The 2008-2009 stock market crash and current deep recession are causing many small public companies to reexamine the costs and benefits of remaining listed on a national securities exchange and continuing as a public reporting company under the Securities Exchange Act of 1934 (the “Exchange Act”). Over the past twelve to eighteen months, many companies have experienced steep declines in their total market capitalization and revenues. For smaller companies, public company compliance costs have increased significantly as a percentage of revenues. In early 2009, more than 200 NASDAQ listed companies and 50 NYSE listed companies were facing delisting for non-compliance with applicable continuing listing requirements. As a result, both NASDAQ and the NYSE have currently suspended certain of such requirements, including the $1.00 minimum bid price standard to avoid an avalanche of delistings.1
Companies facing delisting are more likely to consider “going dark” than those not under immediate pressure to address their listing status. However, many companies not facing near term delisting pressure may also wish to consider this possibility. Public company burdens are particularly acute for companies with a market capitalization of less than $50 million and total revenues of under $100 million. Public company compliance costs can range from $1.0 million to over $3.0 million annually even for such a relatively small company. The more troubled the issuer, the more burdensome public company status can become as a company spends a greater proportion of its diminishing resources dealing with difficult disclosure and accounting questions. In the past there has been some stigma associated with “going dark.” As the current recession has deepened, this negative perception may have less force as companies face the very high costs of remaining a public company in a very difficult business environment.
What “Going Dark” Means
“Going dark” refers to the process of voluntarily delisting a public company’s shares from a national securities exchange or inter-dealer quotation system (if so listed or quoted) and subsequently deregistering the shares under the Exchange Act, thus suspending or terminating the company’s public reporting obligations under the Exchange Act. Delisting alone does not eliminate public reporting requirements. Many non-listed companies are also reporting issuers. However, for such an unlisted public reporting company, the lack of a stock exchange listing may substantially diminish the benefits of remaining a public company.
“Going dark” should not be confused with a “going private” transaction. A “going private” transaction generally involves the cash-out of all or a substantial portion of a company’s public shares so that the company becomes eligible to delist and deregister its shares under the Exchange Act. “Going private” transactions can take many forms and may involve a merger, tender offer or reverse split of the company’s shares. “Going private” transactions require extensive and detailed disclosure filings under Rule 13e-3, the “going private” rule. “Going private” transactions are often undertaken by or at the direction of controlling shareholders or third party acquirors and require extensive board consideration, disclosure, fairness opinions, SEC filings and often a shareholder vote.
“Going dark,” on the other hand, can be accomplished without a shareholder vote, fairness opinion or any shareholder cash out. While some companies electing to delist and “go dark” have considered the possibility of providing shareholders with a liquidity event, such as a tender offer or stock repurchase program, in practice this is not often done because companies which “go dark” rarely have sufficient cash resources to make a meaningful tender offer. Nevertheless, such a liquidity event could be undertaken in connection with a “going dark” transaction by a company that has the cash resources to offer one, provided that care is taken not to trigger the “going private” rules.2
Procedures for “Going Dark”
To understand the “going dark” procedure, it is first necessary to understand what triggers Exchange Act reporting requirements. A company’s Exchange Act obligations can be triggered in any of three ways:
- under Section 12(b) if it has shares listed on a national securities exchange;
- under Section 12(g) based on having over 500 record holders of a class of securities and total assets exceeding $10 million3; and
- under Section 15(d) by having a registration statement declared effective under the Securities Act.
Each of these three independent predicates for Exchange Act registration must be separately addressed as a company considers whether and how to “go dark.”4
Both U.S. domestic issuers and foreign private issuers can delist and/or deregister if there are less than 300 holders of record of the relevant class of its securities as defined in Rule 12g5-1. It is possible for a company to have less than 300 holders of record of a class of securities even though it has thousands of beneficial owners of that class of securities. This is because, in counting record holders, in general, the issuer need only count the number of registered holders on its shareholder list and if depositaries are listed, the number of holders for whom the depositary holds securities. For most U.S. issuers, this mean counting the registered holders and adding the number of participants listed in the security position listing of DTC, the principal depositary for U.S. issuers.5 For purposes of determining whether the Company has less than 300 holders of record, Rule 12g5-1 has been interpreted to mean that an issuer does not have to further “look through” DTC participants to the ultimate beneficial owners. Many companies may therefore be eligible to delist and “go dark” without management or the board of directors even being aware of the possibility.
