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Cases. Trends. Personalities of Interest.
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    The SEC recently (Feb. 9, 2011) proposed rule amendments (PDF) that would eliminate the requirement of credit ratings in determining the eligibility of an issuer to use a short-form registration statement or the expedited shelf registration process.  The SEC announced the rule amendments as the first in a series of proposed rulemaking to remove references to credit ratings as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

    Issuers that are eligible for short-form registration have more limited disclosure requirements and are also able to register securities “on the shelf.”  Currently, one of the ways to satisfy the transaction requirements for eligibility is to have registered nonconvertible securities that have been rated investment grade by at least one nationally recognized statistical rating organization.

    Under the proposed rule changes, the credit rating requirement would be replaced by a test tied to the amount of non-convertible debt and other securities the issuer has sold in the previous three years.  The test would be met if the issuer has issued over $1 billion of non-convertible securities, other than common equity, in the last three years.  The test is modeled after the standard used to determine if an issuer is a WKSI, or well-known seasoned issuer.  The proposed amendments would result in changes to both Form S-3 and Form F-3, as well as other registration statements that refer to Form S-3/F-3 eligibility, such as Form S-4.

    Comments to the proposed amendments must be submitted by Mar. 28, 2011.  The SEC is seeking comments that provide alternative approaches to the proposed $1 billion test.

    OUR TAKE:  Driven by the Dodd-Frank Act, this is the SEC’s first step to eliminate reliance in its rules on credit ratings.  Substantially similar rules were proposed in 2008, but were met with strong objections.  The Dodd-Frank Act requirements reflect the negative view of credit rating organizations as a contributing factor in the U.S. economic downturn and direct the SEC to substitute creditworthiness standards that the SEC determines are appropriate.


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    While Congress is still working to avoid a federal government shutdown at midnight on Friday, Apr. 8, 2011, there is no certainty of success.  In the event of a shutdown, all nonessential services and workers would be affected.  That would include at least some of the SEC’s functions.

    As reported by CNBC yesterday, the SEC has indicated that “certain enforcement and market surveillance activities will continue,” it would stop performing “many of its functions” if the federal government shut downs.  These functions could include securities registrations, accepting and publishing public company filings, and reviewing proxy statements, including merger proxies, and tender offer filings.  As CNBC noted, initial public offerings “may be impossible.”  The exact scope of the shutdown’s impact, however, is still not clear.

    OUR TAKE:  Reporting companies should prepare themselves for the potential impact on the EDGAR filing system, including both ability to file and acceptance of filing, and upon review of registration statements.  However long a shutdown may be, it could have a ripple effect on SEC activities and could result in delays for a longer period, as well as adversely impacting the entire investment community.


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    Professional networking giant LinkedIn is courting investors in advance of its IPO, but its dual-class share structure gives cause for consideration.  No stranger to media heavyweights, including Facebook, Google, the Washington Post and the New York Times, a dual-class share structure is touted by some for its benefits, including the ability of controlling shareholders to:

    •    protect corporate culture;

    •    avoid the short-sightedness of quarterly performance expectations; and

    •    thwart hostile takeovers.

    But shareholders have cried foul in the past.  After a federal court struck down the SEC’s attempt to prohibit dual-class share structures in the late 1980s, the stock exchanges took matters into their own hands with rules forbidding exchange-listed companies from adopting a dual-class share structure.  The glaring loophole, however, remains: a company with an existing dual-class share structure can list its shares.

    Despite recent attention, the dual-class share structure is not a popular choice. On the Standard & Poor’s 500-stock index, only about 6% of companies have a dual-class share structure.  Dual-class shares are designed to give one class of stock control of the company regardless of whether that class has the largest ownership stake.  Vesting control in one class may perpetuate a management team that works to the disadvantage of the company and its shareholders.  Non-controlling shareholders are left with little or no leverage with the value of their shares in the hands of controlling shareholders, which have a greater voting power than economic interest.

