On December 26, 2023, the U.S. Securities and Exchange Commission (SEC) approved a rule change by the New York Stock Exchange (NYSE) narrowing the circumstances under which a listed company must obtain shareholder approval for a sale of securities to holders of five percent or more of either the common stock or voting power of the company (substantial security holders). The NYSE’s proposed rule eliminates the shareholder approval requirement for sales of securities to related parties whose interest in the company is passive in nature, making it easier for companies to raise capital and more closely aligning NYSE rules with those of other exchanges.
Current Rule
Currently, NYSE Rule 312.03(b)(i) provides that shareholder approval is required 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 substantial security holder where the issuance makes up more than one percent of the number of shares of common stock or voting power outstanding before the issuance. NYSE Rule 312.04(e) categorizes a “substantial security holder” as a holder of an interest consisting of at least five percent of the outstanding shares of common stock or the outstanding voting power of the company, without regard for the degree to which the security holder plays a role in company management.
This requirement can impede or prevent financings given the additional time and expense involved in securing a shareholder vote, particularly for pre-revenue stage biotech companies that “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.”
In addition to the above, Rule 312.03(b)(ii) requires shareholder approval where securities are issued as consideration in a transaction or series of related transactions in which i) any Related Party (a director, officer, or substantial security holder of the company) has a five percent or greater interest (or such persons collectively have a 10 percent or greater interest), directly or indirectly, in the company or assets to be acquired or in the consideration to be paid and ii) 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 of the voting power outstanding before the issuance.
Proposed Rule Changes
The NYSE’s changes to Rule 312.03(b)(i) are intended to make capital raising easier by removing from the shareholder approval requirement sales of securities to investors who are considered substantial security holders but play no part in the management of the company (aside from voting their shares). Under the amended rules, Rule 312.03(b)(i) will only require shareholder approval for sales over one percent to an “Active Related Party,” defined to mean i) a director, officer, controlling shareholder or member of a control group of the company, or ii) any other substantial security holder with an affiliated person who is an officer or director of the company.
Explaining its rationale for the rule change, the NYSE acknowledged that existing security holders of a company are typically familiar with the company’s business and are well positioned to invest without requiring the same degree of diligence and oversight that would be necessary for issuances to outside investors, but also highlights potential conflicts of interest issues that may arise in sales to officers, directors, or other control persons who are not purchasing the securities on an arm’s length basis. By limiting the Rule 312.03(b)(1) shareholder vote requirement to issuances to Active Related Parties (i.e., only those participating in management or control of the company), the NYSE is able to avoid conflicts of interest while also facilitating quick capital raises from significant, but passive, investors.
While the NYSE rule removes these passive investors from application of Rule 312.03(b)(i), the amendment clarifies that the proposed rule change would not have any substantive effect on the application of Section 312.03(b)(ii). Therefore, notwithstanding the application of 312.03(b)(i), shareholder approval may nevertheless be required where a Related Party has an interest in the company or assets to be acquired, even if the Related Party is not an Active Related Party. The NYSE also clarifies that other shareholder approval requirements continue to apply, and even if an issuance falls outside of Rule 312.03(b), it still may require shareholder approval under another rule (for example, if the transaction relates to 20 percent or more of the issuer’s common stock at a price above the “Minimum Price” as defined by NYSE).
Conclusion
The changes to Rule 312.03(b)(i) “would allow 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.” Because the NYSE is the only U.S. exchange with such a restriction in place, the proposed changes will make it easier for NYSE-listed companies to raise necessary capital quickly, bringing the rules more in line with those for issuers trading on other U.S. exchanges.
Comments on the proposed rule are due by January 23, 2024. The full text of the amended rule can be found here.
