Nasdaq Amends Its 20% Dilution Shareholder Approval Rule

by Laura Anthony, Esq. on December 18, 2018 in NASDAQ, NASDAQ Listing Requirements, Private Investment in Public Equity (PIPE)

Effective September 26, 2018, Nasdaq amended Rule 5635(d) to provide greater flexibility and certainty for companies to determine when a shareholder vote is necessary to approve a transaction that would result in the issuance of 20% or more of the outstanding common stock or 20% or more of outstanding voting power in a PIPE or similar private placement financing transaction. The amendment did not change the remainder of Rule 5635, which requires shareholder approval for transactions such as issuances involving an acquisition of stock or assets of another company, a change of control, or equity compensation that result in a 20% or greater dilution.

Generally, Rule 5635(d) requires Nasdaq-listed companies to obtain shareholder approval in private placement transactions involving the issuance of (i) 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 of the company, equals 20% or more of common stock or 20% or more of the voting power outstanding before the issuance; or (ii) the sale, issuance, or potential issuance by the company of common stock or securities convertible into or exercisable for 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. The amendment combines these two sections into one and amends the pricing test for triggering shareholder approval. The new pricing test amends the definition of “market value” solely for purposes of Rule 5635(d) to create a new “Minimum Price” as described below.

Prior to the amendment, Rule 5635(d) exempted from the shareholder approval requirement offerings priced at or above the greater of book or market value per share with market value defined as the closing bid price. That is, the Rule generally only required a vote if the dilution resulted from offerings that were priced at a discount to market value or book value. The Rule amendment eliminates the book value test, and revises the definition of market value to incorporate a five-day average and to use the last closing price instead of the consolidating closing bid price. As a result, under the amended Rule, a private offering involving the issuance of 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance will not require shareholder approval if the offer price is greater than or equal to the lesser of: (i) the last closing price immediately preceding the signing of a binding agreement; or (ii) the average closing price of the common stock on Nasdaq for the five trading days immediately preceding the signing of the binding agreement (the “Minimum Price”). Shareholder approval will be required for private placements priced below the Minimum Price.

Nasdaq’s impetus for amending the rule was to strike a balance between the protection of investors via the shareholder approval rule and a company’s flexibility to efficiently negotiate a deal to raise money quickly with a price that accurately reflects the market value of its security. In the Rule change release, Nasdaq noted that book value is based on historic values and, therefore, is not an appropriate measure of whether a transaction is dilutive or should otherwise require shareholder approval. Moreover, book value is one of several financial data points that is already incorporated into the market value of a security.

Using the last closing price, rather than the last closing bid price, reflects sale prices at one of the more liquid times of the day and, therefore, is believed to be more transparent to investors. Adding the option of choosing between the closing bid price and the five-day average closing price provides more flexibility and certainty for companies in their transactions. For example, in a declining market, the five-day average closing price will be above the current market price, which could make it difficult for companies to close transactions because investors could buy shares at a lower price in the market. Likewise, in a rising market, the five-day average could result in a below-market transaction triggering shareholder approval requirements.

The Rule amendment also combines the existing two sections of 5635(d) into one such that a 20% issuance for purposes of the Rule would involve 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, 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. This change does not make any substantive change but certainly makes the language more clear and concise.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service.  The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

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