SEC approves NYSE proposal allowing companies to raise capital in a direct listing
Nasdaq files a revised direct listing rule proposal with the SEC that mirrors the NYSE’s amendments.
More than a year after the New York Stock Exchange (“NYSE”) first proposed allowing companies to raise capital in connection with direct listings, the U.S. Securities and Exchange Commission (the “SEC”) has finally approved the new rule, which is effective immediately. The Nasdaq Stock Exchange (“Nasdaq”) is seeking immediate effectiveness for a substantially similar rule proposal, which is still subject to SEC review.
A company that wishes to list securities in the United States must both register the securities with the SEC and make an application to the relevant U.S. stock exchange, such as the NYSE or Nasdaq. In an initial public offering with a U.S. listing, the offering must be registered under the U.S. Securities Act of 1933 (the “Securities Act”) and the offered securities must be registered under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”).
Most companies that list securities on a U.S. stock exchange have done so via an underwritten public offering. But in recent years, the direct offering and the special purpose acquisition company (“SPAC”) transaction have emerged as powerful alternatives to traditional underwritten IPOs.
Historically, a direct listing involved a company listing its shares on a U.S. stock exchange by registering the offer and sale of existing shares by certain selling shareholders, without engaging an underwriter. The purpose of the transaction was to make the outstanding shares eligible for trading on an exchange, thereby providing existing shareholders with liquidity by allowing them to sell their shares to the public. In the direct listings that have been undertaken to date, the company did not receive any proceeds from these secondary sales of its shares.
In December 2019, however, the NYSE proposed amendments to its direct listing rules that would allow a company to raise capital in connection with a direct listing. In August 2020, the SEC approved the proposal, which had been amended several times, but the approval was stayed in September 2020 following a petition from the Council of Institutional Investors (“CII”) for review of the order. After a de novo review, the SEC approved the rule changes.
Under the amended NYSE rules, two types of direct listings are permitted:
- a Primary Direct Floor Listing, where the company itself (either on its own or with selling shareholders) is selling shares. The company must either:
- sell at least US$100m in market value of shares in the opening auction on the first day of trading; or
- have a market value of publicly held shares immediately prior to listing of at least US$250m, with the market value calculated using a price per share equal to the lowest price of the price range disclosed by the company in its registration statement.
- a Selling Shareholder Direct Floor Listing, where only the company’s existing shareholders are selling shares. The company must either:
- demonstrate that it satisfies the US$100m aggregate market value of publicly held shares requirement based on a combination of both an independent third-party valuation and the most recent trading price for the company's common stock in a private placement market; or
- in the absence of any trading in a private placement market, provide an independent third-party valuation evidencing a market value of publicly held shares of at least US$250m.
For both types of direct listings, the company would also have to satisfy the other NYSE initial listing requirements, including that at the time of the initial listing, there are 400 round lot holders, 1.1 million publicly held shares outstanding and a price per share of at least $4.00. The NYSE had originally proposed a 90-day grace period for the company to meet the round lot requirement, but the final amendments require these listing requirements to be satisfied at the time of initial listing.
The new rules also specify the auction process for a Primary Direct Floor Listing, requiring the company to disclose in the registration statement a price range and the number of shares to be sold. The opening auction price must be within the disclosed price range, meaning that, unlike in a traditional IPO, the company may not open trading below the price range without filing a pre-effective amendment. The NYSE also requires the company to place a limit order for the full quantity of shares offered by the company in its registration statement, with the limit price equal to the bottom of the price range disclosed by the issuer in its registration statement. The limit order may not be cancelled or modified and must be executed in full in the direct listing auction.
Comparison to Nasdaq Proposal
Nasdaq has also recently proposed changes to its rules to allow companies to raise capital in connection with a direct listing on the Nasdaq Global Select Market (a “Direct Listing with a Capital Raise”). An earlier version of Nasdaq’s proposal had provided more flexibility for companies than the NYSE rules. For example, it would have permitted the shares sold in a Direct Listing with a Capital Raise to be sold at a price up to 20% below the bottom of the price range set in the registration statement, while the NYSE rules require shares in a Primary Direct Floor Listing to price within the anticipated price range.
However, on the same day the SEC approved the NYSE’s new direct listing rules, Nasdaq submitted a new proposal to the SEC, revising its amendments to substantially mirror the NYSE’s proposal (for further details, please see our comparison chart). In its filing, Nasdaq argued that its proposal should be immediately effective, as it is “virtually identical” to the NYSE’s proposal that the SEC had approved. The SEC staff has said it is working to review Nasdaq’s amendments as promptly as possible. The SEC has 60 days after Nasdaq’s filing to temporarily suspend the changes and institute proceedings to determine whether the proposal should be approved or disapproved.
Liability and Investor Protection Concerns
In finding that the NYSE had “met its burden” of demonstrating that its proposal is consistent with the Exchange Act, the SEC rejected arguments that the NYSE’s proposal would limit investors’ ability to bring securities law claims and would undermine investor protections.
One of the key concerns CII raised in its petition is that the NYSE’s proposal would make it very difficult for investors to recover losses for false or inaccurate statements made in direct offerings. Aggrieved investors must “trace” their purchases back to the registration statement under which the relevant securities were offered and sold in order to proceed with a claim under Section 11 of the Securities Act. A Primary Direct Floor Listing will often involve concurrent sales by other shareholders, making it challenging to trace a specific trade directly back to the issuer. Other commenters, as well as two of the SEC Commissioners, also argued that removing traditional underwriters from the public offering process would mean the loss of an important gatekeeper with an incentive to conduct an independent check on the quality of the registration statement.
In its approval order, the SEC said that the Section 11 traceability issues are neither exclusive to, nor necessarily inherent in, Primary Direct Floor Listings and noted that there is no court decision to date in the direct listing context that prohibits plaintiffs from pursuing Section 11 claims. With respect to the concerns raised about the loss of the traditional underwriter role, the SEC agreed with the NYSE’s argument that the Securities Act does not require the involvement of an underwriter in registered offerings. Further, the SEC said, a financial advisor to an issuer engaged in a Primary Direct Floor Listing may, depending on the facts and circumstances, be deemed a statutory “underwriter” with respect to the securities offering, with the attendant underwriter liabilities. The SEC reasoned that these potential liabilities, as well as the risk of reputational damage, provide the financial advisors to issuers in Primary Direct Floor Listings with significant incentives to engage in robust due diligence.
As an alternative to traditional IPOs, direct listings seem to have lost out to SPAC IPOs in 2020, but the ability to raise capital under the NYSE’s rules may renew interest in direct listings. We also expect that the SEC will also allow Nasdaq to proceed with its proposed changes, given the similarities to the NYSE’s proposal. However, SEC Chair Jay Clayton, who pushed through the approval of the NYSE proposal in a flurry of activity at the end of his tenure, has already stepped down, and a new SEC Chair may take a different approach.
We will continue to monitor developments in this area and welcome any queries you may have.