    In the case of LinkedIn, investors purchasing shares participating in the company’s IPO will receive Class A shares with one vote per share.  In contrast, the Class B shares, currently owned by co-founder and chairman Reid Hoffman and venture capitalists Sequoia Capital, Greylock Partners and Bessemer Venture Partners, have 10 votes per share.  After the IPO, Hoffman will own approximately 20% of LinkedIn and enjoy control of the company with the existing venture capitalists.  Public shareholders will hold less than 1% of the voting power.

    Although LinkedIn’s dual class structure does contain some protections for Class A shareholders, including severely restricted transferability of Class B shares and the inability of Class B shareholders to use their control to garner additional consideration for themselves in an acquisition,  LinkedIn’s corporate governance structure also is taking fire for other features, including a staggered board and onerous advance-notice bylaws  provisions.    

    OUR TAKE:  Companies contemplating a public offering – and existing public companies – must balance the pros and cons of aggressive corporate governance maneuvers, like a dual-class share structure.  Resistance or outright opposition from shareholders and watch dog groups like ISS, and possibly stock exchanges, is likely.  Prospective shareholders of companies using the dual-class share structure should pay heed to historical criticism and the potential difficulties they will face in taking an active hand in shaping the direction of the company.  These shareholders might just be along for the ride.


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    Nasdaq recently announced SEC approval of its BX Venture Market.  According to Nasdaq, this new exchange will provide smaller issuers, including over-the-counter traded issuers and issuers failing to meet the listing standards of other national exchanges, with a transparent and well-regulated listing alternative. 

    To qualify for listing on the BX Venture Market, issuers must meet numerous listing standards, which are set forth in the SEC’s release (PDF).  These standards will be lower than that of Nasdaq, the NYSE and other national exchanges, attracting smaller, less liquid companies.  Among other requirements, including quantitative listing requirements, these listing standards will require:

    • three independent directors;
    • an independent audit committee;
    • independent director oversight of executive compensation;
    • review of related party transactions by independent directors;
    • shareholder approval of equity compensation;
    • annual shareholder meetings; and
    • a code of conduct for all directors, officers and employees.

    The BX Venture Market anticipates receiving listing applications in the third quarter of 2011, and currently plans to launch in the fourth quarter of 2011. 

    OUR TAKE:  The BX Venture Market may provide emerging businesses and other smaller issuers with an attractive alternative to the OTC Bulletin Board and Pink Sheets, or the more stringent standards of other national exchanges.  Whether the BX Venture Market will spawn a new age of IPOs for smaller and venture-backed issuers remains to be seen.  But the emergence of the BX Venture Market, combined with the SEC’s efforts to review impediments to capital formation, is a step forward for smaller issuers.


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    Groupon announced on Jun. 2, 2011 that it would be going public.  It is rumored that the long-awaited IPO could possibly raise around $3 billion.  That size of IPO would give the social buying site a valuation estimated at $30 billion, a stark difference from the $5 billion that Google offered to purchase it for just months ago. 

    And that’s not the only interesting aspect of the IPO.  Following the likes of LinkedIn, Renren and Google, Groupon also announced that it will use a dual-class share structure. In its SEC filing, Groupon disclosed that while co-founder and chief executive officer Andrew Mason only owns 7.7% of the company’s Class A stock, he additionally owns 41.7% of Groupon’s Class B stock.  Eric Lefkovsky, another co-founder, owns another 41.7% of the Class B Stock.  While the rights of the Class B shares were not disclosed in the filing, they typically allow founders to retain control, through greater voting power, of the company while still having shares traded in the public market.

    With the recent announcements of both LinkedIn (see our earlier post) and Groupon using the dual-class share structure, we can see that investors and owners have strong opinions, both positive and negative, about this corporate governance structure. 

