On March 20, 2019, the Securities and Exchange Commission (the "SEC") approved amendments to Sections 312.03(b) relating to issuances of securities to substantial stockholders (the "Substantial Stockholder Issuance Rule") and 312.03(c) (the "20% Rule") of the New York Stock Exchange's (the "NYSE") Listed Company Manual to, among other things, (i) change the definition of "market value" for purposes of each rule and (ii) eliminate the requirement for shareholder approval of certain private issuances at a price less than book value but greater than market value.
The amendments to the 20% Rule and the Substantial Stockholder Issuance Rule only apply to issuers listed on the NYSE, but the amendments to the 20% Rule are substantially similar to those approved on September 26, 2018, with respect to Nasdaq Rule 5635(d)i (the "Nasdaq Rule") which governs Nasdaq listed issuers. While the Nasdaq Rule is similar to the amended 20% Rule, it contains some important differences in determining which offerings are exempt from shareholder approval. Please see our prior Baker Botts Corporate Update for a more in depth discussion of the Nasdaq Rule and the recent amendments thereto. Additionally, limited partnerships listed on the NYSE should be aware that they are not subject to the 20% Ruleii or the Substantial Stockholder Issuance Rule, so this discussion will not be of particular importance to them.
Background of NYSE Rules
When a company offers 20% or more of its equity in an offering that is priced below the market value of the security, existing public shareholders can be significantly diluted and the company's smaller shareholders may be prohibited from participating in the offer if it is private. In addition, public stockholders can be harmed when significant stockholders participate in a private placement for a discount. The 20% Rule and the Substantial Stockholder Issuance Rule are designed to give shareholders an opportunity to vote on such offerings and prior notice thereof sufficient to allow the shareholders to sell their stock before the consummation of the offering.
Prior NYSE Rules
Prior to the amendments, Section 312.03(b) of the NYSE Listed Company Manual required a listed company to obtain prior shareholder approval for any issuance of common stock, or securities convertible into or exercisable for common stock in any transaction or series of related transactions, to a director, officer or substantial security holder (each, a "Related Party") or certain of their affiliates, related persons or other entities in which such Related Party has a substantial direct or indirect interest, if the number of shares of common stock to be issued or 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 prior to the issuance. However, if the Related Party is only classified as such because it is a substantial stockholder (a "Substantial Stockholder Issuance Transaction"), stockholder approval will not be required if the issuance relates to a sale of stock for cash at a price at least as great as each of the book and market value of the issuer's common stock, unless the shares to be issued or into which the securities may be convertible or exercisable exceeds either five percent of the number of shares or five percent of the voting power prior to the issuance.
Section 312.03(c) of the NYSE Listed Company Manual required a listed company to obtain shareholder approval prior to the issuance of common stock, or securities convertible into or exercisable for common stock, if: (1) the common stock has, or will have upon issuance, voting power equal to or in excess of 20 percent of the voting power outstanding before the issuance of such stock or of securities convertible into or exercisable for common stock or; (2) the number of shares of common stock to be issued is, or will be upon issuance, equal to or in excess of 20 percent of the number of shares of common stock outstanding before the issuance of the common stock or of securities convertible into or exercisable for common stock (either scenario, a "20% Issuance"). However, shareholder approval was not required for any 20% Issuance involving (A) a public offering for cash or (B) any bona fide private financingiii, if such financing involved the sale of common stock, or securities convertible into or exercisable for common stock, for cash, at a price (conversion or exercise price in the case of securities convertible into the issuer's common stock) at least as great as each of the book and market value of the issuer's common stock.
Amended NYSE Rules
Under the amendments, a 20% Issuance in a bona fide private financing and a Substantial Stockholder Issuance Transaction of less than 5% will not need shareholder approval if the sales price (conversion or exercise price in the case of securities convertible into the issuer’s common stock) is greater than or equal to the "Minimum Price." "Minimum Price" means a price that is the lower of: (i) the official closing price on the NYSE as reported to the Consolidated Tape Associationiv (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.
Highlights of Changes to NYSE Rules
The highlights to the changes effected by the amended 20% Rule and the Substantial Stockholder Issuance Rule include:
- Addition of Five Trading-Day Average Closing Price Metric. The amended rules add a new metric in determining whether a shareholder vote is necessary that looks to the five-day average closing price. The NYSE indicated that this metric helps avoid unanticipated and inequitable results that may occur with the use of a single day's closing price if there is unexpected price volatility.
- Elimination of Book Value Measure. A security's book value will no longer be used to determine whether shareholder approval is needed under the amended rules. The NYSE noted that book value was not a meaningful measure of whether a transaction is dilutive because book value is an accounting measure based on the historical costs of assets rather than their current value.
- Lower of the Two Measures. The amended rules require a shareholder vote if the sales price (conversion or exercise price in the case of securities convertible into the issuer's common stock) is less than the lower of the Official Closing Price and the five-day average Official Closing Price, whereas the old rules required a shareholder vote if the sales price was less than the greater of the "market value" and book value.
The amended 20% Rule and Substantial Stockholder Issuance Rule provide issuers greater flexibility in structuring their transactions by allowing them to account for market volatility and one-off events that can create an artificially high or low price. Additionally, the replacement of the book value measure with a five-day price average and use of the lower of the closing price and five-day average will likely reduce the number of transactions requiring a shareholder vote because (i) a security's book value is rarely greater than its market value and (ii) the five-day average closing price will likely be below the final day's closing price if the offering occurs in a rising price environment.
Issuers should be aware that their ability to issue equity in private offerings without shareholder approval is still limited by important NYSE rules which require a shareholder vote for (i) certain Substantial Stockholder Issuance Transactions in excess of either five percent of the number of shares or five percent of the voting power prior to the issuancev, (ii) issuances that result in a change of control of the issuervi and (iii) certain issuances to a Related Party that is an employee, director or service providervii.
i See Nasdaq Rule 5635(d).
ii See NYSE Rule 312.03(e).
iii NYSE Rule 312.04(g) defines a "bona fide private financing" as a sale in which either a registered broker-dealer purchases the securities from the issuer with a view to the private sale of such securities to one or more purchasers; or the issuer sells the securities to multiple purchasers, and no one such purchaser, or group of related purchasers, acquires, or has the right to acquire upon exercise or conversion of the securities, more than five percent of the shares of the issuer's common stock or more than five percent of the issuer's voting power before the sale.
iv The Consolidated Tape Association oversees the dissemination of real-time trade and quote information in New York Stock Exchange LLC and Bats, NYSE Arca, NYSE American and other regional exchange listed securities. See the NYSE's website for more information.
v See NYSE Rule 312.03(b).
vi See NYSE Rule 312.03(d). This rule does not apply to issuances by MLPs.
vii See NYSE Rule 312.03(b) and NYSE Rule 303A.08.
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