Foreign private issuers can also delist and deregister under Exchange Act Rule 12h-6 but that Rule requires the company to have and maintain a foreign listing which is its primary trading market. Since the non-U.S. company would still be listed on a non-U.S. Exchange, using Rule 12h-6 would not technically be “going dark,” although it would involve withdrawal from the U.S. reporting system.6
Delisting and Deregistration under Section 12(b)
The “going dark” rules are simple in conception, but can be complex and highly technical in their practical application. The first step for a listed issuer is to delist. Listed issuers are entitled to delist their securities voluntarily and to deregister them under Section 12(b) of the Exchange Act by filing a Form 25 with the SEC. The issuer must give notice of its intention to file the Form 25 and issue a press release announcing that intention ten days prior to filing the Form 25. The delisting will become effective ten days after filing the Form 25 and most SEC reporting obligations are suspended on that date. However, the actual termination of registration under Section 12(b) does not occur until 90 days after effectiveness of the delisting.7
Deregistration under Section 12(g) and Suspension of Reporting Obligations under Section 15(d)
Once delisted, a company may nonetheless be required to continue reporting pursuant to Section 12(g) of the Exchange Act if it has more than 500 holders of record and total assets exceeding $10 million, or pursuant to Section 15(d) of the Exchange Act if it at any time had an effective Registration Statement under the Securities Act of 1933.8 To avoid this result, a company can deregister under Section 12(g) and suspend its reporting obligations under Section 15(d) if it has less than 300 shareholders of record.9 Section 15(d) reporting obligations may be automatically suspended if the issuer had less than 300 shareholders of record10 on the first day of its fiscal year. In either case, the company will need to file a Form 15 certifying that the number of shareholders of record of the class of securities to be deregistered is less than 300 persons to deregister under Section 12(g) and, if applicable, suspend its reporting obligations under Section 15(d).11 Note that Section 15(d) obligations can never be terminated in this manner, they can only be suspended.12 After “going dark,” an issuer’s reporting obligations can be reinstated if the issuer exceeds the limit on the number of record holders on the first day of any fiscal year after it files a Form 15. For example, brokers and other institutions holding shares in street name can elect to cease holding the shares in that capacity, and cause the transfer agent to record the shares directly in the name of the persons for whom they hold the securities. In such a case, each beneficial owner will become a record holder, and the stockholder count may exceed the limits. To avoid having to reregister, companies which have “gone dark” should carefully monitor the number of record holders they have during the year, and take steps (such as a reverse stock split or stock repurchase or tender) to ensure that they continue to have less than 300 record holders before the applicable test dates under Sections 12(g) and 15(d).
Timeline for Deregistration
An issuer’s periodic reporting obligations under the Exchange Act will be suspended immediately upon its filing of a certification on Form 15 that it has less than 300 holders of record.13 Deregistration under Section 12(g) will become effective 90 days after filing the Form 15. The SEC has the authority to deny such a request for termination, but has rarely done so. The SEC will not accelerate the 90-day period.
Set forth below is a timeline outlining the significant procedural steps in a typical “going dark” transaction for a domestic listed company.
The company files written notice of intent to file a Form 25 with the stock exchange pursuant to Rule 12d2-2(c)(2)(ii), issues a press release and files a Form 8-K announcing that it is delisting and “going dark,” and the reasons therefore. This information should also be placed on the company Web site.
The company files Form 25 with the stock exchange and announces the same.
The company stock continues trading or shortly thereafter begins trading in the Pink Sheets.
The company files a Form 15 to deregister its shares under the Exchange Act. The Form 15 may not be filed prior to the effective date of the Form 25 (ten days after filing).
The company issues a press release announcing deregistration.
Section 12(b) deregistration becomes effective.
The 90-day period after filing of Form 15 passes making effective the deregistration of the company’s stock under Exchange Act Section 12(g) and the suspension of reporting obligations under Section 15(d), if applicable.
Filing the Form 15 will immediately suspend the Company’s reporting obligations under Section 13(a) of the Exchange Act making it no longer necessary to file Forms 10-K, 10-Q or 8-K, or in the case of a foreign private issuer, Forms 20-F or 6-K. However, certain other Company reporting obligations continue for an additional 90 days, including obligations to file proxy statements and tender offer statements. As a result, if a proxy solicitation for an acquisition transaction is conducted during this 90-day waiting period, it will still be subject to the rules and disclosure obligations governing proxy statements. In addition, shareholders continue to be required to file Schedule 13Ds and Schedule 13Gs until expiration of the 90-day period following filing of the Form 15 and Section 16 reporting obligations also continue until such date.