    To most investors, two classes of shares are simply seen as unfair.  By creating a class of shareholders with super-voting rights, power is given to a select group of shareholders.  Typically, senior management is part of the higher voting power class, so there may be less accountability to the publicly traded class, and certainly the publicly traded class has less of a voice.  Dual-class IPOs also tend to be priced at lower price-per-earnings and price-per-sales ratios than comparable single-class IPOs. In addition, research shows that shareholders with super-voting rights dislike raising cash through the sale of additional shares or using shares as currency for acquisitions because this might dilute their voting power influence. Thus, these companies may tend to have more debt than companies with single-class structures.  Consequently, this research also shows that shares of companies with dual-class structures underperform the stock market.

    Nevertheless, the dual-class share structure does have its benefits, at least from a management and founder perspective.  Many praise it because it allows management to ignore all kinds of short and medium-term noise in the market to which most public companies fall prey.  Thus,  the dual-class structure allows managers to create and follow long-term goals that can in turn create long-term value.  Additionally, this structure can prevent hostile takeovers that may bring an end to any opportunity of a long-term franchise.  All in all, if both classes of shareholders’ goals are aligned, long-term success might be more likely than with a single-class structure.

    OUR TAKE: An IPO with dual-class share structures presents a host of benefits and challenges for investors and founders/owners alike.  When considering an IPO, companies should know their options and weigh the good and bad to determine which structure will best set their company on a positive trajectory.  This decision will not only make a long-term impact in how the company operates, but likely also its success.  Investors must weigh the impact of a super-class of stock, and the resulting lack of control, against potential long-term benefits.

    *Many thanks to Lamar Dowling, a Gardere summer associate and JD/MBA student at Southern Methodist University, for his contributions to this post.


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    Soon it may just be a little harder to go public through a reverse merger transaction.  The SEC published proposed rule changes from both the New York Stock Exchange (PDF) and NYSE Amex (PDF) on Aug. 4, 2011 that, if approved, may make you reconsider the reverse-merger route and probably makes the shell-company industry wince.

    Both the NYSE and NYSE Amex in late July 2011 filings proposed additional listing requirements for companies completing a reverse merger with a shell company.  As outlined in the NYSE rule change proposal (PDF), a reverse-merger company would not be eligible for listing unless it could meet the following requirements immediately before filing its initial listing application:

    • the Company’s securities had “traded for at least one year in the U.S. over-the-counter market, on another national securities exchange or on a regulated foreign exchange following consummation of the reverse merger”;
    • the Company filed specified information with the SEC on Form 8-K (for domestic issuers) or Form 20-F (for foreign private issuers), including all required audited financial statements;
    • the Company maintained “on both an absolute and average basis for a sustained period a minimum closing stock price of at least $4” (per the NYSE’s initial listing standards and maintains that stock price through the listing process; and
    • the Company timely filed with the SEC all required reports since the reverse merger, including at least one annual report that included audited financial statements for a full fiscal-year period beginning on the date the company filed the required Form 8-K or Form 20-F.

    The proposed additional listing requirements on NYSE Amex (PDF) mirror the NYSE’s proposal.  Both exchanges propose having discretion to “impose more stringent requirements.”  Examples for exercising this discretion included an inactive trading market or material weaknesses in internal controls that have not been corrected.  There are also some limited exceptions to the additional requirements.

    The NASDAQ Stock Market proposed similar rule changes in an April 2011 filing, which was subsequently withdrawn and replaced by a May 2011 filing (PDF).  The SEC published the proposed NASDAQ rule change in June 2011 (PDF), but has not yet acted on it.  NASDAQ’s proposed additional listing requirements do not appear to be as strenuous as those proposed by NYSE and NYSE Amex.  For example, the trading requirement would be for six months rather than a full year.

    For each of the exchanges, the concern is the absence of registration requirements under the Securities Act of 1933 and the related lack of detailed operational and financial disclosure and the scrutiny of the SEC review process.  The Wall Street Journal also linked the concern to questionable accounting practices of Chinese companies, many of which have used reverse-merger transactions to go public in the United States, as an example of the perceived problem.  (We have previously discussed these accounting concerns and efforts to address them in posts in February, June and July 2011.)

