Happy new year! In September last year, the SEC posted a new NYSE proposed rule change that would “modify the circumstances under which a listed company must obtain shareholder approval of a sale of securities to a substantial security holder,” a holder of 5% or more. (See this PubCo post.) Under current listing rules, shareholder approval is required for sales in excess of 1% of the common stock to a substantial security holder, unless the transaction is a cash sale for a price that is at least equal to the “Minimum Price.” Under the proposal, the shareholder approval requirement would be narrowed to apply only to control parties—that is, in addition to directors and officers, to substantial security holders with indicia of control. By eliminating the shareholder approval requirement for sales to passive holders—which the NYSE views as unnecessary—the proposal is designed to facilitate the ability of NYSE-listed companies to raise necessary capital. Now the SEC has posted Amendment No. 1 to the proposal, which provides additional explanation of the reason the NYSE proposed the rule change and amends the rule text in several ways. The release indicates that the SEC has approved the proposed rule change, as modified by Amendment No. 1, on an accelerated basis.
Currently, Section 312.03(b)(i) requires shareholder approval “prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, in any transaction or series of related transactions, to a director, officer or substantial security holder of the company 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 one percent of the number of shares of common stock or one percent of the voting power outstanding before the issuance.” There is an exception for cash sales for a price that is at least the Minimum Price, defined as “a price that is the lower of: (i) the Official Closing Price immediately preceding the signing of the binding agreement; or (ii) the average Official Closing Price for the five trading days immediately preceding the signing of the binding agreement.” In effect, currently, shareholder approval is required for sales to substantial security holders and other related parties of more than one percent of the shares at a price below the Minimum Price, a requirement that “imposes significant delay and additional costs on the issuer, thereby often making the sale impracticable.” According to the NYSE, it is the only U.S. exchange with this limitation.
The NYSE observes that some listed companies are highly dependent on regular capital raises to fund operations. For example, the NYSE indicates that pre-revenue stage biotech companies “regularly seek additional capital to fund their research and development activities… by selling equity securities in private placements or direct registered sales priced at a small discount to the prevailing market price.” Existing shareholders, the NYSE suggests, are often willing purchasers, and sales to these purchasers can be advantageous because they can be consummated expeditiously and at lower cost. But that’s not the case if shareholder approval is required. And if the shareholder is considered a “substantial shareholder”—under Section 312.04(e), a holder of five percent or more—and the transaction relates to more than one per cent of the common stock, then shareholder approval is required if the price does not meet the minimum. Although shareholder approval provides significant protection against conflicts of interest for sales to control persons—who may be able to “use their influence within the company to obtain superior terms” to the detriment of other shareholders—sales to passive holders—who do not participate in the governance or management of the company—the NYSE believes, are not susceptible to the same potential conflicts of interest. Accordingly, the rule change will amend the shareholder approval requirement in “Section 312.03(b)(i) to limit its application to related parties whose interest in the company is not passive in nature.”
As amended, the rule change will add a new definition of an “Active Related Party” for purposes of Section 312.03(b)(i), but also retain the existing broader concept of “Related Party” for purposes of Section 312.03(b)(ii). Under the amended rules, the Section 312.03(b)(i) shareholder approval requirement will be limited to sales to an Active Related Party, that is, a director, officer, controlling shareholder or member of a control group or any other substantial security holder of the company that has an affiliated person who is an officer or director of the company. Affiliation will be determined taking into account all relevant facts and circumstances, including whether the person is an affiliate as defined under the federal securities laws. The rule will also import other federal securities law definitions, specifically including in amended Section 312.04, (i) a “group,” as determined under Section 13(d)(3) or Section 13(g)(3) of the Exchange Act; and (ii) “control” as defined in Rule 12b-2 of Reg 12B under the Exchange Act. For purposes of determining a “control group,” the NYSE will look to Schedules 13D or Schedules 13G disclosing the existence of a group, along with any additional follow-up inquiry that is needed. The release indicates that the NYSE “intends to revise its internal procedures in reviewing proposed transactions to the extent necessary to obtain the necessary information to make determinations with respect to whether shareholders participating in transactions are Active Related Parties.”
In addition, under current Section 312.03(b)(ii), shareholder approval is required “prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, where such securities are issued as consideration in a transaction or series of related transactions in which a Related Party has a five percent or greater interest (or such persons collectively have a ten percent or greater interest), directly or indirectly, in the company or assets to be acquired or in the consideration to be paid in the transaction or series of related transactions and the present or potential issuance of common stock, or securities convertible into common stock, could result in an issuance that exceeds either five percent of the number of shares of common stock or five percent of the voting power outstanding before the issuance.” The NYSE is amending Section 312.03(b)(ii), but only to clarify that it is retaining the broader definition of “Related Party” included in the current rule (i.e., “a director, officer or substantial security holder of the company”). As a result, the changes will have no substantive effect on the application of Section 312.03(b)(ii). The release also indicates that the other shareholder approval requirements will remain in effect, such as sales of securities in a private placement below the Minimum Price that involve 20% or more of the issuer’s common stock (Section 312.03(c)) or that would result in a change of control (Section 312.03(e)).
In effect, under the amended rules, shareholder approval will be required for below market sales (i.e., below the Minimum Price) over one percent to Active Related Parties. However, the release notes, “as a consequence of the proposed amendment, below market sales over one percent to substantial securityholders who are not Active Related Parties will be permitted without shareholder approval under 312.03(b)(i), but will continue to be subject to all the other applicable shareholder approval requirements under 312.03.” As a result, the change will permit “substantial security holders who do not participate in the governance or management of the company (and who are thus not in the newly defined Active Related Party category) to acquire additional stock below the Minimum Price without the need for shareholder approval under Section 312.01(b)(i), thus making it less burdensome for NYSE listed companies to raise additional capital quickly.”