Traps for the Unwary
Under Rule 12h-3(c), a company may not suspend its Section 15(d) reporting obligations in any fiscal year where it has a registration statement declared effective under the Securities Act or “that is required to be updated” pursuant to Section 10(a)(3) of the Securities Act. However, the SEC has granted no action relief for certain Form S-3 and Form S-8 registration statements in this regard. The SEC has orally stated to us and granted no action letters to the effect that a company can “go dark” after the first day of the fiscal year if the company withdraws all effective registration statements requiring updates under Section 10(a)(3) (e.g., Form S-3s14) before filing its Form 10-K. Once the Form 10-K has been filed and incorporated by reference in such a registration statement, then the company will be required to make all mandated filings for that fiscal year, including the Form 10-K due after the close of the fiscal year unless it obtains no action relief from the SEC.15
In addition, the company must have a good faith belief that it has under 300 shareholders of record when it files its Form 15. Yet a listed company cannot file a Form 15 until at least 20 days after it announces its intention to “go dark.” If the company’s shareholders of record change during that period so that the company has more than 300 record holders due to broker distributions or “kick-outs” to beneficial owners, to ordinary trading or due to the intentional actions of the company’s shareholders, the company may not be able to file the Form 15. A broker “kick-out” occurs when a street name or nominee holder determines it no longer wants to serve in that position and distributes the shares to the beneficial owners, thus increasing the number of record holders. This is always a difficult risk to quantify for companies considering a delisting and Exchange Act deregistration.
Pros and Cons of “Going Dark” The following chart briefly summarizes some of the pros and cons of “going dark.” Of course, these factors will have different weight for different companies depending on the circumstances. It is important for the board of directors to consider and review the specific factors most important to its company and in particular to obtain a detailed analysis of the cost savings expected from “going dark.”
- Significantly lower operating costs and management time commitment for compliance and reporting activities. Sarbanes-Oxley Act compliance is also no longer needed.
- D&O insurance costs may be decreased.
- Personal liability of officers and directors, particularly certifying CEOs and CFOs, is reduced.
- The stock will continue to trade on the Pink Sheets.
- Less public scrutiny and disclosure, making it easier to keep confidential such matters as competitive business information and executive compensation.
- The company will have greater freedom to explore possible extraordinary corporate transactions.
- Corporate governance requirements can be simplified. For example, it would not be necessary to have a majority of independent directors and the board of directors may be decreased in size.
- If the company “goes dark,” but later somehow finds itself back over the 300/500 stockholder limit at a test date, it will once again be subject to SEC reporting requirements.
- Stockholders may bring litigation against the board of directors for, among other things, (a) breach of fiduciary duty caused by decreased liquidity and trading price resulting from “going dark,” if that in fact occurs, (b) insider trading by officers and directors on the basis of material non-public information (because no periodic reports have been filed or adequate information released), or (c) repurchases by the corporation on the basis of material non-public information.
- The absence of public exposure decreases not only the financial markets presence of the company, but can also hurt the company’s business. The securities of an unlisted non-reporting company will (a) be substantially less useful as currency for acquisitions, and (b) be significantly less attractive to employees for equity based compensation.
- Trading volumes and analyst coverage will likely be significantly lower.
- The company will remain subject to anti-fraud provisions of state and federal securities laws. The reduced governance and oversight requirements can result in an increase in conflict transactions, and even breaches of the duty of loyalty and a decreased focus on stockholders as a constituency.
- Stockholders may think the decision to “go dark” means that the company is in play or is trying to hide something.
- “Going dark” will likely reduce liquidity in the trading market for the company’s securities and can sometimes result in a significant decrease in trading prices.
- Many companies which “go dark” are sold or cease doing business within a few years after “going dark.”
Conflicts of Interest
In some cases, conflicts of interest may exist on the board of directors or among shareholders with respect to “going dark.” Large shareholders or a group of controlling shareholders can sometimes be less interested in a public trading market than non-affiliated shareholders would be. Such large shareholders and/or senior management may prefer to operate as a private company and seek M&A opportunities without the burdens of public company disclosures, including Section 16 and Schedule 13D filings. Even though no “going private” transaction is contemplated in such cases, it may be nevertheless desirable to have a special committee of independent disinterested directors consider the decision to “go dark.” The special committee should be able to retain and consult with its own legal and financial advisors in accordance with procedures and practices which have been developed and become customary in the U.S. in change of control and “going private” transactions.
