is common for companies to go public with dual classes of voting stock. Public companies using dual-class are today worth more than $5 trillion, and more than 14% of the 133 companies that listed on U.S. exchanges in 2015 have dual-class voting. That compares with 12% of firms that listed on U.S. exchanges in 2014, and just 1% in 2005. Nearly half of the companies with dual-class shares give corporate insiders super-voting rights in perpetuity.

Commissioner Jackson acknowledges the reasons for a dual-class structure, and the desire by entrepreneurs and founders to go public while retaining control; however, he also quickly asserts that such a structure undermines accountability. Prior to accessing public markets, management control is beneficial in that it allows visionaries and entrepreneurs to innovate and disrupt industries without the short-term pressure of a loss of control over their efforts. However, perpetual outsized voting rights not only provide ultimate control to founders and entrepreneurs, but to their heirs as well, who may or may not be strong managers, entrepreneurs and visionaries.

Although many market players are recently strongly advocating for a change in rules to prohibit companies from going public with a dual-class structure, Commissioner Jackson advocates a change such that a dual-class structure has a time limit or expiration date. There may be benefits to management control for a period of time, but that benefit ultimately runs out after a company is public and certainly once the founding management retires, leaves, passes away or otherwise ceases their entrepreneurial run. He suggests that the exchanges propose amended rules in this regard.

Commissioner Jackson waxes philosophical pointing out the foundation of the United States origins, the Constitution and government structure, all of which are designed to allow for a change in regime and a vote by the masses. Even in public markets, power is not meant to continue in perpetuity, which is one of the reasons that the U.S. requires public companies to report and provide disclosure to investors and shareholders. Jackson likens perpetual super-voting stock as creating corporate royalty.

However, for the sake of the debate, I note that in the free market system, it is likely that if management that holds super-voting shares does not perform, the underlying business will lose value, consumers will stop buying the product, and institutions will stop owning the stock and investing. The corporate royalty would then be under self-preserving pressure to be acquired by a stronger competitor with a better management team.

In fact, Jackson continues his speech with analytics indicating that companies with super-voting insider control, do not perform as well as their counterparts. A recent study by Martijn Cremers, Beni Lauterbach, and Anete Pajuste entitled The Life-Cycle of Dual-Class Firms (Jan. 1, 2018) shows that the costs and benefits of dual-class structures change over time, with such companies trading at a premium shortly after the IPO, but decreasing over time.

Jackson’s staff studied 157 dual-class IPOs that occurred within the past 15 years. Of the 157 companies, 71 had sunset provisions or provisions that terminated the dual-class structure over time, and 86 gave insiders control forever. Whereas the companies traded relatively equally for the first few years, after seven years, those with a perpetual dual-class structure traded at a substantial discount to the others. Furthermore, when a company with a perpetual dual-class structure voluntarily eliminated the second control class, there was a significant increase in valuation.

As mentioned, institutional investors and market participants have vocally opposed dual-class structures for public companies. In December 2017, the Investor as Owner Subcommittee of the SEC’s Investor Advisory Committee published a report entitled Discussion Draft: Dual Class and Other Entrenching Governance Structures in Public Companies strongly opposing the structure. In addition to its letter to Snap, the Council of Institutional Investors has published a page on its website discussing and advocating for one-share equal voting rights for public companies.

Furthermore, the FTSE Russell index will now exclude all companies whose float is less than 5% of total voting power, the S&P Dow will now exclude all dual-class companies and the MSCI will reduce dual-class companies from its indexes. Commissioner Jackson is concerned that excluding dual-class stock companies from indexes does more harm than good. Many Main Street investors own public equities through funds or ETFs that in turn either own or mirror indexes. By removing dual-class companies from index funds, Main Street investors lose the opportunity to invest in these companies, some of which are the most innovative in the country today.

Commissioner Jackson’s suggestion of finding a middle ground whereby a company could complete an IPO with a dual-class structure and allow its visionaries to build without short-term shareholder pressure, but then limiting that sole control to a defined period, was met with praise and approval. Several market participants, including the SEC’s Investor Advisory Committee and the Council of Institutional Investors, made comments supporting the suggestion.

More on Preferred Equity

Although the topic of super-voting features in dual-class stock structures has been hotly debated recently, it is not the only feature that may be in preferred stock. Preferred stock is the most commonly used investment instrument due to its flexibility. Preferred stock can be structured to offer all the characteristics of equity as well as of debt, both in financial and non-financial terms. It can be structured in any way that suits a particular deal. The following is an outline of some of the many features that can be included in a preferred stock designation:

  1. Dividends a dividend is a fixed amount agreed to be paid per share based on either the face value of the preferred stock or the price paid for the preferred stock (which is often the same); a dividend can be in the form of a return on investment (such as 8% per annum), the return of investment (25% of all net profits until the principal investment is repaid) or a combination of both. Although a dividend can be structured substantially similar to a debt instrument, there can be legal impediments to a dividend payment and a creditor generally takes priority over an equity holder. The ability of an issuer to pay a dividend is based on state corporate law, the majority of which require that the issuer be solvent (have the ability to pay creditors when due) prior to paying a dividend. Accordingly, even though the issuer may have the contractual obligation to pay a dividend, it might not have the ability (either legally or monetarily) to make such payments;

