Proposed New Tier for Nasdaq Thinly Traded Securities

Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.

It’s well recognized that the equity markets work pretty well for companies that trade in high volumes, but companies with low trading volumes? Not so much. Thinly traded securities often face liquidity challenges, including wider spreads, higher transaction costs, fewer market makers and potential difficulties for investors that seek to unwind their positions. These issues can discourage small- and medium-sized enterprises from accessing the public markets, a problem that the SEC has been anxious to address. To find potential solutions for these problems, in October 2019, the SEC solicited proposals for changes in equity market structure designed to improve the secondary trading markets for thinly traded securities. Nasdaq has just announced that it has submitted to the SEC an application for exemptive relief that would facilitate its proposal “to establish a tier nestled [sounds very cozy!] within the U.S. public equity markets that is better tailored and far more hospitable to thinly-traded securities than is the all-purpose, undifferentiated market environment in which they suffer today.”

What are “thinly traded securities”? Nasdaq proposes to define them as equity securities that are or will become, at the time of designation as “Thinly-Traded Securities,” listed on one of the existing Nasdaq tiers and that meet the standards for listing on that tier, are issued by an operating company and have an average daily trading volume of 100,000 shares or less during each of six consecutive months. Nasdaq believes it is appropriate for the shares to be required to satisfy a set of the listing requirements “because Nasdaq intends for its proposals to improve the trading environment for securities that are otherwise fit to be listed on Nasdaq, not to establish a new tier for lesser-quality securities.” Currently, there are approximately 1,500 Nasdaq-listed issuers with ADVs of 100,000 shares or less, about 47% of all Nasdaq-listed equity securities. If a security subsequently exceeds the 100,000-share threshold, then Nasdaq would transfer the security to another listing tier for which it qualifies.

Currently, these thinly traded securities have “unlisted trading privileges” (UTP), which allow the shares to trade on any of the national securities exchanges, regardless of whether they are listed on that exchange. The SEC recognized that trading on multiple venues as a result of UTP could adversely affect innovative approaches and offered to consider, as part of a proposal, applications to suspend UTP. Accordingly, Nasdaq’s application seeks exemptive relief to suspend UTP, at the option of the issuer. Nasdaq believes that UTP may “exacerbate market fragmentation,” and that suspending UTP would allow these securities to consolidate thin liquidity by focusing their trading on a specific exchange venue—say, Nasdaq, for example.

Although the application is focused on UTP, Nasdaq plans to separately submit its other proposed reforms to make the market for thinly traded securities more appealing. According to the application, “Nasdaq envisions the establishment of a market tier for Thinly-Traded Securities that would feature [various] market structure reforms and market experience innovations,” available to issuers that choose to terminate UTP. For example, Nasdaq proposes to establish a market-maker incentive program for Thinly- Traded Securities and to require greater transparency regarding the identity and “posture” of the shareholders holding Thinly-Traded Securities. Nasdaq also advocates streamlining the disclosure obligations for Thinly-Traded Securities along the lines the SEC contemplated in its 2018 request for comment regarding earnings releases and quarterly reports—that is, semi-annual reporting with quarterly updates through earnings releases. (See this PubCo post.) In addition, Nasdaq suggests making optional XBRL and conflict minerals and pay-ratio disclosure for these issuers. Nasdaq also supports modernizing the minimum quoting requirements by making the “tick” sizes more flexible, as well as relief from the Order Protection Rule of Reg NMS. Nasdaq also “applauds” the SEC’s recent proposals regarding the proxy process, especially the proposal to raise the eligibility thresholds for shareholder proposals, which would affect smaller issuers most acutely. (See this PubCo post.)

In its application, Nasdaq indicated that it would launch its proposed tier only if it can offer these types of meaningful benefits to attract a critical mass of issuers.

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