NYSE Proposes to Exempt Early Stage Companies from Shareholder Approval Requirement for Issuances to Related Parties | Practical Law

NYSE Proposes to Exempt Early Stage Companies from Shareholder Approval Requirement for Issuances to Related Parties | Practical Law

The NYSE issued a proposed rule change that would exempt early stage companies from the requirements of Section 312.03(b) of its Listed Company Manual.

NYSE Proposes to Exempt Early Stage Companies from Shareholder Approval Requirement for Issuances to Related Parties

by Practical Law Corporate & Securities
Published on 08 Jan 2015 • USA (National/Federal)
The NYSE issued a proposed rule change that would exempt early stage companies from the requirements of Section 312.03(b) of its Listed Company Manual.
Update: The NYSE subsequently issued two replacement filings that made material changes to the original proposal. The proposal was also published in the Federal Register and the SEC later extended the time period it had to take action on the proposal. On August 4, 2015, the SEC announced that it was instituting proceedings to determine whether it should disapprove of the proposal and invited comments. On August 31, 2015, the NYSE filed an amendment to the proposal. On October 16, 2015, the SEC's Investor Advocate recommended that the SEC disapprove the proposal. On October 30, 2015, the SEC extended the time period it had to take action on the proposal. On December 10, 2015, the NYSE filed a second amendment to the proposal. The SEC approved the proposal on December 31, 2015. To learn more, see Updates below.
On January 7, 2015, the NYSE issued a proposed rule change that would exempt any listed company that has not reported annual revenues greater than $20 million in any two consecutive fiscal years since its foundation (Early Stage Company) from the requirements of Section 312.03(b) of the NYSE's Listed Company Manual. Currently, Section 312.03(b) requires a company to obtain shareholder approval, with certain exceptions, before it issues shares exceeding either one percent of the number of shares of common stock or one percent of the voting power outstanding before the issuance to:
  • Directors, officers or holders of 5% or more of the company's common stock (Related Parties).
  • Affiliates of Related Parties.
  • Entities in which a Related Party has a substantial interest.
The proposal would exempt Early Stage Companies from this requirement for shareholder approval. Under the proposal, once a company does report revenues greater than $20 million in each of two consecutive fiscal years, it would lose its designation as an Early Stage Company and would become subject to all shareholder approval requirements set out in Section 312.03(b). A company would not be able to regain its Early Stage Company designation once it is lost, even if the company later reports reduced revenues.
The proposal notes that many Early Stage Companies do not yet generate significant revenue from operations and may need to raise capital quickly in order to fund their ongoing operations, usually through private placement share issuances. Obtaining shareholder approval is expensive and can take several months of advance preparation, which is burdensome for Early Stage Companies that need capital quickly.
The proposal also notes that Early Stage Companies exempt from the requirements of Section 312.03(b) would still be subject to Section 314.00, which requires that all Related Party transactions be reviewed by an appropriate body of the company. The NYSE recommends that the audit committee or another comparable body fulfill this obligation.
Among the NYSE's reasons for the proposal is that, if adopted, it will enable the NYSE to compete with NASDAQ and NYSE MKT for the listing of Early Stage Companies. Neither NASDAQ nor NYSE MKT has a rule comparable to Section 312.03(b).
The proposal follows the NYSE's recent elimination of its Assets and Equity Test initial listing standard, which it replaced with a new initial listing standard that permits companies to list on the NYSE if they demonstrate a total global market capitalization of at least $200 million (Global Market Capitalization Test) (see Legal Update, NYSE Proposes Changes to Initial Listing Standards for Operating Companies). The NYSE adopted the Global Market Capitalization Test to allow it to better compete with NASDAQ for the listing of early stage companies that did not yet meet the requirements of its Assets and Equity Test.
The proposed rule change requires SEC approval.

Updates

First Replacement Filing

On February 2, 2015, the NYSE issued a replacement filing for this proposal. The replacement filing clarified that:
  • The proposal would only apply to issuances that are sales for cash. All other issuances would remain subject to the shareholder approval provisions of Section 312.03(b).
  • An exemption from one provision of Section 312.03 is not a general exemption from all of Section 312.03. Therefore, even if a transaction by an Early Stage Company is exempt under Section 312.03(b), the shareholder approval requirements of Sections 312.03(c) (requiring shareholder approval of issuances relating to 20% or more of the company’s stock) and 312.03(d) (requiring shareholder approval of any issuance giving rise to a change of control) would still apply.

