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E-MailCydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.
On August 26, the SEC’s Division of Trading and Markets took action, pursuant to delegated authority, to approve a proposed NYSE rule change that would allow companies going public to raise capital through a primary direct listing. (See this PubCo post.) This week, that rule change hit a “snag,” as the WSJ put it—the SEC notified the NYSE that the approval order had been stayed because the SEC had received a notice of intention to petition for review of the approval order. What’s that about?
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Essentially, a “direct listing” involves a registered sale directly into the public market with no intermediary underwriter, no underwriting commissions (just advisory fees) and no roadshow or similar expenses. The initial pricing is set during the opening auction, not by agreement among the company and underwriters, as in a traditional IPO. Prior to this new approval, under NYSE rules, only secondary sales were permitted in a direct listing. Of course, the absence of proceeds to the company put a definite crimp in the potential popularity of direct listings, as only companies that did not need to raise capital for their own use were likely to opt for that alternative.
You might recall that the path to SEC approval of primary direct listings was a bit rocky. A little over a week after the NYSE’s initial application was filed, the SEC rejected the proposal, and it was removed from the NYSE website, causing a lot of speculation about the nature of the SEC’s objection and whether the proposal could be resurrected. But the NYSE persevered, and the proposal was refiled in December with some clarifications and corrections. But then—silence. In January and February, the NYSE had four meetings with SEC staff, including folks in Chair Clayton’s office, presumably to make the case for the proposal. A number of public comment letters, of divided opinion, were submitted. Apparently, the SEC remained unconvinced, designating a longer period to decide, and then in late March, issued an Order instituting proceedings to determine whether to approve or disapprove the proposed rule change. Undaunted, the NYSE filed Amendment No. 2, which is discussed in more detail in this PubCo post. Then finally, a positive outcome. As NYSE Vice Chair John Tuttle crowed (justifiably) about the SEC approval, “problem-solving” is “part of the NYSE’s DNA.” Good thing.
There has been a vociferous call from many VCs and others for alternative on-ramps to public-company status, such as direct listings. Those that favor direct listings complain about the cost and rigidity of the traditional underwriting commission structure. Indeed, some of the largest investment banks submitted favorable comment letters to the SEC regarding the proposal. Generally, these favorable letters supported the availability of alternative formats that offer choices to issuers, encouraging more companies to participate in the public markets. (See, e.g., this letter and this letter.) Notably, however, the majority of comment letters opposed the proposal, including two letters in opposition submitted by the Council of Institutional Investors (here and here). CII contended, among other things, that primary direct listings would reduce shareholder protections for several reasons—potential liquidity issues, potential low aggregate market value of publicly held shares at the time of listing, the company’s being the only seller in the opening auction and a lack of clarity with regard to Securities Act liability—principally as a result of difficulty in tracing shares purchased back to the registration statement and the absence of an offering price.
Apparently, CII was more than a little displeased by the SEC’s approval of the NYSE rule change. On August 31, CII advised the SEC of its intent to file a petition for review of the order of approval. CII’s executive director told Pensions & Investments that “CII took the unusual step after rising concern over traceable shares.” Litigation regarding a recent direct listing “raised the issue of whether investors can challenge a misleading registration statement if they cannot trace their shares to those offered in the registration statement. CII has urged the SEC to address this issue by establishing a system of traceable shares as a key component its long-overdue proxy plumbing project….We think the SEC should fix the proxy infrastructure before approving an expansion of the direct listing regime.” A tall order by any account.
In approving the NYSE proposal to allow primary direct listings, the SEC maintained that many of the changes included in Amendment No. 2 to the original application “support a finding that the proposal is consistent with the Act.” In particular, the SEC addressed the concern raised by commenters regarding the difficulty of tracing shares back to the registered offering to pursue claims under Section 11, contending that the problem of tracing is “not exclusive to Primary Direct Floor Listings but rather is a recurring issue, particularly in the context of aftermarket securities purchases. Purchasers in a registered offering may face difficulty tracing their shares back to the registration statement whenever a company conducts a registered offering for less than all of its shares.” For example, even in the context of traditional firm commitment offerings, the SEC said, availability of Rule 144 sales “may result in concurrent registered and unregistered sales of the same class of security at the time of an exchange listing, leading to difficulties tracing purchases back to the registered offering.” At the present time, the SEC was aware of only one case that had considered the issue in the context of direct listings and, in that case, the court allowed the plaintiffs to pursue Section 11 claims. Indeed, the SEC noted, the fact that, in a primary direct listing, all company shares will be sold in the opening auction, makes “it potentially easier to trace those shares back to the registration statement than in other contexts.” Accordingly, the SEC did not believe that permitting primary direct listings “poses a heightened risk to investors, and finds that the proposed rule change is consistent with investor protection.”
Rule 430 of the SEC’s Rules of Practice provides that a “person aggrieved by an action made pursuant to delegated authority may seek Commission review of the action by filing a written notice of intention to petition for review.” Within five days after the filing of the notice of intention, the person seeking review is required to file the petition, which must contain “a clear and concise statement of the issues to be reviewed and the reasons why review is appropriate. The petition shall include exceptions to any findings of fact or conclusions of law made, together with supporting reasons for such exceptions based on appropriate citations to such record as may exist.” Under Rule 431, upon filing with the SEC of the notice of intention to petition for review, the action is automatically stayed until the SEC orders otherwise. Petitioning the SEC for review is a prerequisite to seeking judicial review.
An NYSE spokesperson told the WSJ that the NYSE “would ask the SEC to move quickly and allow its proposed expansion of direct listings to go forward. ‘The ability to raise capital with an NYSE direct listing represents an innovative new path to the public markets, and we intend to ask the SEC to lift its stay to make this important resource immediately available to issuers and investors,’ the NYSE spokesperson said.” Not surprisingly, the general counsel of CII had a different take on the matter: “Given the importance of this change to the market, shouldn’t the full commission take a look at this rather than just have the staff make this decision?” he asked Law360.
Stay tuned.
