The SEC has recently approved an amendment to Nasdaq Rule 5635(d), which became effective on September 26, 2018, that modifies the circumstances in which listed companies must receive shareholder approval before they can issue 20% or more of their outstanding common stock or voting power in a private offering.
Commonly referred to as the “20% rule,” Nasdaq Rule 5653(d) (the “Rule”) is designed to ensure that, in private offerings of 20% or more of an issuer’s equity securities at a price that is below market value, the issuer’s shareholders receive adequate notice and disclosure of the proposed offering so that they might have an opportunity to vote on the offering or exit their investment.
While maintaining the Rule’s focus on potentially significantly dilutive transactions, the amendment changes the pricing test for triggering shareholder approval. Previously, the Rule looked at whether the common stock (or securities convertible into or exercisable for common stock) was being sold, issued or potentially issued at a price less than the greater of book or market value, with market value defined as the consolidated closing bid price immediately preceding the time at which the parties enter into the agreement to issue the securities. As amended, the Rule no longer references book value at all, and instead looks at whether the common stock (or securities convertible into or exercisable for common stock) is being sold, issued or potentially issued at a price less than the lower of: (i) the closing price (as reflected on Nasdaq.com) immediately preceding the signing of the binding agreement; or (ii) 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 (calculated on a simple, not weighted average, basis).
This change to the definition of market value is in part intended to provide listed companies with additional flexibility in structuring their securities transactions, to help smooth out price fluctuations on the eve of an offering, and to reflect the reality that many companies and investors negotiate offering prices based on a trailing average rather than a single recent closing price.
The rule change will be particularly meaningful for structuring opportunistic “private placement in public equity,” or PIPE, transactions. First, the amendment may make companies feel less pressure to conduct PIPE transactions on an intra-day basis. Under the prior Rule, if a listed company wished to launch a private placement for a significant number of shares to take advantage of a spike in trading price, that company faced strong pressure to sign the transaction “intra-day,” so that the discounted price offered to purchasers would still be higher than the prior day’s market close (even if not higher than what would be likely to be reported for that day’s close). The new pricing test means that the company now may have flexibility to price the private placement the next trading day or the trading day after, since as long as the five-day trailing average closing price remains lower than the discounted price offered to purchasers, the company could sell significantly more than 20% of its outstanding shares without running afoul of the Rule.
In addition, the amendment will be helpful for companies whose book values as reported in their most recent periodic reports may be higher than their recent trading prices. For example, such companies no longer need to consider filing a Form 8-K reporting a lower book value as of a subsequent month end or in the days or even hours before signing a deal.
In approving the rule changes, the SEC noted that listed companies remain subject to other important Nasdaq rules that limit the securities that can be issued in private placements without shareholder approval. Specifically, shareholder approval will regardless be required for any discounted issuance of stock in a private placement to a company’s officers, directors, employees, or consultants under Nasdaq’s standard equity compensation rules; for the acquisition of stock or assets of another company; and, most importantly in the context of traditional PIPE transactions, for any issuance that results in a change of control – which, according to longstanding Nasdaq guidance, would include any issuance that causes a single shareholder to hold more than 20% of a company’s outstanding voting stock, if that would then be the largest position in the company.