On Dec. 22, 2020, the U.S. Securities and Exchange Commission (SEC) approved a proposed change to the New York Stock Exchange (NYSE) listing rules that will allow a company, at the time of its initial listing on the NYSE, to conduct a primary direct listing without conducting an underwritten offering.
The proposed rule change underwent several iterations and a lengthy SEC review process. The NYSE amended the proposed rule change twice before the SEC issued an approval order. However, the SEC subsequently stayed its approval order following receipt of a petition for review from the Council of Institutional Investors, a nonprofit association of pension funds and other institutional investors. The SEC granted the petition for review. Following a public comment period and a thorough de novo review, the SEC (a) determined that the NYSE met its burden to show that the proposed rule change was consistent with Section 6(b)(5) of the Securities Exchange Act of 1934, as amended (Exchange Act), which requires, among other things, that listing rules be designed to prevent fraudulent and manipulative acts and practices and, in general, to protect investors and the public interest, and (b) approved the proposed rule change, as amended.
In making its determination, the SEC concluded that the proposed rule change will facilitate the orderly distribution and trading of shares and foster competition, which are consistent with the purposes of the Exchange Act. According to the SEC, the orderly distribution and trading of shares promotes fair and orderly markets and is one of the important roles of a national securities exchange in ensuring that its rules prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and protect investors and the public interest. In addition, the SEC concluded that the proposed rule change will foster competition by providing an alternate method for companies to list on the NYSE without conducting an underwritten offering, thereby removing potential impediments to public market access and supporting capital formation.
What Is a Direct Listing?
In a typical initial public offering, a company enters into an agreement with underwriters whereby the underwriters agree to purchase a specified number of shares of the company’s common stock at a set purchase price. The underwriters’ purchase price for the shares reflects a discount to the public offering price for the shares. The underwriters purchase the shares from the company at the agreed-upon price, resell the shares to investors at the public offering price and pocket the difference. The company and the underwriters determine the public offering price and the discount based on indications of interest from prospective investors. When the shares begin trading on an exchange, the opening price is determined by market orders and may vary significantly from the initial public offering price. In a direct listing, there is no initial sale of the company’s shares to underwriters or any pre-opening sale of those shares by the underwriters to the initial investors. Instead, initial sales of the company’s shares are conducted through the applicable exchange, with the price for such shares determined at the opening auction in accordance with applicable listing rules. A direct listing does not involve underwriters, underwriting discounts or commissions, or road shows. Initially, the NYSE Listed Company Manual (Manual) limited direct listings to secondary offerings by selling stockholders – a company could not avail itself of the direct listing process to raise capital in the public markets.
Summary of Rule Change
Section 102.01B, Footnote (E) of the Manual currently states that the NYSE lists companies in connection with an underwritten initial public offering, upon transfer from another market or pursuant to a spinoff. Footnote (E) currently allows for the possibility of a direct listing, stating that the NYSE recognizes that companies that have not previously had their common stock registered under the Exchange Act but have sold common stock in a private placement may desire to list their common stock on the NYSE for the purpose of allowing company stockholders to sell their shares (i.e., a secondary direct listing). The rule change states that the NYSE intends to recognize both primary direct listings and secondary direct listings. The NYSE, on a case-by-case basis, will exercise discretion to list companies through a primary direct listing or a secondary direct listing. With respect to a secondary direct listing, the rule change retains the existing standards regarding how the NYSE will determine whether a company has met the applicable market value of publicly held shares listing requirement. With respect to a primary direct listing, the rule change provides that a company will be deemed to have met the market value of publicly held shares listing requirement if it will sell at least $100 million in market value of shares in the opening auction on the first day of trading. Alternatively, if the company will sell shares in the opening auction with a market value of less than $100 million, the company will be deemed to have satisfied the market value of publicly held shares listing requirement if the aggregate market value of shares the company will sell in the opening auction on the first day of trading and the shares that are publicly held immediately prior to the listing is at least $250 million.
The NYSE believes that these requirements will ensure that a company conducting a primary direct listing will be of suitable size for listing and that there will be sufficient liquidity for the shares to be suitable for auction market trading. Officers, directors or owners of more than 10% of the company’s common stock may acquire, in a secondary market transaction, shares sold by the company in the primary direct listing that were included in the market value of publicly held shares calculations. In addition, a company using a primary direct listing or a secondary direct listing will continue to be subject to and needs to meet all other applicable NYSE initial listing requirements, including the requirement to have 400 round lot stockholders and 1.1 million publicly held shares outstanding at the time of the initial listing.
The rule change identifies a new order type – an Issuer Direct Offering Order (IDO Order) – that will be used by the company in a primary direct listing and sets forth rules regarding how an IDO Order will operate in a direct listing. An IDO Order will be a limit order traded only in a primary direct listing and will have the following requirements: (a) only one IDO Order may be entered on behalf of the company, and by only one market maker; (b) the limit price of the IDO Order must equal the lowest price of the price range established in the registration statement; (c) the IDO Order must be for the number of shares offered by the company in the prospectus; (d) the IDO Order may not be canceled or modified; and (e) the IDO Order must be executed in full in the primary direct listing.
The rule change imposes requirements on market makers in the primary direct listing process. A market maker conducts a primary direct listing and is responsible for determining the auction price. Under the rule change, a market maker cannot conduct a primary direct listing if (a) the auction price will be below the lowest price or above the highest price of the specified price range set forth in the registration statement or (b) there is insufficient interest by buyers to satisfy both the IDO Order and all better-priced sell orders in full. The NYSE stated that if there is insufficient buy interest and the market maker cannot price the auction and satisfy the IDO Order, the auction will not proceed and the shares will not begin trading. The rule change states that an IDO Order will be guaranteed to participate in the auction at the auction price. If the limit price of the IDO Order is equal to the auction price, the IDO Order will have priority at that price. The NYSE stated that providing priority to an at-priced IDO Order will increase the potential for the IDO Order to be executed in full and therefore for the primary direct listing to proceed.
The rule change further provides that any services provided by a financial adviser to the company or the market maker in connection with a primary direct listing or a secondary direct listing must provide such services in compliance with all federal securities laws, including Regulation M and other anti-manipulation requirements. The NYSE retained the Financial Industry Regulatory Authority to monitor such compliance with Regulation M and other anti-manipulation provisions of the federal securities laws. Finally, the NYSE provided that if a market maker is unable to manually facilitate a direct listing auction, the NYSE will not proceed with the direct listing.