Nasdaq, Inc. recently requested comments regarding possible updates to its “20% voting rule.”1 That rule, adopted in 1990, requires Nasdaq listed companies to obtain shareholder approval when issuing 20% or more of its stock in a private offering for a price less than the greater of book or market value. The proposals eliminate the book value test as outmoded, change the market value from a single day’s closing bid price to a five day average closing price to enhance reliability, and add a new governance safeguard that such 20% or greater issuances, regardless of price, be approved by a majority of independent directors, or by the company’s shareholders. We do not expect the proposed revisions to result in a significant change in current practice, other than perhaps for issuers of securities that trade at a discount to book value. In fact, the proposed revisions will create an additional requirement of independent director approval in certain instances. Nasdaq will accept comments on the proposed changes until July 31, 2017.

Highlights

  • Nasdaq Stock Market Rule 5635(d) currently requires listed companies to obtain shareholder approval prior to the issuance of common stock (or securities convertible into common stock) equal to 20 percent or more of the common stock or voting power outstanding if the offer price for such shares is less than the greater of the book or market value of the stock. Rule 5635(d) does not currently require independent director approval irrespective of the offer price.

  • Nasdaq is now soliciting comments on proposed revisions to Rule 5635(d), which, if enacted, would:

    • Change the manner of calculating the price threshold below which shareholder approval is required from the closing bid price on the day prior to the issuance to the average closing price of the common stock for the five immediately preceding trading days;

    • Remove the concept of “book value” from the determination of the price threshold below which shareholder approval is required; and

    • Introduce a new independent director approval requirement applicable to all transactions where shareholder approval is not obtained, pursuant to which any issuance of 20% or more of a company’s outstanding shares, even if priced above the price threshold, must be approved by either (i) a majority of the listed company’s independent directors or (ii) by a committee comprised solely of independent directors.

Nasdaq Stock Market Rule 5635(d) currently requires listed companies to obtain shareholder approval prior to the issuance of common stock (or securities convertible into common stock) equal to 20 percent or more of the common stock or voting power outstanding if the offer price for such shares is less than the greater of the book or market value of the stock. In determining the market value of the stock, Nasdaq current rules look to the previous day’s closing bid price for the stock. The rules do not require shareholder approval if the issuance is a “public offering.” For this purpose, a public offering is generally considered to be a firm commitment underwritten offering that is registered with the Securities and Exchange Commission, however Nasdaq encourages companies to consult with Nasdaq staff in order to determine if a particular offering is a public offering for the purposes of the shareholder approval rules.2

The proposed revisions to Rule 5635(d), if enacted, would create a new method for determining the price threshold above which shareholder approval is required and would require the approval of a majority of the independent directors or of a committee comprised solely of independent directors for any issuance of more than 20% of a Nasdaq listed issuer’s outstanding shares.

Proposed Revised Rule 5635(d)

(d) Private Placements

Shareholder approval is required prior to the issuance of securities in connection with a transaction, other than a public offering, involving the sale, issuance or potential issuance by the Company of common stock (or securities convertible into or exercisable for common stock), which:

(1) alone or together with sales by officers, directors or Substantial Shareholders of the Company equals 20% or more of common stock or 20% or more of the voting power outstanding before the issuance; and

(2) (A) is at a price less than the average closing price of the common stock (as reflected on Nasdaq.com) for the five trading days immediately preceding the signing of the binding agreement for the issuance; or

(B) is not approved either by: (i) Independent Directors constituting a majority of the Board's Independent Directors in a vote in which only Independent Directors participate, or (ii) a committee comprised solely of Independent Directors.

Please see the Nasdaq website for a redline of the proposed rule marked against the current rule.

Practical Implications of the Proposed Changes

  1. Calculation of Price Threshold: The price threshold for transactions requiring shareholder approval will be based on the average closing price of the common stock (as reflected on Nasdaq.com) for the five immediately preceding trading days, as opposed to a single day’s closing bid price. Also, Nasdaq will no longer consider book value as a factor for establishing the price threshold.

  2. Independent Director Approval: Any transaction of more than 20% of a company’s outstanding shares, even if priced above the price threshold established by Rule 5365(d), must be approved by either (i) a majority of the listed company’s independent directors or (ii) by a committee comprised solely of independent directors (i.e., an independent pricing committee), unless such transaction is approved by that company’s shareholders.

Change to the Manner of Calculating the Price Threshold

Rule 5635(d) currently requires a listed company to obtain shareholder approval when issuing common stock or securities convertible into common stock equal to 20% or more of the shares outstanding at a price less than “the greater of the book value or the market value of the stock.” Listing Rule 5005 currently defines “market value” as the previous day’s closing bid price. As a rationale for the change to the manner of calculating the price threshold to a five-day average, Nasdaq stated that comments received in response to its original request for comment on the shareholder approval rules suggested (i) the use of the closing bid price in setting the price threshold was problematic as the bid price is not always transparent to companies and investors and does not always reflect the final sale price, and (ii) to address typical price volatility, investors and companies often rely on an average price over a period of time.

Based on these comments, the proposed rule modifies the “market value” concept with an average closing price of the securities for the five trading days immediately preceding the signing of a binding agreement for the issuance. Nasdaq notes that the closing price will be more transparent to companies and investors because it is reported on financial websites. In addition, Nasdaq notes that, as the closing price is generally at or above the bid price, establishing the price threshold based on the closing price will result in a more stringent requirement. To provide certainty about the closing price to be used, Nasdaq proposes to codify that Nasdaq.com is the appropriate source of the closing price for the purposes of Rule 5635(d).

Nasdaq also notes that commenters suggested that the use of book value in determining the price threshold be eliminated as book value is an accounting measure and is rarely considered by companies and investors when making pricing decisions. Additionally, Nasdaq notes that the use of book value can disproportionately impact certain industries at certain times. For these reasons, the proposed changes to Rule 5635(d) eliminate the “book value” concept entirely.

Board Approval Requirement

In their release of the proposed changes to Rule 5635(d), Nasdaq raised certain potential negative consequences of using a five-day average as the price threshold for determining whether stockholder approval is required. For example, in a rising market, the five-day average price will appear to be a discount to the most recent closing price, potentially allowing dilutive transactions without shareholder approval. As a safeguard against the potential misuse of the average price threshold, the proposed changes to Listing Rule 5635(d) require that any transaction of more than 20% of the company’s outstanding shares, even if such shares are priced above the price threshold established by Rule 5635(d)(i), be approved by either a committee of independent directors or a majority of the independent directors on the board, unless such issuance is approved by the company’s shareholders. Importantly, this new independent director approval requirement, if adopted, will require that, for any private placement where shareholder approval will not be obtained, a Nasdaq listed company must obtain the approval of the independent directors or a committee of independent directors, separate and apart from the general approval of the board of directors. This new independent director approval requirement will result in an extra procedural step not necessarily required to complete private placements today, but is intended to act as a safeguard against misuse of the five-day average price threshold calculation. Nasdaq listed issuers and their counsel will need to be mindful of this new approval requirement should the changes to Rule 5635(d) be adopted as proposed.

Following Nasdaq’s review of the comments, which will be accepted until July 31, 2017, any proposed rule change will be subject to public notice and comment as part of the U.S. Security and Exchange Commission’s review and approval process.