by Cydney Posner
As discussed in this PubCo post, in early August, the SEC issued an Order instituting proceedings to determine whether to disapprove a proposal from the NYSE to amend Sections 312.03(b) and 312.04 (shareholder approval) of the NYSE Listed Company Manual. The proposal would exempt from the NYSE’s shareholder approval requirements “Early Stage Companies” that seek to issue, subject to audit committee approval, shares, for cash, to related parties, affiliates of related parties or entities in which a related party has a substantial interest. An “Early Stage Company” would be defined as a company that has not reported revenues greater than $20 million in any two consecutive fiscal years since its incorporation. The SEC had received no comments on the proposal either when it was first published or when the comment period was extended. But because of the legal and policy issues involved, the SEC instituted “disapproval proceedings” to encourage comments on whether the proposal was consistent with the Exchange Act requirement that the rules of the securities exchanges be designed to, among other things, prevent fraud and manipulation, promote just and equitable principles of trade and protect investors and the public interest. The two main concerns raised by the SEC were that the proposal would allow shares to be issued at a discount to related parties without shareholder approval, and that audit committee approval of these types of potentially dilutive transactions might not suffice.
So far, the only taker on the SEC’s invitation to comment has been the NYSE, commenting on its own proposal. The comment letter takes issue with the SEC’s conclusion that the proposal would allow shares to be issued at a discount to related parties without shareholder approval. Rather, the letter stresses that the NYSE’s
“longstanding policy is that any time a listed company sells equity securities to a director, officer or employee for a price that is at a discount to the then-current market price, such securities are deemed to be equity compensation requiring shareholder approval under Section 303A.08. Nothing in the proposed amendment will change the Exchange’s application of this policy going forward….When selling up to 19.9% of its outstanding equity securities to a director, officer or employee, in order to be exempt from shareholder approval (under both Section 303A.08 and the proposed Section 312.03(b)), an Early Stage Company would have to price the transaction at or above then then-current market price. When priced at or above then then-current market price, the shares sold are not equity compensation and there is no economic dilution to the Early Stage Company’s shareholders. The Exchange believes that this pricing requirement should alleviate the concern raised by the Commission.”
However, under the proposal, sales for cash of up to 19.9% of the outstanding common stock to (i) a non-employee substantial shareholder, (ii) a subsidiary, affiliate or other closely related person of a related party, and (iii) any company or entity in which a related party has a substantial direct or indirect interest would not require shareholder approval. The NYSE contends that the exemption is appropriate because of the frequent and often immediate need of Early Stage Companies for financing, and typical sources for this financing are non-employee significant shareholders and affiliates of a related party. Not to mention that Nasdaq would not require shareholder approval for these transactions.
With regard to whether approval by the audit committee would be an effective substitute for shareholder approval, the NYSE reiterated its belief that audit committee approval was an “appropriate safeguard to protect shareholder interests…. Directors owe a fiduciary duty to the shareholders whom they represent and can be held personally liable for any violation of that duty.” Because procedures are already in place for approval of all related-party transactions and because, in the NYSE’s view, independent directors are often best “positioned to evaluate related party transactions because of their knowledge of company affairs, the Exchange believes that its proposed requirement protects shareholders….”