    The SEC has previously shown its own concern about reverse mergers by imposing additional regulatory burdens on shell companies, including limitations in Rule 144 and special disclosure obligations in Form 8‑K (PDF).  More recently, the SEC published an Investor Bulletin on Reverse Mergers (PDF) in June 2011 as a public warning about the risks.

    OUR TAKE:  This is not the first time that risks associated with reverse mergers have been highlighted.  The exchanges believe that the additional listing requirements will provide more transparency and reduce the level of risk to investors.  There will still be companies considering reverse mergers as a speedy way to become public, and still more firms and individuals trying to sell that idea.  The additional listing requirements, if approved, should serve a roadblock to these transactions and deter those that are not sound—or realize that a quick exchange listing is no longer a possibility.


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    The SEC recently (Aug. 8, 2011) proposed (PDF) an amendment to Rule 146 under Section 18 of the Securities Act of 1933 to designate certain securities on BATS Exchange, Inc. as “covered securities” for purposes of Section 18.  As a general matter, “covered securities” are exempt from state law registration or qualification requirements pursuant to the National Securities Markets Improvement Act of 1996 (“NSMIA”).  The proposed amendment raises the question:  what securities are “covered securities” today?

    Section 18 of the Securities Act exempts from state registration or qualification requirements, and any other state-imposed limits, any security that is a covered security or will be a covered security upon the completion of a pending transaction.  By statute, covered securities specifically include any security listed or authorized for listing on:

    • the New York Stock Exchange;
    • the American Stock Exchange (now NYSE Amex);
    • the National Market System of the Nasdaq Stock Market (now the NASDAQ Global Market of the NASDAQ Stock Market); and
    • any national securities exchange “that has listing standards that the Commission determines by rule . . . are substantially similar” to the listing standards of the exchanges named in Section 18;
    • as well as any security of the same issuer that is equal in seniority or senior to the security that is a covered security.

    A covered security also includes a security issued by an investment company that is registered (or in the registration process) under the Investment Company Act of 1940.

    Rule 146(b) under the Securities Act identifies additional covered securities as those securities listed (or authorized for listing) on the following national securities exchanges:

    In each case, the designation as covered securities is conditioned on the applicable exchange’s listing standards continuing to be substantially similar to the listing standards of the exchanges named in Section 18.

    The BATS Exchange petitioned the SEC (PDF) for the proposed amendment of Rule 146.  This is the same procedures utilized by the exchanges currently listed in Rule 146(b).  In each case, the SEC carefully reviewed the exchange listing standards compared to those of the named exchanges.  The BATS Exchange proposed revised listing standards to the SEC (PDF) on May 25, 2011 (updated Jul 14, 2011).  In connection with the proposed rule amendment, the SEC has preliminarily determined that the BATS Exchange proposed listing standards are substantially similar to, meaning at least as comprehensive as, the named exchanges.  Comments to the proposed rule amendment are due to the SEC by Sep. 12, 2011.

    OUR TAKE:  Thanks to NSMIA, the concept of “covered securities” has had a significant impact on federal registrations of securities, simplifying the process by insulating these offerings from state registration or qualification requirements.  As this proposed rulemaking indicates, however, the concept is not static.  The SEC will continue to add to add covered securities designations as listing standards evolve and become more sophisticated.


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    In August 2011, we commented on proposals by the major national securities exchanges to impose additional listing requirements on companies completing a reverse merger with a shell companyThe SEC announced earlier this month that it approved each of the rule changes, as amended, on an accelerated basis.  It just became significantly harder for the shares of a reverse-merger shell company to become listed.