Trading in the Pink Sheets
After “going dark,” the company’s shares would generally continue trading in the Pink Sheets. This can be done without subjecting the company to any Exchange Act reporting requirements. If securities that are delisted from NASDAQ are already quoted in the Pink Sheets, any market maker that had been quoting the security for the 30 days prior to delisting could continue to make a market in the Pink Sheets after delisting. The security would then become “piggy-back qualified” the same day it is delisted, which means that any other market maker can then enter its quotes in the Pink Sheets without going through the usual procedures for initiating a quote. If a “piggy-back qualification” is not available, then the company can undertake the fairly simple process of initiating a quote on the Pink Sheets. Once delisted from NASDAQ the Company will get a new Pink Sheets trading symbol.
Trading prices typically decline when a company moves from a stock exchange to the Pink Sheets. Because Pink Sheets companies are not subject to SEC reporting requirements, the level of information available about them varies greatly. There are several different market tiers to denote the level of information that is available about each Pink Sheets company.
- Adequate Public Information: Issuers are considered to have adequate current information publicly available if they provide the required disclosures (described below) through the OTC Disclosure and News Service no later than 90 days after the end of any fiscal year (the “Annual Report”) and 45 days after the end of each fiscal quarter (the “Quarterly Report”). Issuers also need to provide updates within 10 business days (“Current Report”) in the event that any of the information contained in any disclosure statement has become materially inaccurate or incomplete, or upon the occurrence of certain material events (described below).
- Limited Information: This category is designed for companies with financial reporting problems, economic distress, or in bankruptcy to make the limited information they have publicly available. The “Limited Information” category also includes companies that may not be troubled, but are unwilling to meet the guidelines for providing adequate public information described above. In order to qualify for this category, companies must have posted limited financial information not older than six months through the OTC Disclosure and News Service, or have filed interim, quarterly, or annual reports with the SEC with a period end date within the previous six months.
- No Information: Companies in the “No Information” category are not able or willing to provide disclosure to the public markets -- either to a regulator, an exchange or Pink Sheets, or if they do, the available information is older than six months. This category includes defunct companies that have ceased operations as well as “dark” companies and/or companies with non-standard management and market disclosure practices. Most Pink Sheets companies are currently in this category.
- Grey Market: There are no market makers in securities categorized as Grey Market. These securities are not listed, traded or quoted on any stock exchange, or any OTC market. Trades in grey market stocks are reported by broker-dealers to their Self Regulatory Organization (“SRO”) and the SRO distributes the trade data to market data vendors and financial websites so investors can track price and volume.
- Caveat Emptor: There is a public interest concern associated with companies in this category, which may include spam campaigns, questionable stock promotions, known investigations of fraudulent activity committed by a company or insiders, regulatory suspensions, or disruptive corporate actions. During the time it is labeled Caveat Emptor, any stock that is not in the Current Information category will also have its quotes blocked on pinksheets.com.
The market tier of an issuer’s securities is indicated by symbols next to the quote on pinksheets.com. The company’s board of directors will wish to consider where the company should continue to disclose sufficient information to qualify for the Adequate Public Information category or the Limited Information category. Of the companies in the top three tiers for non-reporting issuers, approximately 26% are in the Adequate Public Information tier, 11% are in the Limited Information tier and 63% are in the No Information tier.
In order to trade in the Adequate Public Information category, an issuer needs to make the continuing disclosures described in Annex A. This could include preparing a substantially more abbreviated version of the company’s Annual Report on Form 10-K, which would include the information set forth in Annex A which includes, among other things, financial statements, management and director information, a management’s discussion and analysis section and a Chairman/CEO letter.
The decision by a board of directors whether to “go dark” or remain a public company can be a difficult one, and it is important to engage experienced legal advisors early on in the process. The principal decision for the board of directors is whether remaining a public reporting company outweighs the benefits of “going dark.” Each company will have different factors to consider. Some companies are simply too small to achieve any significant benefit from public company status. On the other hand, public shareholders almost always prefer the more liquid market provided by an exchange listing and continuous disclosure requirements. Factors such as stock price, public float, company performance, and the costs of compliance with Sarbanes-Oxley and public company disclosure and accounting requirements must be weighed against the benefits to the company and its shareholders of having publicly traded stock as incentive compensation and acquisition currency. Creditor and customer requirements, company prestige and the company’s relationship with its stockholders can also be important factors to consider. Some boards of directors and special committees have found it helpful to retain a financial advisor to advise on the effects of “going dark” on comparable companies and on the desirability of providing cash to stockholders in the form of a stock repurchase program, tender offer or other liquidity event in connection therewith. In many instances, after a thorough review, the board of directors may conclude that going over to the “dark side” is not such an unpleasant option after all.