– As a dividend may or may not be paid when promised, a dividend either accrues and cumulates (each missed dividend is owed to the preferred shareholder) or not (we didn’t get the dividend this quarter, but hopefully next);

– Although a dividend payment can be structured to be paid at any interval, payments are commonly structured to be paid no more frequently than quarterly, and often annually;

– Dividends on preferred stock are generally preferential, meaning that any accrued dividends on preferred stock must be fully paid before any dividends can be paid on common stock or other junior securities;

  1. Voting Rights as discussed, preferred stock can be set up to establish any level of voting rights from no voting rights at all, voting rights on certain matters (sole vote on at least one board seat; voting rights as to the disposition of a certain asset but otherwise none), or super-voting rights (such as 10,000 to 1 or 51% of all votes);
  2. Liquidation Preferences a liquidation preference is a right to receive a distribution of funds or assets in the event of a liquidation or sale of the company issuer. Generally creditors take precedence over equity holders; however, preferred stock can be set up substantially similar to a debt instrument whereby a liquidation preference is secured by certain assets, giving the preferred stockholder priority over general unsecured creditors vis-à-vis that asset. In addition, a liquidation preference gives the preferred stockholder a priority over common stockholders and holders of other junior equities. The liquidation preference is usually set as an amount per share and is tied into the investment amount plus accrued and unpaid dividends;

– In addition to a liquidation preference, preferred stockholders can partake in liquidation profits (for example, preferred stockholder gets entire investment back plus all accrued and unpaid dividends, plus 30% of all profits from the sale of the company issuer; or preferred stockholder gets entire investment back plus all accrued and unpaid dividends and then participates pro rata with common stockholders on any remaining proceeds (known as a participating liquidation preference);

  1. Conversion or exchange rights a conversion or exchange right is the right to convert or exchange into a different security, usually common stock;

– Conversion rights include a conversion price which can be set as any mathematical formula, such as a discount to market (75% of the average 7-day trading price immediately prior to conversion); a set price per share (preferred stock with a face value of $5.00 converts into 5 shares of common stock thus $1.00 per share of common stock); or a valuation (converts at a company valuation of $30,000,000);

– Conversion rights are generally at the option of the stockholder, but the issuer can have such rights as well, generally based on the happening of an event such as a firm commitment underwriting (the issuer has the right to convert all preferred stock at a conversion price of $10.00 per share upon receipt of a firm commitment for the underwriting of a $50,000,000 IPO);

– The timing of conversion rights must be established (at any time after issuance; only between months 12 and 24; within 90 days of receipt of a firm commitment for a financing in excess of $10,000,000);

– conversion rights usually specify whether they are in whole or in part and, for public companies, limits are often set (conversion limited such that cannot own more than 4.99% of outstanding common stock at time of conversion);

  1. Redemption/put rights a redemption right in the form of a put right is the right of the holder to require the issuer to redeem the preferred stock investment (to “put” the preferred stock back to the issuer); the redemption price is generally the face value of the preferred stock or investment plus any accrued and unpaid dividends; redemption rights generally kick in after a certain period of time (5 years) and provide an exit strategy for a preferred stock investor;
  2. Redemption/call rights a redemption right in favor of the issuer is a call option (the issuer can “call” back the preferred stock); generally when the redemption right is in the form of a call a premium is placed on the redemption price (for example, 125% of face value plus any accrued and unpaid dividends or a pro rata share of 2.5 times EBITDA);
  3. Anti-dilution protection anti-dilution protection protects the investor from a decline in the value of their investment as a result of future issuances at a lower valuation.  Generally the issuer agrees to issue additional securities to the holder, without additional consideration, in the event that a future issuance is made at a lower valuation such as to maintain the investors overall value of investment; an anti-dilution provision can also be as to a specific percent ownership (the holder will never own below 10% of the total issued capital of the issuer);
  4. Registration rights registration rights refer to SEC registration rights and can include demand registration rights (the holder can demand that the issuer register their equity securities) or piggyback registration rights (if the issuer is registering other securities, it will include the holder’s securities as well);
  5. Transfer restrictions preferred stock can be subject to transfer restrictions, either in the preferred stock instrument itself or separately in a shareholder’s or other contractual agreement; transfer restrictions usually take the form of a right of first refusal in favor of either the issuer or other security holders, or both;
  6. Co-sale or tag along rights co-sale or tag-along rights are rights of holders to participate in certain sales of stock by management or other key stockholders;
  7. Drag-along rights drag-along rights are the rights of the holder to require certain management or other key stockholders to participate in a sale of stock by the holder;
  8. Other non-financial covenants preferred stock, either through the instrument itself or a separate shareholder or other contractual agreement, can contain a myriad of non-financial covenants, the most common being the right to appoint one or more persons to the board of directors and to otherwise assert control over management and operations; other such rights include prohibitions against related party transactions; information delivery requirements; non-compete agreements; confidentiality agreements; limitations on management compensation; limitations on future capital transactions such as reverse or forward splits; prohibitions against the sale of certain key assets or intellectual property rights; in essence non-financial covenants can be any rights that the preferred stockholder investor negotiates for.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of, the OTC Market’s top source for industry news, and the producer and host of, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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