By Amanda Maine, J.D.
The SEC has approved an amended proposal by the New York Stock Exchange (NYSE) which will allow companies to raise capital through direct listings without going through the traditional IPO process. NYSE applauded the move, calling it "great news for capital markets" and stating that it would democratize investor access. A leading investor group, which had challenged the rule upon its proposal, decried the SEC’s action as ignoring investor concerns that direct listings would exacerbate liability and corporate governance problems (Release No. 34-90768, December 22, 2020).
Proposal. NYSE sought approval for its proposed rule change in December 2019, which it subsequently amended in June 2020. Under the NYSE’s proposal, the Exchange would be allowed to list securities in a primary offering (called a "primary direct floor listing") if the company will sell at least $100 million in publicly-held shares in the opening auction; or, alternatively, the company could satisfy the market value requirement if the shares it will sell in the opening auction, along with the shares that are publicly held immediately prior to the listing, have an aggregate total market value of at least $250 million. These $100 million and $250 million thresholds would be analogous to those for secondary direct listings and are above the $40 million threshold for IPOs.
Initial approval and subsequent stay. The SEC’s Division of Trading and Markets approved the NYSE proposal in August 2020. The Council of Institutional Investors (CII), which had voiced concerns on both the initial and the amended rule proposals, notified the SEC only a few days after the approval that it intended to challenge the rule, triggering an automatic stay. In its brief opposing the NYSE rule, CII cited concerns related to investor protection. In addition to compounding problems faced by shareholders in tracing their share purchases to a specific registration statement in private securities litigation, CII also criticized the SEC for its "cursory" review of comment letters in opposition to the NYSE’s proposed rule, claiming it fell short of the reasoned decision-making required under the Administrative Procedure Act. In addition, CII cited the direct listing of Slack Technologies shares, where the company sought to limit its legal liability by asserting that the plaintiffs’ shares were untraceable, as further evidence that direct listings could harm investors. Further, CII recommended that instead of permitting direct listings, the SEC should commit to addressing "proxy plumbing" issues, such as using blockchain technology to support the traceability of shares.
In its reply brief, NYSE argued that the proposal would allow more investors to participate in an initial listing and that, compared to traditional IPOs, which typically require publicly-held shares to have a market value of $40 million, the proposed rule on direct listings would require at least $100 million sold in an open market auction or a market value of $250 million. NYSE also rejected CII’s argument that the absence of lock-up agreements in direct listings would harm investors as highly speculative. And regarding CII’s proxy plumbing argument, NYSE said it was part of a policy agenda that CII is seeking to advance through its petition for review.
Approval (again). In its order approving the rule, the SEC said conducted careful consideration of the entire record, including the amended proposal, CII’s petition for review, and all comments submitted. Based on the record, the proposal is consistent with the Exchange Act Section 6(b)(5) requirement that a national exchange must prevent fraudulent and manipulative conduct. The Commission’s order noted that, in response to concerns from commenters, NYSE made several modifications to its proposal that were designed to clarify the role of the issuer and financial advisor in a direct listing to explain how compliance with various rules and regulations will be addressed.
The order also touted the proposed minimum market value requirements—purportedly designed in part to ensure sufficient liquidity—of $100 million and $250 million for primary direct floor listings, which in addition to being higher than the $40 million minimum market value requirement for IPOs, are also comparable to the aggregate market value of publicly-held shares for companies that list other than at the time of an IPO, spin-off, or initial firm commitment underwritten public offering.
Addressing concerns that the lack of traditional underwriter involvement in direct listings would increase risks for investors by circumventing traditional due diligence processes and underwriter liability, the Commission’s order agreed with NYSE’s argument that underwriter participation in the public capital-raising process is not required by the Securities Act and that companies regularly access the public markets for capital raising and other purposes without using traditional underwriters. In addition, NYSE had argued that in the absence of underwriters, this gatekeeping function can be fulfilled by others who participate in the transaction, such as the company’s board of directors, its senior management, and its independent accountants, a contention the SEC also cited in its order.
According to the SEC, a financial advisor may be deemed a statutory "underwriter" with respect to the securities offering, with attendant underwriter liabilities, resulting in incentives to engage in robust due diligence, especially given their reputational interests and potential liability as statutory underwriters. The SEC added that investors could still pursue claims of false or misleading offering documents even in the absence of a statutory underwriter.
Addressing concerns about traceability issues, the SEC order maintained that these are not exclusive to nor necessarily inherent in primary direct floor listings. For example, aftermarket purchasers following either firm commitment underwritten IPOs or direct listings may face similar difficulties in tracing their shares back to a misleading registration statement, the SEC advised.
In conclusion, the Commission determined that the NYSE proposal will facilitate the orderly distribution and trading of shares and foster competition in a way that is consistent with the purposes of the Exchange Act.
Roisman’s statement. Commissioner Elad Roisman issued a statement expressing his approval of the Commission’s action. While a firm commitment to underwriting may be the right option for many companies seeking to access the U.S. public markets, it is not necessarily the right option for every company, and nor does it need to be the only option, Roisman stated. "Primary direct listings represent an alternative way for companies to fairly and efficiently offer shares to the public in a manner that preserves important investor protections," he added.
Roisman’s statement also sought to assuage fears claimed by CII that allowing these direct listings presents a potential harm to investors. Roisman remarked that these offerings are still registered offerings and are therefore subject to the SEC’s anti-manipulation rules. In addition, gatekeepers traditionally involved in IPOs will still be involved in these direct listings, Roisman said.
At press time, Roisman was the only commissioner who had issued a statement regarding the SEC’s action. The issue had originally been on the agenda for a Commission open meeting on December 21, which was later canceled.
CII reaction. CII was understandably disappointed in the SEC’s action, declaring in a tweet that the SEC failed to give adequate consideration to investor worries about liability and corporate governance concerns that will be worsened by the expansion of direct listings. On its website, CII reiterated its concern that companies choosing to raise capital through these kinds of direct listings may limit their liability to investors for damages caused by untrue statements or material omissions within registration statements associated with direct listings as highlighted by the Slack litigation.
The release is No. 34-90768.