    The SEC approved rule changes for the New York Stock Exchange (PDF), NYSE Amex (PDF) and The NASDAQ Stock Market (PDF) on Nov. 8, 2011.  Prior to the SEC’s approval, each of the NYSE (PDF), NYSE Amex (PDF), and NASDAQ (PDF) amended its rule change proposal so that all three proposals were substantially aligned and to address, in some respects, the small number of comments received by the SEC.

    A “Reverse Merger,” according to new Section 102.01F of the NYSE Listed Company Manual means “any transaction whereby an operating company becomes an Exchange Act reporting company by combining directly or indirectly with a shell company which is an Exchange Act reporting company, whether through a reverse merger, exchange offer, or otherwise.”  Section 101(e) of the NYSE Amex Company Guide and NASDAQ Marketplace Rule 5500(a)(35) provide similar definitions.  Each stock exchange will consider various factors for determining whether a company is a shell company and “Reverse Merger” excludes the acquisition of an operating company by a listed company in compliance with exchange rules.

    For each of the three exchanges, a company resulting from a Reverse Merger would not be eligible for listing unless it meets each of the following requirements immediately before filing its initial listing application:

    • The reverse-merger company’s securities have been “seasoned” by trading for at least one year in the U.S. over-the-counter market, on another national securities exchange or on a regulated foreign exchange following consummation of the Reverse Merger.  (NASDAQ amended its proposed rule change to extend its original six-month seasoning proposal to the one year proposed by both the NYSE and NYSE Amex.)
    • The reverse-merger company has filed all required information with the SEC, including all required audited financial statements after the consummation of the Reverse Merger.  That filing would be Form 8‑K (Item 2.01(f)) for domestic issuers or Form 20-F for foreign private issuers.
    • The reverse-merger company has maintained at least a minimum closing price for a “sustained period of time,” but no less than 30 of the most recent 60 trading days prior to filing the initial listing application.  For the NYSE and NASDAQ, that minimum price is $4 per share.  The NYSE Amex rule specifies the minimum closing stock price under the applicable initial listing standard, which is currently either $3 or $2 depending on the listing standard.  Each of the exchanges amended its original rule proposals to add the “sustained period of time” concept.  This requirement is applicable both at the time the initial listing application is filed and at the time of listing approval.
    • The reverse-merger company has timely filed with the SEC all required reports since the Reverse Merger, including at least one annual report that included audited financial statements for a full fiscal-year period beginning on the date the reverse-merger company filed the required information with the SEC.
    • The reverse-merger company must satisfy all other initial listing requirements of the exchange.
    • Each exchange may also impose more stringent requirements.

    The new additional listing requirements are found in Section 102.01F of the NYSE Listed Company Manual, Section 101(e) of the NYSE Amex Company Guide and NASDAQ Marketplace Rule 5110(c).

    There are two exceptions to these additional listing requirements (but not all other applicable initial listing requirements).  First, the requirements will not be applicable if the listing is in connection with a firm commitment underwritten public offering resulting in at least a minimum level of gross proceeds to the reverse-merger company.  For NYSE Amex and NASDAQ, the rules specify $40 million.  For the NYSE, the reverse-merger company must satisfy the NYSE’s Rule 102.01B regarding aggregate market value of publicly held shares after giving effect to the public offering, which is currently $40 million.

    A second exception under the NYSE and NYSE Amex rules eliminates the closing price requirement if the reverse-merger company has satisfied the one-year “seasoning” requirement and has filed at least four annual reports with the SEC, which each contain all required audited financial statements for a full fiscal year beginning after the reverse-merger company’s filing of the required information with the SEC set forth in the additional listing requirements.  The NASDAQ rule has a similar exception standard, but it operates as an exception to all of the additional listing requirements.

    OUR TAKE:  The risks associated with reverse mergers continue to make headlines.  The new exchange rules, with the SEC’s approval, will result in more transparency, provide for more established company results before listing and hopefully reduce the level of risk to investors.  They will not address or avoid all potential problems or abuses, but are a step in the right direction without unreasonably limiting access to the capital markets.



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