Second Replacement Filing

On April 16, 2015, the NYSE issued a second replacement filing for this proposal. The second replacement filing further:
  • Amends the definition of Early Stage Company to include any listed company that has not reported annual revenues greater than $20 million in any two consecutive fiscal years since its incorporation, rather than since its foundation.
  • Clarifies that the proposal would only exempt Early Stage Companies from the shareholder approval requirement in Section 312.03(b) if the Early Stage Company's audit committee, or a comparable committee comprised solely of independent directors, reviews and approves all transactions prior to their completion.
  • Clarifies that a company's annual financial statements prior to listing would be considered when determining if the company should lose its Early Stage Company designation. For example, if a company files an annual report with the SEC one year after listing on the NYSE and the annual report shows that the company has had revenues greater than $20 million in each of two consecutive fiscal years (even if one of those years was prior to listing on the NYSE), the company would lose its Early Stage Company designation at that time.
  • Clarifies that the provisions of Section 312.03(c) apply to any transaction or series of transactions. The NYSE carefully reviews issuances to determine whether they are related and should be aggregated for purposes of the rule, paying particular attention to whether the transactions occur within a short period of time, are made to the same or related parties or whether there is a common use of proceeds. The NYSE would conduct this analysis for any series of sales made by an Early Stage Company to a Related Party. Should the NYSE determine that it is necessary to aggregate the series of sales and, as aggregated, the total number of shares sold exceeds 19.9% of the shares outstanding, shareholder approval would be required under Section 312.03(c).

Publication in Federal Register

On May 6, 2015, the proposal was published in the Federal Register. The SEC is accepting comments on the proposal until May 27, 2015.

Extension of Time Period for Action

On June 18, 2015, the SEC extended the 45-day period it had to take action on the proposal. The SEC must now take action on the proposal by August 4, 2015.

SEC Institutes Proceedings

On August 4, 2015, the SEC announced that it was instituting proceedings to determine whether it should disapprove of the proposal and invited comments. The SEC highlighted its concern regarding whether the proposal is consistent with the requirements of Section 6(b)(5) of the Exchange Act, which requires that national securities exchanges govern themselves by rules designed to promote just and equitable principles of trade and to protect investors and the public interest.

Partial Amendment No. 1

On August 31, 2015, the NYSE issued Partial Amendment No. 1, which clarifies that the proposal would exempt from shareholder approval transactions involving the sale of stock for cash by an Early Stage Company to:
  • A Related Party.
  • A subsidiary, affiliate or other closely-related person of a Related Party.
  • Any company or entity in which a Related Party has a substantial direct or indirect interest.

Recommendation of Investor Advocate

On October 16, 2015, the SEC's Investor Advocate recommended that the SEC disapprove the proposal.

Extension of Time Period for Action

On October 30, 2015, the SEC extended the period it had to take action on the proposal. The SEC must now take action on the proposal by December 31, 2015.

Amendment No. 2

On December 10, 2015, the NYSE filed Amendment No. 2, which:
  • Clarifies that an Early Stage Company could not rely on the proposal to fund an acquisition of stock or assets of another company that would otherwise require shareholder approval under Section 312.03(b).
  • Would include a statement in Section 312.03(b) codifying the NYSE's longtime policy that any sale of a listed company's securities to a director, employee, or other service provider at a below-market price constitutes equity compensation under Section 303A.08 and is subject to the shareholder approval requirements under that rule. This shareholder approval requirement would continue to be applicable to sales by Early Stage Companies to directors, employees, or other service providers.
  • Would include a statement in Section 312.03(b) reminding listed companies that shareholder approval of any issuance is required if any of the subparagraphs of Section 312.03 require it, even if the transaction does not require approval under Section 312.03(b) or one or more of the other subparagraphs.

SEC Approval

On December 31, 2015, the SEC approved the proposal (see Legal Update, SEC Approves NYSE Proposal to Exempt Early Stage Companies from Shareholder Approval Requirement for Issuances to Related Parties).
To learn more about the NYSE's continued listing requirements, see Qualitative Listing Requirements Chart: New York Stock Exchange.