In January, as discussed in this PubCo post, Nasdaq proposed to modify the listing requirements in Rule 5635(d) to

  • (i) change the definition of market value for purposes of the shareholder approval rule and
  • (ii) eliminate the requirement for shareholder approval of issuances at a price less than book value but greater than market value.

In August, Nasdaq filed Amendment No. 1, which clarified certain terms. The SEC has just approved the proposed rule change, as amended, on an accelerated basis.

Under the old rule, in private placement transactions, shareholder approval was required prior to

“(1) the sale, issuance or potential issuance by the Company of common stock (or securities convertible into or exercisable for common stock) at a price less than the greater of book or market value which together with sales by officers, directors or Substantial Shareholders [holders of a 5% or more of the common stock or voting power outstanding] of the Company equals 20% or more of common stock or 20% or more of the voting power outstanding before the issuance; or

(2) the sale, issuance or potential issuance by the Company of common stock (or securities convertible into or exercisable common stock) equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock.” Rule 5005 defines “market value” as the closing bid price.”

First, the rule change addresses the challenge of interpreting the convoluted language above (to put it euphemistically), making it more readable by combining clauses (d)(1) and (d)(2). Under the readability-enhanced rule, instead of requiring a shareholder vote as described above, shareholder approval would be required “prior to a 20% Issuance at a price that is less than the Minimum Price.” That change is not substantive.

With regard to substantive modifications, in summary, the rule change “modifies Nasdaq Rule 5635(d) to change the definition of market value for purposes of shareholder approval of private placement transactions such that (1) shareholder approval would be required prior to an issuance of 20% or more at a price that is less than the lower of the closing price or the five-day average closing price; and (2) shareholder approval would not be required prior to an issuance of 20% or more at a price that is less than book value but greater than market value.”

More specifically:

20% Issuance. A“20% Issuance” is now defined to mean a transaction that is not a public offering (as defined in IM-5635-3) “involving the sale, issuance or potential issuance by the Company of common stock (or securities convertible into or exercisable for common stock), which, alone or together with sales by officers, directors or Substantial Shareholders of the Company, equals 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance.” Under the amendment, Nasdaq replaced the references to “private placements” with “transactions other than public offerings.”

Minimum Price. One concern that had been expressed to Nasdaq was that the bid price may not be an actual price and may not be transparent. To address that concern, the amendment changed the concept of “market value” for purposes of Rule 5635(d) to “Minimum Price,” which will now be defined as the price that is “the lower of (1) the closing price (as reflected on Nasdaq.com) immediately preceding the signing of the binding agreement or (2) 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.” As amended, shareholder approval will be required only for private placement transactions that are priced below the Minimum Price. Instead of the bid price, companies will need to look to the Nasdaq Official Closing Price, which is based on the closing auction on Nasdaq, “reflects actual sale prices at one of the most liquid times of the day, and is highly transparent to investors.” Nasdaq believes that, in comparison to the bid price, the closing price reported on Nasdaq.com is a better reflection of the market price and less prone to manipulation than the bid price. Nasdaq recognized that although in the event of rising or declining markets or a material event, there are disadvantages to using a trailing average, nevertheless, Nasdaq believed, that risk is already accepted by the market. The minimum price formulation provides additional flexibility in that, Nasdaq observed, “in either a rising or a falling market, the proposal would allow companies to be able to complete transactions by accepting the lower of the average of the closing prices for each of the five days immediately preceding the signing of a binding agreement or the most recent closing price before the signing of a binding agreement.”

The SEC acknowledged that, as commenters noted, the use of a five-day trailing average closing price is related to the way transactions are actually structured to help smooth out price fluctuations. In addition, in approving the rule changes, the SEC noted that companies would also be limited in issuing securities in private placements without shareholder approval by other important Nasdaq rules, such as the requirement for shareholder approval for any discounted issuance of stock to a company’s officers, directors, employees, or consultants under the equity compensation rules; for any issuance that resulted in a change of control; and “for the acquisition of stock or assets of another company, including where an issuance increases voting power or common shares by 5% or more and an officer or director or substantial security holder has a 5% direct or indirect interest (or collectively 10%) in the company or assets to be acquired.”

Book Value Test Eliminated. Nasdaq also eliminated the “book value” measure from the prior rule because Nasdaq believed that it was an accounting measure based on historic values and, as such, was not an appropriate measure of whether a transaction is dilutive or should otherwise require shareholder approval. As a result, private placement transactions priced below book value but above market value (as defined in Minimum Price) would not require shareholder approval.

There are also a few conforming changes.