On Friday last week, 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. 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, the shareholder approval requirement would apply to “a 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.” 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. Comments on the proposal are due 21 days after publication of the proposal in the Federal Register.
According to the NYSE, some listed companies are highly dependent on regular capital raises to fund operations. For example, the NYSE observes 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. 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, the NYSE believes, are not susceptible to the same potential conflicts of interest. Accordingly, the proposal would 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.”
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 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 proposed amendment would limit the shareholder approval requirement to sales to parties whose interest is not passive: directors, officers, “controlling shareholders or members 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.” A “control group” would be defined as set forth in Exchange Act Rule 13D-5, and the NYSE would rely on the filings on Form 13D or 13G disclosing the existence of a group.
Some restrictions would continue to apply, even to passive investors: shareholder approval would still be required for 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)).